Chapter 7: Tracking the Economy

1. How Do We Measure the Economy?

• Tracking the Economy: We use various economic indicators to monitor changes over time.

• Aggregate Measure: A summary of data created by combining multiple values into a single value.

• Price Index: A list tracking price changes for various goods and services (e.g., eggs, haircuts, toothpicks).

2. Measuring the Size of the Economy

• Gross Domestic Product (GDP): The most important measure of an economy’s size.

• National Income and Product Accounts (NIPA):

  • Measures national economic performance.

  • Compares U.S. income and output with other nations.

  • Tracks economic conditions through the business cycle.

GDP Formula

C+I+G+NX=GDPC+I+G+NX=GDP

• Consumer Spending (C): Household spending on goods and services.

• Investment Spending (I): Spending on productive physical capital (e.g., machinery, construction).

• Government Purchases (G): Total spending by federal, state, and local governments.

• Net Exports (NX = X - IM):

  • Exports (X): Goods and services sold to other countries.

  • Imports (IM): Goods and services purchased from other countries.

Three Ways to Calculate GDP

1. Production Approach: Add up the total value of all final goods and services produced.

2. Expenditure Approach: Add up all spending on domestically produced final goods and services.

3. Income Approach: Add up total factor income earned by households from firms.

   • Spending = Income = Production

3. Understanding GDP

• Definition: GDP is the market value of all final goods and services produced within a country in a given year.

• GDP and the Circular Flow:

  • Economic activity moves in a circular pattern.

  • Recession: A slowdown in the circular flow.

What’s Included in GDP?

✅ Domestically produced final goods and services, including:

• Capital goods (e.g., trucks)

• New construction of structures

• Changes in inventories

What’s Not Included in GDP?

❌ Intermediate goods and services
❌ Inputs (raw materials)
❌ Used goods
❌ Financial assets (stocks, bonds)
❌ Goods and services produced outside the country

Examples:

• Cars produced in Mexico by American firms → NOT included in U.S. GDP.

• Cars produced in the U.S. by Japanese firms → INCLUDED in U.S. GDP.

GDP vs. GNP

• Gross Domestic Product (GDP): Measures production within a country’s borders.

• Gross National Product (GNP): Measures production by American firms, regardless of location.

4. Nominal vs. Real GDP

• Nominal GDP: Measures GDP using current prices in a given year.

• Real GDP: Adjusts for inflation by using prices from a base year.

  • Formula for Real GDP Calculation:

    • Calculate output using prices from a selected base year (e.g., 1983-84).

    • Real GDP and Nominal GDP are only the same in the base year.

• If inflation occurs, Real GDP is significantly lower than Nominal GDP.

Chained Dollars

• A method for calculating changes in real GDP by averaging growth rates between an earlier and later base year.

GDP Per Capita

• Formula:Total GDPPopulationPopulationTotal GDP​

• Measures average GDP per person.

• Better than total GDP for comparing living standards, but still an imperfect measure of well-being.

• Top GDP Per Capita Countries: Luxembourg, Switzerland, U.S. (ranked #7).

5. Price Indexes and Inflation

• Aggregate Price Level: Represents the overall price level in an economy.

• Market Basket: A hypothetical set of consumer purchases used to measure price changes.

• Price Index Formula:Price Index in a given year=(Cost of basket in given yearCost of basket in base year)×100Price Index in a given year=(Cost of basket in base yearCost of basket in given year​)×100

• Inflation Rate: Yearly percentage change in a price index, often measured by:

  • Consumer Price Index (CPI)

  • Producer Price Index (PPI) (tracks price changes for producers, often more volatile)

  • GDP Deflator (measures inflation across the entire economy)

Historical Note

• In the late 1970s and early 1980s, the U.S. experienced double-digit inflation, leading to significant economic challenges.

6. GDP and Quality of Life

• GDP does not measure well-being or happiness.

• Key Takeaways:

  • Higher GDP generally means better economic conditions.

  • Wealth improves life, but money isn’t everything.

  • Economic growth should be analyzed alongside social factors.