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.

Review and Practice


  1. GDP is used as a measure of macroeconomic performance. What, precisely, does it measure?
  2. Many economists have attempted to create a set of social accounts that would come closer to measuring the economic well-being of the society than does GDP. What modifications of the current approach would you recommend to them?
  3. Every good produced creates income for the owners of the factors of production that created the product or service. For a recent purchase you made, try to list all the types of factors of production involved in making the product available, and try to determine who received income as a result of your purchase.
  4. Explain how the sale of used textbooks in your campus bookstore affects the GDP calculation.
  5. Look again at the circular flow diagram in Figure 6.5 "Spending in the Circular Flow Model" and assume it is drawn for the United States. State the flows in which each of the following transactions would be entered.

    1. A consumer purchases fresh fish at a local fish market.
    2. A grocery store acquires 1,000 rolls of paper towels for later resale.
    3. NASA purchases a new Saturn rocket.
    4. People in France flock to see the latest Brad Pitt movie.
    5. A construction firm builds a new house.
    6. A couple from Seattle visits Guadalajara and stays in a hotel there.
    7. The city of Dallas purchases computer paper from a local firm.
  6. Suggest an argument for and an argument against counting in GDP all household-produced goods and services that are not sold, such as the value of child care or home-cooked meals.
  7. Suppose a nation’s firms make heavy use of factors of production owned by residents of foreign countries, while foreign firms make relatively little use of factors owned by residents of that nation. How does the nation’s GDP compare to its GNP?
  8. Suppose Country A has the same GDP as Country B, and that neither nation’s residents own factors of production used by foreign firms, nor do either nation’s firms use factors of production owned by foreign residents. Suppose that, relative to Country B, depreciation, indirect business taxes, and personal income taxes in Country A are high, while welfare and Social Security payments to households in Country A are relatively low. Which country has the higher disposable personal income? Why?
  9. Suppose that virtually everyone in the United States decides to take life a little easier, and the length of the average workweek falls by 25%. How will that affect GDP? Per capita GDP? How will it affect economic welfare?
  10. Comment on the following statement: "It does not matter that the value of the labor people devote to producing things for themselves is not counted in GDP; because we make the same ‘mistake’ every year, relative values are unaffected".
  11. Name some of the services, if any, you produced at home that do get counted in GDP. Are there any goods you produce that are not counted?
  12. Marijuana is sometimes estimated to be California’s largest cash crop. It is not included in estimates of GDP. Should it be?