Chapter 7
OUTLINE
I. GDP A Measure of Output
A. Gross Domestic Product (GDP) is the market value of final goods and services
produced within a country during a specific time period, usually a year.
B. What Counts toward GDP?
1. Only final goods and services count.
2. Financial transactions and income transfers are excluded because they do not
involve production.
3. Only production within the geographic borders of the country is counted.
4. Only goods produced during the current period are counted.
C. Dollars The Common Denominator for GDP
1. Each good produced increases output by the amount the purchaser pays for the
good.
2. GDP is equal to the sum of the total spending on all goods and services produced
during the year.
II. GDP as A Measure of Both Output and Income
A. Dollar flow of Dollar flow of
expenditures = GDP = income (and indirect cost)
on final goods of final goods
B. Deriving GDP by the Expenditure Approach
2. When derived by the expenditure approach, there are four components of GDP.
a. Personal consumption purchases
b. Gross private investment (including inventories)
c. Government purchases (both consumption and investment)
d. Net exports (exports imports)
C. Deriving GDP by the Resource Cost-income Approach
1. Sum of the costs incurred and income (including profits) generated producing
goods and services during the period.
2. When derived by the resource cost/income approach, the direct-cost income
components of GDP are:
a. Employee Compensation
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c. Rents
d. Interest
3. Not all cost components of GDP result in an income payment to a resource
supplier. In order to get to GDP, we need to account also for three other factors:
4. When derived by resource cost/income approach, GDP is equal national income
(employee compensation, self-employment income, rents, interest, corporate profit)
plus indirect business taxes, depreciation, and the net income of foreigners.
D. Relative Size of GDP Components
III. Adjusting for Price Changes and Deriving Real GDP
B. Price indexes are use to adjust income and output data for the effects of inflation.
C. A price index measures the cost of
at a point in time relative to the cost of purchasing the identical market basket during
an earlier reference (or base) period.
D. Two Key Price Indexes: Consumer Price Index and GDP Deflator
2. The GDP deflator is a broader price index than the CPI. It is designed to measure
the change in the average price of the market basket of goods included in GDP.
E. The rate of inflation is equal to:
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F. Using the GDP Deflator to Derive Real GDP
1. Real GDP2 = Nominal GDP2 (GDP deflator1/GDP deflator2).
2. Data on both money GDP and price changes are essential for meaningful output
comparisons between two time periods.
IV. Problems with GDP as a Measuring Rod
A. It does not count non-market production.
B. It does not count the underground economy.
C. It makes no adjustment for leisure
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V. Differences in GDP Over Time
A. Per capita real GDP has risen substantially over the past several decades in the U.S.
2. As real GDP per capita has risen, the quality of most goods has risen and the
amount of work time to purchase goods has fallen.
VI. The Great Contribution of GDP
A. In spite of its shortcomings, real GDP is a reasonably accurate measure of short-term
fluctuations in output.
OBJECTIVES
In this chapter the student is introduced to: (a) the technicalities of how we measure the flow of
output; (b) the distinction between nominal and real income; (c) the mechanics of how price indexes
are constructed; (d) the limitations of GDP as a measuring rod of economic activity; and (e) the
importance of real GDP as an indicator of the short-term level of total output. This chapter lays the
foundation for later macro material on cyclical economic conditions and the determinants of
national income.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Be sure to emphasize that GDP is a flow concept designed to measure the amount of production
generated during a period and not the total wealth of an economy.
2. Even though this point is highlighted in the text, instructors will find it useful to work an
3. Use the two alternative methods of measuring GDP to show that there are both positive and
negative aspects to economic activity. The expenditure approach focuses on the positive
4. Calculating real GDP in terms of current dollars will help students to get a better grasp on this
concept. Up-to-date information for both the GDP deflator and nominal GDP are available in
5. It is important to emphasize what is excluded from GDP. Otherwise, students may be led to
believe that it is an indicator of something that it was not intended to measure. Point out that
7. Given the shortcomings of GDP as a measuring rod, many instructors will want to ask their
8. Discussion of the Critical Analysis questions will enhance student understanding of the major
concepts of this chapter.
