Chapter 2

Measuring the
Macroeconomy
2.1 Introduction
In this chapter, we learn
• the importance of gross domestic product (GDP).
• the composition of GDP, and how it has changed
over time.
• how to use GDP to examine
• the evolution of living standards.
• differences in living standards across countries.
Introduction
National income accounting:
• Method of aggregating the production of diverse
goods into a single measure of overall economic
activity
National accounting:
• State of an economy at a given time
• Changes to an economy over time
• Differences across countries
2.2 Measuring the State of the Economy
Gross domestic product (GDP):
• The market value of the final goods and services
produced in an economy over a certain period
• http://www.bea.gov/
United States GDP:
• $12.5 trillion in 2005
• $14.4 trillion in 2008 ($47,000 per person)
• $20.5 trillion in 2018 ($62,00 per person)
 Measuring the State of the Economy—1
2005 2006 2007 2008 U.S. GDP
14.4 7%
GDP 12.6 13.4 14.0 14.3
14.2
(in trillions 6%
of $) 14
13.8 5%
Growth 6.3% 4.5% 2.1%
rate GDP 13.6 4%
13.4
13.2 3%
13 2%
12.8
1%
12.6
12.4 0%
2005 2006 2007 2008
GDP (in trillions of $) Growth rate GDP
Measuring the State of the Economy—2
Production measure of GDP:
• The number of goods produced in the economy
Expenditure measure of GDP:
• The total purchases in the economy
Income measure of GDP:
• All the income earned in the economy
All three approaches give identical measures of GDP:

Production Expenditures Income

The Expenditure Approach to GDP
The national income accounting identity states:

where:
• = GDP (in dollars)
• = Consumption
• = Investment
• = Government purchases
• = X – M = Exports – Imports
Investment
Business fixed investment (nonresidential)
• Spending by firms on plants, machinery and
equipment

Residential investment
• Construction of new houses and apartment
buildings

Inventory investment
• Changes in inventories (of final or intermediate
goods)
 Variables 2018 % of GDP Per Capita
Gross Domestic Product 20,580.20 100.00 62,794.60
Personal Consumption Expenditures 13,998.70 68.02 42,713.03
Goods 4,364.80 21.21 13,317.94
Durable Goods 1,475.60 7.17 4,502.37
Nondurable goods 2,889.20 14.04 8,815.57
Services 9,633.90 46.81 29,395.09
Gross Private Domestic Investment 3,628.30 17.63 11,070.72
Fixed Investment 3,573.60 17.36 10,903.82
Nonresidential 2,786.90 13.54 8,503.43
Structures 633.2 3.08 1,932.03
Equipment 1,222.60 5.94 3,730.41
Intellectual Property Products 931.1 4.52 2,840.99
Residential 786.7 3.82 2,400.39
Change in private inventories 54.7 0.27 166.90
Net Exports of Goods and Services -638.2 -3.10 -1,947.28
Exports 2,510.30 12.20 7,659.46
Goods 1,661.30 8.07 5,068.98
Services 848.9 4.12 2,590.18
Imports 3,148.50 15.30 9,606.75
Goods 2,570.60 12.49 7,843.45
Services 577.9 2.81 1,763.30
Government Consumption Expenditures and Gross
Investment 3,591.50 17.45 10,958.44
Federal 1,347.30 6.55 4,110.90
National Defense 793.6 3.86 2,421.44
Nondefense 553.7 2.69 1,689.46
State and Local 2,244.20 10.90 6,847.54
Source: Bureau of Economic Analysis
Notes: Billions of Dollars (per capita in dollars): Last Revised on: September 30, 2019
Expenditure Shares of U.S. GDP
The Income Approach to GDP
The income approach
• Measures the sum of all income earned in the
economy
Capital
• Inputs into production other than labor that are not
used up in the production process
• Increased by firms through investment
Depreciation
• The deterioration of the capital stock due to wear
and tear

•
The Income Approach to U.S. GDP in 2018
Total Share of GDP to Inputs
Share of GDP to labor
• Two-thirds (approx.)
• Labor’s share of GDP has remained approximately
constant over time.
Share of GDP to capital
• One-third (approx.)
Labor’s Share of GDP
The Production Approach to GDP
No “double counting” in GDP
• Only the final sale of goods and services count.
Value added
• The amount each producer contributes to GDP
• The revenue generated by each producer minus the
value of intermediate products
Only new production of goods and services counts
toward GDP.
What Is Included in GDP and What Is Not?—1
GDP considers only final goods and services.
Intermediate goods are not included in GDP
calculations.
• For example, if Alcoa sells aluminum to Ford to
make a Focus ST, the sale of the car is included in
GDP, but not the sale of the aluminum.
What Is Included in GDP and What Is Not?—2
• Included: • Not included:
• Government spending on • Government transfer
goods/services payments
• Factory production • Environmental conditions
• Healthcare expenditures • A measure of a nation’s
• Ingredients and food health
purchased • Time spent cooking at home
• Kids in day care • Babysitter
Measures of Well-Being
GDP is used by economists as a proxy for standards of
living.
Differences in GDP Over Time
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2.3 Measuring Changes Over Time
When examining GDP over time, we need to take into
account changes in prices.
Nominal GDP:
• A measure of GDP when prices and quantities have not
been separated, using current year prices
•

