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2015, Study Session # 5, Reading # 17


Los 17.a
 GDP = MV (final goods & services) produced
during a period within the country.

Approach to GDP

 Expenditure Approach:
GDP = expenditure (cost) on goods &
services produced in the country within
a specific period.

Los 17.b

 Income Approach:
GDP = income earned by households
& businesses in the country during a

Expenditure Approach

 Sum-of-value added:
GDP = value created at each stage of
production & distribution during a

Los 17.c

 Value-of-final output:
GDP = value of final goods & services
produced during the period.


 Nominal GDP:
GDP =  
Measure goods & services at their
current cost.

 Real GDP:
Measure current year output using
base prices.

 GDP deflator: Price index which is

use to convert nominal GDP to real

 Per capita real GDP =

Los 17.d



Components of GDP

Consumption (C)

Investment (I)

Government spending (G)

Net Exports (X-M)


 National Income:
 NI = Income received by
factors of production used in
the production of final output.

 Personal Income:
PI = Pre-tax income received by

 Personal Disposable Income:

Personal income (1-tax rate).

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2015, Study Session # 5, Reading # 17

Los 17.e

 (G-T) = (S-I) (X-M)

G-T = fiscal balance.
X-M = Trade balance
 Thus If;
G-T > 0
X-M < 0 (Trade deficit), or
S-I > 0 (Excess private savings).

Los 17.f

IS curve:
 (S-I) = (G-T) + (X-M)
 It shows the ve relationship at each level of real interest rate b/w
real interest rate and levels of aggregate income.

LM Curve:
 According to quantity theory of money:
M = Nominal money supply
V = Velocity of money
P = Price level
Y = Real income/expenditure
M/P = Y (1/V)
 It shows the +ve relationship between real interest rate & level of
real income, for a given level of real Ms, at which real MD= real Ms.

 Aggregate demand curve is combination of points where IS & LM

curves intersect each other for different levels of real Ms, keeping
nominal Ms Constant.

Los 17.g

Aggregate Supply Curve:

 It shows the relationship b/w price level and quantity of real GDP
supplied, keeping all other factors constant.
 SRAS curve is upward sloping.
 VRAS curve is perfectly elastic.
 LRAS curve is perfectly inelastic (vertical).
 LRAS shows potential GDP.

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2015, Study Session # 5, Reading # 17

Los 17.h

Aggregate Demand Curve

 Movement: in price level causes

movement along the curve.

Shift in AD curve:
In household wealth.
In consumer & business expectations.
Capacity utilization.
Fiscal & Monetary policy.
Currency exchange rate.
Global economic growth rates.

Aggregate Supply Curve

 Movement: in price level cause

movement along the curve.

Los 17.i

Shifts in AS curve:
 In nominal wages or other input prices.
 Expectations about future prices.
 Business taxes & subsidies.
 Currency exchange rates.
 Factors affecting LRAS.
 In labor supply & quality of labor.
 In physical capital supply.
 Availability of natural resources.
 Level of technology.


 Recessionary Gap: real GDP <

potential GDP  input prices.

 Inflationary Gap: real GDP > potential

GDP  input prices.

 High unemployment and increasing inflation. (Or) weak economic growth +
high inflation (may be caused by sudden  in short-run AS).
  Fixed income investments.
  Investment in equities.
  Investment in commodities.

Los 17.j

Labor Supply

Sources of Economic Growth

Human Capital


Physical Capital Stock

Natural Resources

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2015, Study Session # 5, Reading # 17

Los 17.j

 Potential GDP = Agg. Hours worked labor

productivity (or)
growth in potential GDP = growth in labor-force +
growth in labor-productivity.
 Sustainable rate of economic growth
= f (rate of  in labor force, rate of  in labor

Los 17.k

Production function:
 It shows the relationship between:
 Output & labor,
 Capital stock.
 Total factor productivity advances in

Los 17.L

 Growth in potential GDP = Growth in technology +  (growth in

labor) +  (growth in capital)
 = Labors % share of national income.
 = Capital % share of national income.
 Growth in per-capital potential GDP = growth in technology + 
(growth in capital-to-labor ratio)

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