Measuring the Economy: Gross Domestic Product

What is GDP? National income accounting is a way of evaluating a country’s economy using statistical measures of its income, spending, and output GDP is the most important of those measures Gross domestic product is the market value of all final goods and services produced within a nation in a given time period

Components of GDP To be included in GDP, a good or service has to fulfill 3 requirements: 1) has to be final rather than intermediate (Ex. The fabric used to make a shirt is an intermediate good; the shirt itself is a final good.) 2) the good or service must be produced during the time period, regardless of when it is sold (Ex. Cars made this year but sold next year would be counted in this year’s GDP) 3) The good or service must be produced within the nation’s borders. (Products made in foreign countries by U.S. companies are not included in the U.S. GDP)

Calculating GDP Economists use the expenditures approach Group national spending on final goods and services according to 4 sectors of the economy: 1) Spending by households (consumption – C) 2) Spending by businesses (investment – I) 3) government spending (G) 4) total of exports minus total of imports or net exports (X) To calculate GDP, economists use this equation: C+I+G+X=GDP

Consumption Includes all spending by households on durable goods, nondurable goods and services Movie Theater example: You drive to the movies in a durable good (an item that does not wear out quickly.) You purchase a service when you pay for the movie (since you are not buying to own something) You obtain a nondurable good (a good that is used up relatively soon after purchase) when you buy popcorn

Investment Measures what businesses spend 2 categories: 1) fixed investment = new construction and purchases of capital goods like equipment, machinery, and tools 2) inventory investment (unconsumed output) = made up of unsold goods that businesses keep on hand

Government Spending Includes all the expenditures of federal, state, and local governments on goods and services Spending for defense, highways, public education Spending on transfer payments, like social security and unemployment benefits, is not included

Net Exports Represents foreign trade Takes into account the goods and services produced in the U.S. but sold in foreign countries (exports) Since U.S. consumers and businesses also buy (import) goods made in foreign countries, the GDP only counts net exports The value of U.S. exports minus the value of U.S. imports

Two types of GDP GDP is used to gauge how well a country’s economy is doing Economists use two forms of GDP to see exactly how “healthy” a country’s economy is Nominal GDP = states GDP in terms of the current value (price levels) of goods and services in the year the GDP was measured Real GDP = nominal GDP adjusted for changes in prices from year to year An estimate of the GDP if prices were to remain constant from year to year To find real GDP, economists compare nominal GDP to a base year Real GDP provides a more accurate measure of economic performance

What GDP does not measure Nonmarket activities = services that have potential economic value but are performed without charge doing volunteer work or performing one’s own home repairs Underground economy = market activities that go unreported because they are illegal or because those involved want to avoid taxation Drug dealing, smuggling, gambling, selling stolen goods, illegal trading (black market)

Other Economic Performance Measures of national income accounting Gross National Product (GNP) = the market value of all final goods and services produced by a country Net national product (NNP) = the value of final goods and services minus the value of capital goods that have become worn out National income (NI) = the total income earned in a nation from the production of goods and services Personal income (PI) = the income received by a country’s people from all sources Disposable personal income (DPI) = personal income minus taxes (how much money actually available for consumer spending)

Calculate the GDP Atoll K is small island nation. Its population total is 400, and it has 100 wage earners who earn an average of $50 per year. Each wage earner spends a total of $40 per year buying goods and services of which $3.00 goes to buying imported goods. The island exports a total of $800 worth of goods. The Government tax rate is 10% and all government money is spent on building infrastructure and supporting schools. There is only one industry (uranium mining) on the island and it employs every wage earner. The industry spends $600 each year on new mining equipment. What is the GDP?

GDP = C+I+G+X GDP = C + I + G + X, where X = E - M C = 100 x $40 = $4000 Total Consumer Spending I = 600 Total spent on Investment E = 800 Total received from Exports M = 100 x $3.0 = -300 Total spent on Imports G = .1 x (100 x $50) = 500 10% of total income for workers $5600 Total = GDP

The top 10 countries by GDP United States China Japan Germany France Brazil United Kingdom Italy India Russia What do you think of the GDP as a measure of the standard of living? For instance , China has a huge GDP, but the standard of living is quite poor. Any thoughts?