6...i mean just these sixteen accomplishments or whatever: i mean, we've got a major rapport -...

6“...I mean just these sixteen

accomplishments or whatever: I mean, we've got a

major rapport - relationship of

economics, major in the security, and all

of that, we should not lose sight of.”

George W. Bush

Measuring Domestic Output and National Income

Chapter Objectives

How GDP is Defined and Measured

Circular Flow

The Nature and Function of a GDP Price Index

The Difference Between Nominal GDP and Real GDP

Some Limitations of the GDP Measure

2

Gross Domestic Product

GDP, or gross domestic product, is the market value of all final goods and services produced in a country in a given time period.

US GDP, 2nd quarter 2008 ($ billions) : (Chg from previous period)

Nominal GDP $14,497.8 (+3.5%)Real GDP (2005 dollars) $13,415.3

(+1.5%) US GDP, 2nd quarter 2009 ($ billions) :

Nominal GDP $14,143.3 (- 1.0%)Real GDP (2005 dollars) $12,892.5 (-

1.0%)

Source: www.BEA.gov 3

Gross Domestic ProductMarket Value

GDP is a market value -- goods and services are valued at their market prices.

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

Output in 2009 is greater than output in 2008.

Year Annual Output Market Value

20083 sofas

2 computers(3) ($500) + (2) ($2,000) =

$5,500

20092 sofas

3 computers(2) ($500) + (3) ($2,000) =

$7,000

4

Gross Domestic ProductFinal Goods and Services

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

Only value added is considered in GDP. Excluding intermediate goods and services avoids double counting.Sales

ValueValue Added

Sheep Ranch $120 $120

Wool $180 $60

Suit Maker $220 $40

Macy's Department Store

$350 $130

Total $870 $350

Sales Value

Sheep Ranch $120

Wool $180

Suit Maker $220

Macy's Department Store

$350

Total $870

5

Gross Domestic ProductProduced Within a Country

GDP measures production within a nation’s borders – domestic production – no matter who owns the resources.Cars produced in a Japanese-owned factory in the

US counts in US GDP.Cars produced in a US-owned factory in Mexico

counts in Mexico’s GDP.

How is this different from GNP (Gross National Product)?

6

Gross Domestic ProductIn a Given Time Period

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

$0

$5,000

$10,000

$15,000

1988 1993 1998 2003 2008

Ann

ual G

DP

($B)

Nominal GDP

Real GDP

7

NOT Counted in GDPNon- Production Transactions

Financial:Public transfer payments (payments

made by US government to households for which nothing is required in return):

Social Security/MedicareWelfare benefitsVeteran’s benefits

Private transfer payments such as cash gifts

8

NOT Counted in GDP Non- Production Transactions

Financial:Stock market transactions:

Buying/selling stock certificates or bonds transfers of pieces of paper; it is not producing goods or services.

Second-hand sales or sales of used goodsCount production in GDP for the year it is new. Buying a used car or a house built in 1995 will

NOT count in GDP for this year (counted in the year it was produced).

9

Measuring GDPTwo Approaches

The Expenditure Approach Measures GDP as the sum of consumption

expenditure, investment, government purchases of goods and services, and net exports.

Final-Product or Value-Added The sum of the money spent to buy the output.

The Income Approach Measures GDP by summing the incomes that firms

pay households for the factors of production they hire. Wages (return to labor) Interest (return to

capital) Rent (return to land) Profits (return to

enterprise)10

Expenditure ApproachC = Personal Consumption

Personal Consumption Expenditures, C Durable Consumer Goods (expected life of 3+

years): Cars, Appliances, TV’s . . .

Nondurable Consumer Goods (expected life less than 3 years): Groceries, pencils, toothpaste . . .

Consumer Expenditures for Services Legal advice, healthcare, manicures,

education . . .

