Download value of goods and services that are produced in an economy over a

Gross domestic product (GDP): value of goods and services that are produced in an economy over a
given time period
- Final goods and services: Goods and services consumed by the ultimate user, END PRODUCT
- Intermediate goods/services: Goods/services used up in the production of final
goods/services (not counted a part of GDP).
- Value added: market value of product – cost of input purchased. The value a firm adds to a
product before selling
- Expenditure method
 Adding up market values of all final goods/services produced domestically
 Adding total amount spent by each 4 groups on final goods/services and subtracts
spending on imported goods/services.
 4 groups: households, firm, government, foreign sector
 CONSUMPTION
 Durables: long-lived consumer goods (e.g. cars)
 Non-durables: shorter-lived goods (e.g. food)
 INVESTMENT
 Business fixed investment: Firms buy capital goods to increase capacity to produce
 Residential investment: Construction of homes/apartments
 Inventory investment: Addition of unsold goods to company inventories (goods
firm produces but does not sell)
 GOVERNMENT EXPENDITURE
 NET EXPORTS
 Exports – imports
- GDP = C + I + G + NX (NATIONAL INCOME ACCOUNTING IDENTITY)
- Income method
 Revenue from sale distributed to workers and owners of capital. GDP = labour income +
capital income
 Labour income: wages, salaries and incomes of self-employed
 Physical capital: Profits, rents, interest, royalties (from copyrights/patents)
 Gross national income (GNI) – income earned by all citizens of a country regardless of
where those citizens live.
- Circular flow of income
Nominal vs. Real
- GDP: misleading gauge of economic growth since physical quantities of goods/services
produced in any given year are determined by people’s economic wellbeing.
 Need to remove the effects of price changes (adjust for inflation) -> REAL GDP
- Real GDP: Measure of GDP in which the quantities produced are valued at the prices in a
base year rather than at current prices.
 Measures the actual physical volume of production
 Year 2010 real GDP = (year 2010 quantity * year 2004 prices); 2004 is base year
- Nominal GDP: Valued at current-year prices
- Real GDP ≠ economic wellbeing
 Leisure time: hours of working
 Non-market economic activities: government services, non-market economic activities
(unpaid jobs) -> GDP underestimated
 Environmental quality and resource depletion
 Quality of life
 Inequality
Consumer price index (CPI):
- Measuring the price levels (inflation)
- Measures the cost of living in that period of a basket of goods/services relative to the cost of
the same basket of goods/services in a fixed year (base year)
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑏𝑎𝑠𝑒 − 𝑦𝑒𝑎𝑟 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑘𝑒𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠 𝑖𝑛 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝑦𝑒𝑎𝑟
𝐶𝑃𝐼 =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑏𝑎𝑠𝑒 − 𝑦𝑒𝑎𝑟 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑘𝑒𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠 𝑖𝑛 𝒃𝒂𝒔𝒆 𝑦𝑒𝑎𝑟
- Use CPI for rate of inflation.
 E.g. rate of inflation of Dec 2009, find percentage increase in CPI over 12 months leading
up to Dec 209:
(𝐶𝑃𝐼𝐷𝑒𝑐2009 − 𝐶𝑃𝐼𝐷𝑒𝑐2008
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 𝐷𝑒𝑐 2009 =
∗ 100
𝐶𝑃𝐼𝐷𝑒𝑐2008
- INFLATION: general rise in prices in economy (NOT individual prices)
- RELATIVE PRICES: Price of one good relative to other goods.
- PROBLEMS:
 CPI may overestimate the true rate of inflation
 Quality adjustment bias: Government statisticians cannot always adjust
adequately for changes in quality of goods/services
 Substitution bias: Causes inflation to overstate changes in cost of living caused by
fail to account substitutions towards less expensive g/s.
COST of inflation
- Shoe-leather costs
 Money acts as a medium of exchange
 Inflation, raises the cost of holding money (erode of real purchasing power of any given
amount of cash, longer cash is held during inflation, larger reduction in purchasing
power) -> save
 Cost of going to banks to save (shoes, employers)
- Noise in price system
𝑊𝐷 = 𝑆 + 𝑇 + 𝑀



Therefore decrease
output to short run
equilibrium
𝑃
Equilibrium: 𝐼𝑁𝐽 = 𝑊𝐷
𝑃𝐴𝐸 = 𝐶 𝑑 + 𝐼 𝑃 + 𝐺 + 𝑋
𝑌 = 𝐶 𝑑 + 𝐼𝑃 + 𝐺 + 𝑋
𝑌 − 𝐶 𝑑 = 𝐼𝑃 + 𝐺 + 𝑋
 Y = aggregate income, therefore LHS = amount left over from income after
consumption expenditures on domestic goods/services (this is used elsewhere)
𝑆 + 𝑇 + 𝑀 = 𝐼𝑃 + 𝐺 + 𝑋
𝑊𝐷 = 𝐼𝑁𝐽𝑃
Disequilibrium: Planned aggregate expenditure differs from output (INJ ≠ WD)
 PAE>Y
 Not selling as much output as expected (increase in inventories)
 Firms cut down output in response (reduce income -> consumption decreases and
savings decreases -> no shifts)
45-degree diagram: Visual representation of the economy over the short run,
identification of the equilibrium level of GDP