Macroeconomics – GDP and CPI

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What does GDP Measure?
Total Output of Goods and Services.
Total Income of everyone in the economy.
Total expenditure on the economy’s output of goods and services.
Measure of a society’s economic well-being.
For economy as a whole, income must equal expenditure.
Definition of GDP
Market value of all final goods and services produced within a country in a given period of time.
GDP is Market Value
Convert all kinds to one number.
Exclude: housework, vegetables in backyard, etc
GDP is Final
Excludes intermediate goods
Ex ice cream cone = $3, sugar used = .50.
GDP increase by $3. Avoid double counting.
GDP is produced currently
Only affects GDP of current time period. Buying cars made in 2010 in 2014 do not affect 2014 GDP.
GDP is within a country
Regardless of nationality of producer.
Ex Honda builds a factory in US – US GDP
Consumption – Spending by household goods and services.
– Purchases of NEW HOUSING are EXCLUDED (Residential investment)
Investment – Purchase of capital goods that will be used in the future to produce more goods and services.
Government Purchases – Spending on goods and services by state, local, and federal governments.
Ex National defense, roads, schools
*Exclude social security and other welfare programs
Net Exports. NX = Exports minus imports
Equation for GDP
Y = C + I + G + NX
Business Investment
Capital equipment and structures
Inventory Investment
Produced but not sold yet
Residential Investment
Different from personal investment like buying stock
National Income Account Identity
Y = C + I + G + Ex – Im
NX < 0
Imports > Exports: Trade Deficit
NX > 0
Imports < Exports: Trade Surplus
NX = 0
Imports = Exports: Balanced Trade
Three Measures of GDP
GDP Deflator
Nominal GDP
Production of goods and services valued at current prices.

NomGDP2013 = Pa2013Qa2013 + Pb2013Qb2013

*Greater Nom GDP doesn’t necessarily mean better off – price and quantity can change.

Real GDP
Production of goods and services valued at constant prices.

(To calculate):
Choose base year (2009), then use base year prices.
RealGDP2013 = Pa2009Qa2013 + Pb2009Qb2013

Real vs Nominal GDP
For base year, real GDP always equals nominal GDP.
*Real GDP is a better gauge of economic well-being. Prices are held constant while quantities change.
GDP Deflator
Nominal/Real * 100
A measure of price
GDP Deflator for the base year is ALWAYS 100
Measures the current level of prices relative to the level of prices in the base year.
Things GDP does NOT measure
House work
Leisure time
Income distribution
Education quality
Underground economy
Is GDP a perfect measure of economic well-being?
NO, but it does measure our ability to obtain these items.
Consumer Price Index.
Measure of overall cost of the goods and services bought by a typical consumer.
How to Calculate CPI
– Fix the Basket
– Choose a base year and compute the index.

CPI = (Cost of Basket Current Year/Cost of Basket Base Year) * 100

Inflation Rate
The percentage change in the consumer price index from the preceding period

Inflation = ((CPI this year – CPI last year)/CPI last year) * 100

Inflation is usually measured over a one year period.

Problems of CPI
Tends to OVERESTIMATE the living cost. Assumes fixed basket of goods.
Substitution Bias
CPI does not allow consumers to substitute toward cheaper goods.
Ignores introduction of new goods.
Unmeasured quality change.
Deflator vs. CPI
Deflator – Prices of all goods and services produced domestically.

CPI – Prices of all goods and services bought by consumers.

Real Interest Rate
nominal interest rate – inflation rate

r = i – pi

Can real interest rate be negative? YES.

Categories: Macroeconomics