Economics Chapter 21: Measuring GDP and Economic Growth

Measuring GDP

Definition of GDP

• GDP (Gross Domestic Product) is the market value of all final goods and services produced in a country in a given time period.
• It has four parts: market value, final goods and services, produced within a country, and in a given time period.

Market Value

• GDP is a market value, which means goods and services are valued at their market prices.
• It allows us to add the value of different goods and services, such as apples and computers, to get a total value of output.

Final Goods and Services

• Final goods and services are items bought by their final users during a specified time period.
• They are contrasted with intermediate goods and services, which are produced by one firm and used as a component by another firm.

Produced Within a Country

• GDP measures production within a country, which is also known as domestic production.
• It contrasts with national product, which includes the value of goods and services produced by a nation's residents anywhere in the world.

Time Period

• GDP measures production during a specific time period, such as a year or a quarter of a year.

GDP and the Circular Flow of Expenditure and Income

• GDP measures the value of production, which equals total expenditure on final goods and total income.
• The circular flow model shows the equality of income and expenditure.

The Circular Flow Diagram

• The circular flow diagram illustrates the equality of income and expenditure.
• It shows the transactions among households, firms, governments, and the rest of the world.

The Formula for GDP

• GDP = C + I + G + (X - M)
• Where C is consumption expenditure, I is investment, G is government expenditure, X is exports, and M is imports.

Alternative Approaches to Measuring GDP

• The expenditure approach measures GDP as the sum of consumption expenditure, investment, government expenditure, and net exports.
• The income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire.

Measuring U.S. GDP

• The Bureau of Economic Analysis uses the expenditure and income approaches to measure U.S. GDP.
• The data is collected and published in the National Income and Expenditure Accounts.

Nominal GDP and Real GDP

• Nominal GDP is the value of goods and services produced during a given year valued at the prices that prevailed in that same year.
• Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year.

Limitations of GDP

• GDP measures the market value of goods and services, but it does not account for the value of non-market activities, such as household work.

• It also does not account for the depreciation of capital.### Calculating Nominal and Real GDP

• Nominal GDP in 2009 is $100 million, which is equal to real GDP because 2009 is the base year.

• Nominal GDP in 2014 is $300 million.

• Real GDP in 2014 is calculated using the quantities of 2014 and the prices of 2009, resulting in $160 million.

The Uses and Limitations of Real GDP

• Economists use estimates of real GDP to compare the standard of living over time and across countries.
• Real GDP per person is calculated by dividing real GDP by the population, and it tells us the value of goods and services that the average person can enjoy.
• Real GDP per person is used to compare the standard of living over time, removing the influence of rising prices and cost of living.

Long-Term Trend

• Real GDP per person can be expressed as a ratio of a reference year to compare it over time.
• For example, real GDP per person in 2013 was 2.9 times its 1960 level.

The Growth of Potential GDP

• The growth of potential GDP per person is a feature of our expanding living standard.
• Potential GDP is the value of real GDP when all the economy's labor, capital, land, and entrepreneurial ability are fully employed.

Real GDP Fluctuations

• Real GDP fluctuates around potential GDP due to the business cycle.
• A business cycle has two phases: expansion and recession, and two turning points: peak and trough.
• An expansion is a period of increasing real GDP, while a recession is a period of decreasing real GDP.

The Standard of Living Across Countries

• Two problems arise when comparing living standards across countries using real GDP:
  1. Converting real GDP into the same currency units.
  2. Valuing goods and services at the same prices.

Limitations of Real GDP

• Real GDP only measures the value of goods and services bought in markets.
• Factors that influence the standard of living but are not part of GDP include:
  • Household production
  • Underground economic activity
  • Leisure time
  • Environmental quality

The Bottom Line

• Real GDP may not provide a complete picture of economic well-being and the standard of living.
• Broader measures that combine multiple influences on human happiness can be constructed.
• Despite its limitations, real GDP per person remains the most widely used indicator of economic well-being.