GDP and CPI to Track the Macroeconomy

• GDP and the CPI are used to track the macroeconomy.

What You Will Learn

• Economists use aggregate measures to track the performance of the economy.
• Gross Domestic Product (GDP) definition and calculation.
• Real versus nominal GDP and why real GDP is the better measure of economic activity.
• How price indexes are used to calculate the inflation rate.

How To Measure An Economy

• Gross Domestic Product (GDP) is the most important and common way to estimate a country's economy size.
• Can compare the sizes of two economies when they produce different things by comparing the value of their production.

The National Accounts

• The national income and product accounts (NIPA) measure national economic performance.
• NIPA is used to compare American income and output with that of other nations.
• NIPA tracks the economy's condition throughout the business cycle.

What is GDP?

• Gross Domestic Product (GDP): the market value of all final goods and services produced within a country in a year.
• GDP measures production; sale of used goods are excluded.
• The sale of financial assets, such as stocks and bonds, are excluded.
• Only production within the borders of a country is included in GDP.
• Cars produced in Mexico by American firms are excluded in the U.S. GDP.
• Cars produced in the United States by Japanese firms are included in the U.S. GDP.
• GDP measures a rate of production during a given period like annual income.

Calculating GDP

• GDP can be calculated in three ways: the total value added of all production units, total spending on domestically produced final goods and services, and total factor income earned by households from firms in the economy.
• Value added of a producer is the value of its sales minus the value of its purchases of intermediate goods and services.
• Consumer spending (C) is household spending on goods and services.
• Government purchases of goods and services (G) are total expenditures by federal, state, and local governments.
• Investment spending (I) is spending on productive physical capital and changes to inventories.
• Exports (X) are goods and services sold to other countries.
• Imports (IM) are goods and services purchased from other countries.
• The equation is GDP = C + I + G + X - IM.
• Add up the total factor income earned by households from firms in the economy as Wage + Interest + Rent + Profit.
• One person's spending is another's income, so total spending = total income.

Real GDP: A Measure of Aggregate Output

• We need to be able track the quantity of total output over time.
• Real GDP: the total value of the final goods and services produced during a given year using the prices of a selected base year
• Nominal GDP: the value of all final goods and services produced during a given year using the prices current in the year the output is produced.
• Except in the base year, real GDP is not the same as nominal GDP.
• Real GDP per capita: average Real GDP per person.

Real-Life GDP

• Real GDP is expressed in base year dollars.

Price Indexes and the Aggregate Price Level

• Aggregate price level: a measure of the overall level of prices in the economy.
• Market basket: a hypothetical set of consumer purchases of goods and services used to measure the aggregate price level.
• Price index is the cost of purchasing a given market basket in a given year, normalized to 100 in the selected base year.

Price index in a given year = (Cost of market basket in a given year / Cost of market basket in base year) * 100

• The CPI measures the cost of the market basket of a typical urban American family.

Inflation rate in year 2= (Price index in year 2–Price index in year 1 / Price index in year1) * 100

Other Price Measures

• Producer price index (PPI) is similar to the CPI; it measures changes in the prices of goods purchased by producers.
• The GDP deflator measures the price level by calculating the ratio of nominal to real GDP. The GDP deflator for a given year is 100 times the ratio of nominal GDP to real GDP in that year.