Macroeconomic

Theory and Policy

Session-3

Biswa Swarup Misra

Session-3
Analyze GDP as a measure 1. GDP and the Macroeconomy
of total spending, output
and income: 2. GDP Measures Total Spending, Output,
and Income
➢ Total spending perspective
3. What GDP Captures and What It Misses
➢ Total output perspective
4. Real and Nominal GDP
➢ Total income perspective
5. Millions, Billions, and Trillions
Key Definition (2 of 4)
Diving into the Definition
Gross domestic product: the market value
of all final goods and services produced The GDP of a country tallies up the value
within a country in a given year. of all the goods and services they produce:
➢ Key measure of economic activity. ➢ Add up all the cereal, bananas, t-shirts,
pants, movies, education housing,
In 2021, the GDP of the United States was $23 cars…EVERYTHING that was produced
trillion. in a given year.
➢ We’ll focus on GDP per person (GDP per
Now let’s unpack the formal definition of
capita), $69,200.
GDP piece by piece.
➢ Divide $23 trillion by the 332.2 million
people living in the United States.
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Gross Domestic Product (GDP) (1 of 5)

Gross domestic product: the market value of all final goods and services
produced within a country in a given year.

“The market value…” → value each product at its market price.

➢You are literally adding apples and oranges (by their common unit)!
➢Common unit = the dollar
GDP values each good according to its market price:
➢Example: A $1,500 couch is 100 times as valuable as a $15 water bottle.

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 Gross Domestic Product (GDP) (2 of 5)
Gross domestic product: the market value of all final goods and services produced within a
country in a given year.

“…of all…” → include all goods and services.

Includes not just what you purchase for yourself from the market, but also what the
government purchases for you.
➢ vaccines, public education, road and bridge construction, national defense, etc.

Does NOT include economic activity that occurs outside of markets.

➢ If you wash your car yourself, your labor is not included in GDP. However, if you take
your car to the car wash, then that service is counted as GDP.

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Active Learning 1: Income Equals Expenditure
• Nalah pays James $50 to mow her lawn.
A. What happens with total expenditure?
B. What happens with total income?
• James is a seller of a service and Nalah
is a buyer: James earns $50, and Nalah
spends $50.
A. Total expenditure rises by $50.
B. Total income rises by $50.

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Gross Domestic Product (GDP) (3 of 5)

Gross domestic product: the market value of all final goods and services produced within a
country in a given year.

“…final goods and services…” → count only final goods and services, omitting intermediate
goods.
➢ The price of a final good incorporates all the contributions of the prior stages of production.
➢ Thus, GDP does NOT count intermediate goods: goods and services that are used as inputs in
the production of other products.
Car example: The new car you buy for $35,000 is considered a final product (you are the final
user!). The $35,000 price includes the value of all the contributions that created that car:
➢ Intermediate goods: the metal, wires, plastic, glass, the workers who processed and assembled those
pieces, the truck driver who delivered the car to the sales lot, and the salesperson who sold the car to you.

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 Gross Domestic Product (GDP) (4 of 5)

Gross domestic product: the market value of all final goods and services produced
within a country in a given year.

“…produced…” → omit resale of already-purchased goods.

GDP does NOT count resale of existing finished goods.
➢ Second-hand sales merely change ownership of goods that have already been
produced and were previously counted in GDP.
➢ Example: If you bought a used car, that purchase would not be counted in GDP.

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 Gross Domestic Product (GDP) (5 of 5)
Gross domestic product: the market value of all final goods and services produced within a country
in a given year.