11

Expenditure ApproachGross Private Domestic InvestmentGross Private Domestic Investment, I

Machinery, Equipment, and Tools All Construction (commercial AND

residential) Changes in Inventories (unsold goods,

unconsumed output)

NOT included - Noninvestment Transactions, such as transfer of ownership of assets (like houses, stocks, bonds)

12

Expenditure ApproachGovernment Purchases

Government Purchases, GExpenditures for Goods and Services

Labor, office supplies, uniforms . . .

Expenditures for Social Capital Highways, schools, museums . . .

Remember: G does not include transfer payments

13

Expenditure ApproachNet Exports

Net Exports, XnExports (X=goods sold to other countries)

Dell computers, haircuts for foreign tourists

Imports (M=goods bought from other countries)Toyota Prius made in Japan, haircut you got

in Paris

Xn = Exports (X) – Imports (M)

14

Two Approaches to GDP

GDP

= =

Consumption

by HouseholdsInvestment

by Businesses

Government Purchases

Net Expenditures By Foreigners

Expenditure Approach

Wages

Rents

Interest

Profits

StatisticalAdjustments

Income Approach

15

Expenditure Approach

Putting It All Together: GDP = C + I + G + Xn

Circular Flow of Expenditure and IncomeGDP = production = income =

expendituresThe equality of income and output shows

the link between productivity and living standards.

16

Circular Flow Diagram

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

17

Transactions take place in factor (resource) markets, goods markets, and

financial markets.

18

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

Y = income19

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

C = consumptionY = income20

Households save, S, and pay taxes, T. Firms borrow some of household savings to pay

for investment.

21

Firms buy capital goods from other firms. The red flow I represents this investment

expenditure by firms. (I = investment = creation of capital)

22

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

G = government purchases

23

The rest of the world buys goods and services from us, X and sells us goods and services, M:

net exports are X – M. X = exports, M = imports, so X – M = net exports

24

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

25

The blue and red flows are the circular flow of expenditure and income. The green flows are borrowing and lending.

26

The sum of the red flows (C + I + G +(X-M)) equals the blue flow (Y).

Y = C + I + G + (X-M)

27

Nominal Versus Real GDP

Nominal GDP GDP measured in terms of the price level

at the time of measurement (NOT adjusted for inflation).

Real GDP GDP adjusted for inflation. Nominal GDP is deflated (if prices

increased) or inflated (if prices fell). Only real GDP measures changes in

output accurately, holding price constant.

28


In 2006:Expenditure on hats $100 = (100 x $1.00)Expenditure on bats $100 = ( 20 x $5.00)Nominal GDP $200

Year Item Quantity

Price

2006 Hats 100 $1.00

Bats 20 $5.00

29


In 2007:Expenditure on hats $ 80 (160 x $0.50)Expenditure on bats $495 (22 x $22.50)Nominal GDP $575

Year Item Quantity

Price

2007 Hats 160 $0.50

Bats 22 $22.50

30


Year Item Quantity

Price

2006 Hats 100 $1.00

Bats 20 $5.00

2007 Hats 160 $0.50

Bats 22 $22.50Total spending: 2006 $200

2007 $575

31


Two Methods for Calculating Real GDP1. GDP Price Index Method2. Base Year Prices Method

1.GDP Price Index MethodPrice index = measure of price of a specific

“market basket” of goods in a specific year compared to price of identical goods in a base, or reference, year.PriceIndexIn GivenYear

= x100Price of Market Basket

In Specific Year

Price of Same BasketIn Base Year

32

Nominal Versus Real GDPGDP Price Index Method

PriceIndexIn GivenYear

= x100Price of Market Basket

In Specific Year

Price of Same BasketIn Base Year

Pizzas Qty Price

2005 75 $12.00

2006 90 $15.00

2007 110 $23.50

Base year

Note: Value of any index in the base year is ALWAYS 100.

Do you see why?33

Nominal Versus Real GDPGDP Price Index Method

Price Index

In 2006= x100$15.00

$12.00=125

Price Index

In 2007= x100

$23.50=195.

