APMacro: Macroeconomy

GDP image
Macroeconomics studies the economy as a whole. The ways that all of the smaller pieces and systems of microeconomics interrelate. National income accounts keep track of a country’s diverse goods and services. The horizontal or quantity measure used in macroeconomics is gross domestic product or GDP. GDP is the market value of all final goods and services produced by a country’s economy in a given time period. This time period is generally understood to be a year, unless specifically defined otherwise. GDP reflects the total income earned by the suppliers in an economy, because the production of those goods and services is the source of a country’s income.There are two different ways of computing GDP. Nominal GDP is calculated using current year prices. The nominal GDP for 2015, then, would calculate the value of production using 2015 prices for goods and services. Nominal GDP can vary widely from year to year because we are counting the current market price of the goods and services. Real GDP is calculated using prices from a given base year, which may not be the same as the year being measured or the year in which the calculations are made. By focusing on real GDP, we can realistically compare changes in production across years. Real GDP creates a stable price index so that rising prices in general do not increase real GDP.

GDP is a specific metric. It aims to include only the total market value of all final goods and services produced within a country;s domestic boundaries during a given time period. It does not include the value of nonmarket activities, such as unpaid housework, nor does it include illegal activities. It includes only final goods and services, those that are sold to final or ultimate users or consumers. The GDP does not include intermediate goods and services, those that are used tin the process of production or are purchased for resale. A cotton shirt is a final good, but the cotton thread, dye, buttons, and cloth that go into making it are all intermediate goods. The GDP does not include intermediate goods because to do so would amount to counting their value twice or double counting. If a retailer pays $4 for a hat and resells it for $16, there would be an intermediate transaction, in which the retailer pays $4, and a final transaction, in which the consumer pays $16. Taken together, these add up to $20, which is more than the final value of the product.

GDP Intro
Economic growth is defined as an increase in the real GDP of an economy. We calculate the GDP using two approaches, the expenditure approach and the income approach. Under the expenditure approach, GDP is measured by adding up all spending on final goods and services during a given year. This is an aggregate of all domestic spending on production. The expenditure approach determines GDP by adding these four parts:

  1. Consumption: household’s purchases of final goods and services during the year
  2. Investment: domestic spending on additions to inventories, depreciation (repair of current capital), and new capital goods
  3. Government spending: consumption and investment for all government branches
  4. Net exports: the value of exports less the value of imports

Putting it all together: GDP = C + I + G + X

The income approach measures GDP as an aggregate of all of the income derived from that production. Remember that whatever you spend on purchasing goods and services becomes income for the producers of these goods and services. Expenditures and income are thus two sides of the same coin. The economic concept of circular flow amounts to the idea that one person’s spending is another person’s income.


The U.S. GDP tends to grow about 3% per year. This does not mean that at any one point in time the GDP is increasing at 3%.Sometimes GDP is higher than this trend value of 3% and sometimes it is lower. The fluctuations in real GDP around the trend value is called the business cycle. the highest point of a business cycle is called a peak and the lowest point is called a trough. When the economy moves from a peak to a trough, real GDP is falling and the economy is described as being in a contraction. When the economy moves from a trough to a peak, real GDP is increasing and this is called an expansion. Historically expansions have often lasted longer than contractions, but the length of the cycle as a whole varies. A recession is usually defined as six consecutive months, or two consecutive quarters, of decline in real GDP. When a recession becomes prolonged and deep involving high unemployment, it is called a depression.

1) Read Chapter 6.1 pp.106-113, 6.2 pp.113-116



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