Lecture 2: Measuring economic output:

Economic output refers to the value of economic production. The most common measure of
economic output is GDP.
Gross domestic product: GDP: The total market value of all final goods and services
produced within a given period by factors of production located within a country.
Explaining the definition:
Production: Only measures the production of new goods; not the transfer of ownership of
goods or assets that were already produced. So, buying a used car does not count as part of
GDP.
Market value: We measure the value of economic production through the monetary
value it gets in the market.
Final goods and services: The price of the final good measures the value of all the
production that went into it. The intermediate goods that went into producing a final good will be
paid for several times over, but the final price contains all the added value. If we counted the
value of intermediate and final goods, we would double count the intermediate production.
Another measure of production is Gross National Output: GNP: The total market value of all
final goods and services produced within a given period by factors of production owned by a
country’s citizens, regardless of where the output is produced.
GDP measures all production in a country, regardless of the nationality of the producers.
GNP measures all production done by citizens of a country, regardless of where it takes place.

How to measure production: There are two ways to measure the market value of all
production: either measure how much people spend on production, or how much people earn
from it.
Both these methods should give the same measure: Production is sold on the market, and
every transaction represents two things: the income for the producer, or the expenditure of the
consumer.

Note: we are not interested in measuring all expenditures, only the expenditures that go on new
domestic production.
Similarly, we are not interested in measuring all income, only income that comes from new
domestic production.
 1- Expenditure approach: measures all expenditure on new domestic production:
GDP = C + I + G + (EX − IM)
C: Personal consumption expenditure: only consumption spent to buy final goods and
services: no used goods, no paper transactions.
I: Gross private domestic investment: spending on new capital
Net investment = Gross investment – depreciation
Depreciation is the loss in the value of capital due to tear and wear.

capitalend of period = capitalbeginning of period + net investment

G: Government consumption and investment
(EX-IM): Net exports: measure how much we produce that we did not consume. Keep in mind
that the value of C includes goods

2- Income approach: measures all income made from new domestic production:

 National income
 Compensation of employees
 Proprietors’ income
 Rental income
 Corporate profits
 Net interest
 Indirect taxes minus subsidies
 Net business transfer payments
 Surplus of government enterprises

Real vs Nominal GDP

The value of money changes over time, making comparisons between GDP in different years
not consistent. In order to make different years’ GDP measurements comparable to one
another, we need to measure them with one measure: the price level in one particular year. We
call that year the “base year” and use the price level in that year to measure GDP in all other
years.
Nominal GDP in Year X refers to GDP measured using the prices in Year X.
Real GDP in Year X refers to GDP measured using the prices in a chosen base year.
Why care about GDP?
Only way to improve material standard of living is through more production.
More production means more goods to satisfy more of people’s needs and wants.
If output is growing per capita that means that there is more output per person, which means
that on average, each person is better off.

What GDP is NOT:

GDP does NOT measure welfare, happiness, quality of life, or the environment. It is a measure
of market production only. Increased market production can improve welfare, happiness,
quality of life, and the environment, but it does not necessarily do so!
GDP does NOT measure non-market output: All production which is not made for sale. If you
build a desk at home, that does not count in GDP. All valuable things that are not bought or
sold, like motherhood, fatherhood, housework, and domestic production are not included in
GDP. Something can be really valuable, but if it’s not sold for money, it is not part of GDP.
GDP does NOT measure all activities in the informal economy: black markets, illegal
transactions, and transactions that are not recorded for tax purposes are all excluded from
GDP.
GDP does NOT measure the distribution of income. If GDP goes up, that tells us nothing about
who benefits and who loses from this increase in income.