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Chapter 4
Spending, Income, and GDP
McGraw-Hill/Irwin
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Macroeconomics: Data and Issues
Wages and
Unemployment
Spending,
Income,
and GDP
Inflation and
Price Level
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Learning Objectives
1. Explain how economist define and measure an
economy's output
2. Use the expenditure method for measuring GDP to
analyze economic activity
3. Define and compute nominal GDP and real GDP
4. Discuss the relationships between GDP and
economic well-being
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Measuring Output
Gross Domestic Product (GDP) is
The market value of
Final goods and services
Produced in a country in a given
period of time
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Market Value
 Aggregate measure of quantities produced
 Weighs more expensive items more
 Willingness to pay is an indication of benefit from the
good
Orchardia
Price
Quantity
GDP contribution
Apples
Bananas
Shoes
$0.25
$0.50
$20.00
4
6
3
$1.00
$3.00
$60.00
 Orchardia's GDP is $64
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Market Value
 A convenient way to aggregate the many different
goods and services produced in a modern economy.
 However, non-market activities are not counted in GDP
 Unpaid work of a homemaker
 paid house keeping and child care services
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Women's labor force participation and GDP
measurement
 Women's labor force participation increased since 1960
 Measured GDP increased
 Working women's output measured and counted
 a real addition to GDP
 Paid workers provide previously unpaid childcare
 Not a real addition to goods and services produced
 Measured change in GDP overstates actual change
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Final Goods and Services
 Final goods are consumed by the ultimate user
 End products of production
 Included in GDP
 Intermediate goods are used up in the production of
final goods
 Not included in GDP
 Avoids double counting
 A barber's assistant earns $2 per haircut for providing
services such as shampooing and sweeping up
 Barber charges $10 per haircut
 Haircut's contribution to GDP is $10, not $12.
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Value-added Method
 Value added is the market value of the product minus
the cost of inputs purchased from other firms
 Count value added in the year it is produced
 Hot'n'Fresh buys flour and other inputs to make
bread that sells for $2.00
Revenues
Cost of Purchased
Inputs
Value
Added
ABC Grain
$0.50
$0.00
$0.50
General Flour
$1.20
$0.50
$0.70
Hot'n'Fresh
$2.00
$1.20
$0.80
Company
Total
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Produced in a Country in a Period of Time
 "Domestic" in GDP means the activity is measured
within a country's borders
 Nationality of owners or company is not relevant
 Value must be produced in the year considered
 Sell a 20-year old house for $200,000
 Pay $12,000 commission
 Value added is $12,000
 House was not produced in the period of time
studied
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Expenditure Method for GDP
 Four users of final goods
■
 Households
Firms
■
 Government
Foreigners
 Assumes all goods produced are purchased by one
of these groups in a given year
 Amount spent = market value
 GDP can be measured by:
 Total spending for final goods less value of imports
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US GDP, 2007 (billions of dollars)
Consumption
Durable Goods
$9,732.0
$1,079.6
Non-durable Goods
2,833.0
Services
5,819.4
Investment
Business Fixed Investment
Residential
Inventory
2,132.3
1,483.2
641.5
7.6
Government Purchases
2,691.4
Net Exports
– 712.7
Exports
1,640.3
Imports
2,353.0
GDP
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$13,843.0
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Consumption Expenditure
 Spending by households for goods and services
 Consumer durables are long-lived consumer goods
 Cars
 Furniture
 Appliances
 Consumer non-durable goods are shorter-lived
goods
 Clothing
 Food
 Bedding
 Services are the largest component of consumer
spending
 Education
 Taxi rides
 Haircuts
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Investment
 Business fixed investment is purchases of new
capital goods
 machinery
 Business Buildings
 Residential investment is construction of new homes
and apartment buildings
 Inventory investment is the change in unsold goods
to the company's inventory
 These goods are produced but not yet sold
 This entry can be positive or negative
 Negative inventory investment means less in
inventory at year-end than at the beginning
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Economic Investment and Financial Investment
 Financial investments include purchases of stocks,
bonds, and other financial assets
 Purchase generally transfers ownership of a portion
of the firm's existing capital stock
 Does not correspond to any increase in physical
capital or production capacity
 Economic investment refers to the increase in the
capital goods used to produce other goods
 This value is based on purchase price of the capital
goods, not on stock value
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Government Purchases
 Federal, state, and local government purchase final
goods and services
 Fighter jets
 Teaching
 Office supplies
 Excludes transfer payments
 Transfer payments are made by government but the
government receives no current goods or services
 Food Stamps
 Spending by recipients is included in GDP
 Excludes interest paid on government debt
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Net Exports
 Net exports are exports minus imports
 Exports are goods and services produced
domestically and sold abroad
 Exports reduce the amount available to the
domestic economy
 Imports are purchases in the US of goods and
services produced abroad
 Imports increase the amount available to the
domestic economy
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GDP Expenditures Equation
 Terminology
Y
Gross Domestic Product or output
C
I
G
NX
Consumption Expenditure
Investment
Government Purchases
Net Exports
 Expenditure approach to measuring GDP
Y = C + I + G + NX
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GDP Example
 Total production is 1 million cars, $15,000 each
 Production value is 1 million times $15,000 = $15 billion
Sector
# Cars Purchased
GDP Contribution
Consumers
700,000
$10.500 billion
Investment
Businesses
225,000
200,000
$3.375
$3.000 billion
Government
50,000
$0.750 billion
Net exports
25,000
$0.375 billion
Total
1,000,000
975,000
$15.000
$14.625 billion
 25,000 cars are unsold
 Investment in inventories increases by $0.375
billion, In what category is this number included?
