Week 1 – Measuring a

Nation’s Income

Content

◉ What is Gross Domestic Product (GDP)?

◉ How is GDP related to a nation’s total income
and spending?
◉ What are the components of GDP?
◉ How is GDP corrected for inflation?
◉ Does GDP measure society’s well-being?

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 Economics

◉ Microeconomics
o Study of how households and firms
■ Make decisions
■ Interact in markets
◉ Macroeconomics
o Study of economy-wide phenomena
■ Including inflation, unemployment, and economic growth

Income and Expenditure

Gross Domestic Product (GDP)

◉ Measures total income of everyone in the economy.
◉ Also measures total expenditure on the economy’s output of
goods and services.
Income = expenditure
◉ For the economy as a whole
◉ Because every dollar a buyer spends is a dollar of income for
the seller.
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 Example 1.1: Income equals expenditure

Nalah pays James $50 to mow her lawn.

A. What happens with total expenditure?
B. What happens with total income?

Seller Buyer
James $50 Nalah
Earn Spend

A. Total expenditure rises by $50.

B. Total income rises by $50.

The Circular-Flow

◉ The Circular-Flow Diagram

o Simple depiction of the macroeconomy
o Illustrates GDP as spending, revenue, factor payments, and income
◉ Preliminaries:
o Factors of production: inputs like labor, land, capital, and natural
resources.
o Factor payments: payments to the factors of production (e.g.,
wages, rent).

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 The circular-flow diagram – 1
Households:
 own the factors of production, sell or
rent them to firms for income
 buy and consume goods & services

Firms Households

Firms:
 Buy or hire factors of production, use
them to produce goods and services
 sell goods & services
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The circular-flow diagram – 2

Revenue (=GDP) Spending (=GDP)
Markets for
Goods and Goods & Goods and
services sold Services services
bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, and Production Income (=GDP)
profit (=GDP)
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 What This Diagram Omits

◉ The government
o Collects taxes, buys goods and services
◉ The financial system
o Matches savers’ supply of funds with
borrowers’ demand for loans
◉ The foreign sector
o Trades goods and services, financial assets, and currencies with
the country’s residents

Review Question 1.1

An economy’s gross domestic product is

a. the excess of spending over income.
b. the excess of income over spending.
c. total income and total spending.
d. total income times total spending.

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 Review Question 1.2

Sam bakes a cake and sells it to Carla for $10. Woody pays
Diane $30 to tutor him. In this economy, GDP is
a. $10.
b. $20. 10(expenditure)+30(income)=40=total income

c. $30.
d. $40.

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Gross Domestic Product (GDP)

◉ GDP is the market value of all final goods & services

produced within a country in a given period of time.
◉ Goods are valued at their market prices, so:
o All goods measured in the same units (e.g., dollars in the U.S.)
o Things that don’t have a market value are excluded, e.g.,
housework you do for yourself.
◉ Usually a year or a quarter (3 months)

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 Gross Domestic Product (GDP)
◉ GDP includes all items produced in the economy and sold
legally in markets
◉ GDP excludes most items produced and sold illicitly. It also
excludes most items that are produced and consumed at
home.
◉ GDP only includes final goods
o Final goods: intended for the end user
o Intermediate goods: used as components or ingredients in the
production of other goods
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Gross Domestic Product (GDP)

◉ GDP includes
o tangible goods (like food, mountain bikes, beer)
o and intangible services (dry cleaning, concerts, haicuts).
◉ GDP includes currently produced goods, not goods
produced in the past. only newly, resell will not include in GDP
◉ GDP measures the value of production that occurs within a
country’s borders, whether done by its own citizens or by
foreigners located there.
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 Example 1.2: What is included in GDP?

Nalah pays James $50 to mow her lawn.

A. What happens with GDP?
B. Will your answer to the previous question change if Nalah and
James get married?
A. The payment of $50 from Nalah to James for mowing her lawn would be included in the GDP as it represents a transaction of
final goods and services in the economy.

B. If Nalah and James were to get married, the transaction would no longer be considered a part of GDP. This is because GDP only
includes transactions that occur in the market economy, and the transaction between Nalah and James would now be considered a
non-market transaction between family members. Therefore, it would not contribute to GDP.

