MEASURING GDP AND

ECONOMIC GROWTH
4
CHAPTER
Objectives

After studying this chapter, you will able to

 Define GDP and use the circular flow model to explain
why GDP equals aggregate expenditure and aggregate
income
 Explain the way of measuring GDP
 Explain how we measure real GDP and the GDP deflator
 Explain how we use real GDP to measure economic
growth and describe the limitations of our measure
An Economic Barometer

What exactly is GDP?

How do we use it to tell us whether our economy is in a
recession or how rapidly our economy is expanding?
How do we take the effects of inflation out of GDP to
compare economic well-being over time?
And how do we compare economic well-being across
countries?
Gross Domestic Product
Gross Domestic Product
Gross Domestic Product
Gross Domestic Product
Gross Domestic Product

GDP and the Circular Flow of Expenditure and Income

GDP measures the value of production, which also equals
total expenditure on final goods and total income.
The equality of income and output shows the link between
productivity and living standards.
The circular flow diagram in Figure 4.1 illustrates the
equality of income, expenditure, and the value of
production.
 Gross Domestic Product

The circular flow diagram shows the transactions among

households, firms, governments, and the rest of the world.
Land Consumption Government
Labor Purchases
Capital
Enterp.

Investment EXports - IMports

Gross Domestic Product

Firms hire factors of production from households. The blue flow,

Y,Rent
shows total income paid by firms to households.
Wages
Interest
Profit

Land
Labor
Capital
Enterp.
Gross Domestic Product
Gross Domestic Product
Gross Domestic Product
Gross Domestic Product

These transactions take place in factor markets, goods markets,

and financial markets.
Gross Domestic Product

Households buy consumer goods and services. The red flow, C,

Rent consumption expenditures.
shows
Wages
Interest
Profit
Gross Domestic Product

Households save, S, and pay taxes, T. Firms borrow some of

Renthouseholds save to finance their investment.
what
Wages
Interest Consumption
Profit Savings
Taxes
 Gross Domestic Product

Firms buy capital goods from other firms. The red flow I
Rent
represents this investment expenditure by firms.
Wages
Interest Consumption
Profit Savings
Taxes
Investment

I=Increase in Capital
•Fixed Production
Assets
•Inventory
Gross Domestic Product
Consumption
Governments buy goods and services, G, and borrow Savings
or
Taxes
repay debt if spending exceeds or is less than taxes.
Investment
Rent
Wages G. Purchases
Interest
Profit
Taxes > G. Purchases Surplus
Taxes < G. Purchases Deficit
Taxes = G. Purchases Balanced

Exports > Imports Surplus

Exports < Imports Deficit
Exports = Imports Balanced
 Consumption
Gross Domestic Product Savings
Taxes
Investment
The rest of the world buys goods and services
from us, X,
G. Purchases
and sells us goods and services, M—net exports are X-M
Exports
Rent
Wages IMports
Interest
Profit

X-M = Net
Exports
 Consumption
Gross Domestic Product Savings
Taxes
Investment
And the rest of the world borrows from us or lends to
us
G. Purchases
depending on whether net exports are positive or negative.
Exports
Rent
Wages IMports
Interest
Profit
Gross Domestic Product

The blue and red flows are the circular flow of expenditure and
income. The green flows are borrowing and lending.
Gross Domestic Product

The sum of the red flows equals the blue flow.

Gross Domestic Product

That is: Y = C + I + G + X - M
 Consumption
Gross Domestic Product Savings
Taxes
Investment
G. Purchases
Exports
IMports

World
HH F
World GDP
How to
Calculate 2019
the GDP?
Quantity Price
1000 $10 $ 10000

2000 $8 $ 16000

GDP $ 26000
 Consumption
Gross Domestic Product Savings
Taxes
Investment
G. Purchases
Exports
IMports
 Consumption
Gross Domestic Product Savings
Taxes
Investment
Financial Flows G. Purchases
Exports
Financial markets finance deficits and investment.
IMports
Household saving, S, is income minus net taxes and
consumption expenditure, and flows to the financial
markets;
GDP= National Income = Y = C + S + T,
income equals the uses of income.
Gross Domestic Product

If government purchases exceed net taxes, the deficit

(G – T) is borrowed from the financial markets (if T
exceeds G, the government surplus flows to the markets).
If imports exceed exports, the deficit with the
Gross Domestic Product

