Taking the Nation’s Economic Pulse Macro Chapter 7 Taking the Nation’s Economic Pulse

4 Learning Goals Define gross domestic product and describe the key phrases of the definition List the ways to measure gross domestic product and identify the source of higher income levels Differentiate between real and nominal GDP Examine the limitations of using GDP as a measure of output and income

GDP – A Measure of Output

Definition of Gross Domestic Product (GDP): The market value of final goods and services produced within a country during a specific time period. Gross National Product (GNP): The market value of final goods and services produced by a country’s citizens during a specific time period.

Q7.1 A business produced $10 million of goods in 2005 but sold only $9 million. Is the $1 million increase in inventory counted as part of the 2005 gross domestic product? No, because inventories are intermediate goods. No, because if these inventories were sold in 2006, they would be counted twice. Yes, because these inventories are part of the output of the economy in 2005. Yes, but they will be added to the 2005 GDP only if they are sold in 2006.

Q7. 2 George lived in a home that was newly constructed in 2005 Q7.2 George lived in a home that was newly constructed in 2005. In 2005, he paid $200,000 for the brand new house. He sold the house in 2006 for $225,000. Which of the following statements is correct regarding the sale of the house? The 2006 sale increased 2006 GDP by $225,000 and had no effect on 2005 GDP. The 2006 sale increased 2006 GDP by $25,000 and had no effect on 2005 GDP. The 2006 sale increased 2006 GDP by $225,000; furthermore, the 2006 sale caused 2005 GDP to be revised upward by $25,000. The 2006 sale affected neither 2005 GDP nor 2006 GDP.

GDP as a Measure of Both Output and Income

First way to measure GDP: expenditure approach GDP = sum of purchases GDP = Y = C + I + G + X C = consumption; purchases for goods and services by consumers I = investment G = government purchases X = net exports (exports – imports)

Investment ≠ buying stocks and bonds Investment = businesses buying final goods and services to use in their production of another good AND consumers buying houses

Q7.3 Y = C+I+G+X. Which of the four is the largest component of GDP? Consumption Investment Government purchases Net Exports

Class Activity: What government agency calculates GDP Class Activity: What government agency calculates GDP? How often is GDP calculated? How big is US GDP? See bea.gov

Some GDP facts: 2nd quarter, 2011 GDP = $15,606 billion That’s $15,606,000,000,000 C = 11,080 (71%) I = 2,028 (13%) G = 3,121 (20%) X = -624 (-4%) (exports = 2,184 or 14%; imports = 2,809 or 18%)

Class Activity: The US is the world’s largest economy Class Activity: The US is the world’s largest economy. Name the next four largest economies in order. See 2011 World Bank GDP See 2011 World Bank GNI per capita

Second way to measure GDP: income approach Add up income generated in the production of goods and services

The two methods of calculating GDP are summarized below: Expenditure Approach Resource Cost-Income Approach Personal consumption expenditures Aggregate income: Employee Compensation Income of self-employed Rents Profits Interest + Gross private domestic investment + Government consumption and gross investment + Non-income cost items: Indirect business taxes and depreciation + Net exports of goods and services = GDP Net income of foreigners + = GDP

Key Point: Higher income levels come from (are caused by) more output That is, more output comes first, then higher income comes second

Q7.4 If a used car dealer purchases a used car for $3,000, refurbishes it, and sells it for $8,000, the dealer contributes value added equal to $5,000, but nothing is added to GDP. dealer contributes value added equal to $5,000, and consequently $5,000 is added to GDP. dealer contributes nothing to production because only existing goods are involved. dealer contributes value added equal to $8,000, but only $5,000 is added to GDP.

Q7. 5 (PMA) An American-owned McDonald's opens in Russia Q7.5 (PMA) An American-owned McDonald's opens in Russia. How would the net revenue earned by this restaurant affect the GDP and GNP of the United States? GNP would rise GNP would fall GNP would remain unchanged GDP would rise GDP would fall GDP would remain unchanged

Adjusting for Price Changes and Deriving Real GDP

Watch video: Austin Powers- inflation Watch video: Stossel Macro 02- gas prices

Nominal (money) _________ = current year data only Real __________ = adjusted for inflation Use a price index to adjust nominal data into real data

These two indexes are used to adjust nominal data to real data. CPI: representative sample of goods bought by households, “market basket” See BLS_CPI_FAQ.pdf GDP deflator: accounts for almost all goods bought (broader measure than CPI) Inflation = the percentage change in an index

The simplest example Suppose all prices doubled between 1950 and 2000. Then $1 in 1950 would be equal to $2 in 2000. Or, $1 in 2000 would be equal to $0.50 in 1950.

See “Applications in Economics” on p. 142 of text. See also fueleconomy.gov

Q7.6 If the GDP deflator in 2006 was 130 compared to a value of 100 during the 1996 base year, this would indicate that the inflation rate during 2006 was 30 percent. the general level of prices during 2006 was 30 percent higher than during 1996. the inflation rate during 2006 was 130 percent. nominal GDP grew by 30 percent during 2006. real GDP was 130 percent higher in 2006 than 1996.

Problems with GDP as a Measuring Rod

What GDP misses: Non-market transactions like household work Unreported and illegal transactions The value of leisure and “time off” Quality changes Negative side effects like pollution

So, GDP is a measure of output but it’s not the measure of output It’s a good measure, but not a perfect measure

Question Answers 7.1 = 3 7.2 = 4 7.3 = 1 7.4 = 2 7.5 = 1 & 6 7.6 = 2