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Macroeconomics, Masaryk University
Spring 2017
Lecture 1: Measuring Nation’s Income
Nikoloz Kudashvili
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Seventh Edition
Macroeconomics
Principles of
N. Gregory Mankiw
CHAPTER
10
Measuring a
Nation’s Income
WojciechGerson(1831-1901)
In this chapter,
look for the answers to these questions
• What is Gross Domestic Product (GDP)?
• How is GDP related to a nation’s total income
and spending?
• What are the components of GDP?
• How is GDP corrected for inflation?
• Does GDP measure society’s well-being?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Micro vs. Macro
 Microeconomics:
The study of how individual households and
firms make decisions, interact with one another
in markets.
 Macroeconomics:
The study of the economy as a whole.
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Income and Expenditure
 Gross Domestic Product (GDP) measures
total income of everyone in the economy.
 GDP also measures total expenditure on the
economy’s output of g&s.
For the economy as a whole,
income equals expenditure
because every dollar a buyer spends
is a dollar of income for the seller.
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The Circular-Flow Diagram
 a simple depiction of the macroeconomy
 illustrates GDP as spending, revenue,
factor payments, and income
 Preliminaries:
 Factors of production are inputs like labor,
land, capital, and natural resources.
 Factor payments are payments to the factors
of production (e.g., wages, rent).
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6
The Circular-Flow Diagram
Households:
 own the factors of production,
sell/rent them to firms for income
 buy and consume goods & services
HouseholdsFirms
Firms:
 buy/hire factors of production,
use them to produce goods
and services
 sell goods & services
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7
The Circular-Flow Diagram
Markets for
Factors of
Production
HouseholdsFirms
Income (=GDP)Wages, rent,
profit (=GDP)
Factors of
production
Labor, land,
capital
Spending (=GDP)
G & S
bought
G & S
sold
Revenue (=GDP)
Markets for
Goods &
Services
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What This Diagram Omits
 The government
 collects taxes, buys g&s
 The financial system
 matches savers’ supply of funds with
borrowers’ demand for loans
 The foreign sector
 trades g&s, financial assets, and currencies
with the country’s residents
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9
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
Goods are valued at their market prices, so:
 All goods measured in the same units
(e.g., dollars in the U.S.)
 Things that don’t have a market value are
excluded, e.g., housework you do for yourself.
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10
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
Final goods: intended for the end user
Intermediate goods: used as components
or ingredients in the production of other goods
GDP only includes final goods—they already
embody the value of the intermediate goods
used in their production.
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11
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
GDP includes tangible goods
(like DVDs, mountain bikes, beer)
and intangible services
(dry cleaning, concerts, cell phone service).
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12
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
GDP includes currently produced goods,
not goods produced in the past.
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13
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
GDP measures the value of production that occurs
within a country’s borders, whether done by its own
citizens or by foreigners located there.
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14
…the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is…
Usually a year or a quarter (3 months)
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15
The Components of GDP
 Recall: GDP is total spending.
 Four components:
 Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)
 These components add up to GDP (denoted Y):
Y = C + I + G + NX
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Consumption (C)
 is total spending by households on g&s.
 Note on housing costs:
 For renters,
consumption includes rent payments.
 For homeowners,
consumption includes the imputed rental value
of the house, but not the purchase price or
mortgage payments.
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Investment (I)
 is total spending on goods that will be used in
the future to produce more goods.
 includes spending on
 capital equipment (e.g., machines, tools)
 structures (factories, office buildings, houses)
 inventories (goods produced but not yet sold)
Note: “Investment” does not
mean the purchase of financial
assets like stocks and bonds.
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Government Purchases (G)
 is all spending on the g&s purchased by govt
at the federal, state, and local levels.
 G excludes transfer payments, such as
Social Security or unemployment insurance
benefits.
They are not purchases of g&s.
