2 Measuring GDP and Inflation

		Upon completion of this chapter you should

		understand what GDP is and how it is measured;

		realize that using GDP to measure social welfare or to compare countries must be heavily qualified; and

		know what price indices are and how they are used.

		2.1 What is GDP?

		Gross domestic product, GDP, is the total dollar value of all final goods and services produced in a country during a year. Several things about this definition should be noted:

		1. Both goods, such as automobiles and top hats, and services, such as the help of lawyers and plumbers, are included.

		2. Current market prices, reflecting the value society places on items, are used to aggregate different outputs to a dollar total. Government purchases, many of which do not occur on markets, are valued at their cost of production.

		3. Only final goods and services are included. Intermediate goods, such as steel that has yet to be made into hammers and shovels, are not included. This practice avoids double-counting the steel.

		4. This measure is an annual flow, a rate of production. A GDP of $6 trillion implies that the economy is producing $6 trillion worth of goods and services per year.

		5. U.S. GDP measures production by U.S. citizens and foreigners alike inside the geographic borders of the United States and so unequivocally reflects economic activity in the United States.

		Economists and the media use many names besides GDP to refer to the nation's annual output of goods and services. Output, total output, national output, income, total income, national income, and aggregate supply are common. Algebraic representations use the capital letter Y. These names suggest that economists use the terminology output and income interchangeably; it is important to understand why.

		The essence of why output and income are considered the same thing is that whatever is spent on a product (the value of that output) is divided up as income by those people producing it. Consider one element of GDP, a loaf of bread worth a dollar. With only a few exceptions, every penny of this dollar's worth of bread can be traced back into somebody's pocket as income. Some of the dollar is profit/proprietor income to the grocer, baker, miller,