192 Part 3 The Data of Macroeconomics

Summary
LO 7.1 Understand the We can break expenditures into four
importance of using the market
value of final goods and services to calculate GDP Consumption (C) measures spending on goods and categories:
and services to be consumed by private
explain why cach component of GDP is important. and families. Investment () inciudes any goods that
bought in order to produce other goods
individuals
Most goods and services go through several produc
tion steps and may pass through multiple firms before in the future. Government purchases (G) areand services
goods and
ending up in the hands of the consumer. However, services bought by all levels of gOvernment, for either
when calculating GDP, we should consider only the consumption or investment. Finally, net exports (NX) are
value of the final good or service, in order to avoid foreign spending on domestically produced goods and
double-counting. The value added by each step of services minus domestic spending on foreign-produced
the production process will be included in the price of the goods and services. The sum of these categories and
final product. the equivalence of income () and expenditure gives us the
The most commonly used variable for measuring the equation Y=C+I+G+ NX.
value of a national economy is gross domestic product, The income approach adds up the income earned
or GDP. GDP is the sum of the market values of all final by everyone in a country-including wages (earned hu
goods and services produced within a country in a given workers), interest (earned on capital investments), rental
period of time. The goods and services that count toward income (earned on land and property), and profits
GDP are defined in terms of the location of production, (earned by firms).
not the citizenship of the producer. The valueadded approach accounts for the value that
GDP is usually calculated on both annual and quarterly is added at each stage of production in the economy. This
(three-month) bases; only new goods and services being approach allows economists to investigate the contribution
produced within that time period are counted. Quarterly of each transaction in the economy to overall GDP. it also
GDP estimates are typically given as a seasonally adjusted solves the doublecounting problem; only part of the vaue
annual rate, which projects what annual GDP will be of each transaction is registered, and it does not register the
based on the current quarter's output if the economy total price of intermediate goods and services.
continues to folow expected seasonal patterns. Many countries use all three approaches to calculate
GDP so that policy-makers and researchers can get a full
LO7.2 Explain the equivalence of the expenditure and picture of economic activity.
income approaches tO valuing an economy. LO7.4 Explain the ifference between real and nominal
GDP.
Economists can think about the size of a national
econony in three different ways: how much is produced GDP is a function of both the quantity of goods and
(output), how much is spent (expenditure), and how much services produced (output) and their market value
income is earned (income). All three of these methods (prices); an increase in GDP can result from growth in
add up to the same thing. Total output is the value of the either or both components. To isolate the role of growing
things produced in an economy in dollar terms,which is output, we can control for price changes. Real GDP is
the same as the price for which those outputs sell, which calculated based on goods and services valued at constant
is the same as what people spent to buy those outputs. prices. Nominal GDP is calculated based on goods and
Therefore, the value of output is equal to expenditures. services valued at current prices.
Every transaction has both a buyer and a seller, so expen
ditures by one person translate directly into income for LO 7.5 Calculate the GDP deflator.
someone else; therefore, income equals expenditure. One way to measure price changes is by calculating th
GDP deflator. The GDP deflator summarizes the overall
LO 7.3 Explain the three approaches that are used increase in prices in an economy using the ratio between
to calculate GDP and summarize the categories of real and nominal GDP in a given year. If prices have
spending that are included in the expenditure approach. risen such that nominal GDP is now higher than real
GDP. the deflator will be greater than 100. If prices
The expenditure approach of calculating the size of have fallen such that nominal GDP is now lower thn
an economy involves adding up all spending on goods real GDP, the deflator wil1 be less than 100. The GDP
and services produced in an economy and subtracting deflator allows us to "deflate" nominal GDP by controling
spending on imports. for price changes.
 Macroeconomics.

