Measuring the Macroeconomy Gross Domestic Product GDP Remember

Measuring the Macroeconomy

Gross Domestic Product (GDP) Remember GDP measures the value of all final goods and services produced in a country during a specific period of time. Measures • What? Newly produced final goods and services. • Where? Goods and services produced within the country’s borders. • When? Within the specific period of time.

Intermediate vs. final goods Intermediate goods: Final goods: • Goods that are • The total product processed further sold to the before being sold to consumer. the consumer. • Example: The Hershey candy bar. • Example: Chocolate

Intermediate vs. final goods Continued The chocolate that Hershey produces is not counted in the country’s GDP. It is an intermediate good. The chocolate is further processed and made into a Hershey candy bar, which is sold to the consumer and is counted in the country’s GDP.

Three Approaches to Measuring GDP * Spending Approach * Income Approach * Production Approach

SPENDING APPROACH The economy’s total spending is divided into four categories. * Consumption (C) * Investment (I) * Government Purchases (G) * Net Exports (X)

Consumption: Investment: The total of all final goods and services purchased by individuals. The total of all final goods and services purchased by firms plus newly produced homes by households. Investment represents 14. 7% of the U. S. GDP. Consumption represents 68% of the U. S. GDP.

Government Purchases: Net Exports: The total of all final The value of exports goods and services minus imports. purchased by Net Exports is also federal, state, and called a trade local governments. balance. Gov’t purchases Net Exports represents 18. 6% of -1. 3% of the U. S. GDP.

Exports: The total value of the final goods and services that the domestic country sells to foreign countries. Imports: The total value of final goods and services that the domestic country purchases from foreign countries. Net Exports = Exports - Imports

GDP Equation GDP= C + I + G + X Gross Domestic Product = Consumption + Investments + Government Purchases + (Exports - Imports)

INCOME APPROACH The economy’s aggregate income is divided into five categories. * Labor Income * Capital Income * Depreciation * Indirect Business Taxes *Net Income of Foreigners

Labor Income: The total of all wages, salaries, and fringe benefits paid to workers. Capital Income: The total of all profits, rental payments, and interest payments. Depreciation: The value that an asset decreases over time. Indirect Business Taxes: Taxes that are placed on products when they are sold.

Net Income of Foreigners: Income received by foreigners while producing in the domestic country, but the income is not included in labor or capital incomes.

Production GDP = or = Income Output GDP = C + I + G + X = Y

PRODUCTION APPROACH Measures the value added by each manufacturer to the final product. Value added: the value of the firm’s production minus the value of the intermediate goods.

Circular Flow of Income and Expenditures Savings Financial Intermediaries Investment Goods and Services Wages $$ $$ Households Goods & Government Goods Businesses & Services Labor Purhcases of Goods and Services Foreign Countries Net Exports Payments for Net Exports

Households provide labor for business. Businesses produce goods and services for Households to buy. Households save part of their wages in financial institutions. In return, Businesses provide wages for Households use part of their wages to purchase goods and services. Financial institutions loan part of their funds to businesses for investments.

The Government provides services to both the household and the business sectors. Households provide labor resources to the Government, while Businesses provides goods and services to the Government. In return, households and businesses pay taxes to the Government. In return, the Government provides wages to the Households and payments to the Businesses for the goods and services.

National Saving Is the total aggregate income minus consumption minus government purchases. Saving equation: S=Y-C-G

Equation Manipulation: If Y = C + I + G + X and S=Y-C-G then Y - C - G = I + X and S=I+X Therefore savings equals investment plus net exports.

What does this mean? National Savings can be used to: (a) invest into new factories, equipment, and housing or (b) provide funds to foreigners equal the exports they purchase above what they import.

So? • Well, when more is saved than invested, then exports will exceed imports (net exports will be positive) and the country will experience a trade surplus. • And, when less is saved than invested, then imports will exceed exports (net exports will be negative) and the country will experience a trade deficit.

Remember the distinction between Real and Nominal GDP? Real GDP has been adjusted for inflation.

Assume a three good world. 1995 1996 Q P 1997 Good P Q Videos 30 4000 25 8000 15 15000 CDs 20 5000 15 7000 15 9000 Tapes 15 6000 12 5000 12 4000 With this information, we can now calculate nominal GDP.

To calculate each year’s nominal GDP, you must multiple each goods price times its respective quantity. Then, you must add the totals for each good together. This sum represents the nominal GDP for the year.

Still using a three good world. 1995 1996 Good P Videos 30 4000 25 8000 15 15000 CDs 20 5000 15 7000 15 9000 Tapes 15 6000 12 5000 12 4000 Nominal GDP Q $ 310, 000 P 1997 Q $ 365, 000 P Q $ 408, 000

Nominally, GDP rose by: • 17. 74% from 1995 to 1996 365/310=1. 1774 and • 11. 78% from 1996 to 1997 408/365=1. 1178 Remember when you divide the 1 represents 100 because you divided a smaller number into a larger number. You do not utilize the whole number 1 in your percentage in this calculation.

As you know, this increase is not a true representation of this examples output and GDP. An adjustment for inflation must be made. Therefore, we will use 1995 as the base year to make the adjustment for inflation.

Using 1995 Prices 1995 1996 Good P Videos 30 4000 30 8000 30 15000 CDs 20 5000 20 7000 20 9000 Tapes 15 6000 15 5000 15 4000 Real GDP Q $ 310, 000 P 1997 Q $ 455, 000 P Q $ 690, 000

Real GDP based on 1995 prices rose by: • 46. 77% from 1995 to 1996 455/310=1. 4677 and • 51. 65% from 1996 to 1997 690/455=1. 5165 or • 122. 58% from 1995 to 1997 690/310=2. 2258

Now, use 1996 as the base year to make the adjustment for inflation.

Using 1996 Prices 1995 1996 Good P Videos 25 4000 25 8000 25 15000 CDs 15 5000 15 7000 15 9000 Tapes 12 6000 12 5000 12 4000 Real GDP Q $ 247, 000 P 1997 Q $ 365, 000 P Q $ 558, 000

Real GDP based on 1996 prices rose by: • 47. 77% from 1995 to 1996 365/247=1. 4777 and • 52. 88% from 1996 to 1997 558/365=1. 5288 or • 125. 91% from 1995 to 1997 558/247=2. 2591

In the textbook example, nominal GDP was greater than real GDP. However, this example presented real GDP being greater than nominal GDP. WHY? What was the differnece in the two examples?

Prices made the difference. In the textbook example, the prices were higher in the year 1998 than in the year 1997. This will make nominal GDP greater than real GDP (assuming total output increased). In the presentation example, prices decreased over the three year period while output rose. Thiss will make the nominal GDP less than the real GDP.

GDP deflator The GDP deflator measures the level of prices of goods and services included in real GDP relative to a given base year. Example: 1997 GDP deflator based on 1995 Prices. Nominal GDP = $365, 000 Real GDP = $455, 000 GDP Deflator: 365, 000/455, 000 =. 8022

Weaknesses of the GDP Measurement • Revisions in GDP • Omissions from GDP • • Housework and upkeep Preparing of your own tax returns Leisure Activity Underground economy • Measures of Well-Being • Quality of Life • Quality of the Environment

Complete the assignment for unit 2. Then move on to unit 3. This ends the specific chapter presentations. You have the basics, now you will apply them throughout the rest of the course. Keep on Moving on