Download GDP and the Standard of Living

MONITORING THE MACROECONOMY
GDP and the
Standard of Living
CHAPTER
PART
CHAPTER
2
5
CHECKLIST
When you have completed your study of this chapter,
you will be able to
1
Define GDP and explain why the value of production, income, and
expenditure are the same for an economy.
2
Describe how economic statisticians measure GDP in the United
States.
3
Distinguish between nominal GDP and real GDP and define the GDP
deflator.
4
Explain and describe the limitations of real GDP as a measure of the
standard of living.
You’ve seen that equilibrium quantities and
prices in the markets for goods, services, and
factors of production determine what, how, and
for whom goods and services are produced.
What and for whom goods and services are
produced influence the standard of living, a central concern of macroeconomics.
A focus on the standard of living directs our
attention to the value of total production rather than the
production of each individual good or service.You will discover that several different factors contribute to the standard of living, but one indicator dominates the others. It is
called gross domestic product, or GDP. In this chapter, you
will find out how economic statisticians measure GDP. You
will also learn about other indicators of the standard of living as well as the scope and limitations of GDP as a measure
of the standard of living.
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Part 2 • MONITORING THE MACROECONOMY
5.1 GDP, INCOME, AND EXPENDITURE
How does your standard of living compare with that of your parents when they
were your age? Who is better off: you or a college student in Beijing, China?
We defined the standard of living in Chapter 1 (p. 4) as the level of consumption of goods and services that people enjoy, on the average, measured by average
income per person. So to answer the questions we’ve just posed, you might try to
discover who has the higher income: you today or your parents in the 1970s, and
you or a college student in China.
But it is the quantities of goods and services consumed that determine how
well off people are. To consume goods and services, they must be produced. So
another way to answer the questions posed is to discover who produces the
greater total value of goods and services. Do we produce more per person today
than our parents’ generation did in the 1970s, and do we produce more per person than the people of China produce? To answer these questions, we need to
measure total production.
GDP Defined
Gross domestic product
(GDP)
The market value of all the final goods
and services produced within a
country in a given time period.
We measure total production as gross domestic product, or GDP, which is the
market value of all the final goods and services produced within a country in a
given time period. This definition has four parts that we’ll examine in turn.
Value Produced
To measure total production, we must add together the production of apples and
oranges, computers and popcorn. Just counting the items doesn’t get us very far.
Which is the greater total production: 100 apples and 50 oranges or 50 apples and
100 oranges?
GDP answers this question by valuing items at their market value—at the
prices at which each item is traded in markets. If the price of an apple is 10 cents
and the price of an orange is 20 cents, the market value of 100 apples plus 50
oranges is $20 and the market value of 50 apples and 100 oranges is $25. So by
using market prices to value production, we can add the apples and oranges
together.
What Produced
Final good or service
A good or service that is produced
for its final user and not as a
component of another good or
service.
Intermediate good or service
A good or service that is produced by
one firm, bought by another firm, and
used as a component of a final good
or service.
To calculate GDP, we value all the final goods and services. A final good or service
is a good or service that is produced for its final user and not as a component of
another good or service. It contrasts with an intermediate good or service, which
is a good or service that is produced by one firm, bought by another firm, and
used as a component of a final good or service. For example, a Ford SUV is a final
good, but a Firestone tire on the SUV is an intermediate good.
GDP aims to be a full count of the value of everything that is produced. In
practice, with one exception, GDP includes only those items that are traded in
markets. It does not include the market value of goods and services that people
produce for their own use. For example, GDP includes the value of a car wash that
is bought but excludes the value of washing your own car. The exception is the
market value of homes that people own. GDP puts a rental value on such homes
and pretends that their owners rent them to themselves.
Chapter 5 • GDP and the Standard of Living
113
Where Produced
Only goods and services that are produced within a country count as part of that
country’s GDP. Nike Corporation, a U.S. firm, produces sneakers in Vietnam, and
the market value of those shoes is part of Vietnam’s GDP, not part of U.S. GDP.
Toyota, a Japanese firm, produces automobiles in Georgetown, Kentucky, and the
value of this production is part of U.S. GDP, not part of Japan’s GDP.
When Produced
GDP measures the value of production during a given time period. This time period
is either a quarter of a year—called the quarterly GDP data—or a year—called the
annual GDP data. The Federal Reserve and others use the quarterly GDP data to
keep track of the short-term evolution of the economy, and economists use the
annual GDP data to examine long-term trends.
GDP measures not only the value of total production but also total income
and total expenditure. The circular flow model that you studied in Chapter 2
explains why.
Circular Flows in the U.S. Economy
Four groups buy the final goods and services produced: households, firms, governments, and the rest of the world. Four types of expenditure correspond to these
groups:
•
•
•
•
Consumption expenditure
Investment
Government purchases of goods and services
Net exports of goods and services
Consumption Expenditure
Consumption expenditure is the expenditure by households on consumption
goods and services. It includes expenditures on popcorn and soda, candy and
chocolate bars, and dental and dry cleaning services. Consumption expenditure
also includes house and apartment rents, including the rental value of owneroccupied housing.
Consumption expenditure
The expenditure by households on
consumption goods and services.
Investment
Investment is the purchase of new capital goods (tools, instruments, machines,
buildings, and other constructions) and additions to inventories. Some firms produce capital goods, and other firms buy them. For example, IBM produces PCs
and General Motors buys some of them; Boeing produces airplanes and United
Airlines buys some of them.
Some of a firm’s output might remain unsold at the end of a year. For example, if GM produces 4 million cars and sells 3.9 million of them, the other 0.1 million (100,000) cars remain unsold. In this case, GM’s inventory of cars increases by
100,000. When a firm adds unsold output to inventory, we count those items as
part of investment.
It is important to note that investment does not include the purchase of stocks
and bonds. In macroeconomics, we reserve the term “investment” for the purchase of new capital goods and the additions to inventories.
Investment
The purchase of new capital goods
(tools, instruments, machines,
buildings, and other constructions)
and additions to inventories.
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Part 2 • MONITORING THE MACROECONOMY
Government Purchases of Goods and Services
Government purchases of
goods and services
The purchases by all levels of
government on goods and services.
Government purchases of goods and services are purchases by all levels of government of goods and services from firms. You saw in Chapter 2 (pp. 44–47) that
governments buy a wide range of goods and services. For example, the U.S.
Defense Department buys missiles and other weapons systems, the State
Department buys travel services, the White House buys Internet services, and
state and local governments buy cruisers for law-enforcement officers.
Net Exports of Goods and Services
Net exports of goods and
services
The value of exports of goods and
services minus the value of imports of
goods and services.
Exports of goods and services
Items that firms in the United States
produce and sell to the rest of the
world.
Imports of goods and services
Items that households, firms, and
governments in the United States buy
from the rest of the world.
Net exports of goods and services is the value of exports of goods and services
minus the value of imports of goods and services. Exports of goods and services
are items that firms in the United States produce and sell to the rest of the world.
