CHAPTER

Economic Indicators
12S ECTION 1
Gross Domestic
and Measurements
CONCEPT REVIEW
Macroeconomics is the study of the economy as a whole and how
Product and
major sectors of the economy interact.
Other Indicators
CHAPTER 12 KEY CONCEPT
S ECTION 2 uses statistical measures of income,
National income accounting
Business Cycles spending, and output to help people understand what is happening
to a country’s economy.
S ECTION 3 WHY THE CONCEPT MATTERS
Stimulating
Economic Your economic decisions—combined with those of millions of
Growth other people—determine the fate of the nation’s economy. Can you
afford to buy a new car? Is now a good time to change jobs? Should
you take a risk in the stock market or keep your money safe in the
C ASE S TUDY bank? Understanding what is happening to the country’s economy
Poland: Economic will help youmakebettereconomicdecisions.
Freedom and
Economic
Growth

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Go to ECONOMICS UPDATE for

chapter updates and current news
on the economy of Poland. (See
Case Study, pp. 376–377.)

Go to ANIMATED ECONOMICS for

interactive lessons on the graphs
and tables in this chapter.

How has free enterprise transformed

Go to INTERACTIVE REVIEW for Poland’s economy? See the Case Study
concept review and activities. on pages 376–377.

Economic Indicators and Measurements 349

 SECTION
Gross Domestic Product and
1
OBJECTIVES
Other Indicators
KEY TERMS TAKING NOTES

In Section 1, you will national income accounting,p. 350 As you read Section 1, complete a
• define GDP and describe how gross domestic product (GDP),p. 350 hierarchy chart like the one below
it is measured nominal GDP,p. 352 to record what you learn about
national income accounting.
• explain how GDP has certain real GDP,p. 352
Use the Graphic Organizer at
limitations nonmarket activities,p. 354 Interactive Review @ ClassZone.com
• identify other national income underground economy,p. 354
accounting measures gross national product (GNP),p. 355 National Income
Accounting
net national product (NNP), p. 355
national income (NI),p. 355 GDP
personal income (PI),p. 355
disposable personal income (DPI),
p. 355

What Is GDP?

KEY CONCEPTS
QUICK REFERENCE As you have read, microeconomics and macroeconomics look at the economy
through different lenses. While microeconomics examines the actions of individuals
National income
accounting is a way and single markets, macroeconomics examines the economy as a whole. Macroecon-
of evaluating a country’s omists analyze the economy using national income accounting , statistical measures
economy using statistical that track the income, spending, and output of a nation. The most important of
measures of its income, those measures is gross domestic product (GDP) , the market value of all final goods
spending, and output.
and services produced within a nation in a given time period.
Gross domestic
product (GDP) is
the market value of all The Components of GDP
final goods and services
produced within a nation To be included in GDP, a good or service has
in a given time period. to fulfill three requirements. First, it has to be
final rather than intermediate. For example,
the fabric used to make a shirt is an inter-
mediate good; the shirt itself is a final good.
Second, the good or service must be produced
during the time period, regardless of when it is
sold. For example, cars made this year but sold
next year would be counted in this year’s GDP.
Finally, the good or service must be produced
within the nation’s borders. Products made in Products Included in GDP
foreign countries by U.S. companies are not Cars made in the United States are an example
of goods counted toward U.S. gross domestic
included in the U.S. GDP.
product (GDP).
350 Chapter 12
Calculating GDP
Although there are several different ways to calculate GDP, economists often use the
expenditures approach. With this method, they group national spending on final goods
and services according to the four sectors of the economy: spending by households, or
consumption; spending by businesses, or investment; government spending; and total
exports minus total imports, or net exports. Economists identify consumption with
the letter C ; investment with the letter I ; government spending with the letter G ; and
net exports with the letter X. To calculate GDP, economists add the expenditures from
all sectors together: C+I+G+X=GDP.

FIGURE 12.1 COMPONENTS OF U .S. GROSS DOMESTIC PRODUCT

10
9
Gross Domestic Product (in trillions of dollars)

8
7 Key:
6 Consumption (C)
5 Investment (I)
4 Government
Spending (G)
3
Net Exports (X)
2
1 C I G
0
X
1
2 Find an update on the U.S.
GDP atClassZone.com
Source: U.S. Bureau of Economic Analysis, 2005 data

ANALYZE GRAPHS
1. In 2005, net exports was a negative number. What does this say about
the relative amounts of exports and imports?
2. Did households, businesses, or the government contribute the most to
U.S. GDP in 2005?