9. One good way to motivate students to learn the measurement issues in both Chapters 7 and 8
is to admit that while they are not exactly inherently interesting, they do help one understand
10. A good quick classroom way to introduce the question of how well GDP and other
11. Game one in the next section helps students understand how price indexes are formed, while
GAMES
1. Create a Student Price Index
Type: Take-home Assignment
Topics: Consumer choice
Textbook:
Class limitations: works in any size class
Purpose
This assignment gives students a practical look at how price indices are measured. It also
establishes base prices for calculating inflation rates later in the term. (See 8.2, Changes in the
Student Price Index)
Instructions
The students should pick real transactions prices for goods they actually purchase. If the indices
will be used to calculate the inflation rate, they should save a copy of this assignment in a safe
semester.
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Points for discussion
This assignment makes a good introduction to a discussion of market basket selection for price
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Name____________________ Course __________________
Price Index Assignment
The Consumer Price Index includes the prices of hundreds of goods purchased by consumers. It is
possible to construct many other price indexes.
Your mission: make up a personalized student price index.
1. Choose 5 (or more) different products be specific e.g.: unleaded gasoline, Budweiser beer.
2. Pick a quantity for each product e.g.: 15 gallons gasoline, 12-pack Bud
4. Calculate the total cost of buying these products
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2. Data Hunt
Type: In-class or Take-home Assignment
Topics: macroeconomic data
Textbook:
Fluctuations, Unemployment, and Inflation
Materials Needed: none
Time: 50 minutes, or longer
Class limitations: works in any size class
Purpose
This assignment has the student collect a wide variety of economic data. The numbers provide for
many interesting comparisons. It also familiarizes students with a variety of sources of economic
data.
Instructions
This is a scavenger hunt for economic data. It can be used as a class activity or as a take-home
assignment. Structuring it as a race between teams of students adds a competitive element. Much
of the data is available online from various sources on the World Wide Web. Unless students are
already familiar with the Web sources, the library will be a faster resource.
Give each team of students a copy of the following list and a deadline. Ask them to get current
statistics for each measure. The team with the most answers wins.
Points for discussion
Ask students which data sources were the most informative. This activity can be used to introduce
sources of economic data, both on-line and printed.
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Name____________________ Course ________________
Data Hunt
Find current figures for the following items.
1. U.S. unemployment rate
2. the Consumer Price Index
3. U.S. inflation rate
4. U.S. Gross Domestic Product
6. Net Domestic Product (U.S.)
7. Disposable Income (U.S.)
8. Consumption Spending (U.S.)
9. Government Spending (U.S.)
10. M1
12. the National Debt
13. the government budget deficit
14. Imports
15. Exports
16. the trade deficit
18. the yield on government bonds
19. an interest rate on home mortgages
20. an interest rate on a savings account
21. the prime rate
22. the Dow Jones Industrial Average
26. the value of the US dollar in yen (Japan)
27. the value of the US dollar in pounds (Great Britain)
28. the value of the US dollar in marks (Germany)
29. the inflation rate in any European country
30. the unemployment rate in any European country
31. the Gross Domestic Product of any European country
32. the per capita GDP of any European country
34. the unemployment rate in any African country
35. the Gross Domestic Product of any African country
36. the per capita GDP of any African country
38. the unemployment rate in any Asian country
39. the Gross Domestic Product of any Asian country
40. the per capita GDP of any Asian country
41. the inflation rate in any Central or South American country
42. the unemployment rate in any Central or South American country
44. the per capita GDP of any Central or South American country
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HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
4. Both the construction expenditures and the corporate profits of the plant will increase GDP
8. The table bellows shows the box office receipts in $2012:
Movie
Box Office
Receipts
(Millions)
Year
Released
CPI in
Year
Released
Box
Office
Receipts
in $2012
Avatar $760.5 2009 214.5 $814.04
13. These items are omitted because it is difficult to assign them as a value since they do not involve
a market transaction. The GDP is not intended to be sexist. However, it clearly does omit a
15. a. personal consumption expenditure; gross private domestic investment; government