Lecture Macroeconomics (9/e): Chapter 7 - David C. Colander

Chapter 7 - Measuring the aggregate economy. After reading this chapter, you should be able to: Calculate GDP using the expenditures and, value added approaches; calculate aggregate income and explain how it relates to aggregate production; distinguish real from nominal concepts; describe the limitations of using GDP and national income accounting.

Measuring the Aggregate Economy

The government is very keen on amazing  statistics…They collect them, add them, raise  them to the nth power, take the cube root and  prepare wonderful diagrams. But you must  never forget that every one of these figures  comes in the first instance from the village  watchman, who just puts down what he damn  pleases.

— Sir Josiah Stamp

(head of Britain’s revenue  department in the late 19th  century)

Chapter Goals

Ø Calculate GDP using the expenditures and value added

approaches

Ø Distinguish real from nominal concepts

Ø Calculate aggregate income and explain how it relates

to aggregate production

Ø Describe the limitations of using GDP and national

income accounting

Aggregate Accounting

is a set of rules and definitions for measuring economic

activity in the economy as a whole

Ø Aggregate accounting is a way of measuring total, or

aggregate production, expenditures, and income

of all final goods and services produced in an economy in

Ø GDP is divided into four expenditure categories:

1 Consumption (C) is spending by households on goods and services

2 Investment (I) is spending for the purpose of additional production

3 Government spending (G) is goods and services that government

buys

4 Net exports is spending on exports (X) minus spending on imports

(M)

GDP = Consumption

+ Investment

+ Government spending

+ Net exports

GDP = C + I + G + (X-M)

GDP Measures Final Output

Ø GDP does not measure total transactions in the economy

Ø It counts final output, but not intermediate goods

final use

the production of some other product

Ø Counting the sale of both final and intermediate goods

would result in double counting

Two Ways of Eliminating Intermediate Goods

Ø Calculate only final output

• A firm would report how much it sold to consumers and how much it sold to producers (intermediate goods)

Ø Follow the value added approach

• Value added is the increase in value that a firm contributes to a product or service

• It is calculated by subtracting intermediate goods (the cost of materials that a firm uses to produce

a good or service) from the value of its sales

Gross and Net Concepts

Ø Net domestic product is GDP adjusted for depreciation,

producing that year’s GDP

• NDP measures output available for purchase

NDP = C + I + G + (X-M) – depreciation

Ø Net Investment is gross investment minus depreciation

National and Domestic Concepts

Ø GDP is the total value of all final goods and services

produced in an economy in a one-year period

• GDP is output produced within a country’s borders

output of citizens and businesses of an economy in one

year

• GNP is output produced by a country’s citizens

• GNP = GDP + Net foreign factor income

domestic factor sources minus foreign factor income

earned domestically

Calculating Aggregate Income

Ø Aggregate income is the total income earned by citizens

and businesses in a country in a year

Ø Aggregate income consists of:

• Employee compensation

• Interest

• Profits

Ø Aggregate income = Employee compensation + Rents

Equality of Aggregate Income and Aggregate

Production

Ø Whenever a good or service is produced (output),

somebody receives an income for producing it

Aggregate Income ≡ Aggregate Production

Ø Profit is a residual that makes the income side equal the

expenditures side

Ø This aggregate identity allows us to calculate GDP either by adding up all values of final outputs (C, I, G, net exports) or

by adding up the values of all earnings or income

Ø As globalization has expanded, net exports have become

increasingly important

Real GDP, Nominal GDP and Price Indices

Ø Nominal GDP is GDP calculated at current prices

Ø The GDP deflator is a price index

Real GDP = Nominal GDP

Real GDP X 100

Ø Real GDP is nominal GDP adjusted for inflation

Other Real and Nominal Distinctions

Ø Nominal interest rate is the rate you pay or receive to

borrow or lend money

Ø Real interest rate is the nominal interest rate adjusted for inflation

Real interest rate = Nominal interest rate – Inflation rate

Other Real and Nominal Distinctions

Ø Real wealth is the value of the productive capacity

of the assets of an economy measured by the goods

and services it can produce now and in the future

measured in current prices

Ø Asset price inflation is a rise in the price of assets

unrelated to increases in their productive capacity

Some Limitations of Aggregate Accounting

Ø GDP measures economic activity, not welfare

• GDP does not measure happiness, nor does it measure economic welfare

Ø Measurement problems exist

• Measurements of inflation can involve significant measurement errors

Ø Subcategories are often interdependent

• For example, the line between consumption and investment may be unclear

Some Limitations of Aggregate Accounting

Ø Measurement is necessary, and the GDP measurements

and categories have made it possible to think and talk

about the aggregate economy

of adjustments to GDP to better measure the progress of

society rather than just economic activity

• The GPI includes social goals such as pollution

reduction, education, and health

Chapter Summary

Ø Aggregate accounting is a set of rules and definitions for

measuring economic activity in the aggregate economy

Ø GDP is the total market value of all final goods and

services produced in an economy in one year

Ø Aggregate income = Compensation of employees

+ Rent + Interest + Profit

Ø Aggregate income equals aggregate production because

whenever a good is produced, somebody receives

income for producing it, and profit is key to that equality

Ø GDP = C + I + G + (X - M)

Chapter Summary

Ø To compare income over time, we must adjust for

price-level changes and obtain “real” measures

Ø Real interest rate = Nominal interest rate – Inflation

Ø GDP has its problems:

• It is difficult to compare across countries

• GDP does not measure economic welfare

• It does not include transactions in the underground