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Net Exports (NX)
 NX = exports – imports
 Exports represent foreign spending on the
economy’s g&s.
 Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
 Adding up all the components of GDP gives:
Y = C + I + G + NX
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20
U.S. GDP and Its Components, 2013
–1,577
9,895
8,637
36,394
$53,350
per capita
–2.9
18.5
16.2
68.2
100.0
% of GDP
–500
3,137
2,738
11,537
$16,912
billions
NX
G
I
C
Y
A C T I V E L E A R N I N G 1
GDP and its components
In each of the following cases, determine how much
GDP and each of its components is affected (if at all).
A. Debbie spends $300 to buy her husband dinner
at the finest restaurant in Boston.
B. Sarah spends $1200 on a new laptop to use in her
publishing business. The laptop was built in China.
C. Jane spends $800 on a computer to use in her
editing business. She got last year’s model on sale
for a great price from a local manufacturer.
D. General Motors builds $500 million worth of cars,
but consumers only buy $470 million worth of them.
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A C T I V E L E A R N I N G 1
Answers
A. Debbie spends $300 to buy her husband dinner
at the finest restaurant in Boston.
Consumption and GDP rise by $300.
B. Sarah spends $1200 on a new laptop to use in her
publishing business. The laptop was built in
China.
Investment rises by $1200, net exports fall
by $1200, GDP is unchanged.
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A C T I V E L E A R N I N G 1
Answers
C. Jane spends $800 on a computer to use in her
editing business. She got last year’s model on
sale for a great price from a local manufacturer.
Current GDP and investment do not change,
because the computer was built last year.
D. General Motors builds $500 million worth of cars,
but consumers only buy $470 million of them.
Consumption rises by $470 million,
inventory investment rises by $30 million,
and GDP rises by $500 million.
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Real versus Nominal GDP
 Inflation can distort economic variables like GDP,
so we have two versions of GDP:
 Nominal GDP
 values output using current prices
 not corrected for inflation
 Real GDP
 values output using the prices of a base year
 is corrected for inflation
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25
EXAMPLE:
Compute nominal GDP in each year:
2011: $10 x 400 + $2 x 1000 = $6,000
2012: $11 x 500 + $2.50 x 1100 = $8,250
2013: $12 x 600 + $3 x 1200 = $10,800
Pizza Latte
year P Q P Q
2011 $10 400 $2.00 1000
2012 $11 500 $2.50 1100
2013 $12 600 $3.00 1200
37.5%
Increase:
30.9%
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26
EXAMPLE:
Compute real GDP in each year,
using 2011 as the base year:
Pizza Latte
year P Q P Q
2011 $10 400 $2.00 1000
2012 $11 500 $2.50 1100
2013 $12 600 $3.00 1200
20.0%
Increase:
16.7%
$10 $2.00
2011: $10 x 400 + $2 x 1000 = $6,000
2012: $10 x 500 + $2 x 1100 = $7,200
2013: $10 x 600 + $2 x 1200 = $8,400
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27
EXAMPLE:
In each year,
 nominal GDP is measured using the (then)
current prices.
 real GDP is measured using constant prices from
the base year (2011 in this example).
year
Nominal
GDP
Real
GDP
2011 $6000 $6000
2012 $8250 $7200
2013 $10,800 $8400
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28
EXAMPLE:
 The change in nominal GDP reflects both prices
and quantities.
year
Nominal
GDP
Real
GDP
2011 $6000 $6000
2012 $8250 $7200
2013 $10,800 $8400
20.0%
16.7%
37.5%
30.9%
 The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
$16,000
$18,000
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Nominal and Real GDP in the U.S.,
1965–2013
Real GDP
(base year
2009)
Nominal
GDP
billions
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The GDP Deflator
 The GDP deflator is a measure of the overall
level of prices.
 Definition:
 One way to measure the economy’s inflation
rate is to compute the percentage increase in
the GDP deflator from one year to the next.
