Macroeconomics: Measuring Total Production and Income Chapter 8

Important issues in macroeconomics Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? Why are there recessions? Can the government do anything to combat recessions? Should it??

What is Gross Domestic Product (GDP)?

GDP – A Measure of Output Gross Domestic Product (GDP): The market value of final goods and services produced within a country during a specific time period, usually a year. GDP is the most widely used indicator of economic performance.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. GDP is measured in dollars. Each good produced increases output by the amount the purchaser pays for the good. The total spending on all final-user goods and services produced during the year is summed, in dollar terms, to obtain the annual GDP.

U.S. Gross Domestic Product in billions of chained 2000 dollars long-run upward trend…

U.S. Gross Domestic Product in billions of chained 2005 dollars Recessions longest economic expansion on record

How do you Measure GDP?

There are three methods for calculating GDP: I. Market Value –Adding up total value of all final goods and services produced in an economy during a given time period II. Expenditure approach – Total spending on US production –Adds up the aggregate expenditure on all final goods and services produced during that year III. Income approach –Total income received from that production –Adds up the aggregate income earned during the year by those who produce that output

I. The Market Value Method to Measure GDP

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: YearPrice of CarsQuantity of CarsPrice of CDsQ of CDs 1 $10,0005$204 Market Value = (value of Cars) + (value of CDs) ($10,000 x 5) + ($20 x 4) ($50,000) + ($80) Market Value = $50,080

Value added definition:

Total Payments to Factors = $21,500 4,800 12,500 Sum of Value Added = $21,500 Aggregate Spending $9,000 (steel) 4,200 (ore) 3, ,000 (steel) 10,000 1, ,000 21,500 $21,500 (car) 4,800 12,500 $15,700 2,600 1,000 2,200

GDP = Sum of value added at all stages of production The value of the final goods already includes the value of the intermediate goods, so including intermediate goods in GDP would be double-counting. Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. No Financial transactions No Income Transfers

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time.

II. The Expenditure Method to Measure GDP

GDP in 2014: $15.96 trillion dollars Expenditure Approach: GDP is the sum of expenditures on final-user goods and services purchased by households, investors, governments, & foreigners. When calculated by this method, there are 4 components of GDP: personal CONSUMPTION purchases gross private INVESTMENT GOVERNMENT purchases NET EXPORTS The Expenditure Method of Measuring GDP

Consumption ( C ) durable goods last a long time ex: cars, home appliances non-durable goods last a short time ex: food, clothing services work done for consumers ex: dry cleaning, air travel. def: the value of all goods and services bought by households. Includes:

U.S. Consumption, 2014 GDP in 2014: $15.96 trillion dollars

Investment ( I ) Def. 1: spending on [the factor of production] capital. Def. 2: spending on goods bought for future use. Includes:  business fixed investment spending on plant and equipment that firms will use to produce other goods & services  residential fixed investment spending on housing units by consumers and landlords  inventory investment the change in the value of all firms’ inventories

Note on Inventory Investment: American Motors Inc. produces 5,000 cars in 2011 and sells 4,500 cars in The average price per car is $10,000. In 2012 AMI produces 5,000 cars and sells 5,100 cars in The average price per car is $12,000.

Inventories Net changes in inventories –Net increase in inventories counts as investment because it represents current production not used for current consumption –Net decrease in inventories counts as negative investment, or disinvestment, because it represents the sale of output already credited to a prior year’s GDP

U.S. Gross Private Domestic Investment, 2014 GDP in 2014: $15.96 trillion dollars

Government spending (G) G includes all government spending on goods and services by local, state, and federal governments. Includes the salaries of government workers and spending on public works. Government spending excludes transfer payments.

Government spending, 2014 GDP in 2014: $15.96 trillion dollars

Net exports Def.: the value of total exports (X) minus the value of total imports (M) ( NX = X - M )

2014 Net exports = –$442.5 billion

GDP: The Expenditure Approach ItemSymbol Personal CONSUMPTION Expenditures C Gross Private Domestic INVESTMENT I GOVERNMENT PurchasesG NET EXPORTSNX Gross Domestic ProductY Amount in 2014Percentage of GDP $10, % $2, % $2, % -$ % $15,962100% Aggregate Expenditures = Total Output = Real GDP = Y = C + I + G + (X – M)

GDP: The Expenditure Approach Symbol Percentage of GDP in 2011 C71.1% I12.7% G20.1% NX-3.8% Y100% Percentage of GDP in 2007 Percentage of GDP in %68.6% 16.4%17.8% 19.1%17.4% -5.1%-3.8% 100%

III. The Income Method to Measure GDP

GDP: Income Approach Income approach sums, or aggregates, income arising from that production Recall that double-entry bookkeeping ensures that the value of aggregate output equals the aggregate income paid for resources used to produce that output –Wages –Interest –Rent –Profit arising from production

Personal consumption 68% Net exports - 3% Private investment 17% Gov’t 18% Rental income < 1% Net interest 6% Indirect taxes 7% Corporate profits 9% Self-employed proprietor income 7% Employee compensation 58% Depreciation 13% (a) Expenditure approach(b) Resource cost-income approach a Source: Economic Report of the President, a The net income of foreigners was negligible. Relative Size of U.S. GDP Components:

Chapter 5: Measuring Economic Activity: GDP and Unemployment Slide 37 The Three Faces of GDP == Market value of final goods and services ProductionExpenditureIncomeInvestment Consumption Governmentpurchases Net exports Capital Income Labor Income

Gross Domestic Product v. Gross National Product

GNP vs. GDP Gross National Product (GNP): total income earned by the nation’s factors of production, regardless of where located Gross Domestic Product (GDP): total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

Discussion Question: In your country, which would you want to be bigger, GDP or GNP? Why?

(GNP – GDP) as a percentage of GDP selected countries, 2002

Nominal GDP v. Real GDP

Real GDP Per Person: 1900 – 2000

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: YearPrice of CarsQuantity of CarsPrice of CDsQ of CDs 1 $10,0005$204 Market Value = (value of Cars) + (value of CDs) ($10,000 x 5) + ($20 x 4) ($50,000) + ($80) Market Value = $50,080

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: YearPrice of CarsQuantity of CarsPrice of CDsQ of CDs 2 $15,0005$224 Market Value = $50,080 YearPrice of CarsQuantity of CarsPrice of CDsQ of CDs 1 $10,0005$204 Market Value = (value of Cars) + (value of CDs) ($15,000 x 5) + ($22 x 4) ($75,000) + ($88) Market Value = $75,088

A Measure of the Economy’s Price Level – Consumer Price Index Source: The CPI Home page of the U.S. Bureau of Labor Statistics at requests.cpi\cpia.html

Real GDP controls for inflation Changes in Nominal GDP can be due to: Changes in Real GDP can only be due to:

Practice problem, part 1 Compute nominal GDP in each year Compute real GDP in each year using 2002 as the base year PQPQPQ Toy cars$30900$311,000$361,050 Toy dolls$10850$12900$12925 Plastic$100192$102200$100205

Nominal GDP multiply Ps & Qs from same year 2002: $ 2003: $ 2004: $ Real GDP multiply each year’s Qs by 2002 Ps 2002: $ 2003: $ 2004: $ PQPQPQ Toy cars$30900$311,000$361,050 Toy dolls$10850$12900$12925 Plastic$100192$102200$100205

U.S. Real & Nominal GDP, (base year = 2000)

GDP Deflator

GDP Deflator Example Using the values in the table below, we can compute GDP deflator for 2007 and What is the percentage increase in the price level from 2007 to 2008?