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Review Question 1.3

If the price of a hot dog is $2 and the price of a hamburger is

$4, then 30 hot dogs contribute as much to GDP as _________
hamburgers.
a. 5 The contribution of each hot dog to GDP is $2, so 30 hot dogs contribute a total of
30 x $2 = $60 to GDP.

b. 15 To find out how many hamburgers contribute the same amount to GDP, we need to
divide $60 by the price of one hamburger:
c. 30 $60 ÷ $4 = 15 hamburgers

d. 60

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 Review Question 1.4

Angus the sheep farmer sells wool to Barnaby the knitter for $20.
Barnaby makes two sweaters, each of which has a market price of
$40. Collette buys one of them, while the other remains on the
shelf of Barnaby’s store to be sold later. What is GDP here?
a. $40 Angus produces wool, which is an intermediate good and not included in GDP. Only the final goods and
services are counted.
b. $60 Barnaby produces two sweaters, but only one is sold to Collette, while the other remains unsold.
Therefore, only one sweater is counted as a final good and included in GDP.
c. $80
The market price of the sold sweater is $40, so the contribution of this transaction to GDP is $40.
d. $100
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Review Question 1.5

After graduation, an American college student moves to

Japan to teach English. Her salary is included
a. only in U.S. GDP.
the college student is working in Japan, so her
b. only in Japan’s GDP. salary is a part of Japan's GDP because it
represents a final good (her labor) produced
within Japan's borders. It is not included in the
c. in both U.S. GDP and Japan’s GDP. U.S. GDP because it is not produced within the
U.S. borders.
d. in neither U.S. GDP nor Japan’s GDP.

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 The Components of GDP

◉ Recall: GDP is total spending.

◉ Four components:
o Consumption (C)
o Investment (I)
o Government Purchases (G)
o Net Exports (NX) NX=export - import
◉ These components add up to GDP (denoted Y):
Y = C + I + G + NX
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Consumption (C)

◉ Consumption, C include the rent( kể cả ở hay thuê)

o Total spending by households on goods and services
o Does not include purchases of new housing
◉ Note on housing costs:
o For renters, C includes rent payments.
o For homeowners, C includes the imputed rental value of the
house, but not the purchase price or mortgage payments

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 Investment (I)

◉ Investment, I ( Business, household(new built house), inventory)

o Total spending on goods that will be used in the future to
produce more goods
■ Business capital: business structures, equipment, and
intellectual property products
■ Residential capital: landlord’s apartment building; a
homeowner’s personal residence
■ Inventory accumulations: goods produced but not yet sold
“Investment” does not mean the purchase of financial assets
like stocks and bonds. only talk about capital goods
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Government Purchases (G)

◉ Government purchases (G)

o All spending on the goods and services purchased by the
government
■ At the federal, state, and local levels.
o Excludes transfer payments
■ Such as Social Security or unemployment insurance benefits.
■ They are not purchases of goods and services

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 Net Exports (NX)

◉ Net exports, NX = exports – imports

○ Exports: foreign spending on the economy’s goods and services
○ Imports: are the portions of C, I, and G that are spent on goods and
services produced abroad

◉ Adding up all the components of GDP gives:

Y = C + I + G + NX

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U.S. GDP and its components, 2018

Billions % of GDP Per person
Y $20,494 100.0 $62,407 What is
Vietnam GDP
C 13,948 68.1 42,473 and its
components?
I 3,650 17.8 11,115
G 3,521 17.2 10,722
NX -625 -3.0 -1,903
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 Example 1.3: GDP and its components

What is the effect on GDP and its components?

A. Jahzara spends $300 to buy her husband dinner at the finest restaurant
in Boston.
 C rises by $300
 GDP rises by $300.

B. Nylah spends $1,200 on a new smartphone to use in her publishing

business. The smartphone was built in China.
 I rises by $1,200 Nylah use smart phone as a tool-> biz
 NX fall by $1,200 (because Imports rise by $1,200) NX=-import
 GDP is unchanged.
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Example 1.3: GDP and its components (cont.)

What is the effect on GDP and its components?

C. Joseph spends $800 on a tablet to use in his editing business. He got last
year’s model on sale for a great price from a local manufacturer.
 I and GDP are unchanged
 I (Joseph’s business) rises by $800
 I (inventories) fall by $800

D. GM builds $500 million worth of cars, but consumers only buy $470 million of
them.
 C rises by $470 million
 I (inventory) rises by $30 million 500-470 (hàng tồn kho)
 GDP rises by $500 million. Y=470(C)+30(I)
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 Review Question 1.6

Which of the following does NOT add to U.S. GDP?

a. Boeing manufactures and sells a plane to Air France.
b. General Motors builds a new auto factory in North Carolina.
c. The city of New York pays a salary to a policeman.
d. The federal government sends a Social Security check to
your grandmother. a.as Boeing manufactures and sells a plane to Air France - This transaction adds to U.S. GDP
it represents a final good produced within U.S. borders and sold to a foreign country.

b. General Motors builds a new auto factory in North Carolina - This investment adds to
U.S. GDP as it represents an increase in the production capacity within U.S. borders.

c. The city of New York pays a salary to a policeman - This transaction adds to U.S. GDP28
as it represents a service produced within U.S. borders.
28 d. The federal government sends a Social Security check to your grandmother - This
transfer payment does not add to GDP as it represents a transfer of income from the
government to an individual and not the production of a final good or service.

