GDP:AMeasureof

TotalProductionand
Income

5
CHAPTER CHECKLIST

When you have completed your

study of this chapter, you will be able to

1 Define GDP and explain why the value of production,

income, and expenditure are the same for an economy.
2 Describe how economic statisticians measure GDP
and distinguish between nominal GDP and real GDP.
3 Describe the uses of real GDP and explain its limitations
as a measure of the standard of living.
2011 Pearson Education

5.1 GDP, INCOME, AND EXPENDITURE

GDP Defined
Gross domestic product or GDP :
Final good or service is a good or service that is
produced for its final user and not as a component of
another good or service.

5.1 GDP, INCOME, AND EXPENDITURE

GDP includes only final goods and services in markets.

Intermediate good or service is a good or service

that is produced by one firm, bought by another firm,
and used as a component of a final good or service.

The Circular Flow

Income ($)
Labor

Firms

Households

Goods
Expenditure
($)

5.1 GDP, INCOME, AND EXPENDITURE

When somebody spends his or her money, this money
necessarily goes to the pockets of other people.
So expenditures of some people translate to the incomes
of the others.
So by tracking aggregate income, we may track
aggregate expenditures and, hence, aggregate output.

5.1 GDP, INCOME, AND EXPENDITURE

Total Expenditure in the Economy

5.1 GDP, INCOME, AND EXPENDITURE

10.1 FINANCIAL INSTITUTIONS AND MARKETS

Investment: Spending on goods bought for

future use (i.e., NEW capital goods)

5.2 MEASURING U.S. GDP

The Expenditure Approach

Measures GDP by using data on consumption
expenditure, investment, government expenditure on
goods and services, and net exports.

5.2 MEASURING U.S. GDP

Expenditures Not in GDP
Used Goods
Expenditure on used goods is not part of GDP because
these goods were part of GDP in the period in which
they were produced and during which time they were
new goods.
Financial Assets
When households buy financial assets such as bonds
and stocks, they are making loans, not buying goods
and services.

5.2 MEASURING U.S. GDP

Intermediate Goods
Counting expenditure on intermediate goods and
services as well as the final good is called double
counting. We want to avoid double counting.
Ex. Coke syrup

5.2 MEASURING U.S. GDP

Which one should be in GDP?

A. Social security payment
B. The government pays a computer services to fix
computers.
C. Toyota buys steel to produce its cars.
D. A stay-home parent does housework that they would
have to pay a maid $20,000 a year to perform.

5.1 GDP, INCOME, AND EXPENDITURE

Total Income in the Economy

Labor earns wages.
Capital earns interest.
Land earns rent.
Entrepreneurship earns profits.
(Indirect tax less subsides and depreciation)

5.2 MEASURING U.S. GDP

The Income Approach

Measures GDP by summing the incomes that firms pay
households for the factors of production they hire.
The U.S. National Income and Product Account divide
incomes into two big categories:
Wages
Interest, rent, and profits

5.2 MEASURING U.S. GDP

Wages
Wages, called compensation of employees in the
national accounts, is the payment for labor services.
It includes net wages and salaries plus fringe
benefits paid by employers such health care
insurance, social security contributions, and pension
fund contributions.

5.2 MEASURING U.S. GDP

Interest, Rent, and Profit
Interest, rent, and profit is the sum of the incomes
earned by capital, land, and entrepreneurship.
Interest is the income on lending their capitals.
Rent includes payments for the use of land and other
rented inputs.
Profit includes the profits of corporations and small
businesses.

5.2 MEASURING U.S. GDP

Statistical Discrepancy
The income approach and the expenditure approach do
not deliver exactly the same estimate of GDPthere is
a statistical discrepancy.

Statistical discrepancy is the discrepancy between

the expenditure approach and income approach
estimates of GDP, calculated as the GDP expenditure
total minus the GDP income total.

5.2 MEASURING U.S. GDP

GDP and Related Measures of Production

and Income
Gross national product or GNP is the market value
of all the final goods and services produced anywhere in
the world in a given time period by the factors of
production supplied by residents of the country.

5.2 MEASURING U.S. GDP

Real GDP and Nominal GDP

5.2 MEASURING U.S. GDP

Calculating Real GDP

The goal of calculating real GDP is to measure the
extent to which total production has increased
Real GDP removes the influence of price changes from
the nominal GDP numbers.

EX.1 How can we get the real GDP?

Lets assume that Base year is 2002.

< 2002>
Item
Balls
Bats

Quantity
100
20

Price
$1.00
$5.00

< 2003>
Item
Balls
Bats

Quantity
160
22

Price
$0.50
$22.50

 What is the nominal GDP in 2002 and 2003

respectively?
What is the real GDP in 2002 and 2003 respectively?

We can see that the nominal GDP for base year is the
same with ________ .

5.3 THE USE AND LIMITATIONS OF REAL GDP

The shaded periods

show the
recessions
periods of falling
production that
lasts for at least six
months.

5.3 THE USE AND LIMITATIONS OF REAL GDP

Goods and Services Omitted from GDP

5.3 THE USE AND LIMITATIONS OF REAL GDP

Household Production
Real GDP omits household production and it
underestimates the value of the production of
many people, most of them women.
Underground Production
Hidden from government to avoid taxes and
regulations or illegal.
Because underground economic activity is
unreported, it is omitted from GDP.

5.3 THE USE AND LIMITATIONS OF REAL GDP

Leisure Time
Our working time is valued as part of GDP, but our
leisure time is not.
Environment Quality
Pollution is not subtracted from GDP.
We do not count the deteriorating atmosphere as a
negative part of GDP.
If our standard of living is adversely affected by
pollution, our GDP measure does not show this
fact.

5.3 THE USE AND LIMITATIONS OF REAL GDP

Other Influences on the Standard of Living
Health and Life Expectancy
Good health and a long life do not show up directly
in real GDP.
Political Freedom and Social Justice
A country with a large real GDP per person might
have limited political freedom and social justice.
A country with a lower standard of living might be
one in which everyone enjoys political freedom.