MacroEconomics

Ummad Mazhar, PhD

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Flow of funds in a multi-sector economy

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Focused questions Lecture 2
• How GDP is defined and measured?

• What are the major components of GDP?

• What is the difference between real and nominal GDP?

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What's in a name?
• Gross Domestic Product

• Value of goods and services produced in an economy in a given period

of time

• Gross?
• Domestic?
• Product?

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 Definition

• GDP is the market value of all final goods and services produced
within a country in a given period of time

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Taste of the pudding…
• Measuring GDP of a hypothetical economy

• Method 1: Focus on value added

• Method 2: Focus on expenditures

• Method 3: Focus on income

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 Value added and GDP
• A farmer grows wheat, which she sells to a miller for $100. The miller turns
the wheat into flour, which she sells to a baker for $150. The baker turns the
wheat into bread, which she sells to consumers for $180. Consumers eat the
bread.
• a. What is GDP in this economy? Explain.
• b. Value added is defined as the value of a producer’s output minus the value
of the intermediate goods that the producer buys to make the output.
• Assuming there are no intermediate goods beyond those described above,
calculate the value added of each of the three producers.
• c. What is total value added of the three producers in this economy? How
does it compare to the economy’s GDP?
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GDP Expenditure based
• Government expenditure on final goods and services = $600
• Consumption expenditures = $1950
• Rent and interest: $400
• Indirect taxes less subsidies: $350
• Investment expenditures: $550
• Wages: $1600
• Profit: $500
• Net exports: $200
• Depreciation: $450
• Identify the expenditures and calculate GDP.
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GDP Income based
• Use the data given above to identify the income categories. Calculate
the GDP income based.

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GDP at factor cost and GDP at market prices
• Market prices differ from factor cost if there is tax on market
transactions or if there is subsidy
• Market Price = Factor cost + Tax – Subsidy

• If we want to calculate GDP at market prices, we can add indirect taxes

less subsidies to GDP at factor cost.

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Nominal vs Real GDP
• Welfare of people depend on quantity of goods and services at their
command
• Value = P*Q
• Value can increase because of price increase without any increase in
real quantities
• Real GDP is needed to avoid such confusions

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Calculating nominal and real GDP
Year Prices Quantities Nominal GDP Real GDP
(b=2017)
2017 1 10 10 10
2018 2 12 24 12
2019 3 20 60 20
2020 4 15 60 15

Redo the above calculation using 2018 as the base year.

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Other measures of well being
• Human development index measure the levels of education, health,
and life expectancy of an average citizen to measure well being.

• GDP per person

• CO2 emissions per person

• GNP
• Net national product (adjusted for the depreciation of capital)

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See you next time

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