193
Measuring GDP Chapter7

circular flow
services from companies. How does the and
expenditure
economies and model explain the equivalence of the
capita to compare
LO7.6 Use GDP per
annual growth rate. income methods of valuing an economy? [LO 7.2)
calculate the real GDP $4.41 million
population of 5. In 2022, the average baseball player earned
all
GDP divided by the
GDP percapita is total average income or productivity per year. Suppose that these baseball players spend
income on goods and services each year, and
us the of their
a country. It tells economy. To track changes in an incomes of
in the growth they save nothing. Argue why the sum of the
per person calculate the real GDP
economy over time, we can GDP from all baseball players rnust equal the sum of expenditures
measured as the percent change in real made by the baseball players. [LO 7.2]
rate, typically annually or quarterly
one time period to the next, economy shrinks, the growth 6. Determine whether each of the following counts as
the
at an annual rate. When used consurmption, investment, government purchases, net
is one of the major indicators
rate is negative and economy is in a recession exports, or none of these, under the expenditure approach
to determine whether the to calculating GDP. Explain your answer. (LO 7.3]
or depression.
a. The construction of a courthouse.
to GDP, including
LO 7.7 Discuss some limitations production, the
b. A taxicab ride.
its measurement of well-being, home degradation. C. The purchase of a taxicab by a taxicab company.
underground economy, and environmental
d. A student buying a textbook.
standard of e. The trading of municipal bonds (a type
GDP is a rough measure of the average
the
living in a country, but it does not tell us about of financial investment offered by city or
distribution of wealth. Higher GDP is often associated with state governments).
other indicators of higher well-being, such as health, f. A company's purchase of foreign minerals.
education, and life satisfaction, but does not guarantee
the
those things. 7. If car companies produce a lot of cars this year but hoid
Three other important measures of the economy are new models back in warehouses until they reiease them in
not included in GDP by design: home production (goods the new-model year, will this year's GDP be higher, lower.,
and services that are produced and consumed within a or the same as it would have been if the cars had been
household), the underground economy (illegal transac sold right away? Why? Does the choice to reserve the cars
tions, or legal transactions that simply aren't reported for a year change which category of expenditures they fall
to the government), and externalities (such as pollution) under? [LO 7.3]
that are not fully accounted for in regular production or 8. The value-added method involves taking the cost of
consumption measures. intermediate outputs (i.e., outputs that will in turn be
used in the production of another good) and subtract
ing that cost from the value of the good being produced.
In this way, only the value that is added at each step
Review Questions (the sale value minus the cost of the goods that went
1. U.S. car dealers sell both used cars and newW cars each into producing it) is summed up. Explain why this
year. However, only the sales of the new cars count method gives us the same result as the standard mnethod
toward GDP. Why does the sale of used cars not count? of counting only the value of final goods and services.
[LO 7.1] [LO 7.3]
2. There is an old saying, "You can't compare apples and 9. Imagine a painter is trying to determine the value she
oranges." When economists calculate GDP, are they adds when she paints a picture. Assume that after spend
able to compare apples and oranges? Explain. LO 7.1] ing $200 on materials, she sells one copy of ber painting
3. When Americans buy goods produced in Canada, for $500. She then spends $50 to make 10 copies of her
Canadians earn income from American expenditures. painting, each of which sells for $100. What is the value
Does the value of this Canadian output and American added of her painting? What if a company then spends
expenditure get counted under the GDP of Canada or $10per copy to sell 100 more copies, each for $50? What is
the United States? Why? [LO 7.2] the value the painter adds then? Ifit's unknown how many
copies the painting will sell in the future, can we today
4. Economists sometimes describe the economy as having determine the value added? Why or why not? [LO 7.3]
a "circular flow." In the most basic form of the circu
lar flow model, companies hire workers and pay them 10. In a press conference, the president of a small country
wages. Workers then use these wages to buy goods and displays a chart showing that GDP has risen by
 Mecroeconomics
30

