I n t h I s c h a p t e r y o u w I l L

R
EAL
GDP 
PER
L
IFE
A
DULT
C
OUNTRY
P
ERSON
, 1997
E
XPECTANCY
L
ITERACY
United States
$29,010
77 years
99%
Japan
24,070
80
99
Germany
21,260
77
99
Mexico
8,370
72
90
Brazil
6,480
67
84
Russia
4,370
67
99
Indonesia
3,490
65
85
China
3,130
70
83
India
1,670
63
53
Pakistan
1,560
64
41
Bangladesh
1,050
58
39
Nigeria
920
50
59
Source: 
Human Development Report 1999,
United Nations.
Measuring a nation’s gross domestic
product is never easy, but it becomes
especially difficult when people have
every incentive to hide their economic
activities from the eyes of government.
T h e R u s s i a n E c o n o m y :
N o t e s f r o m U n d e r g r o u n d
B
Y
M
ICHAEL
R. G
ORDON
If you want to know what is happening in
the Russian economy, it helps to think
about bread. Government statistics show
that people are eating more bread and
bakeries are selling less. Or consider vod-
ka. Distillers are able to produce far more
vodka than is officially being sold. But giv-
en the well-deserved Russian fondness for
vodka there is every reason to think the
distilleries are operating at full capacity.
The Russian Government’s top
number crunchers say the contradictions
are easy to explain: high taxes, govern-
ment red tape, and the simple desire to
sock away some extra cash have driven
much of Russia’s economic activity
underground.
For the last six years, the Russian
economy has been going down, down,
down. But as President Boris N. Yeltsin
tries to deliver the growth he has
promised, economists are taking a clos-
er look at the murky but vibrant shadow
economy. It includes everything from
small businesses that never report their
sales to huge companies that understate
their production to avoid taxes.
Government experts insist that if the
shadow economy is taken into account,
the overall economy is finally starting to
grow. In turn, Mr. Yeltsin’s critics com-
plain that the new calculations are more
propaganda than economics. . . .
There is no question that measuring
economic activity in a former Communist
country on the road to capitalism is a
frustratingly elusive task.
“There is a serious problem with
post-socialist statistics,” said Yegor T.
Gaidar, the former Prime Minister and
pro-reform director of the Institute of
Economic Problems of the Transitional
Period.
“Seven years ago to report an
increase in the amount of production
was to become a Hero of Socialist
Labor,” he said. “Now it is to get addi-
tional visits from the tax collector.”
S
OURCE
: 
The New York Times,
May 18, 1997, Week
in Review, p. 4.
I N T H E N E W S
Hidden GDP

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5 0 8
PA R T E I G H T
T H E D ATA O F M A C R O E C O N O M I C S
maternal mortality, higher rates of child malnutrition, and less common access
to safe drinking water. In countries with low GDP per person, fewer school-age
children are actually in school, and those who are in school must learn with
fewer teachers per student. These countries also tend to have fewer televisions,
fewer telephones, fewer paved roads, and fewer households with electricity.
International data leave no doubt that a nation’s GDP is closely associated with
its citizens’ standard of living.
Q U I C K Q U I Z :
Why should policymakers care about GDP?
C O N C L U S I O N
This chapter has discussed how economists measure the total income of a nation.
Measurement is, of course, only a starting point. Much of macroeconomics is
aimed at revealing the long-run and short-run determinants of a nation’s gross
domestic product. Why, for example, is GDP higher in the United States and Japan
than in India and Nigeria? What can the governments of the poorest countries do
to promote more rapid growth in GDP? Why does GDP in the United States rise
rapidly in some years and fall in others? What can U.S. policymakers do to reduce
the severity of these fluctuations in GDP? These are the questions we will take up
shortly.
At this point, it is important to acknowledge the importance of just measuring
GDP. We all get some sense of how the economy is doing as we go about our lives.
But the economists who study changes in the economy and the policymakers who
formulate economic policies need more than this vague sense—they need concrete
data on which to base their judgments. Quantifying the behavior of the economy
with statistics such as GDP is, therefore, the first step to developing a science of
macroeconomics.
◆
Because every transaction has a buyer and a seller, the
total expenditure in the economy must equal the total
income in the economy.
◆
Gross domestic product (GDP) measures an economy’s
total expenditure on newly produced goods and
services and the total income earned from the
production of these goods and services. More precisely,
GDP is the market value of all final goods and services
produced within a country in a given period of time.
◆
GDP is divided among four components of expenditure:
consumption, investment, government purchases, and
net exports. Consumption includes spending on goods
and services by households, with the exception of
purchases of new housing. Investment includes
spending on new equipment and structures, including
households’ purchases of new housing. Government
purchases include spending on goods and services by
local, state, and federal governments. Net exports equal
the value of goods and services produced domestically
and sold abroad (exports) minus the value of goods and
services produced abroad and sold domestically
(imports).
◆
Nominal GDP uses current prices to value the
economy’s production of goods and services. Real GDP
uses constant base-year prices to value the economy’s
production of goods and services. The GDP deflator—
S u m m a r y