Imports of goods and services are items that households, firms, and governments
in the United States buy from the rest of the world. Imports are produced in other
countries, so expenditure on imports is not included in expenditure on U.S-produced
goods and services. If exports exceed imports, net exports are positive and increase
expenditure on U.S.-produced goods and services. If imports exceed exports, net
exports are negative and decrease expenditure on U.S.-produced goods and services.
Total Expenditure
Total expenditure on goods and services produced in the United States is the sum
of the four items that you’ve just examined. We call consumption expenditure C,
investment I, government purchases of goods and services G, and net exports of
goods and services NX. Using these symbols, total expenditure is
Total expenditure = C + I + G + NX.
Total expenditure is the total amount received by producers of final goods and
services.
Income
Labor earns wages, capital earns interest, land earns rent, and entrepreneurship
earns profits. Households receive these incomes. Some part of total income, called
undistributed profit, is a combination of interest and profit that is not paid out to
households. But from an economic viewpoint, undistributed profit is income paid
to households and then loaned to firms.
Expenditure Equals Income
Figure 5.1 shows the circular flows of income and expenditure that we’ve just
described. The figure is based on Figures 2.4 and 2.5 (on p. 43 and p. 45), but it
includes some more details and additional flows.
We call total income Y and show it by the blue flow from firms to households.
When households receive their incomes, they pay some in taxes and save some.
Some households receive benefits from governments. Net taxes equal taxes paid
minus benefits received and are the green flow from households to governments
labeled NT. Saving flows from households to financial markets and is the green flow
labeled S. These two green flows are not expenditures on goods and services. They
are just flows of money.
The red flows show the four expenditure flows described above: consumption
expenditure from households to firms, government purchases from governments
Chapter 5 • GDP and the Standard of Living
115
to firms, and net exports from the rest of the world to firms. Investment flows from
the financial markets, where firms borrow, to the firms that produce capital goods.
Because firms pay out everything they receive as incomes to the factors of production, total expenditure equals total income. That is,
Y = C + I + G + NX.
From the viewpoint of firms, the value of production is the cost of production,
which equals income. From the viewpoint of purchasers of goods and services, the
value of production is the cost of buying it, which equals expenditure. So
The value of production equals income equals expenditure.
The circular flow and the equality of income and expenditure provide two
approaches to measuring GDP that we’ll study in the next section.
FIGURE 5.1
Practice Online
The Circular Flow of Income and Expenditure
HOUSEHOLDS
S
FINANCIAL
MARKETS
C
Y
I
NT
NX
G
FACTOR
MARKETS
REST
GOODS
MARKETS
GOVERNMENTS
OF
WORLD
Data in 2002
G
$ billions
C
I
Y
NX
FIRMS
In the circular flow, the blue flow (Y) is income and the red flows
(C, I, G, and NX) are expenditures on goods and services.The green
flows are flows of money: Households pay net taxes (NT) to
C
I
G
NX
Y
7,255
1,588
1,960
–426
10,377
governments and save (S) some of their income. Firms borrow in
financial markets to buy goods (I) from other firms. Expenditure
equals income and equals the value of production.
C H E C K P O I N T
Study Guide pp. 70–72
1
Practice Online 5.1
5.1
Define GDP and explain why the value of production, income, and
expenditure are the same for an economy.
Practice Problems 5.1
1.
Classify each of the following items as a final good or service or an intermediate good or service:
a. Banking services bought by a student.
b. New cars bought by Hertz, the car rental firm.
c. Newsprint bought by USA Today from International Paper.
d. Ice cream bought by a diner and used to produce sundaes.
2.
During 2001 on Lotus Island, net taxes were $10 billion; consumption expenditure was $30 billion; government purchases of goods and services were $12
billion; investment was $15 billion; and net exports were $3 billion. Calculate
a. Total expenditure.
b. Total income.
c. GDP.
Exercises 5.1
1.
Classify each of the following items as a final good or service or an intermediate good or service:
a. The fertilizer bought by a Florida tomato grower.
b. The Wall Street Journal you bought today.
c. The PlayStation 2 that you bought on eBay.
d. The aircraft fuel bought by United Airlines.
2.
During 2002 on Lotus Island, households spent $60 million of their income
on goods and services, saved $20 million, and paid the rest of their income
in net taxes; government purchases of goods and services were $15 million;
investment was $25 million; and net exports were zero. Calculate
a. GDP.
b. Total income.
c. Total expenditure.
d. Net taxes.
Solutions to Practice Problems 5.1
1a. A final service—The student is the final user.
1b. Final goods—The new cars that Hertz buys are additions to its capital and
as such they are investment.
1c. An intermediate good—Newsprint is a component of the newspaper.
1d. An intermediate good—Ice cream is a component of sundaes.
2a. Total expenditure is $60 billion. Total expenditure = C + I + G + NX.
Inserting the values into the equation, we have:
Total expenditure = $(30 + 15 +12 + 3) billion = $60 billion.
2b. Total income = total expenditure = $60 billion.
2c. GDP = total expenditure = $60 billion.
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Chapter 5 • GDP and the Standard of Living
117
5.2 MEASURING U.S. GDP
U.S. GDP is the market value of all the final goods and services produced within
the United States during a year. In 2002, U.S. GDP almost reached the $10.4 trillion mark. The Bureau of Economic Analysis in the U.S. Department of Commerce
measures GDP. To do so, it uses two approaches:
• Expenditure approach
• Income approach
The Expenditure Approach
The expenditure approach measures GDP by using data on consumption expenditure, investment, government purchases, and net exports. This approach is like
attaching a meter to the circular flow diagram on all the flows running through
the markets for goods and services to firms and measuring the magnitudes of
those flows. Table 5.1 shows this approach. The first column gives the terms used
in the National Income and Product Accounts of the United States. The next column gives the symbol we used in the previous section.
Using the expenditure approach, GDP is the sum of consumption expenditure
on goods and services (C), investment (I), government purchases of goods and
services (G), and net exports of goods and services (NX). The third column gives
the expenditures in mid-2002. GDP measured by the expenditure approach was
$10,377 billion (annual rate) in the second quarter of 2002.
Net exports were negative in 2002 because imports exceeded exports.
Imports were $1,444 billion and exports were $1,018 billion, so net exports—
exports minus imports—were –$426 billion as shown in the table.
The fourth column in Table 5.1 shows the relative magnitudes of the expenditures. Consumption expenditure makes up more than half of total expenditure;
investment and government purchases are about the same percentage of total
expenditure; and net exports is the smallest. In 2002, consumption expenditure
was 69.9 percent, investment was 15.3 percent, government purchases were about
18.9 percent each, and net exports were a negative 4.1 percent of GDP.
TABLE 5.1
Practice Online
GDP:The Expenditure Approach
Amount in 2002
Percentage
of GDP
Item
Symbol
(billions of
dollars)
Consumption expenditure
Investment
Government purchases
Net exports
C
I
G
NX
7,255
1,588
1,960
−426
69.9
15.3
18.9
−4.1
Y
10,377
100.0
GDP
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis.
