Measuring the Economy GDP Copyright Notice Certain materials

Measuring the Economy: GDP

Copyright Notice Certain materials in this presentation are included under the fair use exemption of the U. S. Copyright Law and have been prepared with the multimedia fair use guidelines and are restricted from further use.

Newspaper headline… n “Real GDP, the value of goods and services produced in the U. S. , grew at an annual rate of 1 percent in the fourth quarter…. ”

Simon Kutznetz: Invented GDP in 1934 His idea was to calculate all economic production by individuals, companies and the government in a single measure. According to him, GDP would rise in good times and fall during any crisis. In 1944, the World Bank and the International Monetary Fund accepted GDP as a method to assess a nation's economy. The US Commerce Department described GDP as 'one of the great inventions of the 20 th century. '

Gross Domestic Product: Measuring the Nation’s Output n Gross Domestic Product (GDP) – A measure of the market value of the final goods and services produced in a country during a given period, based on the prices existing during the time of production.

What Good Is It? The Fed uses GDP figures to determine whether the economy is growing too slowly or too quickly and by how much, in order to plan monetary adjustments n Economists at every level of government and private industry use GDP to help plan for the future n

What is our GDP? n n There are two ways of stating U. S. GDP for 2010 (4 th Quarter, seasonally adjusted, as of 1/28/2011) – Current GDP, $14, 870. 4 billion (nominal dollars) – Real GDP, chained (chain-weighting) to 2005 dollars: $13, 382. 6 billion Or about 14. 9 trillion dollars in current (nominal) dollars / 13. 4 trillion in real dollars (one trillion is a thousand times a billion in the U. S. system of counting) GDP is measured by the U. S. Bureau of Economic Analysis (BEA), a research arm of the Commerce Department

Gross Domestic Product: Measuring the Nation’s Output n Market Value – Market value is used to aggregate the quantities of different goods and services into one measurement

Gross Domestic Product: Measuring the Nation’s Output n Market Value – Calculating GDP for Kerfluffistan n Total production = 4 apples, 6 bananas, and 3 pairs of shoes – Price of apples = $0. 25 – Price of bananas = $0. 50 – Price of shoes = $20

Gross Domestic Product: Measuring the Nation’s Output n K’stan’s GDP, measured in market value – Nominal GDP, measured in current dollars … – (4 x $0. 25) + (6 x $0. 50) + (3 x $20) = $64. 00 – Real GDP, adjusted to account for inflation, the changing value of K’stan’s dollars (amounts are rounded to nearest whole cent)… – (4 x 0. 24) + (6 x $0. 47) + (3 x $19. 80) = $63. 18

Gross Domestic Product: Measuring the Nation’s Output n Final Goods or Services – Goods or services consumed by the ultimate user; because they are the end products of the production process, they are counted as part of GDP

Gross Domestic Product: Measuring the Nation’s Output n Intermediate Goods or Services – Goods or services used up in the production of final goods and services and therefore not counted as part of GDP

Gross Domestic Product: Measuring the Nation’s Output n Final Goods and Services – Bread Production n Milling Co. pays $0. 50 for wheat n Bakery pays $1. 20 for flour n Bakery sells bread for $2. 00 n Contribution to GDP = $2. 00

Gross Domestic Product: Measuring the Nation’s Output n Final Goods and Services – Getting a haircut n Barber charges $10 for a haircut n Barber pays his assistant $2 n Contribution to GDP = $10

Gross Domestic Product: Measuring the Nation’s Output n Example: A good that can be either intermediate or final: – Capital Good n. A long-lived good, which is itself produced and used to produce other goods and services

Gross Domestic Product: Measuring the Nation’s Output n Example: A good that can be either intermediate or final: – Capital Good n Newly produced capital goods are classified as final goods.

Gross Domestic Product: Measuring the Nation’s Output n Value Added – For any firm, the market value of its product or service minus the cost of inputs purchased from other firms

Gross Domestic Product: Measuring the Nation’s Output Company Revenues – Cost of purchased inputs = Value added ABC Grain $0. 50 $0. 00 $0. 50 General Flour $1. 20 $0. 50 $0. 70 Hot’n’Fresh $2. 00 $1. 20 $0. 80 Total $2. 00 • The grain and flour are produced in 2005 • Bread is produced in 2006 • $1. 20 is added to 2005 GDP • $0. 80 is added to 2006 GDP

Gross Domestic Product: Measuring the Nation’s Output n Produced Within a Country During a Given Period – Domestic n Only production that takes place within a country’s border n Examples – Cars produced in the U. S. by foreign owned companies are counted. – Cars produced in Mexico by U. S. owned companies are not counted.

Gross Domestic Product: Measuring the Nation’s Output n Produced within a country during a given Period – Given Period n Counts only goods and services produced during the defined period such as a calendar year n Examples – The sale of used goods is not counted. – Real estate commissions are counted.

