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“Foundations of
Economics”
Measuring the Overall
Performance of Economic
Systems
1
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Introduction
• Microeconomic Analysis – supply and
demand in a particular market or industry.
• Macroeconomic Analysis – performance
of the overall economy.
• Gross Domestic Product – best indicator
of overall economic performance.
2
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Some Figures
• World GDP comparison
• GDP per capita
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
• GDP – market value of final goods and
services produced within a country in a
particular time period.
– Market values.
– Final good – purchased by ultimate user.
– Within a country.
– Time period is usually a year.
4
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
Market Value
– GDP is a market value—goods and services
are valued at their market prices.
– To add apples and oranges, computers and
popcorn, we add the market values so we
have a total value of output in dollars.
5
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
Final Goods
– Intermediate goods doesn’t count
– Intermediate Goods
• Goods used up entirely in the production of final
goods.
• Not included in the calculation of GDP.
6
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
Final Goods
– Add value-added at each stage of the
production process.
• Value Added
– The dollar value of an industry’s sales minus the value of
intermediate goods used in production
– Example: farmer, miller, baker, consumer
7
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
Within a country
– Output produced abroad by domestically
owned factors of production doesn’t count.
(e.g. Lululemon factory in China )
- Output produced domestically by foreign
owned factors of production should be
included.
(e.g. General Motor Cars manufactured in
Ontario)
8
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
In the course of a year
– Used goods and second-hand sales do NOT
count.
(e.g. selling a used car )
- inventory should be included.
inventories: goods that are produced but
unsold
count as firms’ own investment
9
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Gross Domestic Product
Three ways of measuring GDP:
– Product approach: the total of the value added by
each producer in the course of contributing to the
year’s total output of final goods;
– Income approach: the total income received, in the
form of wages and salaries, interest, rent, and profits,
by those who contributed the resources used to
produce the year’s total output;
– Expenditure approach: the total purchases of final
goods by households, business firms and
government, plus the purchases by foreigners in
excess of what the foreigners sold us in return.
10
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Calculating GDP
• Expenditure approach
– Consumption (C)
– Investment (I)
– Government purchases of Goods and
Services (G)
– Net Exports - net spending by the Rest of the
World on domestic production (NX)
11
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Case Study:
The Components of Canadian GDP
5-12
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Case Study:
The Components of Canadian GDP
5-13
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Using the expenditure method, how is GDP affected in
2012 and 2013 if 3000 Hondas are produced in 2012 but
sold in 2013? Assume the market price of a Honda is
$20,000 in both
2012 and 2013
A) GDP increases by $60M in both 2012 and 2013
B) GDP increases by $60M in 2012 but is unaffected in
2013
C) GDP increases by $60M in 2013 but is unaffected in
2012
D) GDP is unaffected in both 2012 and 2013
14
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Which one of the following government expenditures is an
example of "government purchases"?
A) $1000 paid to a poor person for income support
B) $600 paid to an unemployed worker for employment
insurance
C) $100 000 paid as interest on the national debt
D) $2000 paid to a retiree
E) $4000 spent for services provided by a private
consultant
15
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Nominal and Real GDP
• Nominal GDP
– Product of prices and quantities (P x Q).
– If prices increase and quantities remain
unchanged nominal GDP increases.
• Question
– If prices increase and quantities remain the
same, has the real output of the economy
increased?
16
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Nominal and Real GDP
• Adjusting GDP for Price Changes
– Real GDP
• The value of all final goods and services produced
in a year stated in unchanging prices (base
year’s price).
17
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Example:
2003
2004
Good
Quantity
Price
Quantity
Price
Milk
500
$2
900
$3
Cheese
1000
$5
1000
$4
Butter
2000
$1
3000
$2
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© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Appendix: Limitations of National
Income Accounting
• GDP
– Only attempts to measure economic
performance.
– Ignores all non-market forms of production.
– Ignores illegal production.
19
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Limitations of GDP
© 2006 Prentice Hall Business Publishing
Copyright © 2014 by Nelson Education
Ltd.
The Economic Way of Thinking, 11/e
5-20
Heyne/Boettke/Prychitko
Active Learning
GDP and Its Components
In each of the following cases, determine how much GDP and each of
its components is affected (if at all).
A. Debbie spends $200 to buy her husband dinner at the finest
restaurant in Toronto.
B.
Sarah spends $1800 on a new laptop to use in her publishing
business. The laptop was built in China.
C. Jane spends $1200 on a computer to use in her editing business.
She got last year’s model on sale for a great price from a local
manufacturer.
D.
General Motors builds $500 million worth of cars, but consumers
only
buy $470 million worth of them.
© 2006 Prentice Hall Business Publishing
Copyright © 2014 by Nelson Education
Ltd.
The Economic Way of Thinking, 11/e
5-21
Heyne/Boettke/Prychitko
Active Learning
Answers
A. Debbie spends $200 to buy her husband
dinner at the finest restaurant in Toronto.
Consumption and GDP rise by $200.
B. Sarah spends $1800 on a new laptop to
use in her publishing business. The laptop
was built in China.
Investment rises by $1800, net exports fall
by $1800,
GDP is unchanged.
© 2006 Prentice Hall Business Publishing
Copyright © 2014 by Nelson Education
Ltd.
The Economic Way of Thinking, 11/e
5-22
Heyne/Boettke/Prychitko
Active Learning
Answers
C.
Jane spends $1200 on a computer to use in her editing business.
She got last year’s model on sale for a great price from a local
manufacturer.
Current GDP and investment do not change because the
computer was built last year.
D.
General Motors builds $500 million worth of cars, but consumers
only buy $470 million of them.
Consumption rises by $470 million, inventory investment rises by
$30 million, and GDP rises by $500 million.
© 2006 Prentice Hall Business Publishing
Copyright © 2014 by Nelson Education
Ltd.
The Economic Way of Thinking, 11/e
5-23
Heyne/Boettke/Prychitko