Real GDP:
• Actual quantity of goods and services, using base year
prices

•
Measuring Changes Over Time
To compute GDP across time, we must use a certain year’s prices.
• Real GDP will be measured in a certain year’s dollars.
• Nominal GDP is measured in current dollars.
Nominal GDP:
• where N is the total number of goods and services in the
economy, and are prices in year t.
Real GDP: prices
• where N is the total number of goods and services in the
economy and are prices in year t-1.
An Example of Changes in Nominal GDP—1
Consider an economy that produces two goods: steak
(s) and basketballs (b).
Nominal GDP in 2014:

If the quantity of goods and services produced does not

change, but prices do change:
• Nominal GDP will change.
• Real GDP will not change.
An Example of Changes in Nominal GDP—2
Suppose: Year Price of Quantity Price of Quantity of
Steak of Steak Basketballs Basketballs
2014 $10 50 $25 100
2015 $12 50 $28 100
Nominal GDP in 2014:

Nominal GDP in 2015:

Real and Nominal GDP in a Simple Economy, 2018–2020
Another Example
Now suppose: Year Price of Quantity Price of Quantity of
Steak of Steak Basketballs Basketballs
2014 $10 50 $25 100
2015 $12 60 $28 105
Nominal GDP in 2015:

Real GDP in 2015 (in 2014 prices):

Quantity Indexes
Calculating real GDP changes over time:
• The Laspeyres index
• Calculates changes in real GDP using the initial
prices
• The Paasche index
• Calculates changes in real GDP using the final year
prices
Over long-time intervals the two indexes can result in
substantial differences.
Chain Weighting—1
The Fisher index (chain weighting) is the preferred
approach to calculating real GDP.
• Average of the Laspeyres and Paasche index
• Can be applied on a year-by-year basis if we
compute real GDP each year
Recall:

• which is the GDP deflator rearranged:

