Gross Domestic Product (GDP)
Total market value of all FINAL goods & services produced within a specific territory in a given period of time
*does not take into account intermediate goods!
3 measures of GDP
- Expenditure measure
- national income accounting identity, Y (GDP) = Consumption + Investments + Gov. purchases + Net Exports - Income measure
- includes depreciation. GDP - dep. = Net domestic product - Production measure
- only NEW production of goods & services adds to GDP, creation of new income!
*doesn’t count if only a transfer of income
Value added = the amount each producer contributes to GDP = revenue generated by each producer - value of intermediate products
Real GDP vs Nominal GDP
Real GDP
- total value of goods and services measured at base-year prices(constant)
Nominal GDP
- total value of goods and services measured at current prices
= price level * real GDP
Measures of price level:
CPI vs Implicit GDP price deflator
CPI (Laspeyres index, has a fixed basket of goods)
- fixes quantities to base year
- if want to measure change in quantities, fix prices from base/initial year
GDP deflator (Paasche index, has a changing basket of goods )
- ratio of nominal GDP to real GDP
- fixes quantities to current year
- if want to measure change in quantities, fix prices from current year
When prices of different goods are changing by diff. amounts, why does the Laspeyres index tend to give a higher inflation rate, & the Paasche index a lower inflation rate?
Laspeyres index has a fixed basket of goods and does not take into account the substitution effect, in which consumers can substitute to the relatively less $$ good.
Paasche index does not reflect the fact that consumers feel worse off by the substitution to the relatively less $$ goods.
What is inflation rate?
Inflation - general increase in prices
% change in price level
Why does real GDP a better measure of wellbeing than nominal GDP?
Economic satisfaction for citizens ultimately depends on quantities of goods & services produced. If prices doubled but quantities stayed the same, nominal GDP doubled but it would be misleading to say that the economy’s ability to satisfy demands has doubled.
3 problems in measuring real GDP, CPI, price level
- Substitution effect cannot be observed in CPI b/c fixed basket of goods
- These measures can count the quantity & prices, but it’s not really the same product anymore (eg. olden day phones vs today’s). The price indexes don’t keep track of QUALITY changes.
- The basket calculated in CPI may be outdated because some G&S became obsolete. + intro of new G&S. This complicates things when we compare CPI across time.