“…within a country…” → include all goods produced within the United States.
Include everything produced in workplaces in the United States.
➢ Even if the goods are made by foreign-owned business within the United States, and even if the
goods are sold to people outside the United States.
➢ Excludes any goods produced in other countries — even if it’s a good produced in an
American-owned factory in another country.
“…in a given year…” → add up the flow of output over a year.
Add up all the activity that’s occurred during a given time period (typically one year).
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 © Worth Publishers
Key take-aways: GDP and the Macroeconomy

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Session-3
Analyze GDP as a measure 1. GDP and the Macroeconomy
of total spending, output
and income: 2. GDP Measures Total Spending, Output,
and Income
➢ Total spending perspective
3. What GDP Captures and What It Misses
➢ Total output perspective
4. Real and Nominal GDP
➢ Total income perspective
5. Millions, Billions, and Trillions
 © Worth Publishers
Three Perspectives on GDP
1. Total Spending 2. Total Output 3. Total Income
Measure GDP by adding Measure GDP by adding Measure GDP by adding
up every dollar of up every dollar’s worth up every dollar of
spending. of output produce. income earned.

Highlights who’s doing Highlights what’s being Highlights where income

the spending, and what made, and by whom. It is going, and who’s
they are buying. helps map the structure enjoying the fruits of all
of production. the economic activity.

These three measurements are all the same in theory, but they get different names because real-
world measurements can differ due to different sources of imperfect data.
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 Perspective 1: GDP Measures Total Spending (1 of 4)

© Worth Publishers
GDP equals total spending on final goods…

…which embodies the value created at earlier stages.

Final goods

GDP includes new inventories:

➢ GDP counts goods in the year they’re made, regardless of the year in which they’re sold.

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 Perspective 1: GDP Measures Total Spending (2 of 4)

© Worth Publishers
When you track GDP by spending, you can track who is doing all the spending.
Economics uses the following identity to describe each type of spending:

Y = C + I + G + NX
GDP Consumption Investment Government Net exports
purchases

The spending summarized in this equation collectively defines all the goods and
services produced in the economy.

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 Perspective 1: GDP Measures Total Spending (3 of 4)

© Worth Publishers
Y = C + I + G + NX
GDP Consumption Investment Government Net exports
purchases

Consumption: household spending on final goods and services.

➢ Clothes, shoes, food, gas, internet bill, haircuts, computers, cars, etc.

Note on housing costs:

• For renters, consumption includes rent payments.
• For homeowners, consumption includes
the imputed rental value of the house,
but not the purchase price.

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 Perspective 1: GDP Measures Total Spending (3 of 4)

© Worth Publishers
Y = C + I + G + NX
GDP Consumption Investment Government Net exports
purchases

Investment: spending on new capital assets that increase the economy’s productive capacity.
➢ Any long-lasting good used in a business.
➢ Research and development spending, office furniture, equipment, etc.
➢ Buying a newly built house counts as an investment (but not if you buy an existing house).

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 Investment (I)
▪ is total spending on goods that will be used in the future
to produce more goods.
▪ includes spending on
• capital equipment (e.g., machines, tools)
• structures (factories, office buildings, houses)
• inventories (goods produced but not yet sold)
Note: “Investment” does not mean
the purchase of financial assets like
stocks and bonds.
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Capital Goods
• There are objects which are not used up during the accounting period and are not intermediate goods.
Neither are they sold as final goods by baker. These objects are called capital goods and economic entity
who purchases them is considered to be final user of the capital good.
• A capital good is a long-lived good that is used in the production of other goods and services.
• The total quantity of a country’s capital goods is called its capital stock. Change in the capital stock from
the beginning of the year to end of the year is denoted as investment for that year.
• If the baker began the year with stock of INR 500 of ovens and ended the year with stock of INR 800 of
ovens, he is considered to have invested INR 300 during the year.
• A capital good is not used up right away but it diminishes in its material respect and is used up
eventually - it undergoes depreciation. If in a given year INR 500 of new capital is created and INR 150 of
old capital wears out, then the capital stock would have increased by INR 350
• A firm’s unused raw materials or unsold output is its inventory. The change in the stock of inventory in an
accounting year is treated as an inventory investment and is classified as a final good.
Investment versus capital

Note: Investment is spending on new capital.

