Measuring a Nation s Income 2 27 12 5 32 PM Gross Domestic Product GDP is the market value of all final goods and services produced within a country in a given period of time Market Value of All o markets o market prices measure the amount people are willing to pay for different goods they reflect the value of those goods includes all items produced in the economy and sold legally in o includes housing services provided by the economy s stock of housing excludes most items produced and sold illicitly such as illegal drugs o excludes most items that are produced and consumed at home and therefore never enter the marketplace EX vegetables grown in your garden Final o does not include the value of intermediate goods because that value is already included in the prices of final goods o does include additions to inventory intermediate good is taken to be final for the moment additions to inventory add to GDP reductions in inventory subtract from GDP Goods and Services o GDP includes both tangible goods food clothing cars and intangible services haircuts housecleaning doctor visits Produced includes goods and services currently produced o o excludes transactions involving items produced in the past EX a used car resold Within a Country o within the geographic confines of a country o items are included in a nation s GDP if they are produced domestically regardless of the nationality of the producer In a Given Period of Time o usually that interval is a year or a quarter 3 months The Components of GDP GDP Y Consumption C Investment I Government Purchases G Net Exports NX Y C I G NX Identity an equation that must be true because of how the variables in the equation are defined No matter what because of inventory investment the firm purchases the inventory for themselves Consumption spending by households on goods and services with the exception of purchases of new housing Durable goods automobiles and appliances Nondurable goods food and clothing Services haircuts and medical care Largest spending in economy 70 Investment the purchase of goods that will be used in the future to produce more goods and services capital equipment inventories and structures Includes expenditure on new housing Government Purchases include spending on goods and services by local state and federal governments Army General part of government purchases Social Security Benefit transfer payment not counted as government purchased Net Exports equal the foreign purchases of domestically produced goods exports minus the domestic purchases of foreign goods imports Imports are subtracted from exports Real vs Nominal GDP Nominal GDP the production of goods and services valued at current prices When calculating you value the good at current price Price in 2006 X Quantity in 2006 Real GDP the production of goods and services valued at constant prices Use price in base year and quantity in year being observed Price of 2004 X Quantity in 2006 In base year Real GDP Nominal GDP GDP Deflator a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 measures inflation GDP Deflator Nominal GDP X 100 Real GDP Inflation describes the situation in which the economy s overall price is rising Inflation Rate the percentage change in some measure of the price level from one period to the next Inflation rate in year 2 GDP deflator in year 2 GDP deflator in year 1 X 100 GDP deflator in year 1 Recessions are associated not only with lower incomes but also with other forms of economic distress rising unemployment falling profits increase bankruptcy and so on Summary Because every transaction has a buyer and a seller the total expenditure in the economy must equal the total income in the economy Gross domestic product GDP measures an economy s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services More precisely GDP is the market value of all final goods and services produced within a country in a given period of time GDP is divided among four components of expenditure consumption investment government purchases and net exports Consumption includes spending goods and services by households with the exception of purchases of new housing Investment includes spending on new equipment and structures including households purchases of new housing Government purchases include spending on goods and services produced domestically and sold abroad exports minus the value of goods and services produced abroad and sold domestically imports Nominal GDP uses current prices to value the economy s production of goods and services Real GDP uses constant base year prices to value the economy s production of goods and services The GDP deflator calculated from the ratio of nominal to real GDP measures the level of prices in the economy GDP is a good measure of economic well being because people prefer higher to lower incomes But it is not a perfect measure of well being For example GDP excludes the value of leisure and the value of a clean environment Measuring the Cost of Living Consumer Price Index CPI a measure of the overall cost of the goods and services bought by a typical consumer How It Is Calculated 1 Fix the basket consumer 2 Find the prices each point in time 3 Compute the basket s cost find the basket of goods and services bought by the typical find the prices of each of the goods and services in the basket at use the data on prices to calculate the cost of the basket of goods and services at different times 4 Choose a base year and compute the index Consumer price index Price of basket of goods and services in current year X 100 Price of basket in base year The price of the basket of goods and services in each year is divided by the price of the basket in the base year and this ratio is the multiplied by 100 The resulting number is the CPI 5 Compute the inflation rate Inflation rate in year 2 CPI in year 2 CPI in year 1 X 100 CPI in year 1 Producer price index a measure of the cost of basket of goods and services bought by firms Problems in Measuring Cost of Living Substitution Bias when prices change from one year to the next they do not all change proportionately some prices raise more than others well being Introduction of New Goods when a new good is introduced consumers have more variety form which to choose and this in turn reduces the cost of maintaining the same level of economic Unmeasured Quality Change if the quality of a good