Measuring Economic Activity - GDP

Question 1

How to measure economic activity?

Answer 1

By measuring an economy’s national income (= the value of output)

Question 2

How to calculate the value of a good?

Answer 2

Quantity x price is the value of an output

Question 3

What is the relation between value of output and national income?

Answer 3

Value of aggregate output = national income

- Because total income = total expenditure = value of output (P x Q)

Question 4

What is GDP?

Answer 4

GDP is the total value of a nation’s final output in a particular period of time

Question 5

What does GDP include?

Answer 5

1. Final products and services
2. Value of what has been produced within the country
3. Emphasis on production rather than sales

Question 6

What does GDP exclude?

Answer 6

1. Purely financial transactions
   - public transfer payments
   - private transfer payments
   - sale of stocks and bonds
2. Second-hand sales
   - contributes to the year in which it was produced
3. Intermediate goods

Question 7

What are the 3 methods of calculating GDP?

Answer 7

1. Income Approach
2. Expenditure Approach
3. Output Approach

Question 8

What is the income approach for calculating GDP?

Answer 8

National Income = Wages for labor + Interest for capital + Rent for land + Profits for entrepreneurship

Question 9

What is the idea behind the income approach?

Answer 9

Income is only generated when a good or service is sold, meaning that the value of the good/service is equal to the amount of income it generates

Question 10

What is the expenditure approach for calculating GDP?

Answer 10

Total Expenditures = Households consumption (C) + Investment in capital by firms (I) + Government spending (G) + net exports (X - M)

Question 11

What is the idea behind the expenditure approach?

Answer 11

When an individual spends something on a good or service, that amount of expenditure is equal to the value of the good

Question 12

What is the relation between income approach and expenditure approach?

Answer 12

An individual’s income is generated through selling a good or service, and an individual’s expenditure is generated by buying that good or service.
Therefore, person A’s expenditure =- person B’s income, which means total income in an economy = total expenditure in an economy = value of output

Question 13

What is consumer spending?

Answer 13

All purchases by households on final goods and services

Question 14

What is investment spending?

Answer 14

Spending by firms on capital (buildings, equipment, etc.) and inventories

Question 15

What is government spending?

Answer 15

• Purchases of factors of production

- Public investments (roads, schools, etc.)

Question 16

What is net exports?

Answer 16

Exports - Imports

Question 17

What is the output approach?

Answer 17

National output = outputs of the primary sector + secondary sector + tertiary sector

Question 18

Why is only the final product value considered for output approach?

Answer 18

The final product value will be the sum of all the value added to the product by earlier firms, thereby avoiding double counting.

Example: Firm A sells raw materials for $700, Firm B sells intermediate good for $1100 (+400 added value), and Firm C sells final good for $1700 (+600 added value).

Therefore, the total added value = 700 + 400 + 600 is equal to the final product value ($1700).

Question 19

What is nominal GDP?

Answer 19

Measures the value of a nation’s output produced in a year, in terms of the sum of the goods produced times their current prices

Question 20

What is a flaw of nominal GDP?

Answer 20

If the average price level of a nation’s output increases in a year, the nominal GDP would increase even if the actual amount of output does not change

Question 21

What is real GDP?

Answer 21

Measures the value of a nation’s output in a particular year, adjusted for changes in the price level from a base year

Question 22

What is an advantage of real GDP?

Answer 22

Offers a more accurate measure of actual quantity of goods and services a nation produces because it adjusts for price changes

Question 23

What is the GDP deflator?

Answer 23

It is a price index that can be used to adjust a nation’s nominal GDP for changes in the price level

Question 24

What is the formula for GDP deflator?

Answer 24

(nominal GDP / real GDP) * 100

Question 25

What is the base year?

Answer 25

Base year is the year whose prices are being considered while calculating real GDP.

Thus, the GDP deflator index of a base year would be 100

Question 26

How does the GDP deflator represent inflation / deflation?

Answer 26

• If index is 110, this means that the prices have risen by 10%
• If the index is 90, this means that the prices have fallen by 10% between those years

Question 27

What is the relation between GDP deflator, real GDP, and nominal GDP?

Answer 27

• If GDP deflator index > 100, real GDP will be lower than nominal GDP
• If GDP deflator index < 100, real GDP will be higher than nominal GDP