•
Chain Weighting—2
We can make the following transformation:
Using Chain-Weighted Data
Main reason for using chain-weighted data:
• Prices of computers rapidly changed in the 1990s
Main disadvantage:
• The sum of real C, I, G, NX will not equal real chain-
weighted GDP because the prices used in
constructing the components are different.
General rule to follow:
• For particular components of GDP, we look at the
ratio of nominal variables.
• When you want real rates of economic growth, use
the chain-weighted real measures.
2.4 Comparing Economic Performance across Countries
The exchange rate:
• Price at which different currencies are traded
To make comparisons of GDP across countries:
• GDP must be expressed in a common currency by
first adjusting it by the exchange rate.
• This value of nominal GDP must be multiplied by the
ratio of prices in the countries.
An Example of Comparisons of Economies
Suppose we are trying to compare GDP in China and
the United States.
1. Use the exchange rate to turn Chinese yuan into U.S.
dollars: $1
26.4 × = $3.5
7.6
2. Adjust for relative price level of goods:
Comparison of Countries
• In general, rich countries tend to have higher price
levels than poor countries.
• This is mainly because poor countries have lower
wages.
Clicker Question 1
Imagine a two-good economy where the quantity of the
goods produced is unchanged over time, but where
prices have increased. In the most recent year, real GDP
will be
a. the largest number when using the Fisher index.
b. the largest number when using the Laspeyres
index.
c. the largest number when using the Paasche index.
d. the same no matter the index used.
Clicker Question 1 – Answer
Imagine a two-good economy where the quantity of the
goods produced is unchanged over time, but where
prices have increased. In the most recent year, real GDP
will be
a. the largest number when using the Fisher index.
b. the largest number when using the Laspeyres
index.
c. the largest number when using the Paasche
index.
d. the same no matter the index used.
Clicker Question 2
Which of the following does NOT increase the U.S.
GDP?
a. The U.S. government purchases a tank from a U.S.
company.
b. The U.S. government increases social security
payments.
c. The U.S. government increases funding for tax
policy at a U.S. university.
d. The French government purchases a tank from a
U.S.-based company.
Clicker Question 2 – Answer
Which of the following does NOT increase the U.S.
GDP?
a. The U.S. government purchases a tank from a U.S.
company.
b. The U.S. government increases social security
payments.
c. The U.S. government increases funding for tax
policy at a U.S. university.
d. The French government purchases a tank from a
U.S.-based company.
Clicker Question 3
When comparing shares of consumption in GDP, it is
best to use _________ variables. When comparing real
rates of economic growth, it is best to use _________
variables.
a. nominal; nominal
b. chain-weighted; chain-weighted
c. nominal; chain-weighted
d. chain-weighted; nominal
Clicker Question 3 – Answer
When comparing shares of consumption in GDP, it is
best to use _________ variables. When comparing real
rates of economic growth, it is best to use _________
variables.
a. nominal; nominal
b. chain-weighted; chain-weighted
c. nominal; chain-weighted
d. chain-weighted; nominal
Clicker Question 4
Which of the following is NOT an example of capital?
a. machines at an automobile factory
b. an automobile factory building
c. screws and bolts used for making cars at an
automobile factory
d. a plant manager’s computer
Clicker Question 4 – Answer
Which of the following is NOT an example of capital?
a. machines at an automobile factory
b. an automobile factory building
c. screws and bolts used for making cars at an
automobile factory
d. a plant manager’s computer
Clicker Question 5
A construction company produces a $200,000 house
using $50,000 worth of wood and steel, in addition to
$50,000 of labor hours. The value added by the
construction company is
a. $200,000.
b. $150,000.
c. $100,000.
d. $50,000.
Clicker Question 5 – Answer
A construction company produces a $200,000 house
using $50,000 worth of wood and steel, in addition to
$50,000 of labor hours. The value added by the
construction company is
a. $200,000.
b. $150,000.
c. $100,000.
d. $50,000.
Clicker Question 6
Which of the following counts as investment?
a. You buy a stock.
b. You buy a computer to use for fun at home.
c. You buy a new house.
d. All of these choices are correct.
Clicker Question 6 – Answer
Which of the following counts as investment?
a. You buy a stock.
b. You buy a computer to use for fun at home.
c. You buy a new house.
d. All of these choices are correct.
Clicker Question 7
Recently, the largest share of GDP is
a. consumption.
b. government purchases.
c. investment.
d. net exports.
Clicker Question 7 – Answer
Recently, the largest share of GDP is
a. consumption.
b. government purchases.
c. investment.
d. net exports.
Clicker Question 8
Under national income accounting, GDP equals
a. the goods produced in the economy.
b. the income earned in the economy.
c. the total purchases in the economy.
d. All of these choices are correct.
Clicker Question 8 – Answer
Under national income accounting, GDP equals
a. the goods produced in the economy.
b. the income earned in the economy.
c. the total purchases in the economy.
d. All of these choices are correct.
Clicker Question 9
Until 1970, labor’s share of GDP was relatively stable at
approximately two-thirds of GDP.
a. true
b. false
Clicker Question 9 – Answer
Until 1970, labor’s share of GDP was relatively stable at
approximately two-thirds of GDP.
a. true
b. false
Clicker Question 10
When price equals marginal cost, economic profits are
positive.
a. true
b. false
Clicker Question 10 – Answer
When price equals marginal cost, economic profits are
positive.
a. true
b. false
Clicker Question 11
When the trade balance is negative, domestic
producers are exporting more goods than are being
imported.
a. true
b. false
Clicker Question 11 – Answer
When the trade balance is negative, domestic
producers are exporting more goods than are being
imported.
a. true
b. false
Clicker Question 12
When comparing GDP across countries, it is better to
use comparisons based on common prices than those
based simply on exchange rate conversions.
a. true
b. false
Clicker Question 12 – Answer