The expenditure approach measures
GDP by adding together consumption
expenditure (C), investment (I), government purchases (G), and net
exports (NX). In 2002, GDP measured
by the expenditure approach was
$10,377 billion.
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Part 2 • MONITORING THE MACROECONOMY
Expenditures Not in GDP
Total expenditure (and GDP) does not include all the things that people and businesses buy. GDP is the value of final goods and services, so spending that is not on
final goods and services is not part of GDP. Spending on intermediate goods and
services is not part of GDP, although it is not always obvious whether an item is
an intermediate good or a final good; see Eye on the U.S. Economy. Also, we do
not count as part of GDP spending on
• Used goods
• Financial assets
Used Goods
Expenditure on used goods is not part of GDP because these goods were part of
GDP in the period in which they were produced and during which time they were
new goods. For example, a 1999 automobile was part of GDP in 1999. If the car is
traded on the used car market in 2002, the amount paid for the car is not part of
GDP in 2002.
Financial Assets
When households buy financial assets such as bonds and stocks, they are making
loans, not buying goods and services. The expenditure on newly produced capital goods is part of GDP, but the purchase of financial assets is not.
Eye on the
U.S.
Economy
Is a Computer Program
an Intermediate Good
or a Final Good?
When American Airlines buys a new
reservations software package, is that
like General Motors buying tires? If it is,
then software is an intermediate good and
it is not counted as part of GDP. Airline
ticket sales, like GM cars, are part of
GDP, but the intermediate goods that
are used to produce air transportation
or cars are not part of GDP.
Or when American Airlines buys
new software, is that like General
Motors buying a new assembly-line
robot? If it is, then the software is a
capital good and its purchase is the
purchase of a final good. In this case,
the software purchase is an investment
and it is counted as part of GDP.
Brent Moulton is a government
economist who works in the Bureau
of Economic Analysis (BEA). Moulton’s
recent job was to oversee a periodic
adjustment to the GDP estimates to
incorporate new data and new ideas
about the economy.
The biggest change was in how the
purchase of computer software by
firms is classified. Before 1999, it was
regarded as an intermediate good. But
since 1999, it has been treated as an
investment.
How big a deal is this? When GDP
in 1996 was recalculated, the change
increased the estimate of the 1996
GDP by $115 billion.That is a lot of
money.To put it in perspective, GDP
in 1996 was $7,662 billion. So the
adjustment was 1.5 percent of GDP.
This change is a nice example of the
ongoing effort by the BEA to keep the
GDP measure as accurate as possible.
Chapter 5 • GDP and the Standard of Living
The Income Approach
The Bureau of Economic Analysis measures GDP using the income approach by
collecting data (from the Internal Revenue Service and other sources) on the
incomes that firms pay households for the services of factors of production they
hire—wages for labor, interest for the use of capital, rent for the use of land, and
profits for entrepreneurship—and summing those incomes. This approach is like
attaching a meter to the circular flow diagram on all the flows of factor incomes
from firms to households and measuring the magnitudes of those flows. Let’s see
how the income approach works.
The National Income and Product Accounts divide incomes into five categories:
•
•
•
•
•
Compensation of employees
Net interest
Rental income of persons
Corporate profits
Proprietors’ income
Compensation of Employees
Compensation of employees is the payment for labor services. It includes net
wages and salaries plus fringe benefits paid by employers such as health care
insurance, social security contributions, and pension fund contributions.
Net Interest
Net interest is the interest households receive on loans they make minus the interest households pay on their own borrowing.
Rental Income of Persons
Rental income of persons is the payment for the use of land and other rented
inputs. It includes payments for rented housing and imputed rent for owneroccupied housing. (Imputed rent is an estimate of what homeowners would pay
to rent the housing they own and use themselves. By including this item in the
national income accounts, we measure the total value of housing services,
whether they are owned or rented.)
Corporate Profits
Corporate profits—the profits of corporations—are a combination of interest on
capital and profit for entrepreneurship. Corporate profits paid out as dividends
and undistributed profits are all counted as income.
Proprietors’ Income
Proprietors are people who run their own businesses. Their income is a mixture
of the previous four items. It is difficult to split the income earned by the owneroperator of a business into compensation for labor, payment for the use of capital, and profit, so the national income accounts lump all these items into a single
category.
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Part 2 • MONITORING THE MACROECONOMY
TABLE 5.2
Practice Online
GDP:The Income Approach
The sum of all incomes equals net
domestic product at factor cost. GDP
equals net domestic product at factor
cost plus indirect taxes less subsidies
plus capital consumption (depreciation). In 2002, GDP measured by the
income approach was $10,377 billion.
The compensation of employees—
labor income—was by far the largest
part of aggregate income.
Amount in 2002
Item
Compensation of employees
Net interest
Rental income of persons
Corporate profits
Proprietors’ income
Net domestic product at factor cost
Indirect taxes less subsidies
Capital consumption
GDP
(billions of
dollars)
5,964
678
153
785
747
8,327
660
1,390
10,377
Percentage
of GDP
57.5
6.5
1.5
7.6
7.2
80.3
6.4
13.3
100.0
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis.
Net domestic product
at factor cost
The sum of the five components
of incomes—compensation of
employees, net interest, rental income
of persons, corporate profits, and
proprietors’ income.
Table 5.2 shows these five components of incomes and their relative magnitudes. These five components of incomes sum to net domestic product at factor
cost. Net domestic product at factor cost is not GDP. We must make two further
adjustments to get to GDP: one from factor cost to market prices and another from
net product to gross product.
From Factor Cost to Market Price
The expenditure approach values goods and services at market prices, and the
income approach values them at factor cost—the cost of the factors of production
used to produce them. Indirect taxes (such as sales taxes) and subsidies (payments
by government to firms) make these two values differ. Sales taxes make market
prices exceed factor cost, and subsidies make factor cost exceed market prices. To
convert the value at factor cost to the value at market prices, we must add indirect
taxes and subtract subsidies.
From Gross to Net
Depreciation
The decrease in the value of capital
that results from its use and from
obsolescence—also called capital
consumption.
The expenditure approach measures gross product, and the income approach
measures net product. The difference is depreciation, the decrease in the value of
capital that results from its use and from obsolescence—also called capital consumption. A firm’s profit before subtracting the depreciation of capital is its gross
profit. And its profit after subtracting the depreciation of capital is its net profit.
Income includes net profit, so the income approach gives a net measure.
Expenditure includes investment, which is the purchase of new capital. Because
some new capital is purchased to replace depreciated capital, the expenditure
approach gives a gross measure. So to get gross domestic product from the income
approach, we must add depreciation to total income.
Table 5.2 summarizes these adjustments and shows that the income approach
gives the same estimate of GDP as the expenditure approach.
