• Microeconomics: the study of how households and firms make decisions and how they interact in markets

• Macroeconomics: the study of economy-wide phenomena including inflation, unemployment, and economic growth

• Gross domestic product (GDP): total income of a nation

23-1 The Economy’s Income and Expenditure

• GDP is the total income of everyone in the economy and the total expenditure on the economy’s output of goods and services

• Income must equal expenditure

• Households do not spend all of their income.

• Households are not always the intended customers of goods/services

23-2 The Measurement of GDP

• Gross domestic product (GDP): the market value of all final goods and services produced within a country in a given period of time

“GDP is the Market Value…”

• GDP adds market prices to compute the value of the economic activity

• Market prices measure the amount consumers are willing to spend on a product

“...of All…”

• GDP measures all the items produced and spent (legally) in the marketed

• It includes the market value of housing services provided by the stock of housing in the economy

• Rental housing value = tenants expenditure + landlord’s income

• Owned houses values are estimated

• GDP does not include illegally produced and sold products. It also does not include products made at home for home use

“...Final…”

• Intermediate good: an item used to manufacture another item

  • Ex: paper to make gift cards

• Final good: an item that is not used to manufacture another item (consumed directly)

  • Ex: gift cards

• GDP uses values of final goods because the intermediate good value is included within it

• One exception is when an intermediate good is saved (for use or later date)

“...Goods and Services…”

• GDP includes tangible goods and intangible services.

“...Produced…”

• GDP includes goods and services currently produced, not products made in the past.

• When used products are sold to each other, the value is not included in the GDP.

“...Within a Country…”

• GDP measures only domestically produced products, without regard to the nationality of the producer

“...In a Given Period of Time.”

• Quarterly GDP presents GDP at an annual rate. This also means the figure reported for quarterly GDP is the amount of income and expenditure during the quarter divided by four.

• Seasonal adjustment: a process that modifies the reported amount of quarterly GDP

23-3 The Components of GDP

• Y = C + I + G + NX

  • Y = GDP

  • C = Consumption

  • I = Investment

  • G = Government purchases

  • NX = net exports

• Identity: an equation that must be true because of how the variables in the equation are defined

Consumption

• Consumption: spending by the household on goods and services with the exception of purchases of new housing

• This includes both goods (durable & non-durable) and services.

Investment

• Investment: spending on business capital, residential capital, and inventories

• Capital goods: goods used to produce more goods and services

• Investment = business capital + residential capital + inventories

• Business capital includes business structures

  • Ex: factories, buildings, equipment, software

• Residential capital includes landlords’ apartment building and household spendings

Government Purchases

• Government Purchases: spending on goods and services by local, state, and federal governments

• A longer-term for this is government consumption expenditure and gross investment

• Salaries that are paid by the government are classified as government purchases.

• Transfer payments alter household income but aren’t made in exchange for a currently produced good or service. Therefore, they aren’t considered to be part of the GDP

Net Exports

• Net exports = domestically produced goods (exports) - domestic purchases of foreign goods (imports)

• Imports are subtracted from exports

23-4 Real versus Nominal GDP

A Numerical Example

• Nominal GDP: the production of goods and services valued at different prices

  • Real GDP: the production of goods and services valued at constant prices

The GDP Deflator

• GDP deflator = Nominal GDP/RealGDP * 100

• GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100

• Nominal GDP and real GDP are in the same base year

• The GDP deflator for the base year always equals 100

• Inflation: when the overall price level rises in an economy

• Inflation rate: 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)/GDP deflator in year 1] * 100

• Macroeconomics aims to explain the long and short fluctuations in real GDP

23-5 Is GDP a Good Measure of Economic Well-Being

• GDP is can describe the income and expenditure of the average person in the economy

• GDP per person can tell us the economic well-being of every person

• A larger GDP is correlated with a standard of living.

• GDP is not perfect, because it does not depict leisure activities. It also excludes activities unrelated to the market. Nor does it take the environmental quality into consideration, or the distribution of income.