Chapter 20

Measuring GDP and Economic

Growth
By
Rafiu Ibrahim
ECO 102
In this chapter,
look for the answers to these questions:
▪ What is Gross Domestic Product (GDP)?
▪ What are the components of GDP?
▪ Difference between Nominal and Real GDP
▪ What are the limitations of Real GDP?
▪ Does GDP measure society’s well-being?

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Gross Domestic Product (GDP) Is…
the market value of all final goods &
services produced within a country
in a given period of time.

Goods are valued at their market prices, so:

▪ All goods measured in the same units
(e.g., dollars in the U.S.)
▪ Things that don’t have a market value are
excluded, e.g., housework you do for yourself.

MEASURING A NATION’S INCOME 3

Gross Domestic Product (GDP) Is…
the market value of all final goods &
services produced within a country
in a given period of time.

Final goods: intended for the end user

Intermediate goods: used as components
or ingredients in the production of other goods
GDP only includes final goods – they already
embody the value of the intermediate goods
used in their production.
MEASURING A NATION’S INCOME 4
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.

GDP includes tangible goods

(like DVDs, mountain bikes, beer)
and intangible services
(dry cleaning, concerts, cell phone service).

MEASURING A NATION’S INCOME 5

Gross Domestic Product (GDP) Is…
the market value of all final goods &
services produced within a country
in a given period of time.

GDP includes currently produced goods,

not goods produced in the past.

MEASURING A NATION’S INCOME 6

Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.

GDP measures the value of production that occurs

within a country’s borders, whether done by its own
citizens or by foreigners located there.

MEASURING A NATION’S INCOME 7

Gross Domestic Product (GDP) Is…
the market value of all final goods &
services produced within a country
in a given period of time.

Usually a year or a quarter (3 months)

MEASURING A NATION’S INCOME 8

 How do we measure GDP?
▪ GDP is calculate by the aggregate income of an
economy
Or
▪ GDP is calculated by the total expenditure on
economy’s output of goods and services.

MEASURING A NATION’S INCOME 9

 Circular flow of Income and Expenditure

MEASURING A NATION’S INCOME 10

 Expenditure Approach
The Components of GDP

▪ Recall: GDP is total spending.

▪ Four components:
▪ Consumption (C)
▪ Investment (I)
▪ Government Purchases (G)
▪ Net Exports (NX)
▪ These components add up to GDP (denoted Y):

Y = C + I + G + NX
MEASURING A NATION’S INCOME 11
 Consumption (C)
▪ is total spending by households on g&s.
▪ Note on housing costs:
▪ For renters,
consumption includes rent payments.
▪ For homeowners,
consumption includes the imputed rental value
of the house, but not the purchase price or
mortgage payments.

MEASURING A NATION’S INCOME 12

 Investment (I)
▪ is total spending on goods that will be used in the
future to produce more goods.
▪ includes spending on
▪ capital equipment (e.g., machines, tools)
▪ structures (factories, office buildings, houses)
▪ inventories (goods produced but not yet sold)

MEASURING A NATION’S INCOME 13

 Government Purchases (G)
▪ is all spending on the g&s purchased by govt
at the federal, state, and local levels.
▪ G excludes transfer payments, such as
Social Security or unemployment insurance
benefits.
They are not purchases of g&s.

MEASURING A NATION’S INCOME 14

 Net Exports (NX)
▪ NX = exports – imports
▪ Exports represent foreign spending on the
economy’s g&s.
▪ Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
▪ Adding up all the components of GDP gives:

Y = C + I + G + NX

MEASURING A NATION’S INCOME 15

PRACTICE Exercise

In each of the following cases, determine how much

GDP and each of its components is affected (if at all).
A. Debbie spends $200 to buy her husband dinner
at the finest restaurant in Boston.
B. Sarah spends $1800 on a new laptop to use in her
publishing business. The laptop was built in China.
C. Jane spends $1200 on a computer to use in her
editing business. She got last year’s model on sale
for a great price from a local manufacturer.
D. General Motors builds $500 million worth of cars,
but consumers only buy $470 million worth of them.
PRACTICE Exercise

A. Debbie spends $200 to buy her husband dinner

at the finest restaurant in Boston.
Consumption and GDP rise by $200.

B. Sarah spends $1800 on a new laptop to use in

her publishing business. The laptop was built in
China.
Investment rises by $1800, net exports fall
by $1800, GDP is unchanged.

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PRACTICE Exercise
C. Jane spends $1200 on a computer to use in her
editing business. She got last year’s model on
sale for a great price from a local manufacturer.
Current GDP and investment do not change,
because the computer was built last year.

D. General Motors builds $500 million worth of cars,

but consumers only buy $470 million of them.
Consumption rises by $470 million,
inventory investment rises by $30 million,
and GDP rises by $500 million.

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19
 The Income Approach
▪ The income approach measures GDP by
summing up the incomes paid by firms to the
factors of production, (i.e; Land, Labor, Capital
and Entrepreneur) :
▪ Wages for Labours;
▪ Rent for Land;
▪ Interest for Capital;
▪ Profit for Entrepreneur

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 The Income Approach
▪ As a result, the Income Approach is an addition of:
>Compensation of employees: Total payments by
firms for labour services
> Gross operating surplus: Total profit made by
companies and surpluses generated by publicly
owned enterprises
> Mixed Income: This is rental income plus self-
employment income- when an owner supplies
labour, capital or perhaps land and buildings to the
business.