Example (assuming no depreciation):
• 1/1/2023:
Economy has $40 trillion worth of capital.
• During 2023:
investment = $5 trillion.
• 1/1/2024:
Economy will have $45 trillion worth of capital.
Stocks versus flows

A stock is a quantity measured at a point in time.

Example:
The U.S. federal government debt was about $32 trillion in 2022.
A flow is a quantity measured per unit of time.
Example: “The U.S. federal government deficit was $1.7 trillion in
2022.”
Stocks vs. Flows - examples

stock flow

a person’s
a person’s wealth
annual saving

# of people with # of new college

college degrees graduates this year

the govt debt fiscal deficit

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 Now you try:
Stock or flow?
▪ the balance on your credit card statement
▪ how much you study economics outside of class
▪ the size of your compact disc collection
▪ the inflation rate
▪ the unemployment rate

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 Perspective 1: GDP Measures Total Spending (4 of 4)

© Worth Publishers
Y = C + I + G + NX
GDP Consumption Investment Government Net exports
purchases

Government purchases: government purchases of goods and services.

➢ Spending on schools, highways, military, vaccine research, etc.
➢ Excludes transfer payments: payments that transfer income from one person to another.
➢ Social security checks, or unemployment insurance checks.
Net exports: spending on exports minus spending on imports.
➢ Exports: goods or services produced domestically and purchased by foreign buyers.
➢ Imports: goods or services produced overseas and purchased by domestic buyers.
➢ We subtract spending on imports to offset the fact that spending on imports has already been counted in other categories.

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Active Learning 3: GDP and its components
What is the effect on GDP and its components?
A. Dipesh spends $300 to buy his friend dinner at
the finest restaurant in Bhubaneswar.
B. Aditi spends $1,200 on a new smartphone to use
in her publishing business. The smartphone was
built in China.
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.
D. GM builds $500 million worth of cars, but
consumers only buy $470 million worth of them.

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Active Learning 3: Answers A, B
A. Dipesh spends $300 to buy his friend dinner at
the finest restaurant in Bhubaneswar.
• C rises by $300
• GDP rises by $300.
B. Aditi spends $1,200 on a new smartphone to use
in her publishing business. The smartphone was
built in China.
• I rises by $1,200
• NX fall by $1,200 (because Imports rise by
$1,200)
• GDP is unchanged.
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Active Learning 3: Answers C, D
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
• GDP rises by $500 million.
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 Perspective 2: GDP Measures Total Output

© Worth Publishers
The “total output” GDP perspective highlights what what is being made and by whom.

Value added: the amount by which the value of an item is increased at each stage of production.
➢ Measures your contribution toward producing that item.
➢ = Total sales − Cost of intermediate inputs

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Value added
• An intermediate good is one that is used up in the production of other goods during the
same period in which it was produced.
• Intermediate goods like wheat and oil should not be double counted when output is
computed.
• To avoid errors from inclusion of intermediate goods agents should be asked to report their
sales of final goods to consumers.
• Value added is the market value of the product of an agent minus the cost of intermediate
inputs purchased. Value added is arrived at by subtracting costs from the revenues.
Capital goods versus Intermediate goods
• Capital goods and intermediate goods are similar in that they are both used to produce other
goods. They are dissimilar in that capital goods are not used up right away like intermediate
goods.
 Perspective 3: GDP Measures Total Income (1 of 2)

© Worth Publishers
The “total income” GDP perspective tracks whether this income is going to workers as wages or
to business owners as profits.
➢ GDP is total income, which is the sum of total wages and total profits.

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 Perspective 3: GDP Measures Total Income (2 of 2)

© Worth Publishers
Labor’s share of income is declining.
What Next?
1.GDP, GNP, GDP AT MARKET PRICE, GDP AT FACTOR COST,
NATIONAL INCOME, PERSONAL INCOME AND PERSONAL
DISPOSABLE INCOME
2. GVA AT BASIC PRICE, GDP AT MARKET PRICE, PRODUCT TAX,
PRODUCTION TAX, PRODUCT SUBSITY, PRODUCTION SUBSIDY
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