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Discuss whether GDP is a good measure of well-being. GDP does not include household production, which refers to goods and services people produce for themselves, nor does it include production in the underground economy, which consists of concealed buying and selling. The underground economy in some developing countries may be more than half of measured GDP. GDP is not a perfect measure of well-being because it does not include the value of leisure, it is not adjusted for pollution or other negative effects of production, and it is not adjusted for changes in crime and other social problems. 8.3 Real GDP versus Nominal GDP (pages 254257)
Discuss the difference between real GDP and nominal GDP. Nominal GDP is the value of final goods and services evaluated at current-year prices. Real GDP is the value of final goods and services evaluated at base-year prices. By keeping prices constant, we know that changes in real GDP represent changes in the quantity of goods and services produced in the economy. When the price level, the average prices of goods and services in the economy, is increasing, real GDP is greater than nominal GDP in years before the base year and less than nominal GDP for years after the base year. The GDP deflator is a measure of the price level and is calculated by dividing nominal GDP by real GDP and multiplying by 100. 8.4 Other Measures of Total Production and Total Income (pages 257259)
Understand other measures of total production and total income. The most important measure of total production and total income is gross domestic product (GDP). As we will see in later chapters, for some purposes, the other measures of total production and total income shown in Figure 8.4 are actually more
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useful than GDP. These measures are gross national product (GNP), national income, personal income, and disposable personal income.
Chapter Review
Chapter Opener: Ford Motor Company Feels the Effects of the Recession (page 241)
Why is GDP important to you? Economic expansions and contractions have a dramatic impact on business outcomes. Ford Motor Company is the oldest auto maker in the United States. In early 2009, the U.S. economy was suffering its worse downturn since the 1930s. Meanwhile, Ford suffered heavy losses as the demand for of its cars and trucks dropped 20 percent from a year earlier. By 2011, as the economy was slowly recovering from the downturn, Fords sales were rising again. Ford and the automobile industry as a whole were experiencing the effects of the business cycle. A business cycle refers the periodic expansion and contraction in the level of production in the nation.
8.1
An economy that produces a large quantity of goods and services creates an interesting measurement problem. How do we add together the production of different goods and services to arrive at an aggregate measure of total production? Economists have developed a method of aggregating the wide variety of production by calculating a measure called gross domestic product or GDP. GDP is defined as the market value of all final goods and services produced in a country during a period of time. We aggregate goods by adding their value, and we determine their value by their price. We count only newly produced goods and services, not all transactions, and we count only transactions that have a market price. Transfer payments, such as Social Security and unemployment insurance, are not counted in GDP because they are payments by the government for which the government does not receive a new good or service in return. Intermediate goods are not counted because they are an input into a final good. For example, General Motors produces cars, but it does not produce the tires that go on the cars. General Motors buys tires from Goodyear and Michelin. The tires are an intermediate good. In calculating GDP, we include the value of the General Motors car but not the value of the tire. If we included the value of the tire, we would be double counting: The value of the tire would be counted once when the tire company sold it to General Motors, and a second time when General Motors sold the car, with the tire installed, to a consumer. GDP is the sum of price multiplied by quantity for all final goods and services produced. When we calculate GDP as the value of production in a country, we are also measuring the value of income in that country. This is because $100 spent on a good will ultimately result in $100 worth of income for the various factors of production that produced that good. The measurement of GDP is often referred to as national income accounting. GDP measures both production and income. We can also look at GDP from the point of view of expenditures. From the expenditure point of view, we divide GDP into four components: 1. Consumption expenditures are expenditures made by households (excluding the purchase of new houses, which we count in investment expenditures).
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2. Investment expenditures are final goods and services purchased by business firms (equipment for production and new buildings), changes in inventories (which is the difference between production and sales), and residential construction purchased by households. Look at the Dont Let This Happen to You Feature in this chapter in the textbook for more discussion of the definition of investment. 3. Government purchases are spending by the federal, state, and local governments. 4. Net exports are exports minus imports.