Econ 114- GDP

National income accounting helps us understand the economy by:

1. Checking if the economy is doing well or struggling.

2. Tracking how the economy changes over time.

3. Helping the government make smart policies.

what is GDP

GDP is the total value of all final goods and services produced in a country during a specific time (like a year).

what is not included in GDP

• Financial transactions (e.g., government benefits, stock trading)

• Used goods (e.g., selling a second-hand car)

1. The Spending Approach (Aggregate Expenditure Approach)- one way how GDP is measured

We calculate GDP by adding up all the money spent on goods and services:

GDP=C+I+G+(X−M)

Where:

• C = Consumer spending (e.g., buying groceries)

• I = Investment spending (e.g., businesses buying machines)

• G = Government spending (e.g., building roads)

• X - M = Exports minus imports (exports bring money into the country, imports take money out)

The Income Approach ( one way in how GDP is measured)

Instead of counting spending, we can count income earned by workers and businesses:

• Wages and salaries

• Business profits

• Investment income

• Farmers’ earnings

• Other business incomes

Then, we add taxes and depreciation (wear and tear of machines and buildings) to get GDP.

GDP vs NDP

• Gross Domestic Product (GDP) = Total production, before subtracting depreciation (damage to machines, buildings, etc.).

• Net Domestic Product (NDP) = GDP minus depreciation, showing how much is truly “new” production.

NDP= GDP−Depreciation

how is investement financed

1. National saving (household & government savings)

2. Government budget surplus (if taxes collected are more than spending)

3. Foreign borrowing (if the country imports more than it exports)

I=S+(T−G)+(M−X)

• S = Private savings

• T - G = Government budget surplus

• M - X = Borrowing from other countries

1⃣ Debbie spends $200 at a restaurant in Vancouver.

✅ This is consumer spending (C), so GDP rises by $200.

2⃣ Sarah buys a laptop for her business for $1800, but it was made in China.

Investment (I) goes up by $1800, but since the laptop was imported, Net Exports (X - M) decreases by $1800.

👉 GDP does not change overall.

3⃣ Jane buys a $1200 computer made last year.

✅ Since it was produced last year, it doesn’t count toward this year’s GDP.

4⃣ General Motors builds $500 million worth of cars, but only sells $470 million worth.

Consumer spending (C) increases by $470 million (cars sold).

✅ Inventory investment (I) increases by $30 million (unsold cars count as investment).

✅ Total GDP increases by $500 million.

Nominal GDP

"Now" prices. The value of all goods and services at current prices (without adjusting for inflation

Real GDP

• Realistic prices (adjusted for inflation to show true growth).gives a clearer picture of actual economic growth.

how to calculate real gdp

constant price gdp

chain weighted output index

constant price gdp

This method uses prices from a base year to measure GDP over time.

Example:

• In 2012, GDP was $200.

• In 2013, at current prices, GDP was $575 (Nominal GDP).

575/270 × 100= 213

575/ 2.13= 270

• But using 2012 prices, real GDP in 2013 was $270.

This means that if prices had stayed the same as in 2012, the economy only grew from $200 to $270.

chain weighted output index

This method uses the prices from two consecutive years to get a more accurate growth rate.

Steps:

1. Calculate real GDP using last year’s prices and find the growth rate.

2. Calculate real GDP using this year’s prices and find the growth rate.

3. Find the average of both growth rates.

4. Repeat this process every year to track real GDP over time.

Example:

• Using 2012 prices, GDP in 2012 was $200, and in 2013 was $270 (270-200/200=35% growth).

• Using 2013 prices, GDP in 2012 was $500, and in 2013 was $575 (575-500/500= 15% growth).

• The average growth rate = (35+15 /2= 25%.)

• Real GDP for 2013 = 2012 GDP × (1 + 0.25)

  = $200 × 1.25 = $250.

This method adjusts for price changes better than just using one base year

how do we measure the price level

GDP deflator

consumer price index

gdp deflator

1. Measures the overall price level for everything included in GDP.
   GDP Deflator=Nominal GDP / Real GDP×100

   • In 2012: 200 / 200×100=100

   • In 2013: 575 / 250×100= 230

   • Prices increased by 130% from 2012 to 2013

Imagine blowing up a balloon (inflation). The GDP deflator "deflates" the extra air (inflation) so we can see the actual size of the balloon (real GDP).

consumer price index

Measures price changes only for consumer goods and services, not investment or government spending.

how does nominal GDP increase

1. More goods and services are produced (real growth).

2. Prices increase due to inflation.

To understand true economic growth, we need real GDP because it removes the effect of inflation

what is economic growth and why do we track it

the increase in real GDP over time. We measure it using the economic growth rate, which is the percentage change in real GDP.

We track economic growth for three reasons:

1. Comparing economic well-being over time – Are people better off than before?

2. Comparing economic well-being between countries – Which country has a higher standard of living?

3. Predicting future trends – Will the economy grow or slow down?

1. Does buying a new iPhone increase GDP

• Yes, but only if it's a new phone. If it's the same price as your old one, GDP may not increase much.

1. Does paying for a car repair in cash or by debit affect GDP differently?

• If it's an official transaction (with a receipt), both payments count toward GDP. If it's an off-the-books cash payment, it might not be counted.

1. Does crime increase GDP?

• Surprisingly, yes! If someone is in prison, the government spends money on jails, lawyers, and security—this adds to GDP

1. Does working more hours mean contributing more to GDP?

• Not necessarily. If you and your friend both earn $1000 but they work more hours, GDP only measures the total money earned, not who worked harder.

what does GDP not measure

✅ Quality improvements – Newer iPhones are better than old ones, but GDP only tracks prices.

✅ Household work – Cooking, cleaning, and childcare at home are not included.

✅ The underground economy – Cash transactions that aren’t reported (e.g., paying under the table).

✅ Health and life expectancy – Living longer and being healthier don’t directly show up in GDP.

✅ Leisure time – Having more free time improves well-being but doesn’t increase GDP.

✅ Environmental damage – Pollution and resource depletion are not deducted from GDP.

✅ Political freedom and fairness – GDP doesn’t measure democracy, justice, or happiness.

✅ Income distribution – A country may have a high GDP, but if the money is concentrated among a few people, many still struggle.

better ways to measure the wellbeing of people

1. GDP per capita – GDP divided by population (measures average income).

2. GDP in PPP (Purchasing Power Parity) – Adjusts GDP to compare what people can actually buy in different countries.

3. Net National Welfare – GDP plus unpaid work, minus environmental damage.

4. Human Development Index (HDI) – Measures income, education, and health for a better picture of well-being.

Example:

• Luxembourg has the highest GDP per capita (~$111,192 in 2013).

• But Norway ranks highest on HDI because it has good education, healthcare, and quality of life.

business cycle

1. Expansion – GDP grows (jobs increase, businesses thrive).

2. Peak – The highest point before a downturn.

3. Recession – GDP shrinks (unemployment rises, businesses slow down).

4. Trough – The lowest point before recovery starts.

To be a recession, GDP must shrink for at least two consecutive quarters (6 months).

Example:

• The 2008 financial crisis caused a global recession.

• The economy recovered after governments took action.