Chapter 7 Key Points Gross domestic product GDP is a measure of the market value of final goods and services produced within the borders of a country during a specific time period usually a year Income transfers purely financial transactions and exchanges of goods and assets produced during earlier periods are not included in GDP because they do not involve current production When derived by the expenditure approach GDP has four major components 1 Personal Consumption 2 Gross private investment 3 Government consumption and ross investment 4 Net exports When derived by the resource cost income approach GDP equals 1 The direct income components wages and salaries self employment income rents interest and corporate profits 2 Indirect business taxes depreciation and the net income of foreigners Price indexes measure changes in the general level of prices over time They can be used to adjust nominal values for the effects of inflation The two most widely used price indexes are the GDP deflator and the consumer price index CPI The rate of inflation is the percentage change in the general level of prices from one year to the next It is equal to PI2 minus PI1 divided by PI1 multiplied by 100 The inflation rate can be estimated with either the consumer price index or the GDP deflator and the two alternatives generally yield similar estimates The following formula can be used to convert the nominal GDP data of the current period 2 to the real GDP measured in terms of the general level of prices of an earlier period 1 Real GDP2 Nominal GDP 2 x GDP Deflator1 GDP Deflator2 Even real GDP is an imperfect measure of current production It excludes household production and the underground economy fails to take leisure and human costs into account and adjusts imperfectly for quality changes Real GDP is vitally important because it is a reasonably accurate measure of how well the economy is doing compared to the recent past Per capita GDP is a broad indicator of income levels and living standards across time periods Key Terms Intermediate Goods or service user Goods purchased for resale or for use in producing another good Final Market Goods and Services Goods and services purchased by their ultimate Personal Consumption the current period Consumption is a flow concept Household spending on consumer goods and services during Private Investment investment plus the addition to inventories inventory investment during a period These expenditures enhance our ability to provide consumer benefits in the future The flow of private sector expenditures on durable assets fixed Depreciation buildings that is worn out or used up producing goods during a period The estimated amount of physical capital for example machines and Changes in the stock of unsold goods and raw materials held Inventory Investment during a period Net Exports Exports minus imports Exports Goods and services produced domestically but sold to foreigners Goods and services produced by foreigners but purchased by domestic Imports consumers businesses and governments Indirect Business Tax therefore the prices charged to consumers Examples are sales excise and property taxes taxes hat increase a business firm s cost of production and National Income The total income earned by a country s nationals citizens during a period It is the sum of employee compensation self employment income rents interest and corporate profits Gross National Product GNP produced by the citizens of a country It is equal to the GDP minus the net income of foreigners The total market value of all final goods and services Net Income of Foreigners The income that foreigners earn by contributing labor and capital resources to the production of goods within the borders of a country minus the income the nationals of the country earn abroad Nominal Values Values expressed in current dollars Real Values Values that have been adjusted for the effects of inflation Consumer Price Index CPI compare the cost of purchasing he market basket bought by atypical consumer during a specific period with the cost of purchasing the same market basket during an earlier period A indicator of the general level of prices It attempts to GDP Deflator A price index that reveals the cost during the current period of purchasing the items included in GDP relative to the cost during a base year currently 2005 Unlike the consumer price index CPI the GDP deflator also measures the prices of capital goods and other goods and services purchased by business and governments Because of this it is thought to be more accurate measure of changes in the general level of prices than the CPI Inflation An increase in the general level of prices of goods and services The purchasing power of the monetary unit such as the dollar declines with inflation present Nominal GDP GDP expressed at current prices It is often called money GDP Real GDP GDP adjusted for the changes in the price level Underground Economy outside recorded market channels Some are otherwise legal activities undertaken to evade taxes Others involve illegal activities such as trafficking drugs and prostitution Unreported barter and cash transactions that take place Chapter 16 Key Points The economic growth of the past two centuries has been unprecedented While the per person income of the world increased by only about 50 percent during the 800 years from 1000 to 1800 it has increased by tenfold during the past 200 years The growth of per person income in the west since 1800 has been even more impressive Economic growth increases the production possibilities of an economy The growth of per capita real GDP means more goods and services per person which typically lads to higher living standards and improvements in life expectancy literacy and health Even seemingly small differences in growth rates sustained over two or three decades will substantially alter relative incomes For example if Country A and Country B have the same initial income but the growth rate of A is 2 percentage points greater than that of B after 35 years the income level of Country A will be twice that of B Economic growth is a complex process Economists stress the importance of three major sources of economic progress 1 Gains from trade and expansion in the size of the market 2 Discover of new technologies and innovative applications 3 Investment in physical and human capital The institutional and policy environment exerts a major impact on growth and income The following institutions
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