8$12.00

Pizzas Qty Price

2005 75 $12.00

2006 90 $15.00

2007 110 $23.50

Base year

34


Base Year Prices Method

Base year

Real GDP= Nominal GDPGDP Price Index/100

GDP price index is also known as “GDP deflator”, because

it “deflates” nominal to real (removes influence of inflation)

Pizzas

Qty Price GDPGDP Price

Index

2005 75 $12.00 $900 100

2006 90 $15.00 $1,350 125

2007 110 $23.50 $2,585 195.8

Base year

35


Base Year Prices Method

Base year

Pizzas

Qty Price GDPGDP Price

Index

2005 75 $12.00 $900 100

2006 90 $15.00 $1,350 125

2007 110 $23.50 $2,585 195.8

Base year

36

Real GDPIn 2006 =

$1,350

1.25 =$1,08000

Real GDPIn 2007 =

$2,585=$1,32

0221.958

Nominal Versus Real GDPBase Year Prices Method

37

Determine market value of basket in successive years assuming the price has not changed from

the base year.Pizza

Quantity

Price Nominal GDP Real GDP

2005 75 $120

0 75x$1200=$900 75x$1200=$900

2006 90 $1500 90x$1500=$1,350

90x$1200=$1,080

2007 110 $2350 110x$2350=$2,585

110x$1200=$1,320Current

Prices

Base-Year Price

Nominal Versus Real GDPCalculating Percentage Change in GDP

38

Reminder: To calculate % change in anything, (New – Old)/Old

Percentage change in real GDP from 2006 to 2007:($1,320 – $1,080) / $,1080 = 0.222 = 22.2% increase

% change in real GDP from 2005 to 2006 = __________________% change in real GDP from 2005 to 2007 = __________________

PizzaQuantit

yPrice Nominal GDP Real GDP

2005 75 $120

0 75x$1200=$900 75x$1200=$900

2006 90 $1500 90x$1500=$1,350

90x$1200=$1,080

2007 110 $2350 110x$2350=$2,585

110x$1200=$1,320

2008 122 $2600 ____________ ________________

Measuring Economic Growth

39

The economic growth rate is the percentage change in GDP from one year to the next.

We measure economic growth so we can make: Economic welfare comparisons International welfare comparisons Business cycle forecasts

Shortcomings of GDPEconomic Welfare Comparisons

40

Economic welfare measures the nation’s overall state of economic well-being.

Real GDP is not a perfect measure of economic welfare for seven reasons:1. Real GDP does not include household

production (nonmarket activities), that is, productive activities done in and around the house by members of the household.

2. The value of “leisure” (time spent NOT working) is not captured in real GDP.


41


Real GDP is not a perfect measure of economic welfare for seven reasons:3. Real GDP does not capture the value of

improvements in quality. (ex, $200 cell phone today is of much higher quality than $200 cell phone 10 years ago).

4. Real GDP does not account for activity in the illegal underground economy, or legal activity with unreported income.


42


Real GDP is not a perfect measure of economic welfare for seven reasons:5. Environmental damage is not deducted from

real GDP.6. Composition and distribution of output is not

accounted for in real GDP. (ex. an assault rifle and a set of encyclopedias is valued equally if prices are equal).

7. Noneconomic sources of well-being, such as peace time, justice, civility, reduced crime, are not included in real GDP.

Key Terms

GDP (gross domestic product)

intermediate goods final goods value added expenditures

approach income approach government

purchases (G) domestic investment

(I)

consumption expenditures (C)

net exports (Xn) nominal GDP real GDP leisure underground

economy

43

Measuring Output and Income Wrap Up

44

Gross Domestic Product (GDP)

Definition

MeasureReal v.

NominalEvaluate

Expenditure

Income

Circular Flow

Definition

Two Ways to

Calculate

Growth

Shortcomings

6...i mean just these sixteen accomplishments or whatever: i mean, we've got a major rapport -...

Documents

income gdp

us gdp

nominal gdp real gdp

measuring gdp

gdp gdpgdp

mexicos gdp

gross domestic product

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