Macroeconomic Measurements,

Part II: GDP and Real GDP

References: Ch. 7, Macroeconomics, Roger A. Arnold
Gross Domestic Product
Gross Domestic Product (GDP) : Total market value of all final goods
and services produced annually within a countrys borders

Final Good : A good meant for the final consumer

Intermediate Good : An input to the production of a final good

Avoiding Double Counting - counting the good more than once when
computing GDP
What GDP Omits / Limitations of GDP
Certain non-market goods and services (no transaction/trade takes place)

Underground activities both legal and illegal (unreported transaction/trade)

Sales of used goods (not part of current production)

Financial transactions (no new production; simply exchange of current assets)

Government transfer payments (not an exchange/trade)

Leisure (it is a good but too difficult to quantify)

GDP is not adjusted for bads (e.g. pollution) generated in the
production of goods

Another limitation of GDP

Any other? (in class discussion)

GDP per capita : GDP divided by the population in the country

Neither measures HAPPINESS or WELL-BEING!

Computing GDP: The Expenditure Approach
Sum the spending in usually four sectors of the economy

Consumption (C) Households

Investment (I) Business / Firms
Government Government
Purchases (G)
Net Exports Rest of the world (Foreign)
Consumption (C) : The sum of spending on durable goods (durability >
3 years), nondurable goods (durability < 3 years) and services

Generally, consumption is the largest spending component of GDP

Investment (I) : The sum of all purchases of newly produced capital

goods, changes in business inventories and purchases of new
residential housing

Government Purchases (G) : Government purchases of goods and

services and investment in infrastructure (roads, bridges, etc.)
Net Exports (NX) : NX = Exports (EX) Imports (IM)

EX : Total foreign spending on domestic goods

IM : Total domestic spending on foreign goods

Putting it all together

GDP = C + I + G + (EX IM)

Computing GDP: The Income Approach
National Income is the sum of five components:
(1) Compensation of employees (wages, pension funds, fringe benefits
bonuses and paid vacations)
(2) Proprietors income (Income earned by self-employed individuals, farm
income)
(3) Corporate Profits (Income earned by stockholders of corporations,
retained earnings and corporate profit taxes)
(4) Rental Income of persons (Income received from non-monetary assets
land, houses and offices)
(5) Net Interest (Interest income received by households and government
minus the interest they paid out)
From National Income to GDP
GDP = National Income (NI) income earned from the rest of the world
+ income earned by rest of the world + indirect business taxes* +
capital consumption allowance** statistical discrepancy***

*Included in the price of goods and services (consumers bear it)

**The cost to replace capital goods - depreciation (not included in NI)

***GDP and NI computed using different data sets / computational

errors
Other NI Accounting Measurements
Net Domestic Product (NDP) = Capital Consumption Capital
consumption allowance measures total value of new goods

Personal Income = NI undistributed corporate profits social

insurance taxes corporate profit taxes + transfer payments

Disposable Income = Personal Income personal taxes

Real GDP
Real GDP : The value of the entire output produced annually within a
countrys borders, adjusted for price changes.

Real GDP =

Real GDP rises ONLY if output rises!

Economic growth => increases in real GDP (annually)

% change in real GDP = ( ) 100

The Business Cycle
Business Cycle - Recurrent swings in real GDP
- Measured from peak to peak (Exhibit 7, p. 159, 11th ed)

Peak : Real GDP at temporary high

Contraction : A decline in real GDP
Trough : The low point in real GDP
Recovery : Real GDP is rising
Expansion : Increase in Real GDP beyond recovery
Recession : Contraction in two consecutive quarters