Economics•Chapter 7•4 min read

National Income and Macroeconomics — GDP, Price Level & Business Cycles

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National Income Concepts

GDP (Gross Domestic Product)

GDP: the market value of all final goods and services produced within a country’s borders during a given period (usually one year)

Key Terms

  • “Given period”: flow concept, not a stock
  • “Within borders”: includes output by foreign residents; excludes output of US residents abroad
  • “Final goods”: intermediate goods excluded (avoids double-counting)
  • “Market value”: price × quantity
  • Source: US Bureau of Economic Analysis (BEA)

GNP (Gross National Product)

  • Based on nationality, not location
  • GNP = GDP + Net factor income from abroad
  • Includes output of US residents abroad; excludes output of foreign residents in the US

The Three Approaches to GDP

Expenditure Approach (most common)

GDP=C+I+G+(X−M)C=Personal consumption expendituresI=Gross private domestic investment(equipment + structures + inventory change)G=Government consumption&investment(X−M)=Net exportsIncome Approach:GDP=wages+interest+rent+profit+depreciation+net indirect taxesProduction Approach:Sum of value added at each stage of production\begin{aligned} GDP &= C + I + G + (X − M) \\ C &= \text{Personal consumption expenditures} \\ I &= \text{Gross private domestic investment} \quad \text{(equipment + structures + inventory change)} \\ G &= \text{Government consumption} \& \text{investment} \\ (X − M) &= \text{Net exports} \\ &\text{Income Approach}: \\ GDP &= \text{wages} + \text{interest} + \text{rent} + \text{profit} \\ &+ \text{depreciation} + \text{net indirect taxes} \\ &\text{Production Approach}: \\ &\text{Sum of value added at each stage of production} \end{aligned}

Nominal vs. Real GDP

  • Nominal GDP: measured at current-year prices
  • Real GDP: measured at base-year prices (inflation stripped out)

GDP Deflator — = (Nominal GDP / Real GDP) × 100 Broadest measure of the overall price level

Price Indexes

  1. GDP Deflator: covers all domestically produced goods (BEA)
  2. CPI (Consumer Price Index): a fixed basket of consumer goods and services (BLS)
  3. PPI (Producer Price Index): prices at the wholesale/producer stage (BLS)

Real Economic Growth Rate — = (Real GDP₁ − Real GDP₀) / Real GDP₀ × 100

Derived National Income Aggregates

GNP=GDP+Net factor income from abroadNNP=GNP−Depreciation(capital consumption)NI=NNP−Net indirect taxesPI=NI−Retained earnings−Social insurance+Transfer paymentsDI=PI−Personal income taxes(Disposable Income=what households actually spendsave)\begin{aligned} GNP &= GDP + \text{Net factor income from abroad} \\ NNP &= GNP − \text{Depreciation} (\text{capital consumption}) \\ NI &= NNP − \text{Net indirect taxes} \\ PI &= NI − \text{Retained earnings} − \text{Social insurance} \\ &+ \text{Transfer payments} \\ DI &= PI − \text{Personal income taxes} \\ (\text{Disposable Income} &= \frac{\text{what households actually spend}}{\text{save}}) \end{aligned}

Business Cycle

Four Phases (NBER definitions)

  1. Expansion: GDP rising, employment rising, inflation tends to accelerate
  2. Peak: the high-water mark of the cycle
  3. Contraction / Recession: GDP declining Two consecutive quarters of negative real GDP growth = technical recession
  4. Trough: the low point before recovery begins

Leading, Coincident, and Lagging Indicators — Leading (move before the cycle): Stock prices (S&P 500), building permits, yield curve spread (10y − 2y Treasury), consumer confidence index Coincident (move with the cycle): Industrial production, nonfarm payrolls, real personal income Lagging (move after the cycle): Unemployment rate, CPI, prime rate

Key Concept Cards

GDP = C + I + G + (X − M) ★★★★★ : Expenditure approach. Personal consumption + gross investment + government spending + net exports. Note: imports are subtracted. Memory hook: GDP = Consumers + Investment + Government + Net exports

Nominal, Real, and the GDP Deflator ★★★★★ : GDP Deflator = (Nominal / Real) × 100. Divide nominal GDP by the deflator (and multiply by 100) to get real GDP. Memory hook: deflator = nominal ÷ real × 100

Leading Indicator Examples ★★★★☆ : Stock prices, building permits, yield curve spread, consumer confidence — all move before the economy turns. Memory hook: leading = stocks and permits signal the turn

Practice Questions

Q. Nominal GDP = $25 trillion; GDP Deflator = 125. What is real GDP?

Real GDP = Nominal GDP / Deflator × 100 = $25 trillion / 125 × 100 = $20 trillion.

Q. Give examples of what IS and what IS NOT included in GDP.

Included: final sales of goods and services by businesses; government salaries paid to federal employees; new residential construction. Not included: used-car sales (already counted when new); stock and bond transactions (financial asset transfers, not production); the underground economy; unpaid household work (cooking, childcare).

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