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Chapter 14:
“The Economic
Way of Thinking”
11th Edition
The Overall
Performance
of Economic
Systems
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Chapter 14 Outline
• Introduction
• Gross Domestic Product
• GDP or GNP?
• GDP as Total Income Created in the Domestic
Economy
• GDP is not a Measure of All Purchases in the
Economy
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Heyne/Boettke/Prychitko
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Chapter 14 Outline
• GDP as Total Value Added
• Is Value Added Always Positive?
• Loose Ends: Unsold Inventories and Used
Goods
• Aggregate Fluctuations
• Inflation
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Chapter 14 Outline
• The Difficulties of Monetary Calculation
• Recession and Inflation Since 1960
• What Causes Aggregate Fluctuations?
• Appendix: Limitations of National Income
Accounting
• Appendix: The Dangers of Aggregation: A
Methodological Approach
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Heyne/Boettke/Prychitko
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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.
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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.
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GDP or GNP?
• GDP – performance of the domestic economy.
• GNP – performance of the nation’s citizens.
– Regardless of where they are producing.
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GDP as Total Income Created
in the Domestic Economy
• GDP
– Purchases of final goods.
– Measure of national income.
• Value of national output = value of national
income
– Every dollar paid for output = income for someone
• Sales taxes = income for government
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GDP Is Not a Measure of All
Purchases in the Economy
• GDP
–
–
–
–
–
Purchases of final goods.
All income created in the economy.
Not all expenditures.
Excludes intermediate goods.
All expenditures would be double counting.
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Heyne/Boettke/Prychitko
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GDP as Total Value Added
• GDP
– Expenditures of final goods and services.
– Total income generated in the economy.
– Total value added in the economy.
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Is Value Added Always Positive?
• Nominal wages, rents and interest will be
positive.
• Profit is positive, loss is negative.
• A loss is “added” as negative amount.
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Loose Ends:
Unsold Inventories and Used Goods
• Unsold Inventories = gross business inventory
investment.
– Estimate market values of unsold goods.
– Revise GDP with actual market values.
• Used Goods – GDP accounts for added value /
market value of the sale.
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Aggregate Fluctuations
• Economic growth occurs through cycles of
expansion and contraction.
• Fluctuations in output and income are
significant.
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Aggregate Fluctuations
• The Great Depression – 1929-1933
– Real GDP fell by 30%.
– 1933 GDP – 40% less than would have been
forecasted in 1929 (assume 3% growth).
– Unemployment
• 1929 – 3.2%
• 1933 – 24.9%
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Inflation
• 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?
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Inflation
• Adjusting GDP for Price Changes
– Real GDP
• The value of all final goods and services produced
in a year stated in unchanging prices.
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Inflation
• GDP Deflator
– Most comprehensive measure of prices.
• Consumer Price Index (CPI)
– Measures the price level of goods and services that
enter in the budgets of typical urban consumers.
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Inflation
• Inflation
– A fall in the value or purchasing power of money.
• Deflation
– A rise in the value or purchasing power of money.
• Disinflation
– A slowing down of the inflation rate.
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The Difficulties of Monetary Calculation
• Inflation, deflation and disinflation make
monetary calculations difficult.
– Expected consequences
– Financial activities
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Recession and Inflation Since 1960
• Recessions
– 1960, 1970, 1974, 1975, 1980, 1982, 1990, and 1991
• Inflation
– 1960’s – 2.5% / year
– 1970’s – 7.5% / year
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Recession and Inflation Since 1960
• Stagflation – a stagnating economy with
inflation.
• Inflation can occur during recession.
• 1974 – 1975
– Severe recession
– 10% inflation
• Recession and Inflation not simple opposites.
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What Causes Aggregate Fluctuations?
• Fluctuations may reflect the natural adjustment
of markets to external shocks.
• Fluctuations may be driven by relatively small
changes in one sector of the economy that
multiplies through many sectors.
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Appendix: Limitations of National
Income Accounting
• GDP
–
–
–
–
Only attempts to measure economic performance.
Ignores all non-market forms of production.
Ignores illegal production.
Ignores economic profits and losses.
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Appendix: The Dangers of Aggregation
• GDP – measure of overall economy
– Difficult task
– Imperfect
– Emphasis on statistical aggregates
• Aggregate variables
– Price level
– Unemployment rate
– Etc.
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Appendix: The Dangers of Aggregation
• Since 1980’s more macroeconomists
– Believe aggregate analysis is limited.
– Rediscovered the value of supply and demand
analysis.
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Once Over Lightly
• Gross Domestic Product – GDP
• GDP Measurements (3)
• Unsold Goods
• Market Values of Services
• Inflation is a decrease in purchasing power of
money
• Deflation is a sustained rise in purchasing power
of money.
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Once Over Lightly
• Disinflation is a slowing down of the rate of
inflation.
• GDP Deflator is a measure of inflation
• Economic growth
• Recession
• Aggregate Fluctuations
• Limitations of GDP measurement
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End of Chapter 14
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