Week02

GDP is the market value of all final goods and services produced within a country in a given period of time.

“GDP is the Market Value . . .”Output is valued at market prices.

“. . . Of All Final . . .”It records only the value of final goods, not

intermediate goods (the value is counted only once).

“. . . Goods and Services . . . “It includes both tangible goods (food,

clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

“. . . Produced . . .”It includes goods and services currently

produced, not transactions involving goods produced in the past.

“ . . . Within a Country . . .”It measures the value of production within

the geographic confines of a country.

“. . . In a Given Period of Time.”It measures the value of production that

takes place within a specific interval of time, usually a year or a quarter (three months)

GDP includes all items produced in the economy and sold legally in markets.

GDP excludes most items that are:produced and consumed at home and

that never enter the marketplace,produced and sold illicitly, such as illegal

drugs.

GDP can be measured as ….1. a sum of spending (or expenditure) on final

products, or2. a sum of income or earningsBoth approach yield exactly the same

measure of GDP, because every transaction has a buyer and a seller. every dollar of spending by some buyer is

a dollar of income for some seller

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods and services

•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

How to avoid double counting?We have to include only final goods that are

produced and sold for consumption or investment, and exclude the intermediate goods that are used up in making the final goods.

We have to calculate value added at each stage of production.○ The value added can be defined as the difference

between a firm’s sales and its purchases of materials and services from other firms.

GDP Sums up Value Added at Each Production Stage

Stage of Production

Sales receipts

Less: Cost of intermediate products

Value added (wages, profits, etc.)

(1) (2) (3) = (1) – (2)

Wheat 23 0 23Flour 53 23 30Baked dough 110 53 57Final product: bread 190 110 80

Total 376 186 190Note: final sales of bread = total earnings = total value added = 190

Expenditure Approach1 Personal consumption expenditures

Durable goods

Nondurable goods

Services

2 Gross private domestic investmentFixed investment (both residential and nonresidential)

Change in private inventories

3 Government consumption expenditure and gross investment(both state and local government)

4 Net export of goods and servicesExport

Import

Gross Domestic Product (GDP) = 1 + 2 + 3 + 4

Income Approach1 Wages, salaries, and other labor incomes2 Interest

3 Rental income of person

4 Indirect business taxes

5 Depreciation6 Income of unincorporated enterprises

7 Corporate profits before taxes

Corporate profit taxesDividendUndistributed profit

Gross Domestic Product (GDP) = sum of 1 - 7

GDP (Y) is the sum of the following:Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX

Consumption (C)The spending by households on goods and

services, with the exception of purchases of new housing.

Investment (I)The spending on capital equipment,

inventories, and structures, including new housing.

Government Purchases (G)The spending on goods and services by

local, state, and federal governments.Does not include transfer payments

because they are not made in exchange for currently produced goods or services.

Net Exports (NX)Exports minus imports.

Nominal GDP values the production of goods and services at current prices.

Real GDP values the production of goods and services at constant prices.An accurate view of the economy requires

adjusting nominal to real GDP by using the GDP deflator.

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The GDP deflator is a measure of the price level calculated as:

It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

Copyright©2004 South-Western

Year Calculating the GDP Deflator2001 ($200/$200) x 100 = 1002002 ($600/$350) x 100 = 1712003 ($1,200/$500) x 100 = 240

Expenditure of Gross Domestic Product 2009 (Billion Rupiahs)

TYPE OF EXPENDITUREat current

market prices

at constant 2000 market

price

1 Private consumption expenditure 3,290,843.3 1,249,011.22 General government consumption expenditure  537,588.8 195,907.73 Gross domestic fixed capital formation 1,744,381.2 510,118.14 a. Change in inventory -7,264.2 -474.3

b. Statistical discrepancy* -118,994.7 -1,124.25 Export of goods and services 1,354,409.4 932,123.66 Less import of goods and services 1,197,092.7 708,586.67 GROSS DOMESTIC PRODUCT (GDP) 5,603,871.2 2,176,975.58 Net Factor income from abroad -196,219.5 -109,819.39 GROSS NATIONAL PRODUK (GNP) 5,407,651.6 2,067,156.210 Less net indirect taxes (indirect taxes minus subsidy) 214,833.2 64,782.011 Less depreciation 280,193.6 108,848.812 NATIONAL INCOME (NI) 4,912,624.9 1,893,525.5

* Defferent between GDP by industrial origin and expenditure of GDP

Gross Domestic Product by Industrial Origin 2009 (Billion Rupiahs)