GDP deflator = 100 x
nominal GDP
real GDP
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31
EXAMPLE:
Compute the GDP deflator in each year:
year
Nominal
GDP
Real
GDP
GDP
Deflator
2011 $6000 $6000
2012 $8250 $7200
2013 $10,800 $8400
2011: 100 x (6000/6000) = 100.0
100.0
2012: 100 x (8250/7200) = 114.6
114.6
2013: 100 x (10,800/8400) = 128.6
128.6
14.6%
12.2%
A C T I V E L E A R N I N G 2
Computing GDP
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Use the above data to solve these problems:
A. Compute nominal GDP in 2011.
B. Compute real GDP in 2012.
C. Compute the GDP deflator in 2013.
2011 (base yr) 2012 2013
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
A C T I V E L E A R N I N G 2
Answers
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A. Compute nominal GDP in 2011.
$30 x 900 + $100 x 192 = $46,200
B. Compute real GDP in 2012.
$30 x 1000 + $100 x 200 = $50,000
2011 (base yr) 2012 2013
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
A C T I V E L E A R N I N G 2
Answers
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C. Compute the GDP deflator in 2013.
Nom GDP = $36 x 1050 + $100 x 205 = $58,300
Real GDP = $30 x 1050 + $100 x 205 = $52,000
GDP deflator = 100 x (Nom GDP)/(Real GDP)
= 100 x ($58,300)/($52,000) = 112.1
2011 (base yr) 2012 2013
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
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GDP and Economic Well-Being
 Real GDP per capita is the main indicator of
the average person’s standard of living.
 But GDP is not a perfect measure of
well-being.
 Robert Kennedy issued a very eloquent
yet harsh criticism of GDP:
Gross Domestic Product…
“… does not allow for the health of our
children, the quality of their education,
or the joy of their play. It does not
include the beauty of our poetry or
the strength of our marriages, the
intelligence of our public debate or
the integrity of our public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures everything,
in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are
proud that we are Americans.”
- Senator Robert Kennedy, 1968
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GDP Does Not Value:
 the quality of the environment
 leisure time
 non-market activity, such as the child care
a parent provides at home
 an equitable distribution of income
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Then Why Do We Care About GDP?
 Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.
 Many indicators of the quality of life are
positively correlated with GDP. For example…
40
50
60
70
80
90
$0 $10,000 $20,000 $30,000 $40,000 $50,000
GDP and Life Expectancy in 12 countries
39
Lifeexpectancy(years)
Real GDP per person
U.S.
Germany
Japan
Mexico
Russia
Brazil
China
India
Indonesia
Pakistan
Bangladesh
Nigeria
GDP and Average Schooling in 12 countries
40
Averageyearsofschool
2
4
6
8
10
12
14
$0 $10,000 $20,000 $30,000 $40,000 $50,000
U.S.
Germany
Japan
Russia
Mexico
Brazil
China
India
Indonesia
Real GDP per person
GDP and Water Quality in 12 countries
41
Satisfactionwithwaterquality
(%ofpopulation)
40%
50%
60%
70%
80%
90%
100%
$0 $10,000 $20,000 $30,000 $40,000 $50,000
U.S.
Germany
Japan
Russia
Mexico
Brazil
China
India
Nigeria
Bangladesh
Indonesia
Pakistan
Real GDP per person
Summary
• Gross Domestic Product (GDP) measures a
country’s total income and expenditure.
• The four spending components of GDP include:
Consumption, Investment, Government
Purchases, and Net Exports.
• Nominal GDP is measured using current prices.
Real GDP is measured using the prices of a
constant base year and is corrected for inflation.
• GDP is the main indicator of a country’s
economic well-being, even though it is not
perfect.
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Summary
• People face tradeoffs.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People respond to incentives.
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Summary
• People face tradeoffs.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People respond to incentives.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Summary
• People face tradeoffs.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People respond to incentives.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.