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Chapter 2
Measurement
Copyright © 2011 Pearson Addison-Wesley.
All rights reserved.
Chapter 2 Topics
• Measuring GDP
• Nominal and real GDP and price indices
Measuring GDP: The National Income
and Product Accounts (NIPA)
• GDP Measured Using: (i) the product approach; (ii) the
expenditure approach; (iii) the income approach.
• Show how this is done using an example.
National Income Accounting Example
• Fictional Island Economy
• Coconut Producer, Restaurant, Consumers, Government
Coconut Producer
Restaurant
After-Tax Profits
After-tax profits =
Total revenue - wages - interest cost of intermediate inputs - taxes
Government
Government services: national
security, other public goods
Consumers
GDP Using the Product Approach
Coconuts: revenue(20m)
Restaurant: revenue(30m) – coconuts(12m)
Government: national security(5.5m)
Product Approach:
Sum of value added to goods and services
across all productive units in the economy
Why value added? – avoid multiple counting of
intermediate goods
GDP Using the Expenditure Approach
Consumer: coconuts(8m) + restaurant(30m)
Government: national security(5.5m)
Expenditure Approach:
Total spending on all final goods and
services production in the economy
Total Expenditure = C + I + G +NX
GDP Using the Income Approach
Income Approach:
Add up all income received by economic agents contributing to
production
Income includes compensation of employees, proprietor’s
income(self-employed), rental income, corporate profits, net interest,
indirect business taxes(sales/excise taxes paid by business),
depreciation
Gross Domestic Product for 2011
Note: Services are a big
part of GDP in the US
Nominal and Real GDP and Price
Indices
• Price Index: Weighted average of a set of observed prices
that gives a measure of the price level.
• Price indices allow us to measure the inflation rate – the
rate of change in the price level.
• A measure of the inflation rate allows us to determine
how much of an increase in GDP is nominal and how
much is real.
Data for Real GDP Example
Simple Exercise:
Nominal GDP in Year 1:
Nominal GDP in Year 2:
Data for Real GDP Example
Real GDP
Year 1
Base year 1
Base year 2
Ratio
Year 2
Data for Real GDP Example
• As we can see from the exercise, g1 = 1.354 and g2 = 1.312
• Because of changes in relative prices, the choice of base year is not
innocuous!
• Chain-weighting: gc
g1 g2
Measures of Price Level
•
•
•
•
Inflation is also different, based on base year
Let’s learn how to calculate the chain-weighted deflator
Implicit GDP Price Deflator = Nominal GDP/Real GDP * 100
Calculate chain-weighting deflators:
• Year 1:
• Year 2:
Inflation Rate Calculated from the CPI and from
the Implicit GDP Price Deflator
• CPI: Cost of base year
quantities at current
prices / Cost of base
year quantities at base
year prices * 100
• CPI includes only goods
and services that are
purchased by consumers
The Price Level as Measured by the CPI and the
Implicit GDP Price Deflator
Note: CPI increases by a
factor of 10.52 over
period, while implicit
GDP deflator increases
by a factor of 8.55
Upward Bias in CPI
1. Relative Prices change over time
- Consumers adjust consumption patterns to shifts in
relative prices
2. Changes in quality of goods over time
- Cars in 2006 are better quality than cars in 1960
3. New goods are introduced over time
- New PCs were introduced at a initially high price, but
at a huge quality advance over calculators and type
writers
 Downward measure of GDP and upward bias of
inflation
GDP, an imperfect measure
• Economic activity in the underground economy cannot
be measured directly – this activity might be measured
indirectly by accounting for the use of currency.
• Home production is not included
• Government production is difficult to measure, as the
output (for example defense services) is typically not
sold in the market.