CHAPTER 6
TRACKING THE U.S. ECONOMY
In this chapter, you will find:
Learning Outcomes
Chapter Outline with PowerPoint Script
INTRODUCTION
This chapter discusses the economy’s scorecard using the national income accounting system to explain
economic activity. It begins with a discussion of the national income accounts. The alternative ways of
LEARNING OUTCOMES
6-1 Describe the two ways of computing GDP and explain why they are equivalent.
Gross domestic product, or GDP, measures the market value of all final goods and services produced
6-2 Trace through the circular flow model, explaining each of the 10 steps along the way.
The circular-flow model summarizes the flow of income and spending through the economy. Saving,
6-3 Identify the limitations of the national income accounting system.
GDP reflects market production in a given period, usually a year. Most household production and
6-4 Define a price index and explain why is it useful.
Chapter 6 Tracking the U. S. Economy 80
Nominal GDP in a particular year values output based on market prices when the output was pro-
duced. To determine real GDP, nominal GDP must be adjusted for price changes. The consumer price
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDE 2-3 FOR THE FOLLOWING SECTION
The Product of A Nation: Measured historically by:
USE POWERPOINT SLIDES 4-6 FOR THE FOLLOWING SECTION
National Income Accounts
• Gross domestic product (GDP): Measures the market value of all final goods and services produced
USE POWERPOINT SLIDES 7-12 FOR THE FOLLOWING SECTION
GDP Based on the Expenditure Approach
• Consumption (C): Personal consumption expenditures by households for services and for durable and
nondurable goods.
USE POWERPOINT SLIDES 13-15 FOR THE FOLLOWING SECTION
GDP Based on the Income Approach: Sum of wages, interest, rent, and profit arising from production.
Avoids double counting by either including only the market value of the good or service or summing the
value added at each stage of production. (Aggregate expenditure = GDP = Aggregate income)
USE POWERPOINT SLIDES 16-23 FOR THE FOLLOWING SECTION
Circular Flow of Income and Expenditure:
• The main stream flows clockwise first as income from firms to households (the upper half) and then as
spending from households back to firms (the lower half). For each flow of money, there is an equal
Chapter 6 Tracking the U.S. Economy 81
USE POWERPOINT SLIDES 24-26 FOR THE FOLLOWING SECTION
Limitations of National Income Accounting
Some Production Is Not Included in GDP:
• Do–it-yourself production
• Production in the underground economy.
What’s gross about Gross Domestic Product?
• GDP is called “gross” because it does not take into account the depreciation of capital.
USE POWERPOINT SLIDES 27-29 FOR THE FOLLOWING SECTION
Accounting for Price Changes: To make meaningful comparisons of GDP across years, nominal
GDP must be deflated. This allows the focus to be on real changes in production.
USE POWERPOINT SLIDES 30-33 FOR THE FOLLOWING SECTION
Problems with the CPI: By failing to reflect new products and improved quality, estimates of the
possibilities of substitution, and shifts to discount outlets, the CPI is overstated.
CHAPTER SUMMARY
Gross domestic product, or GDP, measures the market value of all final goods and services produced
during the year by resources located in the United States, regardless of who owns those resources.
Chapter 6 Tracking the U. S. Economy 82
The expenditure approach to GDP adds up the market values of all final goods and services produced in
the economy during the year. The income approach to GDP adds up all the income generated as a result of
that production.
Nominal GDP in a particular year values output based on market prices when the output was produced. To
determine real GDP, nominal GDP must be adjusted for price changes. The consumer price index, or CPI,
tracks prices for a basket of goods and services over time. The GDP price index tracks price changes for
all output. No adjustment for price changes is perfect, but current approaches offer a reasonably good
estimate of real GDP both at a point in time and over time.
TEACHING POINTS
1. many instructors do not spend a great deal of time discussing national income accounting, but it is
important to realize this chapter deals with actual data and measurement. Students typically
2. The circular flow can be as complicated as you wish to make it. The key point of the circular flow
diagram is that the national output is the same as national income. Emphasize this point, since the
terms output and income will be used synonymously throughout the rest of the text.
