ECON90034 Chap.11 GDP, Growth, Business Cycles and Inflation
GDP, Growth, Business Cycles and Inflation
The last weeks turn to the macroeconomy. GDP can be measured three ways, by value added, by expenditure and by income, and the three must agree. Real GDP values output at base-year prices, and the Laspeyres and Paasche indexes weight prices with different baskets. Growth accounting splits output growth into contributions from capital and labour and a residual, total factor productivity.
The business cycle is explained differently by Keynesian and real business cycle views, with coordination failure linking it back to game theory. The final topic covers the costs of inflation and the expectations-augmented Phillips curve; central bank independence and monetary policy are not on the exam.
The worked examples compute nominal and real GDP with two goods, both price indexes, a growth-accounting split and an inflation rate from the Phillips curve.
What this chapter covers
- 01
Three ways to measure GDP
- 02
Nominal and real GDP, and the GDP deflator
- 03
Laspeyres and Paasche price indexes
- 04
Why GDP rises and falls: trend, cycle, season and shocks
- 05
Growth accounting and total factor productivity
- 06
Is GDP a good measure of wellbeing?
- 07
Keynesian and real business cycle views; coordination failure
- 08
Costs of inflation and the Phillips curve
Worked example · free
Nominal growth, real growth and the deflator
- 1Nominal GDP: 2024 = 100 + 200 = $300; 2025 = 180 + 220 = $400, growth of 33.3%.
- 1Real GDP 2025 at 2024 prices: 60 × 2 + 10 × 20 = $320, growth of 6.7%.
- 1GDP deflator for 2025: 400 ÷ 320 = 1.25, so prices rose 25%.
- 1Check: 1.067 × 1.25 = 1.333, matching nominal growth.
Key terms
- Real GDP
- Output valued at the prices of a fixed base year, so that changes reflect quantities rather than prices.
- GDP deflator
- Nominal GDP divided by real GDP; a Paasche-type price index weighted by current output.
- Total factor productivity
- The part of output growth not explained by growth in capital and labour, measured as a residual in growth accounting.
- Coordination failure
- An outcome in which all agents would be better off acting together, yet each holds back because they expect others to, as when firms all delay investment.
- Phillips curve
- The relationship between inflation and unemployment; in its expectations-augmented form, inflation equals expected inflation plus a term in the gap between natural and actual unemployment.
- Value added
- A producer's sales minus the cost of intermediate inputs; summing it over producers gives GDP without double counting.
- Growth accounting
- A method that splits output growth into the share-weighted growth of capital and labour and a residual attributed to productivity.
GDP, Growth, Business Cycles and Inflation FAQ
What are the three ways of measuring GDP?
Production, summing value added across producers; expenditure, adding consumption, investment, government purchases and net exports; and income, adding the wages, profits, rents and interest earned in production. All three measure the same output.
What is the Solow residual?
Output growth minus the share-weighted growth of capital and labour. It measures total factor productivity growth, including better technology and organisation, and also absorbs any error in measuring the inputs.
How do the Keynesian and real business cycle views differ?
The Keynesian view starts from demand shocks spread by coordination failure, so policy can help. The real business cycle view starts from real shocks such as technology and treats fluctuations as efficient responses.
Why can policy not keep unemployment below its natural rate for long?
If inflation stays above what people expect, expectations adjust upward and the Phillips curve shifts up, so holding unemployment below the natural rate requires ever-rising inflation.
What does GDP leave out?
It counts market production only, so it misses unpaid work at home, leisure, environmental damage and the depletion of resources, and it says nothing about how output is shared. That is why it measures activity rather than wellbeing.
Why does GDP rise and fall from year to year?
A long-run growth trend, the business cycle of expansions and recessions, seasonal patterns within each year, and random events such as droughts or strikes. Growth accounting explains the trend; the cycle sits around it.
Exam move
Practise the calculations that can appear in Part A: real and nominal GDP with two goods, both price indexes, growth accounting with a given capital share, and the Phillips curve with fixed expectations. For the essay-style parts, prepare short paragraphs on the three GDP measures, the sources of GDP variation, what GDP leaves out, the two views of the cycle and the critique of fixed expectations.
Because these topics have fewer worked problems, rehearse definitions aloud as well as calculations.
Working through GDP, Growth, Business Cycles and Inflation in ECON90034? Sia is AskSia’s AI Economics tutor — ask any ECON90034 GDP, Growth, Business Cycles and Inflation question and get a clear, step-by-step explanation grounded in how ECON90034 is taught and assessed. Read this chapter free, then take your hardest questions to Sia.
