Measuring Total Output and Income

Read this chapter, to learn about measuring domestic output, and attempt the "Try It" exercises. The material in this chapter concentrates on the four components of GDP: consumption, investment, government purchases, and net exports. Pay attention to the definition of these components as it may differ from your expectations. For example, note that Investment does not refer to the common knowledge definition of investment as in the trading of stock and bonds. Instead, the Investment component refers mainly to the purchase of physical machinery and equipment needed in the production of goods and services. You will revisit certain sections of the chapter later in this unit.

6.3 GDP and Economic Well-Being


  1. Discuss and give examples of measurement and conceptual problems in using real GDP as a measure of economic performance and of economic well-being.
  2. Explain the use of per capita real GNP or GDP to compare economic performance across countries and discuss its limitations.

GDP is the measure most often used to assess the economic well-being of a country. Besides measuring the pulse of a country, it is the figure used to compare living standards in different countries.

Of course, to use GDP as an indicator of overall economic performance, we must convert nominal GDP to real GDP, since nominal values can rise or fall simply as a result of changes in the price level. For example, the movie Avatar, released in 2009, brought in $761 million - the highest amount to date in gross box office receipts, while Gone with the Wind, released in 1939, earned only $199 million and ranks 117th in terms of nominal receipts. But does that mean that Avatar actually did better than Gone with the Wind? After all, the average price of a movie ticket in 1939 was about 25 cents. At the time of Avatar, the average ticket price was about $7.50. A better way to compare these two movies in terms of popularity is to control for the price of movie tickets - the same strategy that economists use with real GDP in order to determine whether output is rising or falling. Adjusting the nominal box-office receipts using 2012 movie prices to obtain real revenue reveals that in real terms Gone with the Wind continues to be the top real grosser of all time with real box-office receipts of about $1.6 billion. Avatar’s real box-office receipts amounted to a mere $776 million. As illustrated by this example on revenues from popular movies, we might draw erroneous conclusions about performance if we base them on nominal values instead of on real values. In contrast, real GDP, despite the problems with price indexes, provides a reasonable measure of the total output of an economy, and changes in real GDP provide an indication of the direction of movement in total output.

We begin this section by noting some of the drawbacks of using real GDP as a measure of the economic welfare of a country. Despite these shortcomings, we will see that it probably remains our best single indicator of macroeconomic performance.