CHAPTER 10

Gross Domestic Product GDP – measures everyone’s total income in economy

total expenditure on economy’s output of goods and services.

INCOME = EXPENDITURE
Every dollar buyer spends is a dollar of income for the seller

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

“Market value” – all goods are measured in same units (dollars in U.S.). things
that don’t have market value are exclude *housework for self

“Final Goods” intended for end user *intermediary goods – used as inputs
in production for other goods.

“Services” GDP includes tangible goods and intangible services.

“Within a country” eg) Canadian citizen working in U.S. = US GDP

“In a given period” includes currently produced goods, not goods produced in the
past. Yearly vs. quarterly

Y = C + I + G + NX

C = Consumption
Total spending by households on goods and services

I = Investment
Total spending on goods that will be used in the future:
1) Capital equipment 2) Structures 3) inventories 4) new housing

G = Government Purchases
Spending on goods and services purchases by gov’t at the feeral, state, local level.
*Does not include social security

NX = Net Exports (E – M)
Spending on domestically produced goods by foreigners (EXPORTS) minus spending on
foreign goods by domestic residents (IMPORTS)
NX = Export – Imports
EX>IM positive, IM>EX negative

GDP EXCLUDES:
1. Used goods
2. Paper transactions
3. Output produced abroad by domestically owned factors of productions.
GNP – Gross National Product – around the world, by citizen of a country or other factors of
productions.
Eg) Honda (Japanese) in Ohio (U.S.) : GDPus GNPjap
Eg) US Factory behind Mexican border:
Profit: GNPus GDPmex
Wages: GNPus GDPmex

REAL vs. NOMINAL GDP

Total spending rises bc:
1. Economy produces a larger output of Goods and Services
2. Goods and Services are sold at higher prices

[Not fixed] Nominal GDP – production of G&S valued @ current prices

[Fixed for inflation] Real GDP – production of G&S valued @ constant prices (base year)
reflects only chances in quantity.

Year $ Lattes Quantity $ Frappuccinos Quantity

2008 $1 100 $2 50
2009 $2 150 $3 100
2010 $3 200 $4 150

Nominal GDP: Real GDP (base year = 2008)

2008 = 1 x 100 + 2 x 50 = $200 2008 = 1 x 100 + 2 x 50 = $200
2009 = 2 x 150 + 3 x 100 = $600 2009 = 1 x 150 + 2 x 100 = $350
2010 = 3 x 200 + 4 x 150 = $ 1,200 2010 = 1 x 200 + 2 x 150 = $500

GDP Deflator – reflects only the prices of G&S, measures overall level of prices

GDP Deflator = Nominal GDP x 100

Real GDP

2008 = (200/200)100 = 100 *GDP base yr always equals 100

2009 = (600/350)100 = 171
2010 = (1200/500)100 = 240

inflation – raise in overall prices in economy

% CHANGE/inflation rate = GDP deflator in year 2 – GDP deflator in year 1 x 100

GDP deflator in year 1

CHAPTER 11
Consumer Price Index CPI – measures typical consumers cost of living.
Dept of Labor - Bureau of Labor Stats

How it’s calculated:

1. Fix the Basket -BLS surveys consumers to determine typical shopping basket
2. Find the Prices – BLS collects data of prices of all goods in basket @ each pt in time
 3. Compute Basket’s Cost
4. Compute Index
CPI = 100 x Cost of Basket in Current Yr
Cost in Base Year
5. Compute inflation rate (w/Base Year)
Inflation Rate = CPI This Year – CPI Last Year x 100
CPI Last Year

PROBLEMS W/CPI

1. Substitution Bias
When prices change from one year to the next and do not change
proportionally. Consumers respond by buying less of goods w/raised prices and
more of goods with cheaper prices.
2. Introduction of New Goods
Increase in variety, CPI overstates cost of living.
3. Unmeasured Quality Change
Dollar becomes more or less valuable depending on increase/decrease in
quality. CPI misses effect bc of fixed basket.

CPI vs. GDP Deflator

1. Imported Consumer Goods: included in CPI, excluded in GDP deflator
2. Capital Goods: excluded in CPI, included in GDP deflator
3. The Basket: CPI uses fixed basket for 10 yrs, GDP uses basket of currently produced
goods and services (quarterly).

CHAPTER 12
Productivity – quantity of goods and services produced from each labor input living
standard tied w/productivity. More productivity = higher living standard.

Productivity is Determined By:

1. Physical Capital per Worker (K) -the stock of equipment and structures that are
used to produce G&S.
2. Human Capital per Worker (H) – knowledge and skill workers learn in education &
training
3. Natural Resources per Worker (N)– Nature’s raw materials, provides input for
production.
a. RENEWABLE
b. NONRENEWABLE
4. Technological Knowledge – society’s understanding of best way to produce G&S

PRODUCTION FUNCTION = Y = AF(L, K, H, N)

L = Quantity of Labor

Y/L = AF(1, K/L, H/L, N/L)

Economic Growth & Public Policy

 I. Savings and Investent (K/L rises)
Society consumes less and saves more of current income to invest
more in the future,
II. Diminishing Returns and the Catch-Up Effect
Diminishing returns – benefit from extra unit of input, declines as quantity of
input rises.
Not very beneficial in the long-term.
Catch-up effect – Easier for poor countries to grow more rapidly than rich
countries.
III. Investments from Abroad (K/L rises)
1. Foreign Direct Investment: Capital investment owned and operated
by a foreign entity. Eg) Ford buils company in Mexico.
2. Foreign Portfolio Investment: Capital investment financed with
foreign money but operated by domestic residents Eg.) Google invests in a
stock for small Swedish company.
IV. Education (H/L rises)
Invest in human capital, increases productivity.
Opportunity Cost: education vs job. Forgo potential wages.
Less developed countries: children drop out of school to support
families.
BRAIN DRAIN – emigration of highly educated worker to rich
countries
V. Health and Nutrition (H/L rises)
healther workers are more productive
VI. Property Rights and Political Stability
Ability of people to exercise authority over the resources they own
THREATS: political instability
economic prosperity depends on political prosperity
VII. Free Trade
1. Inward-Oriented Policies
tariffs
aim to rise living standards by avoiding interaction
w/other countries
2. Outward-Oriented Policies
elimination of restrictions on trade or foreign
investment. Promotes integration of whole
economy.
VIII. Research and Development
Technological progress
Public good: ideas can be shared freely, increases productivity

Attitudes towards POPULATION GROWTH

1. Stretching Natural Resources
Malthus = wrong, pop growth will strain natural resources. INSTEAD, nat
resources have steadily increased.
2. Diluting the Capital Stock
Bigger pop = higher L, lower K = lower productivity and living standards
Fast pop growth – more children – greater strain, lower edu attainment
3. Promoting Technological Progress – Miachel Kreno
More people, more scientists, inventors, engineers. More discoveries and
faster tech progress and economic growth.