Chapter 6 Measuring Total Output and Income Hossain: MSMC

Gross Domestic Product  Formal definition:  Nominal GDP Total value of all final goods and services produced in an economy in given year valued at the current price  Real GDP Hossain: MSMC2 Total value of all final goods and services produced in an economy in given year valued at the current price Total value of all final goods and services produced in an economy in given year adjusted to eliminate the effect of price change final current price adjusted to eliminate the effect of price change

GDP Accounting  Bureau of Economic Analysis (BEA) measures nation’s GDP  How do economists at BEA measure the total value of goods and services produced in an economy  We can go to each and every producers in the economy and ask the value of their output  Well, even if you do that, how do you define value? Hossain: MSMC3

GDP Accounting  To a producer, value of his product might be different from those who buy that product  BEA looks at the market value or the value at which the product is bought and sold  So, if Apple produces 1m ipod in 2010 and each is sold at $150  Total value created in the economy is 1m x $150 = $150m Hossain: MSMC4

GDP Accounting  It is not hard to visit companies like Apple, GM, General Mills and IBM, but for smaller companies, manufacturers, self employed individual it is almost impossible  To simplify their job, BEA does not ask output and price information and multiply them to get the value, but ask the company’s income information  Note, the income will already have the price and quantity information in it Hossain: MSMC5

GDP Accounting  So what BEA would get the following from Apple  Note, by doing so they will directly get the market value Hossain: MSMC6 Income fromAmount ipod150m iphone500m Mac Book1b ipad300m

Approaches to GDP Accounting  Also note, someone’s income is always someone else’s expenditure  Apple’s income is Bob’s expenditure who just bought his first iphone  There are two approaches to GDP accounting:  Income Approach Hossain: MSMC7 Expenditure Approach

Expenditure Approach to GDP  In this approach, BEA counts the expenditures of all major spenders in the economy  There are four of them: Hossain: MSMC8  Consumption  Investment  Government Purchases  Net Export

Component of GDP  Consumption measures the value of goods and services purchased by households during a time period  Investment is the value of all goods produced during a period that will be used in the production of other goods and services.  This is often the capital investment  Inventory investment is also counted as investment

Component of GDP  Government purchases  Goods and services produced in an economy, but purchased by government agencies during a time period, and  Total value of output produced by government agencies themselves during a time period.

Component of GDP  Transfer payments are payments that do not require the recipient to produce a good or service in order to receive them  This means, Transfer Payments are government expenditure but not a GDP contributing expenditure  Therefore, it will not be included in the GDP  BEA needs to be careful here

Component of GDP  The final component of expenditure approach is Net Exports that counts the part of the US GDP that goes to the rest of the world  But, note US also imports a lot of goods and services from the rest of the world  Since we are trying to measure GDP using expenditures, we want to include only the part of expenditure that foreigners do on US made products  However, we only have Export and Import expenditures

Component of GDP  Exports (X) Total value of a country’s goods and services to buyers in the rest of the world  Imports (M) Total value foreign-produces goods and services purchased by a country’s residents  Net Exports are exports minus imports.  Exports (X) – Imports (M) = Net exports (X n )

Components of GDP Hossain: MSMC14

How to compute Final Output GoodsProduced by Purchased by Price LogsLoggerSawmill12,000 LumberSawmillBuilders25,000 HouseBuildersHousehold125,000 Total Value with double counting162, 000 Final market value 125,000 Hossain: MSMC15 Total Value Added 12,000 13, , , 000