What is GDP? What is not GDP? Why do we need to know the GDP? What is GDP? What is not GDP? Why do we need to know the GDP?

GROSS DOMESTIC PRODUCT (GDP) The market value of all final goods and services produced in the economy in a given year. Take all final goods and services produced; Multiply them times their respective prices; Add up all the totals. The market value of all final goods and services produced in the economy in a given year. Take all final goods and services produced; Multiply them times their respective prices; Add up all the totals.

GDP Two interconnected sides: Output -- Firms produce output; for example, a computer manufacturer produces new computers. Income -- When firms produce output, they also generate income; wages; rents; interest; profit. Two interconnected sides: Output -- Firms produce output; for example, a computer manufacturer produces new computers. Income -- When firms produce output, they also generate income; wages; rents; interest; profit.

TOTAL MARKET VALUE  Take the quantity of goods produced and multiply them by their respective prices and add up the totals. -- Example: If an economy produced two cars at $15,000 a car and three computers at $3,000 a computer, the total value of these goods and services would be: ( 2 * $15,000 ) + ( 3 * $3,000 ) = $39,000  Take the quantity of goods produced and multiply them by their respective prices and add up the totals. -- Example: If an economy produced two cars at $15,000 a car and three computers at $3,000 a computer, the total value of these goods and services would be: ( 2 * $15,000 ) + ( 3 * $3,000 ) = $39,000

FINAL GOODS AND SERVICES Those goods and services that are sold to ultimate or final purchasers.

WHAT IS NOT INCLUDED IN GDP 1) Intermediate Products  Tires on a Car. A part of the final product. 2) Secondhand Sales  The sale of used goods. 3) The underground economy  Services performed in the home, such as, cleaning, cooking and providing free child care;  Transactions which occur that are not reported to official authorities -- these may be legal or illegal;  IRS estimates that about $100 billion in income escapes federal taxes each year;

WHAT IS INCLUDED IN GDP GDP=C+I+G+Xn (F) Consumption Expenditures Private Investment Government Purchases Net Exports: Exports - Import

WHO PURCHASES GOODS AND SERVICES ? GDP Consumption Private Government Net Expenditures Investment Purchases Exports Expenditures Purchases Consumers Firms Federal, state foreign and local sector: governments exports minus imports $ 7,297 $ 4,965 $ 1,067 $ 1,366 - $ 101 billion billion billion billion billion *Keynes Output-Expenditure Model: GDP=C+I+G+F.  Consider that the U.S. population is 255 million people, GDP per person is approximately $28,600. GDP Consumption Private Government Net Expenditures Investment Purchases Exports Expenditures Purchases Consumers Firms Federal, state foreign and local sector: governments exports minus imports $ 7,297 $ 4,965 $ 1,067 $ 1,366 - $ 101 billion billion billion billion billion *Keynes Output-Expenditure Model: GDP=C+I+G+F.  Consider that the U.S. population is 255 million people, GDP per person is approximately $28,600.

CONSUMPTION EXPENDITURES  Durable Goods -- Those goods which last for a longer period of time, such as automobiles and refrigerators;  Nondurable goods -- Those goods which last for short periods of time, such as food;  Services -- Reflect work done in which people play a prominent role in delivery, such as a dentist filling a cavity.

PRIVATE INVESTMENT EXPENDITURES  Structures:  Spending on new plants and equipment during the year;  Newly produced housing;  Additions to the stock of inventories; Gross Investment -- The total of new investment; Depreciation -- The deterioration or wearing out of existing plants, equipment and housing; Net investment -- Gross Investment minus depreciation.

GOVERNMENT PURCHASES  Purchases of newly produced goods and services by federal, state, and local governments;  It includes any goods the government purchases plus the wages and benefits of all government workers;  The majority of spending in this category actually comes from state and local governments.

TRANSFER PAYMENTS  Not included in the category of government purchases.  Funds paid to individuals not associated with the production of goods and services; It includes payments for: social security; welfare; interest on government debt;  In 1995, approximately two-thirds of federal government expenditures were transfer payments.

NET EXPORTS  Purchases of foreign goods by consumers, firms and the government are subtracted when we calculate GDP because these goods were not produced in the U.S.  We must add to GDP any goods produced in the U.S. and sold abroad. Trade Deficit -- Occurs when we buy more goods from abroad than we sell; Trade Surplus -- Occurs when our exports exceed our imports;

REALITY PRINCIPLE What matters to people is the real value or purchasing power of money or income, not its face value. $$$

REAL GDP A measure of GDP that controls for price changes.