How Investment Is Financed

Investment is financed from three sources:
 Private saving, S
 Government budget surplus, (T – G)
 Borrowing from the rest of the world (M – X)
 Consumption
Gross Domestic Product Savings
Taxes
Investment
G. Purchases
Exports
IMports
National Income = GDP
How to
Calculate 2019
the GDP?
Quantity Price
100 $100 $ 10000

2000 $8 $ 16000

GDP $ 26000
 2019 2020
Quantity Price Total
Quantity Price
1000 $12 $ 12000
1000 $8 $ 8000

2000 $8 $ 16000 2000 $10 $ 20000

GDP $ 24000 $ 32000

GDP
Nominal GDP
Real GDP and the Price Level
Real GDP and the Price Level
Nominal GDP= ∑ Q current Period X Prices Current Period
Real GDP and the Price Level
Nominal GDP= ∑ Q current Period X Prices Current Period
Real GDP and the Price Level
Real GDP= ∑ Q current Period X Prices Base Period
Real GDP and the Price Level
Real GDP= ∑ Q current Period X Prices Base Period

Base
period
Real GDP and the Price Level

Nominal GDP ∑ Q current Period X Prices Current Period

X 100
Real GDP = ∑ Q current Period X Prices Base Period
Real GDP and the Price Level

Year Nominal Real GDP

GDP GDP deflator The prices of the
current period is
2000 $200 $200 100 about 2time and one
third the prices of the
2003 $575 $270 230
base period
Real GDP and the Price Level

Deflating the GDP Balloon

Nominal GDP increases because production—real GDP–
increases.
Real GDP and the Price Level

Deflating the GDP Balloon

Nominal GDP also increases because prices rise.
Real GDP and the Price Level

Deflating the GDP Balloon

We use the GDP deflator to let the air out of the nominal
GDP balloon and reveal real GDP.
Measuring Economic Growth

We use real GDP to calculate the economic growth rate.

The economic growth rate is the percentage change in
the quantity of goods and services produced from one
year to the next.
We measure economic growth so we can make:
 Economic welfare comparisons
 International welfare comparisons
 Business cycle forecasts

Economic Growth = [(Real GDP Current Period – Real GDP Last Period)/ Real GDP Last Period] x100
2003 2002 2002
Measuring Economic Growth
 2000 Base 2010
Year

1000
$100
$10

GDP ignores the change in quality and

Nominal GDP = 1000 X
the new products
100 = $100,000
Tend to overestimate the inflation and
Real DGP = 1000X10 =
underestimate the production
$10,000
Measuring Economic Growth

72 68
Measuring Economic Growth

Economic Welfare Comparisons

Economic welfare measures the nation’s overall state of
economic well-being.
Real GDP is not a perfect measure of economic welfare
for seven reasons:
3,642.5
Measuring Economic Growth

Purchasing Power Parity (PPP)

4 X EGP 0.25 = 1 EGP 4 X SR 0.5 = 2 SR

4 X $ 0.25 = $1

EGP 10 EGP 5/SR 4 X $ 0.25 = $1

Piece of Loaf of Bread in th

U.S. = $ 0.10
Measuring Economic Growth

Using the exchange rate to compare GDP in one country

with GDP in another country is problematic because prices
of particular products in one country may be much less or
much more than in the other country.
Using the exchange rate to value Chinese GDP in dollars
leads to an estimate that U.S. real GDP per person was 69
times Chinese real GDP per person.
Measuring Economic Growth
Egypt Economic Growth
Measuring Economic Growth

Business Cycle Forecasts

Real GDP is used to measure business cycle fluctuations.
These fluctuations are probably accurately timed but the
changes in real GDP probably overstate the changes in
total production and people’s welfare caused by business
cycles.
Three Big Macroeconomic Questions

Q1 2%
Q2 4%
Q3 7%
Q1 2%
Q2 1%
Q3 0.5%

Q1 -2%
Q1 -2% Q2 -1%
Q2 -4% Q3 -0.5%
Q3 -6%
GDP
What in it for me?
Economic Growth

• Is your main indicator of the

economic activity

• Sales Leaders as to use the

expected growth as base to
their sales forecasting.

• Countries with high rate of

Economic growth are
attractive for new investment.
MEASURING GDP AND
ECONOMIC GROWTH
4
CHAPTER

THE END