Slide 1An Expanded Circular-Flow DiagramThe National AccountsGross Domestic ProductTHE MEASUREMENT OF GROSS DOMESTIC PRODUCTTHE MEASUREMENT OF GROSS DOMESTIC PRODUCTTHE MEASUREMENT OF GROSS DOMESTIC PRODUCTCounted as U.S. 2012 GDP?Calculating Gross Domestic ProductCalculating Gross Domestic ProductCalculating Gross Domestic ProductReal versus Nominal GDPTable Real and Nominal GDPTable Real and Nominal GDPTable Real and Nominal GDPNominal vs. Real GDPThe GDP DeflatorGDP deflatorReal versus Nominal GDPECONOMICS IN ACTIONGDP and Well-beingPrice Indexes and the Aggregate Price LevelConsumer Price IndexPrice Indexes and the Aggregate Price LevelInflation Rate, CPI, and other IndexesPrice IndexSlide 29Slide 30Slide 31Slide 32Slide 33Bias of calculating Price IndexU.S. CPI TrendOther Price MeasuresMeasures of Inflation: TrendInflation and IndexingCorrecting InflationCorrecting InflationCorrecting InflationCorrecting InflationCorrecting InflationGDP and the CPI: Tracking the MacroeconomyChapter 7(22)THIRD EDITIONECONOMICSandMACROECONOMICSPaul Krugman | Robin WellsAn Expanded Circular-Flow DiagramGovernmentFirmsMarkets for goods and servicesFinancial MarketsHouseholdsFactor MarketsRest of the worldGovernment purchases of goods and servicesGovernment borrowingPrivate savingsGovernment transfersWages, profit, interest, rentWages, profit, interest, rentBorrowing and stock issues by firmsForeign borrowing and sales of stockForeign lending and purchases of stockExportsImportsGDPTaxesConsumer spendingInvestmentThe National Accounts•Almost all countries calculate a set of numbers known as the national income and product accounts. •The national income and product accounts, or national accounts, keep track of the flows of money between different parts of the economy.Gross Domestic Product•Gross domestic product or GDP measures the total market value of all final goods and services produced in the economy during a given year.THE MEASUREMENT OF GROSS DOMESTIC PRODUCT•“GDP is the Market Value . . .”Output is valued at market prices.•“. . . Of All Final . . .”It records only the value of final goods, not intermediate goods (the value is counted only once).•“. . . Goods and Services . . . “It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).THE MEASUREMENT OF GROSS DOMESTIC PRODUCT•“. . . Produced . . .”It includes goods and services currently produced, not consumed.•“ . . . Within a Country . . .”It measures the value of production within the geographic confines of a country.THE MEASUREMENT OF GROSS DOMESTIC PRODUCT•“. . . In a Given Period of Time.”It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).Counted as U.S. 2012 GDP?•Dell computers manufactured in Mexico 2012 and sold in US in 2012.•Toyota Camry manufactured in Arizona, 2012, and sold in Canada in 2012.•Jack, a US citizen, had a haircut in Paris, France in May 2012.•An excellent antique mustang 1948, sold in 2012 at $1 million.•Mike, a US citizen, won $10 mil from a lottery in Atlanta in June 2012.8Calculating Gross Domestic Product•GDP can be calculated three ways:1) Add up the value added of all producers2) Add up all spending on domestically produced final goods and services. Aggregate spending — the sum of consumer spending, investment spending, government purchases of goods an services, and exports minus imports — is the total spending on domestically produced final goods and services in the economy.This results in the equation: GDP = C + I + G + X - IM3) Add up all income paid to factors of productionCalculating Gross Domestic ProductCalculating Gross Domestic Product$15,00010,0005,0000-5,000Value added by government = 12.5%Value added by households= 12.7%Value added by business= 74.9%Consumer spending= 70.5%Investment spending= 12.4%Government purchases of goods and services= 20.7%Components of GDP (billions of dollars) C + I + G = $14,527 Net exports X – IM = –$517 (–3.6%)Spending on domestically produced final goods and servicesValue added by sectorReal versus Nominal GDP•Real GDP is the total value of the final goods and services produced in the economy during a given year, calculated using the prices of a selected base year. •Nominal GDP is the value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced.Table Real and Nominal GDPCopyright©2004 South-WesternTable Real and Nominal GDPCopyright©2004 South-WesternTable Real and Nominal GDPCopyright©2004 South-WesternNominal vs. Real GDPYear Apple PriceApple QuantityOrangePriceOrangeQuantity2007 2 10 1 52008 4 10 2 5•Nominal GDP 2007 = 2 X $10 + 1 X $5 = $25•Nominal GDP 2008 = 4 X $10 + 2 X $5 = $50•Real GDP 2007 = 2 X $10 + 1 X $5 = $25•Real GDP 2008 = 2 X $10 + 1 X $5 = $25 (base year 2007)17The GDP Deflator•The GDP deflator is a measure of the aggregate price level calculated as the ratio of nominal GDP to real GDP times 100.•It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. •The GDP deflator is calculated as follows:G D P d e f l a t o r =N o m i n a l G D PR e a l G D P1 0 0GDP deflatorYear Nominal GDP Real GDP2007 $ 25 $252008 $50 $25192007 GDP deflator = Nominal GDP 2007 / Real GDP 2007 X 100= 2008 GDP deflator=Nominal GDP 2008 / Real GDP 2008 X 100=7 $25$25´100 =1007 $50$25´100 =200Real versus Nominal GDPMiracle in Venezuela?•No, it’s just suffering from unusually high inflation. ECONOMICS IN ACTIONGDP and Well-being22Real GDP per capita is a measure of average output per person, but is not by itself an appropriate policy goal. Welfare, quality of life not included.Kennedy Speech, example of European countriesPrice Indexes and the Aggregate Price Level•The aggregate price level is a measure of the overall level of prices in the economy.•To measure the aggregate price level, economists calculate the cost of purchasing a market basket.Consumer Price IndexOther goods and services; 4%Education and communication; 6%Recreation; 5%Motor fuel; 7%Apparel; 4%Price Indexes and the Aggregate Price Level•A price index is the ratio of the current cost of that market basket to the cost in a base year, multiplied by 100.Inflation