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, or 2. a sum of income or earnings Both 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

Revenue

Goods and services sold

MARKETS FOR GOODS AND SERVICES Firms sell Households buy

Spending

Goods and services bought

FIRMS Produce and sell goods and services Hire and use factors of production

HOUSEHOLDS Buy and consume goods and services Own and sell factors of production

Factors of production

MARKETS FOR FACTORS OF PRODUCTION Households sell Firms buy

Labor, land, and capital

Wages, rent, and profit

Income = Flow of inputs and outputs = Flow of dollars

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 firms sales and its purchases of materials and services from other firms.

GDP Sums up Value Added at Each Production Stage

Stage of Production Wheat Flour Baked dough Final product: bread Total

Sales receipts
(1) 23 53 110 190 376

Less: Cost of intermediate products (2) 0 23 53 110 186

Value added (wages, profits, etc.) (3) = (1) (2) 23 30 57 80 190

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

Expenditure Approach
1 Personal consumption expenditures Durable goods Nondurable goods Services 2 Gross private domestic investment Fixed investment (both residential and nonresidential) Change in private inventories 3 4 Government consumption expenditure and gross investment (both state and local government) Net export of goods and services Export Import Gross Domestic Product (GDP) = 1 + 2 + 3 + 4

Income Approach
1 2 3 4 5 6 7 Wages, salaries, and other labor incomes Interest Rental income of person Indirect business taxes Depreciation Income of unincorporated enterprises Corporate profits before taxes Corporate profit taxes Dividend Undistributed 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.

Copyright2004 South-Western

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.

Year 2001 2002 2003

Calculating the GDP Deflator ($200/$200) x 100 = 100 ($600/$350) x 100 = 171 ($1,200/$500) x 100 = 240

Copyright2004 South-Western

Expenditure of Gross Domestic Product 2009 (Billion Rupiahs)

TYPE OF EXPENDITURE 1 2 3 4 5 6 7 8 9 10 11 12 Private consumption expenditure General government consumption expenditure Gross domestic fixed capital formation a. Change in inventory b. Statistical discrepancy* Export of goods and services Less import of goods and services GROSS DOMESTIC PRODUCT (GDP) Net Factor income from abroad GROSS NATIONAL PRODUK (GNP) Less net indirect taxes (indirect taxes minus subsidy) Less depreciation NATIONAL INCOME (NI) at current market prices 3,290,843.3 537,588.8 1,744,381.2 -7,264.2 -118,994.7 1,354,409.4 1,197,092.7 5,603,871.2 -196,219.5 5,407,651.6 214,833.2 280,193.6 4,912,624.9 at constant 2000 market price 1,249,011.2 195,907.7 510,118.1 -474.3 -1,124.2 932,123.6 708,586.6 2,176,975.5 -109,819.3 2,067,156.2 64,782.0 108,848.8 1,893,525.5

* Defferent between GDP by industrial origin and expenditure of GDP

Gross Domestic Product by Industrial Origin 2009 (Billion Rupiahs)

INDUSTRIAL ORIGIN 1 2 3 4 5 6 7 8 9 Agriculture, Livestock, Forestry and Fishery Mining and Quarrying Manufacturing industry Electricity, Gas and Water Supply Construction Trade, Hotel and Restaurant Transport and Communication Financial, Ownership and Business Services Services GROSS DOMESTIC PRODUCT at current market prices at constant 2000 market price

858,252.0 296,369.3 591,531.7 179,974.9 1,480,905.4 569,550.8 46,823.1 17,059.8 554,982.2 140,184.2 750,605.0 367,958.8 352,407.2 191,674.0 404,116.4 208,832.2 573,818.7 205,371.5 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 abroad IP = factor income paid to abroad IR IP = net factor income received from abroad

GDP = C + I + G + NX
Less Depreciation Less Indirect Taxes

Equal to National Income (NI)

Minus Direct Taxes Minus Net Business Saving

Plus 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 wellbeing 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 economys 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 bias
The 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 goods

The 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 changes

If 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:
Salary 2001 Salary1931 $80,000 $931,579 Price level in 2001 Price level in 1931

177 15.2

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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