Macroeconomics

Ninth Edition

Chapter 8
GDP: Measuring Total
Production and Income

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Chapter Outline
8.1 Gross Domestic Product Measures Total Production
8.2 Does GDP Measure What We Want It to Measure?
8.3 Real GDP versus Nominal GDP
8.4 Other Measures of Total Production and Total Income

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Is FedEx the Canary in the Economic
Coal Mine?
When the U.S. economy is
growing, the demand for services
from companies like FedEx
increases.
By mid-2023, the amount of freight
hauled by trains and trucks was
sharply lower than during late
2022, and the demand for diesel
fuel was down, prompting WSJ
headlines like these:
• “Trucking Recession Flashes
Warning for the U.S. Economy”
• “Sliding Diesel Prices Signal
Warning for U.S. Economy.”

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Microeconomics and Macroeconomics

Microeconomics is the study of how households and

firms make choices, how they interact in markets, and
how the government attempts to influence their choices.

In contrast, macroeconomics is the study of the

economy as a whole, including topics such as inflation,
unemployment, and economic growth.

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Some Important Macroeconomic Terms

Business cycle: Alternating periods of economic

expansion and economic recession.
Expansion: The period of a business cycle during which
the total production and total employment are increasing.
Recession: The period of a business cycle during which
total production and total employment are decreasing.
Economic growth: The ability of an economy to produce
increasing quantities of goods and services.
Inflation rate: The percentage increase in the price level
from one year to the next.
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Goal of This Chapter
Over the coming chapters, we will explore many aspects
of the economy, including how all the elements on the
previous slides relate to one another.

For this chapter, we have a less lofty goal: to figure out

how to measure the total output of an economy.

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8.1 Gross Domestic Product Measures
Total Production

Gross domestic product (GDP): The market value of all

final goods and services produced in a country during a
period of time, typically one year.

We will examine each of the parts of this definition in turn.

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“Market Value”
Gross domestic product: The market value of all final
goods and services produced in a country during a period
of time, typically one year.

Market value refers to the price that each good or service

is sold for.

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“Final Goods and Services”
Gross domestic product: The market value of all final goods
and services produced in a country during a period of time,
typically one year.

A final good or service is a good or service purchased by a

final user. These are what are used to calculate GDP.
• Why? Intermediate goods and services are inputs into
another good or service, such as a tire on a truck. If we
counted these goods and services at each transaction, we
would end up double counting.

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“Produced in a Country”
Gross domestic product: The market value of all final
goods and services produced in a country during a
period of time, typically one year.

GDP measures output produced within a country’s

borders. The ownership of that production is irrelevant
• For example, production by a U.S. firm or a foreign firm
counts equally, as long as the production takes place in
the United States
• Production overseas does not count, even if it is
performed by a U.S. firm.

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“During a Period of Time”
Gross domestic product: The market value of all final
goods and services produced in a country during a period
of time, typically one year.
To measure total output in a given year, we measure the
goods and services produced only in that given year.
• So, GDP counts only new goods and services. Used
items were previously produced and counted, so don’t
need to be counted again.

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Production and Income
There are two main conceptual ways to measure the total
economic activity in an economy:
(1) Total production or
(2) Total income.

Each is valid as total production (what is sold) = total

income
In this class, we will use the expenditure method which
measures total production (sales)

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Figure 8.1 The Circular Flow and the
Measurement of GDP (1 of 4)
To measure overall economic
activity, we could measure the
amount of money that
households spend on goods
and services.
Or we could measure income
to households.

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Figure 8.1 The Circular Flow and the
Measurement of GDP (2 of 4)
How does the government affect
economic activity?
• It takes in taxes from households and
firms.
• It uses those taxes to buy goods and
services, and to make transfer
payments—payments by the
government to households for which
the government does not receive a
new good or service in return.

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Figure 8.1 The Circular Flow and the
Measurement of GDP (3 of 4)
Some economic activity
takes place between
households, firms, and the
rest of the world.
• Households buy goods
and services from firms in
other countries; these are
known as imports.
• Firms sell goods and
services to households in
other countries; these are
known as exports.