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C H A P T E R 2 2
M E A S U R I N G A N AT I O N ’ S I N C O M E
5 0 9
calculated from the ratio of nominal to real GDP—
measures the level of prices in the economy.
◆
GDP is a good measure of economic well-being because
people prefer higher to lower incomes. But it is not a
perfect measure of well-being. For example, GDP
excludes the value of leisure and the value of a clean
environment.
K e y C o n c e p t s
microeconomics, p. 494
macroeconomics, p. 494
gross domestic product (GDP), p. 496
consumption, p. 499
investment, p. 499
government purchases, p. 499
net exports, p. 499
nominal GDP, p. 502
real GDP, p. 502
GDP deflator, p. 503
Q u e s t i o n s f o r R e v i e w
1.
Explain why an economy’s income must equal its
expenditure.
2.
Which contributes more to GDP—the production of an
economy car or the production of a luxury car? Why?
3.
A farmer sells wheat to a baker for $2. The baker uses
the wheat to make bread, which is sold for $3. What is
the total contribution of these transactions to GDP?
4.
Many years ago Peggy paid $500 to put together a
record collection. Today she sold her albums at a garage
sale for $100. How does this sale affect current GDP?
5.
List the four components of GDP. Give an example of
each.
6.
Why do economists use real GDP rather than nominal
GDP to gauge economic well-being?
7.
In the year 2001, the economy produces 100 loaves of
bread that sell for $2 each. In the year 2002, the economy
produces 200 loaves of bread that sell for $3 each.
Calculate nominal GDP, real GDP, and the GDP deflator
for each year. (Use 2001 as the base year.) By what
percentage does each of these three statistics rise from
one year to the next?
8.
Why is it desirable for a country to have a large GDP?
Give an example of something that would raise GDP
and yet be undesirable.
P r o b l e m s a n d A p p l i c a t i o n s
1.
What components of GDP (if any) would each of the
following transactions affect? Explain.
a.
A family buys a new refrigerator.
b.
Aunt Jane buys a new house.
c.
Ford sells a Thunderbird from its inventory.
d.
You buy a pizza.
e.
California repaves Highway 101.
f.
Your parents buy a bottle of French wine.
g.
Honda expands its factory in Marysville, Ohio.
2.
The “government purchases” component of GDP does
not include spending on transfer payments such as
Social Security. Thinking about the definition of GDP,
explain why transfer payments are excluded.
3.
Why do you think households’ purchases of new
housing are included in the investment component of
GDP rather than the consumption component? Can you
think of a reason why households’ purchases of new
cars should also be included in investment rather than
in consumption? To what other consumption goods
might this logic apply?
4.
As the chapter states, GDP does not include the value of
used goods that are resold. Why would including such
transactions make GDP a less informative measure of
economic well-being?
5.
Below are some data from the land of milk and honey.