20959913 crecimiento-economico-y-pib

1. Measuring GDP and Economic Growth CHAPTER 21

Define GDP and use the circular flow model to explain why GDP equals aggregate expenditure and aggregate income

Explain the two methods used by the Bureau of Economic Analysis to measure U.S. GDP

Explain how the Bureau of Economic Analysis measuresrealGDP and the GDP deflator to separate economic growth from inflation

Explain the uses and limitations of real GDP

What exactly is GDP?

How do we use GDP to tell us whether our economy is in a recession or how rapidly our economy is expanding?

How do we take the effects of inflation out of GDP to reveal the rate of growth of our economic well-being?

And how to we compare economic well-being across countries?

GDP Defined

GDPorgross domestic productis the market value of all final goods and services produced in a country in a given time period.

This definition has four parts:

Market value

Final goods and services

Produced within a country

In a given time period

Market Value

GDP is a market valuegoods and services are valued at their market prices.

To add apples and oranges, computers and popcorn, we add the market values so we have a total value of output in dollars.

Final Goods and Services

GDP is the value of thefinal goods and servicesproduced.

Afinal good(or service) is an item bought by its final user during a specified time period.

A final good contrasts with anintermediate good , which is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service.

Excluding intermediate goods and services avoids double counting.

Produced Within a Country

GDP measures production within a countrydomestic production.

In a Given Time Period

GDP measures production during a specific time period, normally a year or a quarter of a year.

GDP and the Circular Flow of Expenditure and Income

GDP measures the value of production, which also equals total expenditure on final goods and total income.

The equality of income and output shows the link between productivity and living standards.

The circular flow diagram in Fig. 5.1 illustrates the equality of income, expenditure, and the value of production.

The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world.

These transactions take place in factor markets, goods markets, and financial markets.

Firms hire factors of production from households. The blue flow,Y , shows total income paid by firms to households.

Households buy consumer goods and services. The red flow,C , shows consumption expenditure.

Households save,S , and pay net taxes,T . Firms borrow some of what households save to finance their investment.

Firms buy capital goods from other firms. The red flowIrepresents this investment by firms.

Governments buy goods and services,G , and borrow or repay debt if spending exceeds or is less than net taxes.

The rest of the world buys goods and services from us,X , and sells us goods and services,M . Net exports areX M.

And the rest of the world borrows from us or lends to us depending on whether net exports are positive or negative.

The blue and red flows are the circular flow of expenditureand income. The green flows are financial flows.

The sum of the red flows equals the blue flow.

That is:Y=C+I+G+XM

The circular flow demonstrates how GDP can be measured in two ways.

Aggregate expenditure

Total expenditure on final goods and services, equals the value of output of final goods and services, which is GDP.

Total expenditure= C+I+G+ ( XM ).

Aggregate income

Aggregate income equals the total amount paid for the use of factors of production: wages, interest, rent, and profit.

Firms pay out all their receipts from the sale of final goods, so income equals expenditure,

Y=C+I+G+ ( XM ).

Financial Flows

Flows through financial markets finance deficits and investment.

Household savingSis income minus net taxes and consumption expenditure.

That is,

S=Y ( T+C ) .

Saving flows into the financial markets.

IfGexceedsT , the government has a budget deficit ( G T ) and the government borrows from the financial markets.

IfTexceedsG , the government has a budget surplus( TG ) and this surplus flows to the financial markets.

If U.S. imports exceed U.S. exports, the United States borrows an amount equal to ( MX ) from the rest of the world. Rest of world saving finances some investment in the United States.

If U.S. exports exceed U.S. imports, the United States lends an amount equal to ( XM ) to the rest of the world. U.S. saving finances some investment in other countries.

How Investment Is Financed

Investment is financed from three sources:

1. Private saving,S

2. Government budget surplus, ( TG )

3. Borrowing from the rest of the world ( MX ).

We can see these three sources of investment finance by using the equality of aggregate expenditure and aggregate income.

Start with

Y=C+S+T=C+I+G+ ( XM ).

Then rearrange to obtain

I=S+ ( TG ) + ( MX )

Private savingSplus government saving ( TG ) is callednational saving .