Review Question 1.7

An American buys a pair of shoes made in Italy. How do the

U.S. national income accounts treat the transaction? import for the US->
not include in GDP
a. Net exports and GDP both rise.
b. Net exports and GDP both fall.
c. Net exports fall, while GDP does not change.
d. Net exports do not change, while GDP rises.
The transaction of an American buying a pair of shoes made in Italy would be treated as an import by the U.S. national
income accounts. Therefore, the correct answer is (b) Net exports and GDP both fall.

Net exports refer to the value of exports minus the value of imports, and since this transaction is an import, it would
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decrease the net exports. Similarly, since GDP is calculated as the sum of all final goods and services produced within a
country's borders, the purchase of the shoes, which is a final good, would not contribute to GDP, but the decrease in net
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 Real versus Nominal GDP

◉ Nominal GDP express in monitory terms

o Values output using current prices
o Not corrected for inflation
◉ Real GDP will express in monitory term if price level not change
o Values output using the prices of a base year in 1 năm
o Is corrected for inflation
◉ For the base year
Nominal GDP = Real GDP

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Example 1.4: Calculating nominal GDP

Compute total spending (nominal GDP) in each year:
Pizza Chocolate
year P Q P Q Increase:
2019 $15 300 $2.50 1,000 42.9% (10-7)/7
2020 $16 400 $3.00 1,200
2021 $17 500 $3.50 1,300 30.5%

2019: $15 x 300 + $2.50 x 1,000 = $7,000

2020: $16 x 400 + $3.00 x 1,200 = $10,000
2021: $17 x 500 + $3.50 x 1,300 = $13,050 31

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 Example 1.5: Calculating real GDP
Compute real GDP in each year (base year 2019): lấy giá của 2019 là mốc
Pizza $15 Chocolate $2.50
year P Q P Q Increase:
2019 $15 300 $2.50 1,000 28.6%
2020 $16 400 $3.00 1,200
2021 $17 500 $3.50 1,300 19.4%

2019: $15 x 300 + $2.50 x 1,000 = $7,000

2020: $15 x 400 + $2.50 x 1,200 = $9,000
2021: $15 x 500 + $2.50 x 1,300 = $10,750 32

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Example 1.6: Correcting for inflation

year Nominal GDP Increase: Real GDP Increase:

2019 $7,000 42.9% $7,000 28.6%
2020 $10,000 $9,000
30.5% 19.4%
2021 $13,050 $10,750

◉The change in nominal GDP reflects both prices and quantities.

◉The change in real GDP is the amount that GDP would change if prices
were constant (i.e., if zero inflation).
◉Hence, real GDP is corrected for inflation. = price level change
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 Nominal and real GDP in the U.S., 1965–2019

Real GDP
(base year 2012)

Nominal GDP

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price level thường tăng mà real GDP chỉ lấy 2012 là mốc nên sau 2012 thì nominal
GDP >real cho price level

The GDP Deflator relative btw real and nominal

kết quả >100 -> nominal>real
◉ GDP deflator = 100 ×

o A measure of the price level

o Measures the current level of prices relative to the level of prices in the
base year
◉ Economy’s inflation rate
o Compute the percentage increase in the GDP deflator from one year to
the next

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 Example 1.7: Calculate the GDP deflator
Compute the GDP deflator in each year:
Nominal Real GDP
Year Inflation rate
GDP GDP deflator
2019 $7,000 $7,000 100.0
2020 $10,000 $9,000 111.1 11.1% = (111.11-100)/100
2021 $13,050 $10,750 121.4 9.3%

2019: 100 x (7,000/7,000) = 100

2020: 100 x (10,000/9,000) = 111.1
2021: 100 x (13,050/10,750) = 121.4
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Review Question 1.8: Computing GDP

2019
2020 2021
(base year)
P Q P Q P Q
Cookies $1 900 $2 1,000 $3 1,250
Smartphones $900 185 $1,000 200 $1,200 210

Use the above data to solve these problems:

A. Compute nominal GDP in 2019. 167.400
B. Compute real GDP in 2020. 181.000
C. Compute the GDP deflator in 2021. 134.4% -> nominal>real
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 Review Question 1.9

An economy produces 10 cookies in year 1 at a price of $2 per

cookie and 12 cookies in year 2 at a price of $3 per cookie.
From year 1 to year 2, real GDP increases by
a. 20 percent. Real GDP in year 1 = 10 cookies x $2/cookie = $20
Real GDP in year 2 = 12 cookies x $2/cookie = $24 (using year 1 as the base year)
b. 50 percent. The real GDP growth rate from year 1 to year 2 is then:
c. 70 percent. Real
100%
GDP growth rate = (Real GDP in year 2 - Real GDP in year 1) / Real GDP in year 1 x

d. 80 percent. == ($24
20%
- $20) / $20 x 100%

Therefore, the correct answer is (a) 20 percent.