Consumption includes all spending by households on durable goods, nondurable

goods, and services. You drive to the movies in a durable good (an item that does
not wear out quickly). You purchase a service when you pay for the movie (since you
are not buying to own something). And you obtain a nondurable good (a good that
is used up relatively soon after purchase) when you buy popcorn.
Investment , which measures what businesses spend, has two categories. One is fixed
investment, which includes new construction and purchases of such capital goods as
equipment, machinery, and tools. The other is inventory investment. This category,
also called unconsumed output, is made up of the unsold goods that businesses keep
on hand.
Government spending includes all the expenditures of federal, state, and local gov-
ernments on goods and services. Examples include spending for defense, highways,

Economic Indicators and Measurements 351

 and public education. However, government spending on transfer payments, such as
social security and unemployment benefits, is not included. These payments allow
the recipients to buy goods and services, and these are counted as consumption.
Net exports , the final component of GDP, represents foreign trade. This component
takes into account the goods and services produced in the United States but sold
in foreign countries—in other words, exports. However, U.S. consumers and busi-
nesses also buy, or import, goods made in foreign countries. Cars, car parts, and
crude oil are the largest imports in dollar value. The GDP counts only net exports—
the value of U.S. exports minus the value of U.S. imports.

Two Types of GDP

Economists use GDP to gauge how well a country’s economy is doing. When GDP
is growing, an economy creates more jobs and more business opportunities. When
GDP declines, jobs and more business opportunities become less plentiful. To get
QUICK REFERENCE a clearer picture of a country’s economic health, economists calculate two forms of
GDP—nominal and real.
Nominal GDP states The most basic form is nominal GDP, which is stated in the price levels for the
GDP in terms of the year in which the GDP was measured. If prices never changed, nominal GDP would
current value of goods and
be sufficient. But prices tend to increase over time. In Figure 12.2, find the line
services.
that represents nominal GDP. If you estimate the difference from 1990 to 2005, the
Real GDP states GDP
nominal GDP of the United States about doubled. However, during this time prices
corrected for changes in
prices from year to year. went up, adding dollars to GDP without adding value to the nation’s output.
To factor out rising prices, economists use real GDP, which is nominal GDP
adjusted for changes in prices. Real GDP is an estimate of the GDP if prices were to

FIGURE 12.2 U . S . NOMINAL AND REAL

GROSS DOMESTIC PRODUCT

14
Gross Domestic Product (in trillions of dollars)

NOMINAL GDP
12 REAL GDP (IN 2000 DOLLARS)

10

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Source: U.S. Bureau of Economic Analysis Year

ANALYZE GRAPHS
1. About how much did nominal GDP increase from 1990 to 2000?
2. About how much did real GDP increase over the same period?
3. Why do the two lines cross at the year 2000?

352 Chapter 12
 MATH CHALLENGE
FIGURE 12.3 Understanding Nominal and Real GDP

To better understand nominal and real GDP, imagine 2004 2005 2006
a country that produces only one good: TVs. If you TVs
500 600 600
know the price of TVs and the number produced, you Produced
can calculate that country’s nominal and real GDP. TV Price $100 $100 $120
Use the table to find the data for these calculations. Nominal
$50,000 $60,000 $72,000
GDP
Step 1: Calculate nominal GDP for 2004. Nominal Real GDP,
$50,000 $60,000 $60,000
GDP is the product of the number of TVs produced base: 2004
and the price of TVs that year.

Number Nominal
Price in that year 500 $100 $50,000
produced GDP

The table shows that nominal GDP grew each year. If you judged only by nominal
GDP, the economy of this country would seem to be growing.

Step 2: Analyze the nominal GDP figures. Why did nominal GDP increase from
2004 to 2005? The number of TVs produced increased. Why did nominal GDP
increase from 2005 to 2006? The price of TVs increased.

The output of the country’s economy grew from 2004 to 2005, but it stayed the
same from 2005 to 2006, despite the increase in prices. Calculating real GDP
produces a better estimate of how much a country’s economy is growing.

Step 3: Calculate real GDP for 2006. Real GDP is the product of the number of TVs
produced in the current year and the price of TVs in the base year. In this case, use
2004 as the base year.