Part 3 The Data of Macroeconomics

194
TABLE 7P-1
years. He argues that
10 percent every year for five
of his economic policy. Fabric Sewing and
this growth shows the brilliance GDP numbers.
Cotton
However, his chart Uses nominal farmer ($) maker ($) printing (S)
this chart? If you were a
What might be wrong with questions could 1.10 3.50
conference, what Inputs
reporter at the press country's
more accurate picture of the
you ask to get a Value of 1.10 3.50 18.00
cconomic growth? [LO .4] output
percent frotn
GDP deflator grew by 10
11. Suppose that the inflation rate this year a. What is the total contribution
of this
year to this year. That is, the happened
last what does this mnean shirt to GDP, using the standard expenditure
Was 10percent. In words, does this inflation rate imply method?
What
in the economy? 7.5] summing
about the growth rate in realGDP? (LO b. If we use a value-added method (i.e.,
the aver the value added by producers at each step of the
researcher wants to examine of
12. An inexperienced countries. In order to do production process, equal to the value
age standard ofliving in two inputs), what is the
GDPs of those two
countries. What output minus the price of
so, he compares the does not lead to an contribution of this shirt to GDP?
are two reasons why
this comparison
standards of of both inter
accurate measure of the countries'
average c. If we mistakenly added the price
mediate and final outputs without adjusting for
living? [LO 7.4, 7.6] that this shirt
the International Monetary value added, what would we find
13. In 2022, according to 6th-highest nominal GDP, contributes to GDP? By how much does
this
Fund, India had the world's overestimate the true contribution?
GDP per capita, and the
the 139th-highest nominal What does each of income support to many
7th-highest real GDP growth rate. > 3. The U.S. government gives
the Indian economny and does each of the
these indicators tell us about families living in poverty. How
life in other countries? contribute to GDP?
how life in India compares to following aspects of this policy
[LO 7.6] [LO 7.2]
of
growing country. It has high levels a. Does this government's
expenditure on income
14. China is a rapidly low levels of envi If so, in which
bureaucracy and business regulation, support count as part of GDP?
tradition of entre fal1?
ronmental regulation, and a strong category of expenditure does it
why official GDP
preneurship. Discuss several reasons portions of b. When the families buy groceries
with the money
significant
estimates in China might miss they've received, does this expenditure count
activity. [LO 7.71 category does
the country's economic as part of GDP?If so, in which
15. Suppose a college student
is texting while driving and it fall?
$2,000 worth of damage houses with the money
gets into a car accident causing C. If the families buy new
repairs her car, does GDP?
part of
to her car. Assuming the student accident? What they've received, does this count as
GDP rise, fall, or stay constant with this If so, in which category does it fall?
GDP as a measure
does yOur answer suggest about using
of well-being? [LO 7.7] information about each economy,
4. Given the following
or determine that it
either calculate the missing variable
Problems and Applications cannot be calculated. [LO 7.2, 7.3]
billion,
the a. IfC = $20.1 billion, I=$3.5
1. Supp0se a gold miner finds a gold nugget and sells -$1 billion, what
nugget to a mining company for $500. The mining com G= $5.2 billion, and NX=
is total income?
pany melts down the gold, purifies it, and sells it to a $0.3 trillion,
jewelry maker for $1,000. The jewelry maker fashions the b. If total incomne is $1 trillion, G=
gold into a necklace that it sells to a department store for and C = $0.5 trillion, what is I?
$1,500. Finally, the departmnent store sells the necklace C. If total expenditure is $675 billion,
to a customer for $2,000. How much has GDP increased C=$433 bilion, I= $10S billion, and
as a result of these transactions? [LO 7.1,7.3] G=$7S billion, what is NX? How much are
2. Table 7P-1 shows the price of inputs and the price of out exports? How much are imports?
puts at each step in the production process of making a
shirt. Assume that each of these steps takes place within 5. Using Table 7P-2, calculate the following. [LO 7.2,
the country. (LO 7.1, 7.3] 7.3]
 Macroeconomics: Improve Your World. 2024 Release 31

Measuring GDP m Chapter 7 195

TABLE 7P-2 TABLE 7P-3

Sector Value (millions)

Activity Total value
Consumption $770,000 (thousands of $)
Investment $165,000 Families buy groceries 600

Government spending $220,000 Electronics company sells HD projectors

to households 100
Net exports -$55,000
Personal trainer gives Zumba class 5
Population 50
Custard stand sells pistachio ice cream 2

a. Total gross domestic product and GDP Police department buys new cars 500
per person.
Mayor leads creation of new education
b. Consumption, investment, government budget 300
purchases, and net exports, each as a percentage
of total GDP. Elevator construction company builds
new factory 600
c. Consumption, investment, government
purchases, and net exports per person. Local businessperson purchases corn
from Mexico 400
6. Determine which category each of the following
economic activities falls under: consumption (C), Sports-gear company sells hockey
investment (D), government purchases (G), net exports gloves to Canadian team 200
(NX), or not included in GDP. [LO 7.3]
Bike store sells used carbon-fiber bikes 200
a. The mayor of Chicago authorizes the construction
of a new stadium using public funds. Local stockbroker executes trades for
clients 2,000
b. A student pays rent on her apartment.
C. Parents pay college tuition for their son. a. Consumption.
d. Someone buys a new Hyundai car produced in b. Investment.
South Korea. C. Government purchases.
e. Someone buys aused Hyundai car. d. Net exports.
e. GDP.
f. Someone buys anew General Motors car
produced in the United States. 8. During the 2008 recession sparked by financial crisis,
the U.S. economy suffered tremendously. Suppose
g. A family buys a house in a newly constructed
that, due to the recession, the U.S. GDP dropped from
housing development. $14 trillion to $12.5 trillion. This decline in GDP was
h. The U.S. Army pays its soldiers. due to a drop in consumption of $1trillion and a drop in
i. A Brazilian driver buys a Ford car produced investment of $500 billion. The U.S. government, under
in the United States. the current president, responded to this recession by
/. The Department of Motor Vehicles buys a new increasing government purchases. [LO 7.3]
machine for printing drivers licenses. a. Suppose that government spending had no
k. An apple picked in Washington in October impact on consumption, investment,or net
is bought at a grocery store in Mississippi exports. If the current presidential administration
in December. wanted to bring GDP back up to $14 trillion, how
much would government spending have to rise?
1. Hewlett-Packard produces a computer and
sends it to a warehouse in another state for sale b. Many economists believe that an increase in
next year. government spending doesn't just directly increase
GDP, but that it also leads to an increase in
7. Table 7P-3 shows economic activity for a very tiny coun consumption. If government spending rises by
try. Using the expenditure approach, determine the fol $1 trillion, how much would consumption have to
lowing. [LO 7.3] rise in order to bring GDP back to $14 trillion?
 32 Macroeconomles

