3 MACROECONOMICS

Biswa Swarup Misra

Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
Goods are valued at their market prices, so:

GDP measures all goods using the same units

(e.g., dollars in the U.S.), rather than adding
apples to oranges.

Things that dont have a market value are

excluded, e.g., housework you do for yourself.
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Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
Final goods are intended for the end user.
Intermediate goods are used as components
or ingredients in the production of other goods.
GDP only includes final goods, as they already
embody the value of the intermediate goods
used in their production.
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Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes tangible goods
(like DVDs, mountain bikes, soaps)
and intangible services
(dry cleaning, concerts, cell phone service).

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Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes currently produced goods,
not goods produced in the past.

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Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
GDP measures the value of production that occurs
within a countrys borders, whether done by its own
citizens or by foreigners located there.

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Gross Domestic Product (GDP) Is

the market value of all final goods &
services produced within a country
in a given period of time.
usually a year or a quarter (3 months).

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National Income Accounting

National income accounts: an accounting

framework used in measuring current economic

activity

Three alternative approaches give the same

measurements
Product approach: the amount of output
produced
Income approach: the incomes generated by
production
Expenditure approach: the amount of spending
by purchasers

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National Income Accounting

The Bakery example shows that all three
approaches are equal
Important concept in product approach:
value added = value of output minus value of
inputs purchased from other producers

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National Income Accounting

Why are the three approaches equivalent?
They must be, by definition
Any output produced (product approach) is

purchased by someone (expenditure approach)

and results in income to someone (income
approach)
The fundamental identity of national income
accounting:

total production = total income = total expenditure

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Exercise:
A farmer grows a kilo of wheat

and sells it to a miller for Rs10.00.

The miller turns the wheat into flour
and sells it to a baker for Rs.30.00.
The baker uses the flour to make a loaf of
bread and sells it to an engineer for Rs.60.00.
The engineer eats the bread.

Compute & compare

value added at each stage of production
and GDP
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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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Investment vs. Capital

Note: Investment is spending on new capital.
Example (assumes no depreciation):
1/1/2007:
economy has $500b worth of capital
during 2007:
investment = $60b
1/1/2008:
economy will have $560b worth of capital

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Stocks vs. Flows

Flow

Stock

A stock is a
quantity measured
at a point in time.
E.g.,
The U.S. capital stock
was $26 trillion on
January 1, 2006.

A flow is a quantity measured per unit of time.

E.g., U.S. investment was $2.5 trillion during 2006.
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Stocks vs. Flows - examples

Session 2-3

stock

flow

a persons wealth

a persons
annual saving

# of people with
college degrees

# of new college
graduates this year

the govt debt

the govt budget deficit

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Now you try:

Stock or flow?

the balance on your credit card statement

how much you study economics outside of class
the size of your compact disc collection
the inflation rate
the unemployment rate

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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.
These payments represent transfers of income,
not purchases of g&s.

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Net Exports (NX)

NX = exports imports
Exports represent foreign spending on the
economys 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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Share of different components in Indias GDP

in 2011-12 at 2004-05 base (%)

C
G
I
NX
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11
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U.S. GDP and Its Components, 2005

billions

% of GDP

per capita

$12,480

100.0

$ 42,035

8,746

70.1

29,460

2,100

16.8

7,072

2,360

18.9

7,950

NX

726

5.8

2,444

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U.S. GDP and Its Components, 2013

GDP
Y

16768.1

11484

2648

3144

NX

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% of GDP
68
16
19
-3

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Exercise 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. Abhinav spends Rs.200 to buy his friend dinner
at Mayfair, the finest restaurant in Bhubaneswar.
B. Aditi spends Rs.1800 on a new laptop to use in his business. The
laptop was built in China.
C. Ispsita spends Rs.1200 on a computer to use in her business. She
got last years model on sale for a great price from a local
manufacturer.
D. Tata Motors builds Rs.500 million worth of cars,
but consumers only buy Rs.470 million worth of them.

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Exercise 1:

Answers
A. Abhinav spends Rs. 200 to buy his friend dinner

at Mayfair.
Consumption and GDP rise by Rs. 200.
B. Aditi spends Rs.1800 on a new laptop to use in his

business. The laptop was built in China.

Investment rises by Rs.1800, net exports fall
by Rs.1800, GDP is unchanged.

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Exercise 1:

Answers
C. Ipsita spends Rs.1200 on a computer to use in her
business. She got last years 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. Tata Motors builds Rs.500 million worth of cars, but
consumers only buy Rs.470 million of them.
Consumption rises by Rs.470 million,
inventory investment rises by Rs.30 million,
and GDP rises by Rs.500 million.

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How will the following events affect GDP and

why?
a. An earthquake destroys part of

Rajasthan.
b. You sell your old macroeconomics
textbook to another student.
c. You sell your holdings of Infosys
stock.
d. A retired worker gets an increase in
Pension benefits.
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Answers
a. When an earthquake destroys property, wealth is
affected, not income (or GDP). However, if a significant
amount of the capital stock is destroyed, then less can be
produced in the time period under study, leading to a
decrease in GDP. On the other hand, the rebuilding of
destroyed property means that increased economic
activity will take place, leading to an increase in GDP.
b. b. The sale of your old textbook will not constitute an
official market transaction. In addition, the textbook has
already been used and is not currently produced.
Therefore GDP will not be affected.

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Answers
c. The sale of existing stock holdings is a transfer of wealth
and, as such, does not affect GDP. Any fees that you may
have to pay your broker for his or her services, however,
constitute payment for services rendered. GDP will
increase by that amount.

d. Transfer payments that do not arise from productive

activity are not counted in GDP. Thus GDP will not be
affected when pension benefits are paid. (Only later, when
these payments are spent, will consumption increase.)

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