Lecture 12 Measuring GDP w What is the

Lecture 12: Measuring GDP w What is the circular flow of income and expenditure? w How are GDP, real GDP, and the average price level measured? w What are the shortcomings of each measure of economic performance? w We will be adding some slides to todays talk

Direction for Next Week w Have seen that Unemployment and Inflation are the twin evils § inflation: see pgs 127 -128 for discussion of index calculation w Today GDP as a barometer of the economys well-being w Next. How is GDP determined? ?

Your Weekend w Parkin Chapter 6 and 7 w EIA 7, w There is nothing else to do!!!!!!!

Economic Barometers w The U. S. Department of Commerce publishes GDP statistics every quarter (three months). These statistics are a barometer of the economy, telling us: § how fast it has grown § the rate of inflation w Companies use this data to forecast future demand for their products.

Gross Domestic Product w Gross domestic product (GDP) is the dollar value of total production of goods and services in a country during a calendar year. w you can plot the time path of GDP in EIA w the easiest way to understand GDP is to use a circular flow diagram.

The Circular Flow of Income and Expenditure

Sectors of the Economy w The economy has four sectors: § § households firms governments the rest of the world

Markets of the Economy w The economy has three aggregate markets: § factor markets § goods and services markets (heart) § financial markets

Gross Domestic Product w Gross domestic product is the value of aggregate production in a country during a year. w GDP can be valued one of two ways: § By what buyers pay for it § By what it costs producers to make it w These two ways of adding up GDP always give the same answer.

Aggregate Expenditure w The total amount that buyers pay for the goods produced is aggregate expenditure. w Aggregate expenditure includes: § § Consumption (C) Investment (I) Government purchases (G) Net exports (NX)

Injections and Leakages w Leakages from the circular flow of spending and income are saving, net taxes, and imports. w Injections into the circular flow include investment, government purchases, and exports. w Injections always equal leakages. w why is this important?

The Expenditure Approach w The expenditure approach measures GDP by collecting data on: § § consumption expenditure (C) investment (I) government purchases (G) net exports (NX)

Gross Domestic Product w Expenditure Equals Income Y = C + I + G + NX

Gross Domestic Product w Measuring U. S. GDP 1) Expenditure Approach 2) Income Approach

Gross Domestic Product w Expenditure Approach § Uses data on consumption expenditure, investment, government purchases, and net exports

Gross Domestic Product w Expenditure Approach § Personal consumption expenditures are the expenditures by households on goods and services produced in the United States and the rest of the world

Gross Domestic Product w Expenditure Approach § Gross domestic investment is expenditure on capital equipment and buildings by firms and expenditure on new homes by households. Also, it includes the change in inventories.

Gross Domestic Product w Expenditure Approach § Government purchases of goods and services are the purchases of goods and services by all levels of government. • Does not include transfer payments

Gross Domestic Product w Expenditure Approach § Net exports of goods and services are the value of exports minus the value of imports

GDP in 1997

Expenditures Not in GDP w Aggregate expenditure equals GDP. w However, not all the things that people and businesses buy are included in this final expenditure. w Spending not part of GDP includes: § Intermediate goods and services § Used goods § Financial securities w Why are these excluded?

Value Added and Final Expenditure Farmer’s value added Value added Intermediate expenditure Final expenditure

Value Added and Final Expenditure Farmer’s value added Miller Value of wheat Value added Miller’s value added Intermediate expenditure Final expenditure

Value Added and Final Expenditure Farmer’s value added Miller Value of wheat Baker Value of flour Value added Intermediate expenditure Miller’s value added Bakers value added Final expenditure

Value Added and Final Expenditure Value added Farmer’s value added Miller Value of wheat Baker Value of flour Grocer Wholesale value of bread Intermediate expenditure Miller’s value added Bakers value added Final expenditure Grocer’s value added

Value Added and Final Expenditure Value added Farmer’s value added Miller Value of wheat Baker Value of flour Grocer Wholesale value of bread Consumer Retail value of bread; Final Expenditure on bread Intermediate expenditure Miller’s value added Bakers value added Final expenditure Grocer’s value added

Intermediate Goods and Services w Intermediate goods and services are the goods and services that firms buy from each other and use as inputs in the goods and services they eventually sell to final users. w The way a good is counted depends on its use. Ice cream sold to you is a final good, while ice cream sold to a restaurant is an intermediate good.

Used Goods w Expenditure on used goods (previously owned goods) is not part of GDP because these goods were counted as GDP in the period in which they were originally produced. w However, the services of sales people and firms who sell used goods are included in GDP.

Financial Securities w Firms often sell financial securities such as stocks and bonds to finance purchases of capital goods. w Since GDP already includes the amount spent on producing new capital goods, it would be double counting to include the amount raised financing the purchase.

Aggregate Expenditure, Income, and GDP w Aggregate expenditure equals aggregate income. w The Department of Commerce uses both approaches to estimate GDP because their estimates are based on samples of information. w They can check one aggregate against the other.

We will use the aggregate expenditure approach in any calculation of GDP on an exam.

Distinguishing Real and Nominal GDP w Ck out EIA w Real gdp = Nom gdp / price index w economic well-being is increased with an increase in real gdp so we have to subtract price inflation from nominal gdp growth. w the numbers you see reported in the WSJ are inflation adjusted numbers or real gdp

The U. S. GDP Balloon 1996

The U. S. GDP Balloon GDP deflator 1996

The U. S. GDP Balloon GDP deflator 1992 1996

Limitations of GDP as a measure of well-being w see pages 132 -133 in your text w GDP is used as a measure of economic well-being. Think of GDP as output (or aggregate income). When GDP increases the total economic pie increases so presumably each individual has the opportunity to consume a bigger piece of the pie

But is GDP a good measure of well-being? w ? overadjustments for inflation. confusing quality changes with inflation w household production w underground economic activity w quality of life issues § health, liesure, pollution, political freedom.