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Figure 8.1 The Circular Flow and the
Measurement of GDP (4 of 4)
Finally, there are firms that
deal specifically in flows of
money; we label these
firms the financial system.
• Households elect not to
spend some of their
income and instead save
it with financial system
firms like banks.
• These financial system
firms lend money to
other firms and the
government.
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Follow the Spending to Measure GDP
To measure GDP, the Bureau of Economic Analysis (BEA) in the
Department of Commerce measures four major categories of
expenditures:
• Personal consumption expenditures, or consumption (C)
• Gross private domestic investment, or investment (I)
• Government consumption and gross investment, or government
purchases (G)
• Net exports of goods and services, or net exports (NX)

GDP can be expressed as the sum of these:

Y = C + I + G + NX
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Consumption
Y = C + I + G + NX

Consumption is spending by households on goods and

services, not including spending on new houses (which are
counted instead in investment).
In BEA statistics, consumption is further divided into expenditure
on:
• Services
• Nondurable goods
• Durable goods

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Investment
Y = C + I + G + NX
Investment is spending by firms on new factories, office
buildings, machinery, and additions to inventories, plus
spending by households and firms on new houses.

The BEA measures the following categories of investment:

• Business fixed investment
• Residential investment
• Changes in business inventories

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Government Purchases
Y = C + I + G + NX

Government purchases are spending by federal, state,

and local governments on goods and services.

This includes…
• Government consumption
• Government investment
This does not include transfer payments, since those do
not result in immediate production of new goods and
services.

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Net Exports
Y = C + I + G + NX
Net exports are exports minus imports.

Since we want to count domestic production (production in

the United States), we add up the value of the goods and
services sold to foreigners and subtract the value of the
goods and services sold to Americans by foreigners.

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Figure 8.2 Components of GDP in 2022

Consumption is the largest component of GDP; within that, services

are the largest component—almost half of GDP.
American net exports are negative, since the value of our imports
exceeds the value of our exports.
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Table 8.1 Calculating Value Added
Firm Value of Product Value Added Blank

Value added by cotton

Cotton farmer Value of raw cotton = $1 = $1
farmer
Value of raw cotton woven into Value added by textile
Textile mill = $2
cotton fabric = $3 mill = ($3 − $1)
equals left parentheses $3 minus $1 right parentheses

Value of cotton fabric made into Value added by shirt

Shirt company = $12
a shirt = $15 company = ($15 − $3) equals left parentheses $15 minus $3 right parentheses

Value of shirt for sale on Value added by

L.L.Bean = $20
L.L.Bean’s website = $35 L.L.Bean = ($35 − $15) equals left parentheses $35 minus $15 right parentheses

Blank

Total value added Blank

= $35

An alternative method to measure GDP is to measure the value added: The

market value a firm adds to a product.
The final selling price of a product must equal the sum of the values
added to the product at each stage of production.
The table illustrates this method for a shirt sold on L.L.Bean’s website.

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8.2 Does GDP Measure What We Want It
to Measure?

GDP has shortcomings as both a

• Measure of total production and a
• Measure of well-being.

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Shortcomings of GDP as a Measure of
Total Production

Two important types of production are omitted from the BE

A’s measurement of GDP:

Household production such as childcare, cleaning, and

cooking is not typically paid for with money.

Underground economy: Buying and selling of goods and

services that is concealed from the government to avoid
taxes or regulations, or because the goods and services
are illegal.
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How Important Are These Shortcomings?
If we are comparing GDP from year to year, the size of
household production and the underground economy is
probably about the same from year to year, so GDP growth
is a reasonable measure of the growth in total production.

However over long periods of time, these shortcomings

might be more serious.

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Apply the Concept: Underground
Economies in Developing Countries (1 of 2)
In developing countries, the
underground economy is also called
the informal sector, as opposed to
the formal sector, in which output of
goods and services is measured.
• In many developing countries, the
informal sector is very large; often
above 50 percent of total output.

Economists studying economic

development say this often reflects
poor government policies: high
taxes and regulations and low
confidence in the security of private
property from government seizure.

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Apply the Concept: Underground
Economies in Developing Countries (2 of 2)
Underground Economy as
Because firms in the informal Country
Percentage of GDP
sector are operating illegally, they
Bolivia 63%
tend to be smaller and have less
Georgia 62
capital than firms that are
Nigeria 57
operating legally.
Russia 40
The entrepreneurs who start firms
Brazil 37
in the informal sector may be
Poland 24
afraid the government could
India 24
someday close or confiscate their
firms. China 14
United Kingdom 11
Therefore, the entrepreneurs limit
United States 8
their investments in these firms,
reducing growth rates in countries Switzerland 6

with large informal sectors.

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Shortcomings of GDP as a Measure of
Well-Being

GDP per capita (i.e., GDP divided by population) is often

used to represent differences in standards of living from
country to country. However, even if it accurately measured
total production, it would not reflect:
• The value of leisure
• Pollution and other negative effects of production
• Crime and other social problems
• The distribution of income

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8.3 Real GDP versus Nominal GDP
Suppose GDP increases; is the increase in GDP due to
production increasing or due to prices increasing?

