Chapter 7 Macroeconomics

Real GDP, which adjusts for changes in the price level, is an imperfect measure of current output and income because

(1) excludes production that does not involve market transactions (e.g., household production), (2) omits underground economic activities (e.g., payments for illegal products), (3) fails to take leisure and human costs into account, (4) adjusts imperfectly for the introduction of new products and product improvements (5) doesn't account for harmful side effects or economic "bads."

Problems with using GDP

-Does not count household production (Not a market transaction) -Underground Economy (sometimes illegal) -Leisure and human costs (hours worked / working conditions [how hard it is to work]) -Quality variation -Harmful sideffects (Destruction) -New Technology has reduced GDP (No more blockbusters bc we can stream music and tv, which has reduced expenditures)

A large retailer sells $100,000 of household furnishings from inventories - How does this affect GDP?

-Furniture was produced last year, so the sale does not affect GDP this year. -Reduces inventory investment by $100,000 and increases consumption by $100,000, leaving GDP unchanged.

Factors that contribute to GDP

1.) Only Final Goods and Services 2.) Transactions involving production (NOT FINANCIAL / INCOME TRANSFERS) 3.) Only production within the Country 4.) Only goods produced during the current period

Four components of GDP expenditure approach

1.) Personal *Consumption* Expenditures - Durable goods, Non durable goods, Services 2.) Gross Private *Investment* - Fixed Investment -Inventories 3.) *Government* consumption + Gross Investment -Federal -State and Local 4.) Next exports *C + I + G + (X-I)*

Two ways of measuring GDP

1.) Totaling all the expenditures on goods and services produced during the year. 2.) Summing the costs incurred and income generated by the production of goods and services

Suppose nominal GDP increased by 8% during a year, while the GDP deflator increased by 6%. During the year, real GDP changed by

2% By definition, the GDP deflator is a price index that reveals the cost during the current period of purchasing the items included in GDP relative to the cost during a base year. We can use the GDP deflator together with nominal GDP to measure real GDP, which is GDP in dollars of constant purchasing power. If prices are rising, we simply deflate the nominal GDP during the latter period to account for the effects of inflation. In this case, although nominal GDP increased by 8%, the GDP deflator increased by 6%. Thus, accounting for price increases, real GDP increased by only 8%−6%=2%8%−6%=2%.

If you want to measure whether your hourly earnings this year were higher than they were last year, should you use CPI or GDP Deflator?

CPI because it allows one to compare the cost of purchasing a market basket bought by a typical consumer during a specific period with the cost of purchasing the same market basket during an earlier period.

True or False: Typically, the inflation rate as measured by the Consumer Price Index (CPI) tends to be higher than the inflation rate as measured by the GDP deflator.

CPI tends to be higher than GDP deflator because CPI overstates inflation bc it does not account for the fact that consumers reduce their purchases of items that increase in price (and vice versa). There is an alternate version available called the "chained CPI" that does correct for this problem.

Consumer Price Index

Designed to measure the impact of general price changes.

GDP Equation:

GDP = C + I + G + (X - M) **private consumption + gross investment + government investment + government spending + (exports - imports).

GDP per capita

GDP divided by population

Hoe does Smith's $500 doctor bill for seting her son's broken arm affect GDP?

Increases GDP by $500 (EXPENDITURE)

How does a $5,520 purchase of 100 shares of stock at $50 per share plus the sales of commission ($250) affect GDP?

Increases GDP only by $250

GDP deflator

Nominal GDP/Real GDP x 100

Real GDP

Nominal GDP[20B] * (GDP DEFLATOR[20A]/GDP DEFLATOR[20B]

Why might even real GDP be a misleading index of changes in output between 1950 and 2015?

Real GDP does not account for: -Economic Bads -Improvements in Technology -Househould Production (Non Market Transactions) -Underground Markets -Human Costs

Indirect tax

Taxes that increase the firm's production costs and therefore final prices. (APART OF RESOURCE COST APPROACH)

Suppose a group of British investors finances the construction of a plant to manufacture bay boats in Albuquerque, New Mexico. The construction of the plant will have what affect on GDP? If the plant generates $100,000 in corporate profits, will they contribute to GDP? Why or why not?

The construction will increase GDP, and the profits will also increase GDP under the resource cost-income approach.

CPI vs GDP deflator

The consumer price index (CPI) designed to measure the *impact of price changes on the cost of a typical bundle of goods purchased by households.* GDP deflator is a broader price index than the CPI. It is designed to *measure the change in the average price of the market basket of all goods and services included in GDP*

What is Gross Domestic Product (GDP)?

The market value of A*LL FINAL GOODS + SERVICES* produced within a country during a specific period.

Components of GDP by resource cost - INCOME approach

The sum of the costs incurred + income generated by production: -Aggregate Income (Compensation of employees / wages / salaries) -Income of Self Employed proprietors -Rents -Profits -Interest *-Depreciation -Indirect Business taxes -Net Income of Foreigners*

Which of the following is true of indirect business taxes?

They are imposed on the sale of a good.

Gross National Product

Total market value of all final goods + Services produced by citizens of a country GNP = National income + Depreciation + Indirect business taxes

Real Values

Values that have been adjusted for inflation

Net Exports

exports - imports

The net income of foreigners is equal to:

the income foreigners earn in the United States minus the income that Americans earn abroad.

Nominal Values

values expressed in current dollars