Part 3 The Data of Macroeconomics

196
TABLE 7P-6
9. Assume Table 7P4 summarizes the income of Paraguay.
LO 7.3] Goods Quantitles produced Prices ($)
Apples 5 2.00
TABLE 7P-4
Bananas 10 1.00
Value (billions of $)
Category 20 1.50
Carrots
8.3
Wages
0.7 a. Calculate thc GDP of the United States in this
interest
three-goods version of its economy.
21.0
Total business expenditures b. Suppose thata drought hits the state of Washing.
ton. This drought causes the quantity of apples
Total business revenues 30.0 produced to fall to 2. Assuming that all prices
remain constant, calculate the new U.S. GDP.
quantities
a. Calculate profits. C. Assume, once again, that the
the produced and the prices of the three goods are
b. Calculate the GDP of Paraguay using
income approach. as listed in Table 7P6. Now, given this situation.
is
to use the value carrot sellers decide that the price of carrots
C. What would GDP be if you were too low, so they agree to raise the
price. What
added approach? must be the new price of carrots if the
U.S.
use the
d. What would GDP be if you were to GDP is $60?
expenditure approach? two goods:
12. Suppose that the British economy produces and the
about the cost of inputs produced
10. Table 7P-5 provides information production of a road laptops and books. The quantity
are shown in
and the value of output for the prices of these items for 2023 and 2024
stages of production.
bike. Note there are four different Table 7P-7. [LO 7.4, 7.5]
[LO 7.3]
supplier of the
a. What value isadded by the TABLE 7P-7
raw materials?
tire maker? Quantities Price ($)
b. What value is added by the Year produced
c. What value is added by the maker of the frame
Laptops =50 Laptops = 200
and conmponents?
bike mechanic? 2023 Books = 1,000 Books =?
d. What value is added by the
bike store?
e. What value is added by the Laptops= 100 Laptops =$150
contribution of the bike to GDP?
f. What is the total 2024 Books =? Books = 10
produces only three
11. Imagine that the United States
goods: apples, bananas, and carrots. The quantities base year was 2023, so that
goods are listed in a. Let's assume that the GDP in 2023.
produced and the prices of the three real GDP in 2023 equals
nominal
Table 7P6. [LO 7.4]

TABLE 7P-5
Construction Sale by the retailer
Raw materials Manufacturing
Tire maker sells tires for $30 each " Bike mechanic puts " Retailer sells the bike
Rubber for one tire ($20) everything together and for $500
Aluminum for the frame ($80) Frame maker sells bike frame and
components for a total of $250 sells the bike for $350
Other component
materials ($70)
 Macroeconomics: Improve Your World, 2024 Release 33

Measuring GDP Chapter 7 197

TABLE 7P-8

Quantity of Price of Quantity of Price of Nominal Real GDP GDP

Year Inflation
oranges orange ($) beach balls beach ball ($) GDP (S) ($) deflator rate (%)
2022 500 1.00 850 5.00

2023 600 1.50 900 7.50

2024 750 1.65 1,000 8.25

TABLE 7P-9

2021
2022
Nominal GDP RealGDP Nominal GDP
Country Real GDP
(billions of $) (billions of $) Population Population
(billions of $) (billions of $)
Artemis 554.10 458.25 44,044,811 625.92 446.731 44,494,502
Gaia 332.48 271.710 96,442,593 253.25 286.149 98,423,595
Hermes 3,479.23 3,883.870 82,657,002 4,211.64 3,939.23 82,927,922
Pan 42.78 50.620 29,121,471 53.79 29,767,108
Zeus 18,624.95 17,348.63 325,147,121 20,412.87 17,844.28 327,167,434