Chapter 5 • GDP and the Standard of Living
121
Valuing the Output of Industries
The methods that are used to measure GDP can be used to measure the contribution that each industry makes to GDP. To measure the value of production of an
industry, we count only the value added by that industry. Value added is the
value of a firm’s production minus the value of the intermediate goods it buys
from other firms. Equivalently, a firm’s value added equals the sum of the
incomes (including profits) that the firm paid for the factors of production it used.
Figure 5.2 illustrates value added by looking at the brief life of a loaf of bread.
It starts with the farmer, who hires factors of production and grows wheat. We’ll
assume that the farmer uses no intermediate goods. The miller buys the wheat (for
a loaf) from the farmer for 20¢. The value of the farmer’s production is 20¢, and
the farmer’s value added is 20¢. The farmer’s value added equals the incomes that
the farmer paid for the factors of production plus the farmer’s profit.
The miller hires factors of production to turn the wheat into flour. The baker
buys the flour from the miller for 70¢. The miller’s value added is 50¢—the value
of the flour (70¢) minus the cost of the intermediate good (20¢ for wheat). The
miller’s value added equals the incomes that the miller paid for the factors of production plus the miller’s profit.
The baker adds a further 80¢ of value by turning the flour into bread. The consumer buys the bread for its market price, $1.50. The market price equals the value
added by the farmer (20¢), the miller (50¢), and the baker (80¢).
To value output, we count only value added because the total of the values
added at all stages of production equals expenditure on the final good. By totaling values added, we avoid double counting. In Figure 5.2, the only final good is
a loaf of bread. The red bar shows the value of the final good. The blue bars show
the value added at each stage, and the sum of the blue bars equals the red bar. The
transactions involving intermediate goods, shown by the green bars, are not part
of value added and are not counted as part of the value of output or of GDP.
FIGURE 5.2
Value added
The value of a firm’s production
minus the value of the intermediate
goods it buys from other firms.
Practice Online
Value Added and Final Expenditure
Value added
Intermediate goods
Final expenditure
Farmer 20¢
20¢
Miller
Baker
50¢
70¢
80¢
Consumer
$1.50
0
0.50
1.00
1.50
(dollars)
Value added is the value of a firm’s
production minus the value of the
intermediate goods it buys from
other firms.The baker’s value added
is the consumer’s expenditure on
bread minus the baker’s intermediate
expenditure on flour.The baker’s
value added equals the incomes paid,
including profit, for the factors of
production hired by the baker.The
value of the bread (the final good) is
equal to the sum of all values added.
C H E C K P O I N T
Study Guide pp. 73–75
2
Practice Online 5.2
5.2
Describe how economic statisticians measure GDP in the
United States.
Practice Problem 5.2
TABLE 1
Item
Compensation of employees
Consumption expenditure
Indirect taxes less subsidies
Net interest
Corporate profits
Capital consumption
Rental income of persons
Investment
Net exports
Proprietors’ income
Amount
(billions
of dollars)
5,875
6,987
630
650
732
1,329
138
1,586
–349
728
Table 1 shows some of the items in the U.S. National Income and Product
Accounts in 2001.
a. Calculate U.S. GDP in 2001.
b. Did you use the expenditure approach or the income approach to make this
calculation?
c. How much did the U.S. government spend on goods and services in 2001?
d. By how much did capital in the United States depreciate in 2001?
Exercises 5.2
1.
Table 2 shows some of the items in the U.S. National Income and Product
Accounts in 1997.
a. Use the expenditure approach to calculate U.S. GDP in 1997.
b. Use the income approach to calculate U.S. net domestic product at factor
cost in 1997.
c. Calculate GDP minus net domestic product at factor cost in 1997.
d. Calculate indirect taxes less subsidies in 1997.
2.
At the American Diner, the price of a mango smoothie is $3.00. The diner
buys the mango for 50¢, skim milk for 20¢, and flavoring for 1¢ from other
firms and pays 25¢ for the labor and capital. Calculate the value added by
the American Diner when it produces a mango smoothie.
TABLE 2
Item
Consumption expenditure
Government purchases
Net interest
Corporate profits
Rental income of persons
Investment
Net exports
Compensation of employees
Proprietors’ income
Capital consumption
Amount
(billions
of dollars)
5,529
1,488
424
834
128
1,391
–89
4,651
581
1,013
Solution to Practice Problem 5.2
a.
GDP = C + I + G + NX (the expenditure approach) and GDP =
Compensation of employees + Net interest + Rental income of persons +
Corporate profits + Proprietors’ incomes + Indirect taxes less subsidies +
Capital consumption (the income approach). Inspect the data and notice that
Government purchases (G) is missing. So you can’t use the expenditure
approach. But you can use the income approach. Insert the items in the
equation and get
GDP in billions = $5,875 + $650 + $138 + $732 + $728 + $630 + $1,329
= $10,082 billions.
b. You totaled the incomes for factors of production, so you used the income
approach.
c. Use the expenditure approach to calculate G:
GDP = C + I + G + NX.
Insert the numbers that you know into this equation:
GDP in billions = $10,082 = $6,987 + $1,586 + G − $349.
G = $10,082 billion − $8,224 billion = $1,858 billion.
d. Depreciation equals capital consumption, which in 2001 was $1,329 billion.
122
123
Chapter 5 • GDP and the Standard of Living
5.3 NOMINAL GDP VERSUS REAL GDP
You’ve seen that GDP measures total expenditure on final goods and services in a
given period. In 2001, GDP was $10,082 billion. In 2002, GDP was $10,377 billion.
Because GDP in 2002 was greater than in 2001, we know that one or two things
must have happened during that period:
• We produced more goods and services.
• We paid higher prices for our goods and services.
Producing more goods and services contributes to an improvement in our
standard of living. Paying higher prices means that our cost of living has
increased but our standard of living has not. So it matters a great deal why GDP
has increased.
You’re going to learn how economists at the Bureau of Economic Analysis
split the increase in GDP into two parts: one part that tells us the change in production and another that tells us the change in prices. The method they use has
changed in recent years, and we will describe the new method.
We measure the increase in production by a number called real GDP. Real
GDP is the value of the final goods and services produced in a given year when
valued at constant prices. By comparing the value at constant prices of the goods
and services produced, we can measure the increase in production.
Real GDP
The value of the final goods and
services produced in a given year
when valued at constant prices.
Calculating Real GDP
Table 5.3 shows the quantities produced and prices in 2002 for an economy that
produces only apples and oranges. The first step toward calculating real GDP is
to calculate nominal GDP, which is the value of the final goods and services produced in a given year valued at the prices that prevailed in that same year.
Nominal GDP is just a more precise name for GDP that we use when we want to
make it clear that we are not talking about real GDP.
Nominal GDP Calculation
= $100.
= $100.
= $200.