Gross and Net Domestic Product

Gross means before deducting the depreciation of capital. The opposite ofgrossisnet .

To understand this distinction, we need to distinguish between flows and stocks.

Flows and Stocks in Macroeconomics

Aflowis a quantity per unit of time.

Astockis the quantity that exists at a point in time.

Wealth and Saving

Wealth , the value of all the things that people own, is a stock.

Savingis theflowthat changes thestock of wealth .

Wealth at the start of this year equals wealth at the start of last year plus saving during last year.

Capital and Investment

Capitalis the plant, equipment, and inventories of raw and semi-finished materials that are used to produce other goods.

Capital is a stock.

Investmentis theflowthat changes thestock of capital .

Depreciationis the decrease in the capital stock that results from wear and tear and obsolescence.

Gross investmentis the total amount spent on purchases of new capital and on replacing depreciated capital.

Net investmentis the change in the capital stock.

Net investment = Gross investmentDepreciation.

Figure 21.2 illustrates the relationships among the capital stock, gross investment, depreciation, and net investment.

Back to Gross in GDP

Gross profits, and GDP, include depreciation.

Similarly, gross investment includes that amount of purchases of new capital goods that replace depreciation.

Net profits, net domestic product, and net investment subtract depreciation from the gross concepts.

The Short Run Meets the Long Run

Capital and investment play a central role in the understanding the growth and fluctuations in real GDP.

Investment adds to the capital stock, so investment is one source of real GDP growth.

Investment fluctuates, so investment is one source of fluctuations in real GDP.

The Bureau of Economic Analysis uses two approaches to measure GDP:

The expenditure approach

The income approach

The Expenditure Approach

Theexpenditure approachmeasures GDP as the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports.

GDP =C+I+G+(X M )

Table 21.1 in the textbook shows the expenditure approach with data for 2006.

GDP = $9,079 + $2,215 + $2,479$765

= $13,008

The Income Approach

Theincome approachmeasures GDP by summing the incomes that firms pay households for the factors of production they hire.

TheNational Income and Expenditure Accountsdivide incomes into five categories:

1. Compensation of employees

2. Net interest

3. Rental income

4. Corporate profits

5. Proprietors income

These five income components sum tonet domestic income at factor cost .

Two adjustments must be made to get GDP:

Indirect taxes minus subsidies are added to get fromfactor costtomarket prices .

Depreciation (or capital consumption) is added to getfromnetdomestic product togrossdomestic product.

Table 21.2 in the textbook shows the income approach with data for 2006.

Real GDPis the value of final goods and services produced in a given year when valued at constant prices.

Calculating Real GDP

The first step in calculating real GDP is to calculate nominal GDP.

Nominal GDPis the value of goods and services produced during a given year valued at the prices that prevailed in that same year.

Nominal GDP Calculations

The table provides data for 2005 and 2006.

In 2005,

Expenditure on balls = $100

Expenditure on bats = $100

Nominal GDP = $200

Quantity

In 2006,

Expenditure on balls = $80

Expenditure on bats = $495

Nominal GDP = $575

Quantity

Base-Year Prices Value of Real GDP

This method of calculating real GDP is to value each years output at the prices of a base year.

In the base year, real GDP equals nominal GDP.

Suppose 2005 is the base year, then real GDP in 2005 is $200.

This methodis the traditional method.

Quantity

Using the traditional base-year prices method to calculate real GDP in 2006:

Expenditure on balls in 2006 valued at 2005 prices is $160.

Expenditure on bats in 2006 valued at 2005 prices is $110.

So real GDP in 2006 would be recorded as $270.

Quantity

The new method of calculating real GDP, which is called the chain-weighted output index.

Thechain-weighted output indexmethod, uses the prices of two adjacent years to calculate the real GDP growth rate.

This calculation has four steps described on the next slide.

Step 1: Value last years production and this years production atlast years pricesand then calculate the growth rate of this number from last year to this year.

Step 2: Value last years production and this years production atthis years pricesand then calculate the growth rate of this number from last year to this year.