GDP that is measured using current prices It can increase for one of two reasons:  Production of goods and services has increased  The prices of the goods and services has increased GDP that is measured using current prices It can increase for one of two reasons:  Production of goods and services has increased  The prices of the goods and services has increased NOMINAL GDP

GDP EXAMPLE YEAR 1 YEAR 2 Production 10 computers 12 computers Price $1,000 $1,100  Nominal GDP in year 1 is $10,000 (10 * $1,000) = $10,000  Nominal GDP in year 2 is $13,200 (12 * $1,100) = $13,200  Real GDP in year 1 is $10,000 (10 * $1,000) = $10,000  Real GDP in year 2 is $12,000 (12 * $1,000) = $12,000 YEAR 1 YEAR 2 Production 10 computers 12 computers Price $1,000 $1,100  Nominal GDP in year 1 is $10,000 (10 * $1,000) = $10,000  Nominal GDP in year 2 is $13,200 (12 * $1,100) = $13,200  Real GDP in year 1 is $10,000 (10 * $1,000) = $10,000  Real GDP in year 2 is $12,000 (12 * $1,000) = $12,000

,000 4,000 6,000 8,000 U.S. REAL GDP, Real GDP 1992 $$ YEAR Source: U.S. Department of Commerce

U.S. REAL GDP  The data for real GDP control for changes in prices and thus capture movements in real output only  Real GDP has grown substantially over the period graphed  This is what economists term economic growth  sustained increases in real production of an economy over a period of time  Differences in economic growth between countries and changes in economic growth over time are among the most important issues of macroeconomics  The data for real GDP control for changes in prices and thus capture movements in real output only  Real GDP has grown substantially over the period graphed  This is what economists term economic growth  sustained increases in real production of an economy over a period of time  Differences in economic growth between countries and changes in economic growth over time are among the most important issues of macroeconomics

GROSS NATIONAL PRODUCT GNP Add to GDP any income earned abroad by U.S. firms or residents; Subtract any income earned in the United States by foreign firms or residents. Add to GDP any income earned abroad by U.S. firms or residents; Subtract any income earned in the United States by foreign firms or residents.

NET NATIONAL PRODUCT Obtain GNP from GDP; Subtract depreciation from GNP; Obtain GNP from GDP; Subtract depreciation from GNP;

NATIONAL INCOME The income that flows to the private sector; To get National Income, economists make adjustments to GDP: -- obtain Net National Product: * add income earned abroad by U.S. firms or residents; * subtract income earned in the U.S. by foreign firms or residents; * subtract depreciation; -- subtract indirect taxes, which are sales or excise taxes on products. The income that flows to the private sector; To get National Income, economists make adjustments to GDP: -- obtain Net National Product: * add income earned abroad by U.S. firms or residents; * subtract income earned in the U.S. by foreign firms or residents; * subtract depreciation; -- subtract indirect taxes, which are sales or excise taxes on products.

Gross Domestic Product$7,297 Plus net income earned from abroad = Gross National Product$7,281 minus depreciation = Net National Product$6,452 minus indirect taxes (and other adjustments) = National Income$5,845 Source: Economic Report of the President (Washington, DC: U.S. Government Printing Office, 1996) FROM GDP TO NATIONAL INCOME

COMPOSITION OF U.S. NATIONAL INCOME National Income $5,845 Compensation of employees $4,233 Corporate profits $ 614 Rental income $ 118 Proprietor’s income $ 480 Net Interest $ 400 Source: Economic Report of the President Washington, DC: Government Printing Office, 1996 National Income $5,845 Compensation of employees $4,233 Corporate profits $ 614 Rental income $ 118 Proprietor’s income $ 480 Net Interest $ 400 Source: Economic Report of the President Washington, DC: Government Printing Office, 1996

VALUE ADDED  Value added of a firm is the sum of all income (wages, profits, rents, and interest) that it generates;  By adding up the value added for all firms in the economy (plus nonprofit and governmental organizations), national income can be calculated;  Value added for a typical firm is measured by starting with its total sales and subtracting the value of any inputs it purchases from other firms.