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Review Question 1.10

If all quantities produced rise by 5 percent and all prices fall by 5

percent, which of the following best describes what occurs?
a. real GDP rises by 5 percent, while nominal GDP falls by 5 percent.
b. real GDP rises by 5 percent, while nominal GDP is unchanged.
c. real GDP is unchanged, while nominal GDP rises by 5 percent.
d. real GDP is unchanged, while nominal GDP falls by 5 percent.
Real GDP measures the value of goods and services produced in an economy adjusted for changes in prices, while nominal
GDP measures the value of goods and services produced in an economy at current market prices.

If all quantities produced rise by 5 percent, this means that the economy is producing more goods and services. If all prices
fall by 5 percent, this means that the prices of the goods and services being produced have decreased.
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As a result, the increase in quantity produced will be reflected in the real GDP, which will rise by 5 percent. However, the
decrease in prices will cause nominal GDP to remain unchanged, since the value of the goods and services being produced
41 will be the same even though their prices have decreased.
 GDP and Economic Well-Being
◉ Real GDP per capita
o Main indicator of the average person’s standard of living
◉ But GDP is not a perfect measure of well-being.
◉ GDP Does Not Value:
o The quality of the environment pollution
o Leisure time
o Non-market activity
■ Such as the child-care a parent provides at home
■ Volunteer work
o An equitable distribution of income
◉ GDP is a good measure of economic well-being for most—but not all—
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Then Why Do We Care About GDP?

◉ Having a large GDP enables a country to afford

o Better schools, a cleaner environment, health care, etc.

◉ Many indicators of the quality of life are positively

correlated with GDP. For example…

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 GDP and life expectancy in 12 countries

85
Japan Germany
80 Mexico United
Life expectancy (years)

Brazil States
75 China
Bangladesh
Russia
70 India Indonesia
65 Pakistan

60
55 Nigeria
50
$0 $20,000 $40,000 $60,000
Real GDP per capita
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GDP tăng-> fell more life staticfaction

GDP and average schooling in 12 countries

16
Germany
Average years of schooling

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12 Russia Japan
Bangladesh United
States
10
Indonesia Mexico
8 China
Nigeria Brazil
6 India
Pakistan
4
$0 $20,000 $40,000 $60,000
Real GDP per capita
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 GDP and overall life satisfaction in 12 countries
9.0
Overall life satisfaction (0 to 10 scale)

8.0
Germany
7.0 Brazil Mexico
United
Pakistan
6.0 Japan States
Indonesia Russia
5.0 Nigeria China
4.0 Bangladesh
India
3.0
$0 $20,000 $40,000 $60,000
Real GDP per capita
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Review Question 1.11

If Mr. Keating quits his job as a teacher to home school his own
children, GDP
a. stays the same because he is engaged in the same activity.
b. rises because he now pays lower income taxes.
c. falls because his market income decreases.
d. could rise or fall, depending on the value of home schooling.
The correct answer is (c) falls because Mr. Keating's decision to quit his job as a teacher and homeschool his own children
would result in a decrease in his market income. GDP is a measure of the market value of all final goods and services produced
within a country's borders in a given time period. Since Mr. Keating is no longer employed as a teacher, his contribution to the
production of goods and services would be reduced, resulting in a decrease in GDP. The value of home schooling would not
directly affect GDP as it is not a market transaction.
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 Review Question 1.12

What components of GDP (if any) would each of the following

transactions affect? Explain.
a. Uncle Fester buys a new refrigerator from a domestic manufacturer.
b. Aunt Dolly hires a local contractor to build her a new house.
c. The Huang family buys an old Victorian house from the Ellis family.
d. You pay a hairdresser for a haircut.
e. Ford sells a Mustang from its inventory to the Martinez family.

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Review Question 1.12 (cont.)

What components of GDP (if any) would each of the following

transactions affect? Explain.
f. Ford manufactures a Focus and sells it to Avis, the car rental company.
g. California hires workers to repave Highway 66.
h. The federal government sends your grandmother a Social Security
check.
i. Your parents buy a bottle of French wine.
j. Honda expands its factory in Ohio.

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 LECTURE IN A NUTSHELL

• Gross Domestic Product (GDP) measures a country’s total

income and expenditure.
• The four spending components of GDP include: Consumption,
Investment, Government Purchases, and Net Exports.
• Nominal GDP is measured using current prices. Real GDP is
measured using the prices of a constant base year and is
corrected for inflation.
• GDP is the main indicator of a country’s economic well-being,
even though it is not perfect.
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End of Week 1

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