Table 5.4 shows the quantities produced and prices in 2003. The quantity of
apples produced increased to 160 and the quantity of oranges produced increased
to 220. The price of an apple fell to 50¢, and the price of an orange increased to
$2.25. To calculate nominal GDP in 2003, sum the expenditures on apples and
oranges in 2003 as follows:
Expenditure on apples = 160 apples × $0.50
Expenditure on oranges = 220 oranges × $2.25
Nominal GDP in 2003 = $80 + $495
The value of the final goods and
services produced in a given year
valued at the prices that prevailed in
that same year.
TABLE 5.3
To calculate nominal GDP in 2002, sum the expenditures on apples and oranges in
2002 as follows:
Expenditure on apples = 100 apples × $1
Expenditure on oranges = 200 oranges × $0.50
Nominal GDP in 2002 = $100 + $100
Nominal GDP
= $80.
= $495.
= $575.
To calculate real GDP, we choose one year, called the base year, against which
to compare the other years. The choice of the base year is not important. It is just
a common reference point. We’ll use 2002 as the base year. By definition, real GDP
equals nominal GDP in the base year. So real GDP in 2002 is $200.
Item
Apples
Oranges
TABLE 5.4
Item
Apples
Oranges
GDP DATA FOR 2002
Quantity
Price
100
200
$1.00
$0.50
GDP DATA FOR 2003
Quantity
Price
160
220
$0.50
$2.25
124
Part 2 • MONITORING THE MACROECONOMY
Traditional Real GDP Calculation
TABLE 5.5
Item
2003 QUANTITIES AND
2002 PRICES
Quantity
Price
160
220
$1.00
$0.50
Apples
Oranges
The traditional method of calculating real GDP values the quantities produced in
each year at the prices of the base year. Table 5.5 summarizes these prices and
quantities for 2002 and 2003. The value of the 2003 quantities at the 2002 prices is
calculated as follows:
Expenditure on apples = 160 apples × $1.00
Expenditure on oranges = 220 oranges × $0.50
Value of the 2003 quantities at 2002 prices
= $160.
= $110.
= $270.
Using the traditional method, $270 would be recorded as real GDP in 2003.
New Method of Calculating Real GDP
TABLE 5.6
Item
2002 QUANTITIES AND
2003 PRICES
Quantity
Price
100
200
$0.50
$2.25
Apples
Oranges
Year
Real
GDP
Chain-linked
percentage
change
The new method of calculating real GDP builds on the old method but takes a further step. The new method compares the quantities produced in 2002 and 2003 by
using not only 2002 prices but also the 2003 prices. It then averages the two sets of
numbers in a special way that we’ll now describe.
To compare the quantities produced in 2002 and 2003 at 2003 prices, we need
to calculate the value of 2002 quantities at 2003 prices. Table 5.6 summarizes these
quantities and prices. The value of the 2002 quantities at the 2003 prices is calculated as follows:
Expenditure on apples = 100 apples × $0.50
Expenditure on oranges = 200 oranges × $2.25
Value of the 2002 quantities at 2003 prices
= $50.
= $450.
= $500.
We now have two comparisons between 2002 and 2003. At the 2002 prices, the
value of production increased from $200 in 2002 to $270 in 2003. The increase in
value is $70, and the percentage increase is ($70 ÷ $200) × 100, which is 35 percent.
At the 2003 prices, the value of production increased from $500 in 2002 to $575
in 2003. The increase in value is $75, and the percentage increase is ($75 ÷ $500) ×
100, which is 15 percent.
When we value production in 2002 prices, it increased by 35 percent in 2003.
When we value production in 2003 prices, it increased by 15 percent in 2003. The
new method of calculating real GDP uses the average of these two percentage
increases. The average of 35 percent and 15 percent is (35 + 15) ÷ 2, which equals
25 percent. Real GDP is 25 percent greater in 2003 than in 2002. Real GDP in 2002
is $200, so real GDP in 2003 is $250.
Chain Linking
2004
$300
+20%
2003
$250
+25%
2002
$200
Base year
The calculation that we’ve just described is repeated each year. Each year is compared with its preceding year. So, in 2004, the calculations are repeated but using
the prices and quantities of 2003 and 2004. Real GDP in 2004 equals real GDP in
2003 increased by the calculated percentage change in real GDP for 2004. For
example, suppose that real GDP for 2004 is calculated to be 20 percent greater than
in 2003. You know that real GDP in 2003 is $250. So real GDP in 2004 is 20 percent
greater than this value and is $300. In every year, real GDP is valued in base-year
(2002) dollars.
By applying the calculated percentage change to the real GDP of the preceding real GDP, each year is linked back to the dollars of the base year like the links
in a chain.
Eye on the
U.S.
Economy
Deflating the
GDP Balloon
Nominal GDP increased every year
between 1992 and 2002. Part of the
increase reflects increased produc-
tion, and part of it reflects rising
prices.
You can think of GDP as a balloon
that is blown up by growing production
and rising prices. In the figure, the GDP
deflator lets the inflation air—the contribution of rising prices—out of the
nominal GDP balloon so that we can
see what has happened to real GDP.
The red balloon for 1992 shows real
GDP in that year.The green balloon
shows nominal GDP in 2002.The red
balloon for 2002 shows real GDP for
that year.To see real GDP in 2002, we
use the GDP deflator to deflate nominal
GDP.
With the inflation air removed,
real GDP shows how the total value
of production has changed. Production grew from 1992 through 2000,
but in 2001, real GDP shrank. Over
the 10 years, real GDP grew by 3.1
percent a year, and in 2002, it was 38
percent higher than it was in 1992.
GDP (trillions of dollars)
11
10
GDP
deflator
Nominal
GDP
Nominal
GDP
9
8
Real
GDP
7
Real
GDP
6
5
Real
GDP
4
3
2
1
0
1992
1997
2002
1992
2002
Year
(a) Nominal GDP and real GDP
Year
(b) The GDP balloon
SOURCE: Bureau of Economic Analysis.
Calculating the GDP Deflator
The GDP deflator is an average of current prices expressed as a percentage of
base-year prices. The GDP deflator measures the price level. We calculate the GDP
deflator by using nominal GDP and real GDP in the following formula:
GDP deflator = (Nominal GDP ÷ Real GDP) × 100.
You can see why the GDP deflator is a measure of the price level. If nominal
GDP rises but real GDP remains unchanged, it must be that prices have risen. The
formula would deliver that result in the form of a higher GDP deflator. The larger
the nominal GDP for a given real GDP, the higher are prices and the larger is the
GDP deflator.
Table 5.7 shows how the GDP deflator is calculated. In 2002, the deflator is
100. In 2003, it is 230, which equals nominal GDP of $575 divided by real GDP of
$250 and then multiplied by 100.
GDP deflator
An average of current prices
expressed as a percentage of baseyear prices.
TABLE 5.7
CALCULATING THE
GDP DEFLATOR
Year
Nominal
GDP
Real
GDP
GDP
Deflator
2002
2003
$200
$575
$200
$250
100
230
125
C H E C K P O I N T
Study Guide pp. 75–77
Practice Online 5.3
3
5.3
Distinguish between nominal GDP and real GDP and define the GDP
deflator.