3. The idea that leakages must equal injections gives rise to the twin deficits idea. Make sure that the
4. The increasing importance of the underground economy has made it essential to discuss its relation
to GDP estimation. You should make a distinction between the cash economy and the illegal goods
5. Students may get the idea that national income accounting is a little like accounting for the firm.
You should remind them that an estimate of GDP that errs by as little as 1 percent will be off by more
than $160 billion. Also, the United States has excellent statistics compared with those of most other
Chapter 6 Tracking the U.S. Economy 83
SOLUTIONS TO PROBLEMS APPENDIX
1. (Income Approach to GDP) How does the income approach to measuring GDP differ from the
expenditure approach? Explain the meaning of value added and its importance in the income
approach. Consider the following data for the selling price at each stage in the production of a
five-pound bag of flour sold by your local grocer. Calculate the final market value of the flour.
Stage of Production Sale Price
Farmer $0.30
Miller $0.50
Wholesaler $1.00
Grocer $1.50
The expenditure approach adds up the total spending on new production, while the income
2. (Expenditure Approach to GDP) Given the following annual information about a hypothetical
country, answer questions a through d.
Billions of Dollars
Personal consumption expenditures $200
Personal taxes 50
Exports 30
Depreciation 10
Government purchases 50
Gross private domestic investment 40
Imports 40
Government transfer payments 20
a. What is the value of GDP?
b. What is the value of net domestic product?
c. What is the value of net investment?
d. What is the value of net exports?
3. (Investment) Given the following annual data, answer questions a through c.
Chapter 6 Tracking the U. S. Economy 84
Billions of Dollars
New residential construction
$500
Purchases of existing homes
250
Sales value of newly issued stocks and bonds
600
New physical capital
800
Depreciation
200
Household purchases of new furniture
50
Net change in firms’ inventories
100
Production of new intermediate goods
700
a. What is the value of gross private domestic investment?
b. What is the value of net investment?
c. Are any intermediate goods included in the measure of gross investment?
4. (Circular Flow Model) First describe in general terms the point of the circular flow model.
Next describe the 10 steps along the way.
The circular-flow model summarizes the flow of income and spending through the economy.
5. (Leakages and Injections) What are the leakages from and injections into the circular flow? How
are leakages and injections related in the circular flow?
Leakages include net taxes, saving, and imports. Injections consist of investment spending,
6. (National Income Accounts) What relevant aspects of the economy are not reflected in the
national income accounting system.
GDP reflects market production in a given period, usually a year. Most household production
7. (Limitations of National Income Accounting) Explain why each of the following should be taken
into account when GDP data are used to compare the “level of well–being” in different countries:
a. Population levels
b. The distribution of income
c. The amount of production that takes place outside of markets
Chapter 6 Tracking the U.S. Economy 85
d. The length of the average work week
e. The level of environmental pollution
This question highlights some of the problems that accompany the indiscriminate use of GDP
comparisons across countries or over long periods to compare welfare levels.
8. (Consumer Price Index) Calculate a new consumer price index for the data in the following ex-
hibit. Assume that current year prices of Twinkies, fuel oil, and cable TV are $0.95/package,
$1.25/gallon, and $15.00/month, respectively. Calculate the current year’s cost of the market bas-
ket and the value of the current year’s price index. What is this year’s percent change in the price
level compared to the base year?
Good or
Quantity in
Prices in
Cost of
Basket
Service
Market
Basket
Current Year
in Current
Year
Twinkies
365 packages
$
.95/package
$346.75
Fuel Oil
500 gallons
1.25/gallon
625.00
Cable TV
12 months
$15.00/month
180.00
$1,151.75
Current expenditures now equal $346.75 for Twinkies, $625.00 for fuel oil, and $180.00 for
9. (Consumer Price Index) Given the following data, what was the value of the consumer price in-
dex in the base year? Calculate the annual rate of consumer price inflation in 2013 in each of the
following situations:
a. The CPI equals 200 in 2012 and 240 in 2013.
b. The CPI equals 150 in 2012 and 175 in 2013.
Chapter 6 Tracking the U. S. Economy 86
c. The CPI equals 325 in 2012 and 340 in 2013.
d. The CPI equals 325 in 2012 and 315 in 2013.
A price index always equals 100 in the base year.
d. −3.1 percent (the price level fell)
Experiential Assignments
1. Data on the consumer price index are released near the middle of each month. Data on GDP are
released on the last Friday of each month (in preliminary, revised, and then final form). Analysis of
these data releases appears in the first section of the following weekday’s Wall Street Journal. Ask
2. New economic data are regularly reported in the Wall Street Journal. Look in section C of the pa-