economics 1

MEASURING THE ECONOMY 1

Introduction and Summary

Macroeconomists use a variety of different observational means in their effort to study and explain how the economy as a whole functions and changes over time. One such method relies on personal experience. It is relatively simple to notice that your company is producing more than it has in the past or that a paycheck does not go as far as it used to. Yet while personal observations do provide information about the economy, that information can often be localized rather than universal, and may not accurately reflect the state of the economy as a whole.

In order to move beyond the limitations inherent in personal experiences, macroeconomists begin by systematically measuring the basic elements of the economy in order to derive standard and comprehensive statistics. This data provides information about the entire economy rather than simply about a single household or firm. Two of the most fundamental elements macroeconomists study are the total output of an economy (GDP) and the cost of living within an economy (CPI). Gross domestic product, or GDP, is an indicator of economic performance that measures the market value of goods and services produced within a country. This measurement is of great importance to consumers since it also equals the total income within an economy. The consumer price index, or CPI, is a cost of living indicator; it measures the total cost of goods and services purchased by a typical consumer within a country. This index allows economists and consumers to see just how much purchasing power a dollar yields, and to compare that power between different years and eras. Together, GDP and CPI show how much income exists within an economy and how much this income can purchase.

The concepts of GDP and CPI open the door to a scientific understanding of the functioning of the economy on a large, or macro, level. These are the most basic tools of measurement used by macroeconomists, policy makers, and consumers to understand and describe the economy. In fact, GDP and CPI are published and discussed regularly in the media. Through understanding the concepts of GDP and CPI, the world of macroeconomics begins to unfold.

Terms and Formulas

Terms

Base year  -  The year from which constant prices or quantities are taken in calculations of such indices as real GDP and CPI.

Bureau of Labor Statistics  -  The government organization responsible for regularly gathering data about the economic status of the population.

Consumer price index (CPI)  -  A cost of living index that measures the total cost of goods and services purchased by a typical consumer within a country.

Fixed basket  -  A set group of goods and services whose quantities do not change over time. This is used, for instance, in the calculation of the CPI.

Gross domestic product (GDP)  -  The sum of the market values of all final goods and services produced within a particular country during a period of time.

Gross domestic product deflator (GDP deflator)  -  The ratio of nominal GDP to real GDP for a given year minus 1. The GDP deflator shows how much of the change in the GDP from a base year is reliant on changes in the price level.

Gross domestic product per capita (GDP per capita)  -  GDP divided by the number of people in the population. This measure describes what portion of the GDP an average individual gets.

Gross national product (GNP)  -  An alternative measure of economic activity to GDP. GNP is the sum of the market values of all goods and services produced by the citizens of a country regardless of their physical location.

Nominal gross domestic product (nominal GDP)  -  The sum value of goods and services produced in a country and valued at current prices.

Real gross domestic product (real GDP)  -  The sum value of goods and services produced in a country and valued at constant prices, calibrated from some base year. Real GDP frees year-to-year comparisons of output from the effects of changes in the price level.

Formulae

Gross Domestic Product

GDP = [(quantity of A X price of A) + (quantity of B X price of B) + ... + (quantity of N X price of N)] for every good and service produced within the country GDP = (national income) = Y = (C + I + G + NX)

GDP Growth Rate

GDP growth rate = [(GDP for year N) / (GDP for year N-1)] - 1

GDP Deflator

GDP deflator = [(nominal GDP) / (real GDP)] - 1

GDP Per Capita

GDP per capita = (GDP) / (population)