How many Ways to Measure Are There? n There are three ways to measure GDP; all three yield similar results: – The Expenditure method – The Income method – The Production method

Expenditure Components of U. S. GDP, 2004 (billions of dollars) Consumption Durable goods 8, 214. 3 987. 8 Nondurable goods 2, 368. 3 Services 4, 858. 2 Investment Business fixed investment Residential investment Inventory investment 1, 928. 1 1, 198. 8 673. 8 55. 4 Government purchases 2, 215. 9 Net exports -624. 0 Exports 1, 173. 8 Imports 1, 797. 8 Total: Gross domestic product

The Expenditure Method for Measuring GDP n Consumption Expenditure, or simply Consumption – Spending by households on goods and services, such as food, clothing, and entertainment n Consumer durables n Consumer nondurables n Services

The Expenditure Method for Measuring GDP n Investment – Spending by firms on final goods and services, primarily capital goods and housing n Business fixed investment n Residential investment n Inventory investment

The Expenditure Method for Measuring GDP n Government Purchases – Purchases by federal, state, and local governments of final goods and services – Does not include transfer payments – Does not include interest paid on government debt

The Expenditure Method for Measuring GDP n Net Exports – Exports minus imports

The Expenditure Method for Measuring GDP Y = gross domestic product, or output n C = consumption expenditure n I = investment n G = government purchases n NX = net exports n

The Expenditure Method for Measuring GDP n GDP

The Expenditure Method for Measuring GDP n Example – An economy produces 1 million cars valued at $15, 000 each.

The Expenditure Method for Measuring GDP n Production – GDP = 1 million x $15, 000 = $15 billion

The Expenditure Method for Measuring GDP n Expenditure – 700, 000 sold to consumers n. C = 700, 000 x $15, 000 = $10. 5 billion – 200, 000 sold to businesses n. I = 200, 000 x $15, 000 = $3. 0 billion – 50, 000 sold to government n. G = 50, 000 x $15, 000 = $. 75 billion – 25, 000 exported (no imports) n NX = 25, 000 x $15, 000 = $. 375 billion

The Expenditure Method for Measuring GDP n Expenditure – 975, 000 sold – 25, 000 inventory n. I n = 25, 000 x $15, 000 = $. 375 billion GDP = C + I + G + NX – $10. 5 + (3. 0 +. 375) +. 75 +. 375 = $15. 0 billion

GDP and the Incomes of Capital and Labor n GDP = Labor Income + Capital Income – Labor income n Equals 2/3 of GDP n Includes: – Wages – Salaries – Income of the self-employed

GDP and the Incomes of Capital and Labor n GDP = Labor Income + Capital Income – Capital income n Equals 1/3 of GDP n Includes: – Profits – Rents – Interest – Royalties

The Three Faces of GDP Production Market value of final goods and services Expenditure Income Consumption Labor Income = = Investment Government purchases Net exports Capital Income

Prices and Quantities in 2004 and 2008 Quantity of pizzas Price of pizzas Quantity of calzones 2004 10 $10 15 $5 2008 20 $12 30 $6 GDP • 2004 = (10)($10) + (15)($5) = $175 • 2008 = (20)($12) + (30)($6) = $420 Price of calzones Observations • Output doubled • GDP increased by 2. 4 times • Prices also rose • GDP overstates economic growth

Nominal GDP versus Real GDP n Real GDP – A measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices – Real GDP measures the actual physical volume of production

Nominal GDP versus Real GDP n Nominal GDP – A measure of GDP in which the quantities produced are valued at current-year prices – Nominal GDP measures the current dollar value of production

Prices and Quantities in 2004 and 2008 Quantity of pizzas Price of pizzas Quantity of calzones Price of calzones 2004 10 $10 15 $5 2008 20 $12 30 $6 • 2004 = base year • 2008 Real GDP = (20)($10) + (30)($5) = $350 • 2004 Real GDP = (10)($10) + (15)($5) = $175 Real GDP = Nominal GDP in the base year

Real GDP is not the Same as Economic Well-Being n Leisure Time – Shorter work week – Start working later – Retire earlier

Real GDP is not the Same as Economic Well-Being n Thinking economically – Why do people work fewer hours today than their great-grandparents did? n Hint: Use the concept of opportunity cost

Real GDP is not the Same as Economic Well-Being n Nonmarket Economic Activities – Household production – Volunteer services – Nonmarket activities are more important in poor countries – Underground economy

Real GDP is not the Same as Economic Well. Being n Environmental Quality and Resource Depletion – Benefits of environment quality are not measured. – GDP is not adjusted for resource depletion.

Real GDP is not the Same as Economic Well-Being n Quality of Life – Crime rates – Traffic congestion – Civic organizations – Open space

Real GDP is not the Same as Economic Well-Being n Poverty and Economic Inequality – GDP does not capture the effects of income inequality

But GDP is Related to Economic Well. Being But GDP is Related to Economic Well-Being n Thinking Economically – Why do far fewer children complete high school in poor countries than in rich countries? ?

Alternatives to GDP Gross National Happiness (GNH) is the main index for defining the quality of life in a more holistic manner in Bhutan.

Works Cited Rediff. com. GDP: Interesting Facts You Must Know. ” 9 Feb. 2010. Web. 8 Feb. 2011. Measuring the Economy: Principles of Economics. New York: 2007, Mc. Graw-Hill. Presentation. Various photographs. Wikipedia. com. Images.