MEASURING GDP

AND ECONOMIC
GROWTH 4
CHAPTE
R
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

GDP Defined
GDP or gross domestic product is the market value of
all final goods and services produced in a country in a
given time period.
This definition has four parts:
 Market value
 Final goods and services
 Produced within a country
 In a given time period
Gross Domestic Product

Market value
GDP is a market value—goods and services are valued at
their market prices.
To add apples and oranges, computers and popcorn, we
add the market values so we have a total value of output
in dollars.
Gross Domestic Product

Final goods and services

GDP is the value of the final goods and services produced.
A final good (or service) is an item bought by its final user
during a specified time period.
A final good contrasts with an intermediate good, which is
an item that is produced by one firm, bought by another
firm, and used as a component of a final good or service.
Excluding intermediate goods and services avoids double
counting.
Gross Domestic Product

Produced within a country

GDP measures production within a country—domestic
production.
In a given time period
GDP measures production during a specific time period,
normally a year or a quarter of a year.
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
Labor
Capital
Enterp.
Gross Domestic Product

These transactions take place in factor markets, goods

markets, and financial markets.
Gross Domestic Product

Firms hire factors of production from households. The blue

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

Land
Labor
Capital
Enterp.
Gross Domestic Product

Households buy consumer goods and services. The red flow,

Rent
C, shows consumption expenditures.
Wages
Interest Land
Profit Labor
Capital
Enterp.
Gross Domestic Product

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

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

Firms buy capital goods from other firms. The red flow I
Rent
represents
Wages
this investment expenditure by firms.
Interest Consumption
Profit Savings
Taxes
Investment
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
 Consumption
Gross Domestic Product Savings
Taxes
Investment
And the rest of the world borrows from us or lends
toG.usPurchases
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
GDP
How to
Calculate 2019
the GDP?
Quantit Price
y
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)
Gross Domestic Product
How to
Calculate 2019
the GDP?
Quantit Price
y
1000 $100 $ 8000

2000 $8 $ 16000

GDP $ 24000
 2019 2020
Quantity Price Total
Quantity Price
1000 $12 $
1000 $8 $ 8000 12000

2000 $8 $ 16000 2000 $10 $

20000
GDP $ 24000 $ 32000
GDP
Nominal GDP
Real GDP and the Price Level

Real GDP is the value of final goods and services

produced in a given year when valued at constant prices.
Calculating Real GDP
The first step in calculating real GDP is to calculate
nominal GDP, which is the value of goods and services
produced during a given year valued at the prices that
prevailed in that same year.
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 and the Price Level

Calculating the Price Level

The average level of prices is called the price level.
One measure of the price level is the GDP deflator, which
is an average of the prices of the goods in GDP in the
current year expressed as a percentage of the base year
prices.
The GDP deflator is calculated in the table on the next
slide (and in Table 19.7 in the textbook).
Nominal GDP= ∑ Q current Period X Prices Current Period
Real GDP = ∑ Q current Period X Prices Base Period
Real GDP and the Price Level

Nominal GDP and real GDP are calculated in the way

that you’ve just seen.
GDP Deflator = (Nominal GDP/Real GDP)  100.
In 2000, the GDP deflator is ($200/$200)  100 = 100.
In 2003, the GDP deflator is ($575/$270)  100 = 230.
Year Nominal Real GDP
GDP GDP deflator
2000 $200 $200 100

2003 $575 $270 230

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)/ Real GDP
Last
Measuring Economic Growth
2000 2010

1000

$100
$10
Measuring Economic Growth
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

International Comparisons
Real GDP is used to compare economic welfare in one
country with that in another.
Two special problems arise in making these comparisons.
Real GDP of one country must be converted into the same
currency units as the real GDP of the other country, so an
exchange rate must be used.
The same prices should be used to value the goods and
services in the countries being compared, but often are
not.
4 X EGP 0.25 = 1 EGP 4 X SR 0.5 = 2 SR

EGP 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
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.
Egypt Economic Growth
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
CHAPTE
R

THE
END