When comparing GDP across countries, it is better to
use comparisons based on common prices than those
based simply on exchange rate conversions.
a. true
b. false
Clicker Question 13
A U.S. citizen works for a U.S. company in Germany. The
income earned by the citizen increases U.S. GDP.
a. true
b. false
Clicker Question 13 – Answer
A U.S. citizen works for a U.S. company in Germany. The
income earned by the citizen increases U.S. GDP.
a. true
b. false
Clicker Question 14
If real GDP increases by 2 percent and nominal GDP
increases by 4 percent, then inflation is approximately
2 percent.
a. true
b. false
Clicker Question 14 – Answer
If real GDP increases by 2 percent and nominal GDP
increases by 4 percent, then inflation is approximately
2 percent.
a. true
b. false
Clicker Question 15
Suppose we compare GDP per person in Uganda and
the United States in two ways: first using the exchange
rate method, and second using the relative price-based
conversion. Uganda will appear to be richer under the
relative price-based conversion than with the exchange
rate conversion.
a. true
b. false
Clicker Question 15 – Answer
Suppose we compare GDP per person in Uganda and
the United States in two ways: first using the exchange
rate method, and second using the relative price-based
conversion. Uganda will appear to be richer under the
relative price-based conversion than with the exchange
rate conversion.
a. true
b. false
Clicker Question 16
Consider a simple economy producing two goods: coffee and TVs.
In 2014 the economy produced 2,000 pounds of coffee and 10
TVs. In 2015 the economy produced 1,000 pounds of coffee and
12 TVs. The price of one TV was $1,000 in both years, while the
price of coffee decreased from $6 per pound in 2014 to $5 per
pound in 2015. Based on this information, the percentage change
in real GDP in chained prices benchmarked to 2015 is
a. 22 percent.
b. 16.5 percent.
c. -16.5 percent.
d. -22.0 percent.
Clicker Question 16 – Answer
Consider a simple economy producing two goods: coffee and TVs.
In 2018 the economy produced 2,000 pounds of coffee and 10
TVs. In 2019 the economy produced 1,000 pounds of coffee and
12 TVs. The price of one TV was $1,000 in both years, while the
price of coffee decreased from $6 per pound in 2018 to $5 per
pound in 2019. Based on this information, the percentage change
in real GDP in chained prices benchmarked to 2019 is
a. 22 percent
b. 16.5 percent.
c. -16.5 percent.
d. -22.0 percent.
Clicker Question 17
Consider a simple economy producing two goods: coffee and
TVs. In 2018 the economy produced 2,000 pounds of coffee and
10 TVs. In 2019 the economy produced 1,000 pounds of coffee
and 12 TVs. The price of one TV was $1,000 in both years, while
the price of coffee decreased from $6 per pound in 2018 to $5
per pound in 2019. Based on this information, the inflation rate
is approximately
a. -50 percent.
b. -28.3 percent.
c. -6.2 percent.
d. -2.7 percent.
Clicker Question 17 – Answer
Consider a simple economy producing two goods: coffee and
TVs. In 2018 the economy produced 2,000 pounds of coffee and
10 TVs. In 2019 the economy produced 1,000 pounds of coffee
and 12 TVs. The price of one TV was $1,000 in both years, while
the price of coffee decreased from $6 per pound in 2018 to $5
per pound in 2019. Based on this information, the inflation rate
is approximately
a. -50 percent.
b. -28.3 percent.
c. -6.2 percent.
d. -2.7 percent.
Clicker Question 18
One reason for the larger trade deficit in the last
several decades is
a. increased consumption.
b. increased government purchases.
c. increased exports.
d. increased investment.
Clicker Question 18 – Answer
One reason for the larger trade deficit in the last
several decades is
a. increased consumption.
b. increased government purchases.
c. increased exports.
d. increased investment.
Clicker Question 19
This year, a real estate agent helped you buy a house for
$200,000. The house was originally built in 1985. The agent’s
commission was $12,000. How will this transaction affect this
year’s GDP?
a. Consumption expenditures will increase by $212,000.
b. Consumption expenditures will increase by $12,000.
c. Investment expenditures will increase by $212,000.
d. Investment expenditures will increase by $12,000.
Clicker Question 19 – Answer
This year, a real estate agent helped you buy a house for
$200,000. The house was originally built in 1985. The agent’s
commission was $12,000. How will this transaction affect this
year’s GDP?
a. Consumption expenditures will increase by $212,000.
b. Consumption expenditures will increase by $12,000.
c. Investment expenditures will increase by $212,000.
d. Investment expenditures will increase by $12,000.
Clicker Question 20
In 2017, China's economy was larger than the United States'
economy. After we apply the correct exchange rates we get the
following:
China GDP = $11.1 trillion
U.S. GDP = $17.7 trillion
Why does it seem like China's GDP is still smaller than the GDP
of the United States?
a. The exchange rate was wrong.
b. The initial measure of GDP was wrong in China.
c. The initial measure of GDP was wrong in the United States.
d. We need to measure China's GDP in U.S. prices.
Clicker Question 20 – Answer
In 2017, China's economy was larger than the United States'
economy. After we apply the correct exchange rates we get the
following:
China GDP = $11.1 trillion
U.S. GDP = $17.7 trillion
Why does it seem like China's GDP is still smaller than the GDP of
the United States?
a. The exchange rate was wrong.
b. The initial measure of GDP was wrong in China.
c. The initial measure of GDP was wrong in the United States.
d. We need to measure China's GDP in U.S. prices.
Clicker Question 21
Consider two countries: Country A and Country B. Country A
produces potatoes, and Country B produces shoes. Using year
3030 as the base year,
Year Potatoes Shoes
3030 10 $1.00 10 $1.00
3031 10 $2.00 12 $1.00
Which country had the biggest change in real GDP?
a. They are the same.
b. Country A
c. Country B
Clicker Question 21 - Answer
Consider two countries: Country A and Country B.
Country A produces potatoes, and Country B produces
shoes. Using year 3030 as the base year,

Which country had the biggest change in real GDP?

a. They are the same.
b. Country A
c. Country B
Credits

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Charles I. Jones
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