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Income Approach to GDP
 When a good is sold, its proceeds are distributed to
workers or business owners
 GDP = labor income + capital income
 Labor income is wages, salaries, benefits, and incomes
of the self-employed
 About ⅔ of GDP
 Capital income pays for physical capital and intangibles
 Profits for business owners
 Rent for land
 Interest for bond holders
 Royalties
 Measured before taxes
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Three GDP Approaches
Production
Expenditure
Market
Value of
Final Goods
and
Services
Consumption
Labor
Income
Investment
Government
purchases
Net exports
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Income
Capital
Income
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Adjusting for Price Changes
 Compare GDP for different years to see how much
output has changed
 GDP changes over time because
 Prices change AND
 Quantity of output changes
 To see how much output has grown, use only the
changes in quantities
 Hold prices constant
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The Pizza and Calzone Economy
 GDP in 2009 is $175; GDP in 2013 is $420
 GDP in 2013 is 2.4 times the GDP in 2009
 Only twice as many pizzas and calzones were
produced in 2013
 Market value of output grew faster than the physical
volume of output
Number of
Pizzas
Price of
Pizza
Number of
Calzones
Price of
Calzones
2009
10
$10
15
$5
2013
20
$12
30
$6
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Real GDP and Nominal GDP
 Nominal GDP values output in the current year using
prices from the current year
 Nominal GDP is the current dollar value of production
 Real GDP values output in the current year using the
prices from the base year
 Real GDP measures the physical volume of
production
 Nominal GDP adjusted for inflation
Comparisons of economic activity at different times
should always be done using real GDP.
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Calculating Real GDP for 2013
 Use 2009 as the base year
 Nominal GDP for 2009 is $175 and for 2013, $420
 Calculate real GDP using current year quantities and
base year prices
 Real GDP in 2013 is
(20 pizzas) ($10) + (30 calzones) (5) = $350
 Real GDP doubled between 2009 and 2013
Number of
Pizzas
Price of
Pizza
Number of
Calzones
Price of
Calzones
2009
10
$10
15
$5
2013
20
$12
30
$6
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Real GDP and Economic Well-Being
 Real GDP is a flawed measure of well-being
 It values only market transactions
 Omits illegal transactions, volunteer work, and
household production
 Maximizing GDP will not necessarily maximize national
well-being
 Whether increases in output increase welfare is a
case-by-case issue
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GDP Does Not Value Leisure
 Amount of leisure time has increased in the past 100
years
 Work weeks are shorter
 People enter the labor force at an older age
 People retire earlier
 Leisure produces no goods for market
 GDP places a value of zero on all leisure time
 Opportunity cost of an hour of leisure is your hourly
wage
 Omission of the value of leisure time makes GDP
seem smaller
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Environmental Quality and resource depletion
 Suppose a factory is built in your town
 People are employed and output is produced
 Productive activity is included in GDP
 the factory creates pollution
 No adjustment is made for the decline in resource
availability when mining is done
 One more barrel of oil on the market means one less
barrel for future use
 Environmental quality and resource depletion are
difficult to value
 They have value and that value is omitted from GDP
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Other Quality of Life Considerations
 GDP does not account for intangibles people value
 Crime rates
 Traffic congestion
 Civic organizations
 Open space
 Sense of community
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Poverty and Economic Inequality
 GDP does not capture the effects of income inequality
 Most would prefer living in a relatively equal society
to one with a few wealthy and many poor
 Inequality matters and it is increasing in the US
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GDP as a Welfare Measure
 GDP per capita is positively associated with several
measures of well-being
 Material standard of living: more goods and services
 Health and life expectancy
 Residents of industrialized countries fare better than
residents of developing countries in a range of
health measures
 Education
 Literacy and school enrollment rates are higher in
high-income countries
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Spending, Income, and GDP
Gross Domestic
Product
Production
Method
Expenditure
Method
Real and
Nominal
Values
LO 16 - All
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Income
Method
GDP and
Well-Being
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