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N. Gregory Mankiw
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The Science of Macroeconomics
(edited by L. Lamb, 2011)
© 2011 Worth Publishers, all rights reserved
2010 UPDATE
CHAPTER
SEVENTH EDITION
MACROECONOMICS
In this chapter, you will learn:
…the meaning and measurement of the
most important macroeconomic statistics:
 2.1 Gross Domestic Product (GDP)
 2.2 The Consumer Price Index (CPI)
 2.3. The unemployment rate
2.1 Gross Domestic Product:
Expenditure and Income
Two ways to look at GDP:
 Total expenditure on domestically-produced
final goods and services.
 Total income earned by domestically-located
factors of production.
Expenditure equals income because
every dollar spent by a buyer
becomes income to the seller.
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The Circular Flow
Income ($)
Labor
Firms
Households
Goods
Expenditure ($)
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Value added
Value added:
The value of output minus
the value of the intermediate goods
used to produce that output
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Final goods, value added, and GDP
 GDP = value of final goods produced
= sum of value added at all stages
of production.
 The value of the final goods already includes the
value of the intermediate goods,
so including intermediate and final goods in GDP
would be double-counting.
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Table 2.1 GDP and the Components of Expenditure: 2008
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Copyright © 2011 by2
Worth Publishers
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The expenditure components of GDP




consumption, C
investment, I
government spending, G
net exports, NX
An important identity:
Y
=
value of
total output
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C + I + G + NX
aggregate
expenditure
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Consumption (C)
definition: The value of all
goods and services bought
by households. Includes:
 durable goods
 nondurable goods
 services
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Investment (I)
 Spending on goods bought for future use
(i.e., capital goods)
 Includes:
 Business fixed investment
 Residential fixed investment
 Inventory investment
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Investment vs. Capital
Note: Investment is spending on new capital.
Example (assumes no depreciation):
 January 1, 2012:
economy has $500b worth of capital
 during 2012:
investment = $60b
 January 1, 2013:
economy will have $560b worth of capital
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Government spending (G)
 G includes all government spending on goods
and services.
 G excludes transfer payments
because they do not represent spending on
goods and services.
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NOW YOU TRY:
An expenditure-output puzzle?
Suppose a firm:
 produces $10 million worth of final goods
 only sells $9 million worth
Does this violate the
expenditure = output identity?
GNP vs. GDP
 Gross National Product (GNP):
Total income earned by the nation’s factors of
production, regardless of where located
 Gross Domestic Product (GDP):
Total income earned by domestically-located
factors of production, regardless of nationality
GNP – GDP = factor payments from abroad
minus factor payments to abroad
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Real vs. nominal GDP
 GDP is the value of all final goods and services
produced.
 nominal GDP measures these values using
current prices.
 real GDP measure these values using the prices
of a base year.
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GDP Deflator
 Inflation rate: the percentage increase in the
overall level of prices
 One measure of the price level: GDP deflator
Definition:
Nominal GDP
GDP deflator = 100 
Real GDP
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Chain-Weighted Real GDP
 Over time, relative prices change, so the base
year should be updated periodically.
 In essence, chain-weighted real GDP
updates the base year every year,
so it is more accurate than constant-price GDP.
 Your textbook usually uses
constant-price real GDP, because:
 the two measures are highly correlated.
 constant-price real GDP is easier to compute.
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2.2 Consumer Price Index (CPI)
 A measure of the overall level of prices
 In Canada, it is published by Statistics Canada
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How CPI is constructed
1. Survey consumers to determine composition of
the typical consumer’s “basket” of goods
2. Every month, collect data on prices of all items
in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
100 
Cost of basket in base period
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Why the CPI may overstate inflation
 Substitution bias
 Introduction of new goods
 Unmeasured changes in quality
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Figure 2.3 The Inflation Rate as Measured
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2.3 Measuring Joblessness:
Categories of the population
 employed
 unemployed
 labor force
 not in the labor force
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Figure 2.4 The Three Groups of the Population
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Copyright © 2011 by Worth Publishers
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Two important labor force concepts
 unemployment rate
 labor force participation rate
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Figure 2.5 Okun’s Law
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Copyright © 2011 by Worth Publishers
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2.4 Chapter Summary
 Gross Domestic Product (GDP) measures both
total income and total expenditure on the
economy’s output of goods & services.
 Nominal GDP values output at current prices;
real GDP values output at constant prices.
Changes in output affect both measures,
but changes in prices only affect nominal GDP.
 GDP is the sum of consumption, investment,
government purchases, and net exports.
Chapter Summary
 The overall level of prices can be measured
by either:
 the Consumer Price Index (CPI),
the price of a fixed basket of goods
purchased by the typical consumer, or
 the GDP deflator,
the ratio of nominal to real GDP
 The unemployment rate is the fraction of the
labor force that is not employed.
Homework
End of chapter 2 in textbook:
Questions for review: 1,2,3,4
Problems & Applications: 2, 3, 4, 6, 7, 8 & 9
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