Number Price in the

Real GDP 600 $100 $60,000
produced base year

Since 2004 is the base year, nominal and real GDP are the same for 2004. Real GDP
allows you to compare the output of the country’s economy in different years.

remain constant from year to year. To find real GDP, economists compare nominal
GDP to a base year. Look again at Figure 12.2, which uses 2000 as a base year. Since
real GDP eliminates price differences, the line for real GDP rises more gradually
than the line for nominal GDP. Real GDP provides a more accurate measure of eco-
nomic performance.

APPLICATION Applying Economic Concepts

A. If output remained the same, how would a year of falling prices affect nominal GDP?
How would it affect real GDP?

Economic Indicators and Measurements 353

 What GDP Does Not Measure

KEY CONCEPTS

Although GDP provides an important estimate of how well the economy is performing,
QUICK REFERENCE
it does not measure all output. It does not measurenonmarket activities, such as home
childcare or performing one’s own home repairs. GDP also does not measure output
Nonmarket activities
are services that have from the underground economy , market activities that go unreported because they
potential economic value are illegal or because those involved want to avoid taxation. Further, GDP does not
but are performed without measure “quality of life” issues related to economic output.
charge.
Underground
economy describes
Nonmarket Activities
market activities that go Some productive activities do not take place
unreported because they
in economic markets. For example, there is no
are illegal or because those
involved want to avoid effective way to measure the output of plumb-
taxation. ers who install or repair plumbing systems in
their own homes or people who do volunteer
work for schools or hospitals. By far the biggest
nonmarket activity, also left out of GDP, con-
sists of the many services—cooking, cleaning,
childcare—provided by homemakers.
Nonmarket Activities Housework is
Underground Economy an example of a productive activity not
measured by GDP.
Also missing from GDP is the underground
sector of the economy. Some activities are kept
underground because they are illegal—drug dealing, smuggling, gambling, and
selling stolen goods, for example. When goods are rationed or otherwise restricted,
illegal trading occurs on what is called the black market. Other underground activi-
ties are themselves legal, but the way the payment is handled is not. For example,
a plumber who does repairs for a neighbor might receive payment in cash and not
declare it as taxable income. Estimates suggest that the underground economy would
make up 8 to 10 percent of the U.S. GDP.

Quality of Life
Countries with high GDPs have high living standards. But GDP does not show how
the goods and services are distributed. The United States has the largest GDP of any
country, but more than 10 percent of its people still live in poverty. GDP also does
not express what products are being built and services offered: for example, are there
more jails being built than schools?

APPLICATION Explaining an Economic Concept

B. If you get paid in cash to baby-sit, mow lawns, or do other chores for neighbors, are
you part of the underground economy? Why or why not?

354 Chapter 12
SECTION 1 Assessment ClassZone.com

REVIEWING KEY CONCEPTS ECONOMICS IN PRACTICE

1. Explain the relationship between the terms in each of these pairs.

a. nominal GDP b. gross national product c. personal income
real GDP net national product disposable personal
income

2. What are the four components of GDP?

3. What is an example of a durable good? a nondurable good?

4. Name two economic activities that GDP does not measure.

5. Why are transfer payments not included as a government expenditure

when calculating GDP?

6. Using Your Notes Write a brief National Income

Accounting
summary of the methods used
to calculate national income and GDP Identifying Intermediate and
the purposes of each accounting Final G oods
method. Refer to your completed Look at the following list of goods
hierarchy chart. and who purchased them.
Use the Graphic Organizer at Interactive Review @ ClassZone.com
Goods Purchaser

copier paper accounting firm

CRITICAL THINKING refrigerator home consumer

stainless steel manufacturer

7. Drawing Conclusions List some things that have become more eggs home consumer
expensive during your lifetime. Explain how a rise in price level
factory that makes
affects nominal GDP and real GDP. eggs frozen baked
8. Making Inferences If consumption is especially high compared goods
with other years, what might you generalize about the health of battery car owner
the economy? paint furniture maker
9. Explaining an Economic Concept What is the underground
economy? What impact does it have on a nation’s GDP? Categorize Economic
10. Drawing Conclusions Imagine that a new country is discovered Information Decide whether each
on an island in the middle of the Pacific Ocean. The country’s good is an intermediate good or a
people have never left the island, and no foreigners have ever final good.
been there. What would the relationship be between the Challenge Why is it important to
country’s GDP and its GNP? Why? make a distinction in national income
11. Challenge How would the following affect GDP? accounting between intermediate
a. Government transfer payments increase. and final goods?
b. Student sells used CD to record store.
c. Car owner pays auto repair shop $500 to fix his car.

355