To separate these effects, the BEA gives two calculations:

• Nominal GDP: the value of final goods and services
evaluated at current-year prices
• Real GDP: the value of final goods and services
evaluated at base-year prices.

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Calculating Real GDP: An Example
2017 2017 2025 2025
Product
Quantity Price Quantity Price
Eye examinations 80 $40 100 $50
Pizzas 90 11 80 10
Shoes 15 90 20 100

The table shows output and prices in 2017 and 2025.

• Calculating the total value of output in 2017 gives:

$3,200 + $990 + $1,350 = $5,540.

To calculate real GDP in 2025, we use the prices from 2017.

• This gives real 2025 GDP in 2017 dollars of $6,680.
• Compare this to nominal GDP in 2025 of $7,800.
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Figure 8.3 Nominal GDP and Real GDP,
1995–2022

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Apply the Concept: The Unusual Movements in
Real GDP during the Covid-19 Pandemic (1 of 2)

The figure shows quarterly changes in real GDP between 1999 and 2022
Real GDP in the second quarter of 2020 declined by 29.9 percent; the next
quarter saw a 35.3 percent increase, by far the largest increase in U.S. history.
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Apply the Concept: The Unusual Movements in
Real GDP during the Covid-19 Pandemic (2 of 2)

This figure shows the (annualized) changes in each of the components of GDP in the
second and third quarters of 2020.

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The GDP Deflator
Economists and policymakers are interested in the price level: A
measure of the average prices of goods and services in the economy.
• One way to measure the price level is by using the GDP deflator: a
measure of the price level, calculated by dividing nominal GDP by
real GDP and multiplying by 100:

Nominal GDP
GDP deflator =  100
Real GDP

Since nominal and real GDP will be the same in the base year, the GDP
deflator will be 100 in the base year.

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 Calculating GDP Deflator: An Example

Blank

2021 2022
Nominal GDP $23,594 billion $25,744 billion
Real GDP $21,408 billion $21,822 billion

Formula Applied to 2021 Applied to 2022

 Nominal GDP   $23,594billion   $25,744billion 

GDP deflator =    100
G D P deflator equals Nominal G D P over Real G D P all times 100.

   100 = 110.2
21,433 billion dollars over 19,092 billion dollars all times 100 equals 112.3

   100 = 118.0
20,933 billion dollars over 18,423 billion dollars all times 100 equals 113.6

 Real GDP   $21,408billion   $21,822billion 

The first table gives nominal and real GDP for 2021 and 2022.
We can use this to calculate the GDP deflator in each year.
• The GDP deflator increased from 110.2 to 118.0:

 118.0 − 110.2 
   100 = 7.1%
 110.2 
So, we can say the price level rose by 7.1 percent over this period: this inflation rate was
the highest the United States had experienced since 1981.
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8.4 Other Measures of Total Production
and Total Income
Each quarter, the BEA publishes the National Income and Product
Accounts (NIPA) tables. These include GDP computations but also:

• Gross national product (GNP): Production performed by citizens of a

nation, including overseas production.

• National income: GDP minus the consumption of fixed capital; that is, G
DP minus depreciation.

• Personal income: Income received by households; includes transfer

payments but excludes firms’ retained earnings.

• Disposable personal income: Personal income minus personal tax

payments; this measures the amount that households are able to spend or
save.

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Figure 8.4 Measures of Total Production
and Total Income, 2022
Measure Billions of Dollars

GDP $25,744

GNP 25,926

National income 21,678

Personal income 21,841

Disposable
18,703
personal income

The table and graph show the various measures of the national income accounts for the
United States in 2022.
• National income must be smaller than GDP, since it is just GDP minus depreciation.
• Similarly, disposable personal income must be less than personal income, since it is
just personal income minus taxes.

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Figure 8.5 The Division of Income, 2020

All production must be rewarded with income; so, in theory, we could count
either production or income in order to calculate GDP.
• In practice, data limitations make us unlikely to come up with the same
number; there will always be some statistical discrepancy.

The figure illustrates the division of income as measured by the BEA in 2022.

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Apply the Concept: Was There a
Recession during 2022? GDP v s GDI (1 of 2) ersu

GDP measures output by focusing on production; we also measure from the income
side: GDI, or Gross Domestic Income.

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Apply the Concept: Was There a
Recession during 2022? GDP v s GDI (2 of 2) ersu

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