If the real GDP in Britain was $ 15,000 in 2023, 15. Table 7P-10 describes the real GDP and
what was the price of books? population of a
fictional country in 2023 and 2024. [LO 7.6]
b. Using your answer from part a, if the growth
rate in nominal GDP was 10 percent, how many TABLE 7P-10
books must have been produced in 2024?
Year Real GDP Population
C. Using your answers from parts a and b, what is (billions of $)
the real GDP in 2024? What was the growth rate
(millions)
in real GDP between 2023 and 20242 2023 10 1.0
13. Based on Table 7P-8, calculate nominal GDP, real GDP, 2024 12 1.1
the GDP deflator, and the inflation rate in each ycar,
and fill in the missing parts of the table. Use 2022 as the a. What is the real GDP per capita in 2023
base year. [LO 7.4, 7.5) and 2024?
14. Based on Table 7P-9, calculate nominal GDP per cap b. What is the growth rate in real GDP?
ita in 2021 and 2022, and the real GDP growth rate c. What is the growth rate in population?
between the two years. Which countries look like they d. What is the growth rate in real GDP
experienced recession in 2021-2022? [LO 7.6] per capita?
34 Macroeconomles

198 Part ! Ihe bata of Macoeconomtes

TABLE 7p11

Country C($) I($) G($) Net exports ($)

9,800,000,000 230,000,000 950,000,000
Bohemia -120,000,000
450,000,000 78,000,000 100,000,000
Silesia 13,000,000
Bavaria 2,125,000,000 319,000,000 597,000,000
134,000,000
2,750,000,000 75,000,000 1,320,000,000
Saxony -45,000,000
6,225,000,000 567,000,000 1,435,000,000
Ottoman Empire 1,000,000

Country Population Home production Underground Environmental

($) economy ($) externalities ($)
Bohemia 1,200,000 1,250,000,000 5,770,000,000 -1,560,000,000
Silesia 160,000 75,000,000 128,000,000 -45,000,000
Bavaria 425,000 386,000,000 1,450,000,000 -523,000,000
Saxony 760,000 146,000,000 250,000,000 -820,000,000
Ottoman Empire 800,000 432,000,000 654,000,000 -396,300,000
16. Table 7P-11 shows fictional data on population and 3. [Link]
expenditures in five countries, as well as the value of home china-gdp-estimate-shows-cconomy grewat-least44in-2022
production, the underground economy, and environmental 4. https:// [Link]/series/GCE#0, https://
externalities in each. [LO 7.6, 7.7]
a. Calculate GDP and GDP per capita in each
[Link]/series/GDP#0
5. [Link]
country. fourth-quarter-and-year-2022-advance-estimate#: text
b. Calculate the size of home production, the under Current-dollar%20GDP%20increased %209.2, (tables%20
ground economy, and environmental externalities 1%20and%203)
in each country as a percentage of GDP. 6. To find out more about the chain-weighted index, see this
c. Calculate total and per capita "GDP-plus" in explanation from the Federal Reserve: [Link]
each country by including the value of home publications/economics/letter/ 2002/[Link]
production, the underground economy, and 7. [Link]
environmental externalities. WEO/USA/HKG
d. Rank countries by total and per capita GDP, 8. World Bank World Development Indicators. http:// databank.
and again by total and per capita "GDP-plus." [Link]/data/[Link]?source-2&[Link].
Compare the two lists. Are the biggest and the
smallest economies the same or different? [Link]#advancodDownloadOptions.
9. [Link]
17. Suppose a parent was earning $20,000 per year working 10. Below certain thresholds, some carnings from sclfemployment
at a local firm. The parent then decides to quit his don't need to be reported, so failure to report isn't necessarily
job in
order to care for his child, who was being against the tax laws. In any case, if they're not reported, those
watched by a
babysitter for $10,000 per year. Does GDP rise, fall, or activities are not captured in GDP calculations.
stay constant with this action, and how much does GDP 11. htps://[Link]/terms/u/underground
change (if at all)? [LO 7.7]
[Link]#::text-While%2Oestimates%20vary%2C%20
Endnotes
some%20put
municipality ,some%20cases%2C%20municipality%20
1. [Link] [Link]/data/[Link]?source-28& 12. https:llopenknowledge. [Link]/bitstream/handle/

country-CHN&series-&period=, [Link] 10986/3928/[Link]?sequence-1

13. Ibid.
Opinion/201510/t20151016_800040481.htm, and [Link] 14. [Link] 26china.
[Link]/2010/08/ 16/business/global/[Link]?_r-0,
2. https:/[Link]/poverty html?pagewanted-2
15. https:/[Link]/countries/groups/imf