Practice Problem 5.3
TABLE 1
In 2001:
Item
Quantity
Price
Bananas
Coconuts
100
50
$10 a bunch
$12 a bag
In 2002:
Item
Quantity
Price
Bananas
Coconuts
110
60
$15 a bunch
$10 a bag
TABLE 2
An island economy produces only bananas and coconuts. Table 1 gives the quantities produced and prices in 2001, and Table 2 gives the quantities produced and
prices in 2002. The base year is 2001. Calculate
a. Nominal GDP in 2001.
b. Nominal GDP in 2002.
c. The value of 2002 production in 2001 prices.
d. The percentage increase in production when valued at 2001 prices.
e. The value of 2001 production in 2002 prices.
f. The percentage increase in production when valued at 2002 prices.
g. Real GDP in 2001 and 2002 by using the chain-linking method.
h. The GDP deflator in 2002.
Exercise 5.3
TABLE 3
In 2001:
Item
Quantity
Lobsters
Crabs
90
20
Price
$15 each
$20 each
TABLE 4
In 2002:
Item
Quantity
Lobsters
Crabs
100
25
Price
$20 each
$25 each
An island economy produces only lobsters and crabs. Table 3 gives the quantities
produced and the prices in 2001, and Table 4 gives the quantities produced and
the prices in 2002. The base year is 2001. Calculate
a. Nominal GDP in 2001.
b. Nominal GDP in 2002.
c. The value of 2002 production in 2001 prices.
d. The percentage increase in production when valued at 2001 prices.
e. The value of 2001 production in 2002 prices.
f. The percentage increase in production when valued at 2002 prices.
g. Real GDP in 2001 and 2002 by using the chain-linking method.
h. The GDP deflator in 2002.
TABLE 5
Solution to Practice Problem 5.3
2002 quantities and 2001 prices
Item
Quantity Price Expenditure
a. Nominal GDP in 2001 is $1,600—expenditure is $1,000 on bananas and $600
on coconuts (Table 1).
b. Nominal GDP in 2002 is $2,250—expenditure is $1,650 on bananas and $600
on coconuts (Table 2).
c. The value of 2002 production in 2001 prices is $1,820 (Table 5).
d. In 2001 prices, the value of production increased from $1,600 to $1,820, an
increase of $220. The percentage increase is (220 ÷ 1,600) × 100, or 13.75 percent.
e. The value of 2001 production in 2002 prices is $2,000 (Table 6).
f. In 2002 prices, the value of production increased from $2,000 to $2,250, an
increase of $250. The percentage increase is (250 ÷ 2,000) × 100, or 12.5 percent.
g. Real GDP in 2001 is $1,600. The average percentage increase in production is
(13.75 + 12.5) ÷ 2, which is 13.125 percent. Real GDP in 2002 is 13.125 percent
greater than $1,600, which is $1,810.
h. The GDP deflator in 2002 is (nominal GDP ÷ real GDP) × 100, which is 124.3.
Bananas
110
$10
Coconuts
60
$12
Value in 2001 prices
$1,100
$720
$1,820
TABLE 6
2001 quantities and 2002 prices
Item
Quantity Price Expenditure
Bananas
100
$15
Coconuts
50
$10
Value in 2002 prices
126
$1,500
$500
$2,000
Chapter 5 • GDP and the Standard of Living
5.4 REAL GDP AND THE STANDARD OF LIVING
We use estimates of real GDP to compare the standard of living across countries
and over time. In 2002, real GDP per person in the United States was $36,000,
which (at 2002 prices) is twice what it was in 1965. But are we twice as well off?
Does this expansion of real GDP provide a full and accurate measure of the
change in our standard of living?
It does not, for two reasons. First, the standard of living depends on all goods
and services, not only on those included in GDP. Second, the standard of living
depends on factors other than the goods and services produced.
Goods and Services Omitted from GDP
GDP measures the value of goods and services that are bought in markets. But it
excludes
•
•
•
•
Household production
Underground production
Leisure time
Environment quality
Household Production
An enormous amount of production takes place every day in our homes.
Preparing meals, cleaning the kitchen, changing a light bulb, cutting the grass,
washing the car, and helping a student with homework are all examples of productive activities that do not involve market transactions and are not counted as
part of GDP.
Because real GDP omits household production, it underestimates the value of
the production of many people, most of them women. But market production is
increasingly replacing household production. Two trends point in this direction.
One is the number of people who have jobs outside the home, which has increased
from 59 percent in 1965 to 67 percent in 2002. The other is the purchase of traditionally home-produced goods and services in the market. For example, more and
more families now eat in fast-food restaurants—one of the fastest-growing industries in the United States—and use day-care services. These trends mean that an
increasing proportion of food preparation and child care that were once part of
household production are now measured as part of GDP. So real GDP grows more
rapidly than does real GDP plus home production.
Underground Production
The underground economy is the part of the economy that is hidden from the
view of the government either because people want to avoid taxes and regulations
or because the goods and services being produced are illegal. Because underground economic activity is unreported, it is omitted from GDP.
The underground economy is easy to describe, even if it is hard to measure. It
includes the production and distribution of illegal drugs, production that uses illegal workers who are paid less than the minimum wage, and jobs done for cash to
avoid paying income taxes. This last category might be quite large and includes
tips earned by cab drivers, hairdressers, and hotel and restaurant workers and a
large range of other legal cash transactions.
127
128
Part 2 • MONITORING THE MACROECONOMY
Edgar L. Feige, an economist at the University of Wisconsin, estimates that the
U.S. underground economy peaked at 20 percent of GDP in 1987 and decreased to
about 16 percent of GDP during the early 1990s. The underground economy is
larger than this in some Eastern European countries, which are making a transition from communist economic planning to a market economy.
Leisure Time
Leisure time is an economic good. Other things remaining the same, the more
leisure we have, the better off we are. Our working time is valued as part of GDP,
but our leisure time is not. Yet that leisure time must be at least as valuable to us
as the wage we earn for working. If it were not, we would work instead. Over the
years, leisure time has steadily increased. The workweek has become shorter,
more people take early retirement, and the number of vacation days has increased.
These improvements in our standard of living are not measured in real GDP.
Environment Quality
An industrial society produces more atmospheric pollution than an agricultural
society does. For example, an industrial society burns more coal, oil, and gas. And
it depletes resources, clears forests, and pollutes lakes and rivers.
But industrial activity increases wealth, and wealthy people value a clean
environment and are better able to devote resources to protecting it. So pollution
does not necessarily increase when production increases. Pollution in Germany
provides an example. When East Germany, a relatively poor part of the country,
opened its borders with West Germany in the late 1980s, it was discovered that
East German rivers, lakes, and air were much more severely polluted than those
of its richer West German neighbor.
Resources that are used to protect the environment are valued as part of GDP.