MEASURING A NATION’S INCOME 21

 The Income Approach
▪ So how the calculation Works ?
▪ Can you tell what is
the Indirect Tax
and Subsidy in the
calculation?

Note: Indirect Tax makes market price exceed factor price

And Subsidy makes factor price exceed market price
MEASURING A NATION’S INCOME 22
 Real versus Nominal GDP
▪ Inflation can distort economic variables like GDP,
so we have two versions of GDP:
One is corrected for inflation, the other is not.
▪ Nominal GDP
▪ Real GDP.

MEASURING A NATION’S INCOME 23

▪ Nominal GDP is the value of final goods and
services produced in a given year when valued
at the prices of that year.

▪ Real GDP is the value of final goods and

services produced in a given year when valued
at the prices of a reference base year. By
comparing the value of production in the two
years at the same prices, we reveal the change
in production. It is thus adjusted for inflation.

MEASURING A NATION’S INCOME 24

EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10 400 $2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200

Compute nominal GDP in each year: Increase

2005: $10 x 400 + $2 x 1000 = $6,000 :
37.5%
2006: $11 x 500 + $2.50 x 1100 = $8,250
30.9%
2007: $12 x 600 + $3 x 1200 = $10,800

MEASURING A NATION’S INCOME 25

EXAMPLE:
Pizza Latte
year P Q P Q
2005 $10$10 400 $2.00
$2.00 1000
2006 $11 500 $2.50 1100
2007 $12 600 $3.00 1200

Compute real GDP in each year,

using 2005 as the base year: Increase
2005: $10 x 400 + $2 x 1000 = $6,000 :
20.0%
2006: $10 x 500 + $2 x 1100 = $7,200
16.7%
2007: $10 x 600 + $2 x 1200 = $8,400
MEASURING A NATION’S INCOME 26
EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
2006 $8250 $7200
2007 $10,800 $8400

In each year,
▪ nominal GDP is measured using the (then)
current prices.
▪ real GDP is measured using constant prices from
the base year (2005 in this example).

MEASURING A NATION’S INCOME 27

EXAMPLE:
Nominal Real
year GDP GDP
2005 $6000 $6000
37.5% 20.0%
2006 $8250 $7200
30.9% 16.7%
2007 $10,800 $8400

▪ The change in nominal GDP reflects both prices

and quantities.
▪ The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
MEASURING A NATION’S INCOME 28
Nominal and Real GDP in the U.S.,
1965-2007

Real GDP
(base year
2000)

Nominal
GDP

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The uses of Real GDP
We use Real GDP for:
1. Compare Standard of Living over time
2. Compare Standard of Living across countries
• We can also use Real GDP per person to analyse
standard of living

MEASURING A NATION’S INCOME 30

 Standard of living over time

MEASURING A NATION’S INCOME 31

 Standard of living over time
▪ Standard of living over time is calculated as real gdp
per person across different year.(Real-gdp divided by
total population.
▪ The following graph shows
the real gdp per capita for
Bangladesh.It shows:
▪ Long term trend
▪ Short-term trend (Fluctuations of Real GDP)

MEASURING A NATION’S INCOME 32

 Fluctuations of Real GDP
▪ Potential GDP is the value
of production when all the
economy’s labour, capital,
land and entrepreneurial
activities are fully employed
• Recession- A period during
when Real GDP decreases-
i.e. its growth is negative. It
is a period of significant decline
in total output, income, employment
and trade usually lasting from six months to a year
• Expansion- Is the vice versa of recession
Reading a Business

MEASURING A NATION’S INCOME 33

 Reading a Business Cycle
▪ The business cycle
is a periodic but
irregular up-and-down
movement of total
production and other
measure of economic
activity and have 2 phases:
1. Expansion
2. Recession
And two turning points:
1. Peak
2. Trough
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 Standard of Living across countries
▪ Real gdp is also used to compare standard of
living across countries.

MEASURING A NATION’S INCOME 35

 Uses and Limitations of
Real GDP
▪ Quality improvements
▪ Household production
▪ Underground economic activity
▪ Health and life expectancy
▪ Leisure time
▪ Environmental quality
▪ Political freedom and social justice

MEASURING A NATION’S INCOME 36

 Then Why Do We Care About GDP?
▪ Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.
▪ Many indicators of the quality of life are
positively correlated with GDP. For example…

MEASURING A NATION’S INCOME 37

 GDP and Life Expectancy in 12 countries

Indonesia
Japan
China
Life expectancy (years)

U.S.
Mexico Germany
Brazil
Pakistan
Russia
India
Bangladesh

Nigeria

Real GDP per capita 38

 GDP and Literacy in 12 countries
China Russia U.S.
Germany Japan
Mexico
(% of population)

Brazil
Adult Literacy

Indonesia

Nigeria

India

Pakistan

Bangladesh

Real GDP per capita 39

 GDP and Internet Usage in 12 countries

Japan
U.S.
(% of population)
Internet Usage

Germany

Brazil
Indonesia
Mexico
Pakista
Russia
n
China
Nigeria India

Bangladesh Real GDP per capita 40