Step 3: Calculate the average of the two growth rates. This average growth rate is the growth rate of real GDP from last year to this year.

Step 4: Apply the growth rate this year to last years real GDP to calculate this years real GDP.

Weve done step 1.

Value of 2005 quantities at 2005 prices (GDP in 2005) is $200.

Value of 2006 quantities at 2005 prices is $270.

At 2005 prices, the value of production increased from $200 to $270 an increase of35 percent.

Quantity

Step 2.

Value of 2005 quantities at 2006 prices is $500.

Value of 2006 quantities at 2006 prices (GDP in 2006) is $575.

At 2006 prices, the value of production increased from $500 to $575 an increase of15 percent.

Quantity

Step 3.

At 2005 prices, the 2006 growth rate is 35 percent.

At 2006 prices, the 2006 growth rate is 15 percent.

The average of these two growth rates is 25 percent.

Quantity

Step 4.

So with 2005 as the base year, real GDP in 2006 is $250 25 percent more that $200 in 2005 .

Real GDP in 2005 is $200

Real GDP in 2006 is $250

Quantity

Calculating the Price Level

The average level of prices is called theprice level .

One measure of the price level is theGDP deflator , which is an average of the prices of the goods and services in GDP in the current year expressed as a percentage of the base-year prices.

The GDP deflator is calculated in the table on the next slide.

Nominal GDP and real GDP are calculated in the way that youve just seen.

GDP Deflator = (Nominal GDPReal GDP)100.

In 2005, the GDP deflator is ($200$200)100 = 100.

In 2006, the GDP deflator is ($575$250)100 = 230.

Nominal GDP

GDP deflator

Real GDP

Deflating the GDP Balloon

Nominal GDP increases because productionreal GDP increases.

Nominal GDP also increases because prices rise.

We use the GDP deflator to let the inflation air out of the nominal GDP balloon and reveal real GDP.

We use real GDP to calculate the economic growth rate.

Theeconomic growth rateis the percentage change in the quantity of goods and services produced from one year to the next.

We measure economic growth so we can make

Economic welfare comparisons across time

International comparisons across countries

Business cycle forecasts

Economic Welfare Comparisons Over Time

Economic welfare measures the nations overall state of economic well-being.

Real GDP is not a perfect measure of economic welfare for seven reasons:

1. Inflation rate tends to be overestimated because qualityimprovements are neglected, so real GDP isunderestimated.

2. Real GDP does not include household production productive activities done in and around the house bymembers of the household.

3. Real GDP, as measured, omits theunderground economy , which is illegal economic activity or legal economic activity that goes unreported for tax avoidance reasons.

4. Health and life expectancy are not directly included in real GDP.

5. Leisure time, a valuable component of an individuals welfare, is not included in real GDP.

6. Environmental damage is not deducted from real GDP.

7. Political freedom and social justice are not included in real GDP.

Economic Welfare Comparisons Across Countries

Real GDP is used to compare economic welfare in one country with that in another.

Two special problems arise in making these comparisons.

Real GDP of one country must be converted into the same currency units as the real GDP of the other country, so an exchange rate must be used.

The same prices should be used to value the goods and services in the countries being compared, but often are not.

Using the exchange rate to compare GDP in one country with GDP in another country is problematic because prices of particular products in one country may be much less or much more than in the other country.

For example, using the market exchange rate to value Chinese GDP in dollars leads to an estimate that in 2006, U.S. real GDP per person was 28 times Chinese real GDP per person.

Figure 21.4 illustrates the problem.

Using the market exchange rate and domestic prices leads to an estimate that China is very poor.

U.S. GDP per person is 28 times that in China.

Using purchasing power parity prices leads to an estimate that U.S. GDP per person is (only) 12 times that in China.

Business Cycle Forecasts

Real GDP is used to measure business cycle fluctuations.

These fluctuations are probably accurately timed, but the changes in real GDP probably overstate the changes in total production and peoples welfare caused by business cycles.

20959913 crecimiento-economico-y-pib

Economy & Finance

gross domestic product

gross domestic product

income gdp

services gdp

goods markets

market value final goods

gdp deflator

measuring gdp