For example, the production of catalytic converters that help to protect the atmosphere from automobile emissions is part of GDP. But pollution is not subtracted
from GDP. If we didn’t produce catalytic converters but instead polluted the
atmosphere, we would not count the deteriorating atmosphere as a negative part
of GDP. So if our standard of living is adversely affected by pollution, our GDP
measure does not show this fact.
Other Influences on the Standard of Living
The quantity of goods and services consumed is a major influence on the standard
of living. But other influences are
• Health and life expectancy
• Political freedom and social justice
Health and Life Expectancy
Good health and a long life—the hopes of everyone—do not show up directly in
real GDP. A higher real GDP enables us to spend more on medical research, health
care, a good diet, and exercise equipment. And as real GDP has increased, our life
expectancy has lengthened—from 70 years at the end of World War II to nearly 80
years today. Infant deaths and death in childbirth, two scourges of the nineteenth
century, have almost been eliminated.
Chapter 5 • GDP and the Standard of Living
129
But we face new health and life expectancy problems every year. Diseases
such as AIDS and drug abuse are taking young lives at a rate that causes serious
concern. When we take these negative influences into account, real GDP growth
overstates the improvements in the standard of living.
Political Freedom and Social Justice
A country might have a very large real GDP per person but have limited political
freedom and social justice. For example, a small elite might enjoy political liberty
and extreme wealth while the majority of people have limited freedom and live in
poverty. Such an economy would generally be regarded as having a lower standard of living than one that had the same amount of real GDP but in which everyone enjoyed political freedom. Today, China has rapid real GDP growth but
limited political freedom, while Russia has slower real GDP growth and an emerging democratic political system.
Because of the limitations of real GDP, other measures such as the Human
Development Index have been proposed (see Eye on the Global Economy).
Eye on the
Global
Economy
The Human
Development Index
The limitations of real GDP that
we’ve reviewed in this chapter affect
the standard of living of every country. So to make international comparisons of the standard of living, we
must look at real GDP and other indicators. Nonetheless, real GDP per
person is a major component of
international comparisons.
The United Nations has constructed
a broader measure called the Human
Development Index, or HDI, which
combines real GDP, life expectancy and
health, and education levels.
The figure shows the relationship
between GDP and the HDI. Each dot
represents a country.The United
States, labeled in the figure, has the
highest real GDP per person but the
fourth highest HDI.The small African
nation of Sierra Leone, also labeled,
has the lowest HDI and the lowest
real GDP per person.
Why is the United States not the
highest-ranked nation on the HDI?
It’s because life expectancy at birth
in the United States is a bit shorter
than it is in Norway, Sweden, and
Canada—the three slightly more
highly ranked nations.
Human Development Index
1.2
1.0
United
States
0.8
0.6
0.4
Sierra
Leone
0.2
0
0.2
0.4
0.6
0.8
1.0
1.2
Real GDP per person (index)
SOURCE: United Nations Human Development Report, 2002, http://www.undp.org/hdro/
C H E C K P O I N T
Study Guide pp. 77–80
Practice Online 5.4
4
5.4
Explain and describe the limitations of real GDP as a measure of the
standard of living.
Practice Problem 5.4
The United Nations Human Development Report gives the following data for real
GDP per person in 2000: China, $3,976; Russia, $8,377; Canada, $27,840; United
States, $34,142. Other information suggests that household production is similar
in Canada and the United States and smaller in these two countries than in the
other two. The underground economy is largest in Russia and China and a similar proportion of the economy in these two cases. Canadians and Americans enjoy
more leisure hours than do the Chinese and Russians. Canada and the United
States spend significantly more to protect the environment, so air, water, and land
pollution is less in those countries than in China and Russia. Given this information and ignoring any other influences on the standard of living
a. In which pair (or pairs) of these four countries is it easiest to compare the
standard of living? Why?
b. In which pair (or pairs) of these four countries is it most difficult to compare
the standard of living? Why?
c. What more detailed information would we need to be able to make an accurate assessment of the relative standard of living in these four countries?
d. Do you think that real-GDP-per-person differences correctly rank the standard of living in these four countries?
Exercise 5.4
Life expectancy at birth is 78.8 in Canada, 77.0 in the United States, 70.5 in China,
and 66.1 in Russia. Freedom House rates political freedom each year, and its ratings are as follows: Canada and the United States, 1.1 (1.0 is the most free); Russia,
4.5; and China, 7.6 (ratings in the 7+ range are the least free). How do these facts
change the relative rankings of living standards indicated by differences in real
GDP per person?
Solution to Practice Problem 5.4
a. Two pairs—Canada and the United States, and China and Russia—are easy to
compare because household production, the underground economy, leisure
hours, and the environment are similar in the two countries in each pair.
b. Canada and the United States are the most difficult to compare with China
and Russia because household production and the underground economy
narrow the differences and leisure hours and the environment widen them.
c. We would need more detailed information on the value of household production, the underground economy, the value of leisure, and the value of environmental differences.
d. Differences in real GDP per person probably correctly rank the standard of
living in these four countries because where the gap is small (Canada and the
United States), other factors are similar, and where other factors differ, the
gaps are huge.
130
Chapter 5 • GDP and the Standard of Living
C H A P T E R
131
C H E C K P O I N T
Key Points
1
Define GDP and explain why the value of production, income, and
expenditure are the same for an economy.
• GDP is the market value of production of final goods and services in a
given time period.
• We can value goods and services either by what it costs to produce
(incomes) or by what people are willing to pay (expenditures).
• The value of production equals income equals expenditure.
2
Describe how economic statisticians measure GDP in the United States.
• We measure GDP by summing either expenditures on final goods and
services (the expenditure approach) or incomes of all the factors of production (the income approach).
• GDP measures expenditure on final goods and services but excludes
expenditure on intermediate goods, used goods, and financial assets.
• To value the output of a sector, we measure only the sector’s value added.
3
Distinguish between nominal GDP and real GDP and define the GDP
deflator.
• Nominal GDP is the value of production using the prices of the current
year and the quantities produced in the current year.
• Real GDP is the value of production using the prices of a base year and
the quantities in a current year.
• Changes in real GDP measure changes in production. Changes in nominal GDP combine changes in both production and prices.
• The GDP deflator is the ratio of nominal GDP to real GDP (multiplied by 100).
4
Explain and describe the limitations of real GDP as a measure of the
standard of living.
• Real GDP per person is a major indicator of the standard of living.
• Real GDP omits household production, underground production, leisure
time, environment quality, health and life expectancy, and political freedom and social justice.
• Broader indexes of the standard of living, such as the Human
Development Index, take some of these omitted factors into account.
Key Terms
Practice Online
Consumption expenditure, 113
Depreciation, 120
Exports of goods and services,
114
Final good or service, 112
GDP deflator, 125
Government purchases of goods and
services, 114
Gross domestic product (GDP), 112
Imports of goods and services, 114
Intermediate good or service, 112
Investment, 113
Net domestic product at factor cost, 120
Net exports of goods and services, 114
Nominal GDP, 123
Real GDP, 123
Value added, 121
132
Part 2 • MONITORING THE MACROECONOMY
Exercises
FIGURE 1
HOUSEHOLDS
V
FINANCIAL
MARKETS
W
Q
R
FACTOR
MARKETS
GOVERNMENTS
U
X
GOODS
MARKETS
Z
REST
OF
WORLD
FIRMS
1.