INDUSTRIAL ORIGINat current

market prices

at constant 2000 market

price

1 Agriculture, Livestock, Forestry and Fishery 858,252.0 296,369.32 Mining and Quarrying 591,531.7 179,974.93 Manufacturing industry 1,480,905.4 569,550.84 Electricity, Gas and Water Supply 46,823.1 17,059.85 Construction 554,982.2 140,184.26 Trade, Hotel and Restaurant 750,605.0 367,958.87 Transport and Communication 352,407.2 191,674.08 Financial, Ownership and Business Services 404,116.4 208,832.29 Services 573,818.7 205,371.5

GROSS DOMESTIC PRODUCT 5,613,441.7 2,176,975.5

GDP is the total market value of all final goods and services produced within a country in a given period of time.

GNP is the total market value of final goods and services produced during a given period by the factors owned by a nation.

GNP = GDP + (IR – IP)IR = factor income received from abroadIP = factor income paid to abroadIR – IP = net factor income received from abroad

GDP = C + I + G + NXLess DepreciationLess Indirect Taxes

Equal to National Income (NI)Minus Direct TaxesMinus Net Business SavingPlus Transfer payment

Equal to Disposable Income (DI)

GDP is the best single measure of the economic well-being of a society.

GDP per person tells us the income and expenditure of the average person in the economy.

Higher GDP per person indicates a higher standard of living.

However, GDP is not a perfect measure of the happiness or quality of life.

Some things that contribute to well-being are not included in GDP.The value of leisure.The value of a clean environment.The value of almost all activity that takes

place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

GDP, Life Expectancy, and Literacy

Price index (P) is a measure of the average level of price.

Inflation refers to a situation in which the economy’s overall price level is rising.

The inflation rate () is the percentage change in the price level from the previous period.

THE CONSUMER PRICE INDEX The consumer price index (CPI) is a

measure of the overall cost of the goods and services bought by urban consumer.

The fixed weight is used to calculate CPI. CPI is used to monitor changes in the cost of

living over time.When the CPI rises, the typical family has to

spend more dollars to maintain the same standard of living.

Calculating the CPI and the Inflation Rate

GDP PRICE INDEX The GDP price index (or GDP deflator)

is the price of all goods and services produced domestically.

It is a chain-weighted index that take into account the changing shares of different goods.

THE PRODUCER PRICE INDEX The produces price index (PPI)

measures the cost of a basket of goods and services bought by firms rather than consumers.

It measure the level of prices commodity at the wholesale or producer stage.

The fixed weight used to calculate PPI are the net sales of each commodity.

The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.

1. Substitution biasThe basket does not change to reflect

consumer reaction to changes in relative prices.○ Consumers substitute toward goods that have

become relatively less expensive.○ The index overstates the increase in cost of

living by not considering consumer substitution.

2. Introduction of new goodsThe basket does not reflect the change in

purchasing power brought on by the introduction of new products.○ New products result in greater variety, which

in turn makes each dollar more valuable.○ Consumers need fewer dollars to maintain

any given standard of living.

3. Unmeasured quality changesIf the quality of a good rises from one year

to the next, the value of a dollar rises, even if the price of the good stays the same.

If the quality of a good falls from one year to the next, the value of a dollar falls, even if the price of the good stays the same.

The BPS tries to adjust the price for constant quality, but such differences are hard to measure.

The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living.The issue is important because many

government programs use the CPI to adjust for changes in the overall level of prices.

The CPI overstates inflation by about 1 percentage point per year.

Price indexes are used to correct for the effects of inflation when comparing dollar figures from different times. For example:

S ala ry S a la ry P rice lev e l in 20 01P rice lev e l in 19 3120 0 1 19 31

$8 0 ,.

$9 3 1,

00 0 1 771 5 2

5 79

Indexation

When some dollar amount is automatically corrected for inflation by law or contract, the amount is said to be indexed for inflation.

Real and Nominal Interest Rates

Interest represents a payment in the future for a transfer of money in the past.

The nominal interest rate is the interest rate usually reported and not corrected for inflation. It is the interest rate that a bank pays.

The real interest rate is the nominal interest rate that is corrected for the effects of inflation.

Real and Nominal Interest Rates

You borrowed $1,000 for one year. Nominal interest rate was 15%. During the year inflation was 10%.

Real interest rate = Nominal interest rate – Inflation = 15% - 10% = 5%

Assignment-2 Questions for discussion, problems and

application at the end of the chapter.

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