econ1102 chapter 1

macroeconomics 1

What does GDP measure?

The monetary value of final goods and services produced in a country during a given period of time.

Why is household production, like cooking or cleaning for your own family, excluded from GDP?

Because GDP only counts market production, and household production involves no market transaction.

Is the sale of second-hand goods between two individuals counted in GDP?

No, since it's not new production. But if a business sells second-hand goods, the value it adds through resale IS counted.

How is GDP valued for a good or service with no market price, like a free police search?

By estimating a market value, or more commonly by using the cost of the inputs (labour and capital) used to provide it.

What is the difference between an intermediate good and a final good?

An intermediate good is used up in producing another good or service; a final good is the end product sold to the final user.

Why do we use 'value added' rather than total sales to calculate GDP via the production approach?

To avoid double-counting intermediate goods that get resold at each stage of production.

How is 'value added' calculated at each stage of production?

Sales minus the cost of intermediate goods used.

How does the production approach calculate GDP?

By summing the value added by all businesses operating in the economy.

Does Australia's GDP include production done within Australia by foreign workers, e.g. backpackers?

Yes — GDP measures location of production, not the nationality of the producer.

Does Australia's GDP include the value of goods Australia imports?

No, imported goods are excluded from Australia's GDP.

What is the minimum period over which GDP is measured?

A quarter (three months).

What is the expenditure-approach equation for GDP (Y)?

Y ≡ C + I + G + X − M.

In the expenditure approach to GDP, what does 'C' represent?

Household consumption spending.

In the expenditure approach to GDP, what does 'I' represent?

Private (business) investment spending.

In the expenditure approach to GDP, what does 'G' represent?

Government (public) spending.

Why do we subtract imports (M) in the expenditure approach to GDP?

Because imports are already embedded in C, I, and G but weren't produced domestically, so they must be removed to avoid overstating domestic production.

What is net exports (NX)?

NX = X − M, exports minus imports.

Why is the GDP identity Y ≡ C + I + G + X − M written with a triple-equals sign?

Because it's an accounting identity — true by definition, not by economic behaviour.

Do the expenditure, income, and production approaches to GDP always give exactly the same number in practice?

No — measurement errors cause them to differ slightly, so the ABS's official GDP figure is an average of the three.

Give an example of non-durable household consumption.

Food and drinks.

Give an example of durable household consumption.

Cars or household appliances.

Give an example of household consumption of services.

Going to the dentist or the movies.

What does 'change in inventories' measure within business investment?

Inventory level at the start of the period minus inventory level at the end of the period.

What is the difference between government 'current' and 'capital' spending?

Current spending is consumption-type spending (day-to-day operating costs); capital spending is investment (e.g. building new infrastructure).

How does the income approach calculate GDP?

As the sum of payments to labour and capital (wages, profits, interest, rents) plus net indirect taxes.

What is the income-approach equation for GDP?

Y ≡ (W×L) + (R×K).

In the income-approach GDP equation, what do W and L represent?

W is the wage per unit of labour; L is labour.

In the income-approach GDP equation, what do R and K represent?

R is the rate of return to a unit of capital; K is capital.

Why are the expenditure and income approaches to GDP conceptually equal?

Because one person's spending is another person's income.

How does Gross National Income (GNI) differ from GDP?

GNI adjusts GDP's income measure by adding net factor income receivable from non-residents, capturing income by country of origin rather than location of production.

What's the key difference between nominal GDP and real GDP?

Nominal GDP is affected by both price and quantity changes; real GDP only reflects changes in quantity (volume).

How is 'real' (constant price) GDP calculated?

By valuing quantities produced in different years using prices from one common base year.

Why do economists use 'chain-weighted' GDP calculations?

To improve real GDP estimates by averaging growth rate estimates across successive year-pairs, reducing distortion from a single fixed base year.

What is the GDP deflator (price index) also known as?

The price index is also known as the deflator.

Why do we divide real GDP by total population?

To get real GDP per capita, isolating economic growth per person from growth that's simply due to population increase.

Why might a high GDP not fully capture a country's economic welfare?

Because GDP omits non-market activities, pollution/externalities, and factors like income inequality, life expectancy, and quality of life.

What alternative index attempts to measure broader economic welfare beyond GDP?

The Better Life Index (BLI).

What is the 'business cycle'?

Variations in the rate of utilisation of resources in an economy over time.

In the classical business cycle, what phase comes immediately after the expansion?

The peak.

In the classical business cycle, what phase comes immediately after the peak?

Contraction/recession.

In the classical business cycle, what is the lowest point called?

The trough.

What is the 'Great Moderation'?

The historical decline over time in the level of fluctuation (volatility) of GDP.

What is the technical definition of a recession?

At least two consecutive quarters of negative growth in real GDP.

What does the Consumer Price Index (CPI) measure?

How the cost of purchasing a fixed basket of goods and services changes over time relative to a base year.

What is 'quality adjustment bias' in CPI measurement?

Overestimating the cost of living because a price rise partly reflects genuine quality improvement, not just inflation.

What is 'substitution bias' in CPI measurement?

Overestimating the cost of living because the fixed basket doesn't account for consumers substituting away from goods that become relatively more expensive.

Why is indexation (linking wages/prices to inflation) difficult in practice?

Because uncertainty around future inflation makes it hard to know the correct rate to index by.

What is 'menu cost'?

The cost businesses incur from having to change and reprint prices (e.g. menus) due to inflation.

What is 'shoeleather cost'?

The transaction cost of switching more frequently between liquid and non-liquid assets to avoid holding cash that's losing value to inflation.

What is the generally accepted 'optimal' inflation rate range?

Roughly 1–3%.

Why do central banks avoid targeting zero inflation?

A small positive inflation rate gives room to effectively cut real wages when needed, and gives more scope to cut nominal interest rates before hitting the zero lower bound.