In Figure 1, name each of the flows labeled Q, R, U, V, W, X, and Z.
2.
You are provided with the following data on the economy of Iberia: GDP
was $100 billion, net taxes were $18 billion, government purchases of goods
and services were $20 billion, household saving was $15 billion, consumption expenditure was $67 billion, investment was $21 billion, and exports of
goods and services were $30 billion.
a. Find the value of Iberia’s import goods and services.
b. Find Iberia’s net exports.
c. Label all the items in Figure 1 with their values in Iberia.
3.
The values of some of the flows shown in Figure 1 in the U. S. economy in
1999 were U = $1.6 trillion, W = $6.2 trillion, X = $1.4 trillion, and Z = −$0.2
trillion. Calculate
a. Q.
b. R + V.
c. GDP.
4.
The values of some of the flows shown in Figure 1 in the Canadian economy
in 2001 were Q = $1,092 billion, U = $204 billion, W = $621 billion, and
Z = $57 billion. Calculate
a. X.
b. GDP.
c. Compare Canada’s GDP in 2001 with the U.S. GDP of 1999 and comment
on the possible sources of the difference.
5.
The national income accounts of Parchment Paradise are kept on (you
guessed it) parchment. A fire destroyed the national statistics office, and the
national income and product accounts are now incomplete. But they contain
the following information for 2002: Net domestic product at factor cost was
$2,900; consumption expenditure was $2,000; indirect taxes less subsidies
Chapter 5 • GDP and the Standard of Living
133
was $80; net interest was $200; rental income of persons was $100; investment was $800; government purchases of goods and services were $800; proprietors’ income was $200; compensation of employees was $2,000; and net
exports were –$200. You’ve been hired as an economist to reconstruct the
missing numbers by calculating for 2002
a. GDP.
b. Corporate profits.
c. Capital consumption.
6.
Nominal GDP in the United States in 2001 was $10,082.2 billion, and real
GDP (in 1997 dollars) was $9,214.5 billion. Real GDP in 1997 (in 1997 dollars)
was $7,813.2 billion.
a. Calculate the GDP deflator in 2001.
b. What was the GDP deflator in 1997?
c. By what percentage did the price level rise between 1997 and 2001?
d. By what percentage did real GDP rise between 1997 and 2001?
e. By what percentage did nominal GDP rise between 1997 and 2001?
7.
The GDP deflator in the United States in 1990 was 86.5, and real GDP in
1990 (in 1997 dollars) was $6,707.9 billion. The GDP deflator in the United
States in 2000 was 106.9, and real GDP in 2000 (in 1997 dollars) was $9,191.4
billion.
a. Calculate nominal GDP in 1990.
b. Calculate nominal GDP in 2000.
c. By what percentage did the price level rise between 1990 and 2000?
d. By what percentage did real GDP rise between 1990 and 2000?
e. By what percentage did nominal GDP rise between 1990 and 2000?
8.
9.
Use the information provided in Table 1 to calculate
a. Nominal GDP in 2002.
b. Nominal GDP in 2003.
c. Real GDP in 2003 with base year 2002 using the traditional method.
d. Real GDP in 2003 with base year 2002 using the chain method.
e. The GDP deflator in 2003.
f. Comment on the growth rate of real GDP in 2003.
g. How does the growth rate of nominal GDP in 2003 divide between real
GDP growth and inflation?
Use the information provided in Tables 1 and 2 to calculate
a. Nominal GDP in 2004.
b. Nominal GDP in 2005.
c. Real GDP in 2004 with base year 2002 using the traditional method.
d. Real GDP in 2005 with base year 2002 using the traditional method.
e. Real GDP in 2004 with base year 2002 using the chain method.
f. Real GDP in 2005 with base year 2002 using the chain method.
g. The GDP deflator in 2004 and 2005.
h. Comment on the growth rate of real GDP between 2003 and 2005.
i. Comment on the changes in the price level between 2003 and 2005.
j. How much of the growth of nominal GDP between 2002 and 2005 was
the result of inflation and how much was the result of real GDP growth?
TABLE 1
(a) In 2002:
Item
Quantity
Price
Fun
Food
40
60
$2
$3
Item
Quantity
Price
Fun
Food
44
72
$3
$2
Item
Quantity
Price
Fun
Food
50
72
$3
$3
Item
Quantity
Price
Fun
Food
51
80
$4
$6
(b) In 2003:
TABLE 2
(a) In 2004:
(b) In 2005:
134
Part 2 • MONITORING THE MACROECONOMY
Critical Thinking
10. In 2002, the oil tanker Prestige sank in the Atlantic Ocean and the oil washed
ashore on the beaches of Spain . Millions of dollars were spent cleaning up
the mess, and much wildlife was killed.
a. Describe how the effects of this oil spill appear in the national income
accounts of Spain.
b. Does the national accounts treatment of this event properly record the
effects of the spill on the standard of living of the people who were
affected? Explain why or why not.
11. How do underground economic activities affect the usefulness of the
national income accounts for comparing the value of production over time
and across countries? What underground economic activities do the national
income accounts miss? Do these activities contribute to the standard of living? Do you think that it would be worth expanding the scope of the
accounts to include estimates of the value of underground activities?
12. The United Nations Index of Human Development is based on the levels of
GDP per person, life expectancy at birth, and indicators of the quality and
quantity of education. Do you think the United Nations should expand its
index to include items such as pollution, resource depletion, and political
freedom? Are there any other factors that influence the standard of living
that you think should be included in a comprehensive measure?
Practice Online
Web Exercises
Use the links on your Foundations Web site to work the following exercises.
13. Read the article on one of the great inventions of the twentieth century and
the article in the Naples Daily News. Summarize the argument that the
national income accounts are one of the great inventions and describe the
improvement reported in the news article.
14. Visit the Bureau of Economic Analysis Web site and obtain the most recently
released National Income and Product Account data for the United States.
For the most recently available quarter,
a. What are the values of consumption expenditure, investment, government
purchases, and net exports?
b. Check that when you sum the items in part a, the total equals GDP.
c. Find the GDP deflator with the base year of 1997.
d. Calculate real GDP.
e. Was the cost of living higher in the most recent quarter than in 1997?
Explain your answer.
15. Visit the International Monetary Fund World Economic Outlook Web site
and obtain the most recently released real GDP data for the global economy.
a. In which countries is real GDP growth the fastest?
b. In which countries is real GDP shrinking?
c. What is the GDP of the United States as a percentage of world GDP?
d. On the basis of the growth rates over the past decade, in which regions
does the standard of living appear to be improving fastest and in which
does it appear to be improving the slowest?