CONSUMER PRICE INDEX (CPI)  Widely used by government and private sector to measure changes in prices facing consumers;  Measures changes in fixed “basket of goods,” a collection of items chosen to represent the purchasing pattern of a typical consumer;  Find out how much basket of goods costs in a base year, then how much it costs in other years; CPI = ( cost in today’s prices / cost in base year ) * 100  Each month Bureau of Labor Statistics sends its employees out to sample over 90,000 specific items around the country to compile the CPI.

PERSONAL INCOME The total payments that flow directly into the hands of households; Personal income = national income + transfer payments - profits retained by firms; The amount of personal income that households keep after paying taxes is called personal disposable income. The total payments that flow directly into the hands of households; Personal income = national income + transfer payments - profits retained by firms; The amount of personal income that households keep after paying taxes is called personal disposable income.

UNEMPLOYED Those people who are looking for work but do not currently have jobs.

UNEMPLOYMENT DATA, 1995 U.S. Civilian Population over 16 years of age ( 198,584,000 ) Source: Economic Report of the President (Washington, DC: U.S. Government Printing Office, 1996 Government Printing Office, 1996

UNEMPLOYMENT DATA, 1995 U.S. Civilian Population over 16 years of age ( 198,584,000 ) Source: Economic Report of the President (Washington, DC: U.S. Government Printing Office, 1996 Government Printing Office, 1996 Labor Force ( 132,304,000 ) Not in labor force ( 66,280,000 )

UNEMPLOYMENT DATA, 1995 U.S. Civilian Population over 16 years of age ( 198,584,000 ) Source: Economic Report of the President (Washington, DC: U.S. Government Printing Office, 1996 Government Printing Office, 1996 Labor Force ( 132,304,000 ) Not in labor force ( 66,280,000 ) Employed ( 124,900,000 ) Employed Unemployed ( 7,404,000 )

UNEMPLOYMENT STATISTICS Population represented are all over 16 years of age; population is divided into two groups: those in labor force; those not in labor force; labor force is divided into two groups: employed; unemployed; Population represented are all over 16 years of age; population is divided into two groups: those in labor force; those not in labor force; labor force is divided into two groups: employed; unemployed;

UNDEREMPLOYED Workers who hold a part-time job but prefer to work full time; Workers who hold jobs far below their capabilities; Workers who hold a part-time job but prefer to work full time; Workers who hold jobs far below their capabilities;

Total 5.6% Male, 20 years & over 4.8% Female, 20 years & over 4.7% Both Sexes, % White 4.9% African American 10.2% White, % African American, % Married Men 3.2% Married Women 3.8% Women maintaining families 6.8% Source: Bureau of Labor Statistics, Employment and Earnings Total 5.6% Male, 20 years & over 4.8% Female, 20 years & over 4.7% Both Sexes, % White 4.9% African American 10.2% White, % African American, % Married Men 3.2% Married Women 3.8% Women maintaining families 6.8% Source: Bureau of Labor Statistics, Employment and Earnings SELECTED U.S. UNEMPLOYMENT STATISTICS, UNEMPLOYMENT RATES FOR DECEMBER 1995

UNEMPLOYMENTUNEMPLOYMENT Frictional unemployment occurs naturally in the labor market as workers search for jobs; Structural unemployment arises from a mismatch of skills and jobs; Cyclical unemployment rises and falls with economic fluctuations; it can be either positive (in a recession) or negative (in a boom). Frictional unemployment occurs naturally in the labor market as workers search for jobs; Structural unemployment arises from a mismatch of skills and jobs; Cyclical unemployment rises and falls with economic fluctuations; it can be either positive (in a recession) or negative (in a boom).

UNEMPLOYMENT (cont.) Seasonal unemployment changes in seasonal demand for workers. Ex. Christmas; Technological unemployment arises from new technology that need less workers to complete the same job. Ex. Automotive Industry; Seasonal unemployment changes in seasonal demand for workers. Ex. Christmas; Technological unemployment arises from new technology that need less workers to complete the same job. Ex. Automotive Industry;

FULL EMPLOYMENT Corresponds to zero cyclical unemployment; When the economy is at full employment, the only unemployment is frictional and structural. Corresponds to zero cyclical unemployment; When the economy is at full employment, the only unemployment is frictional and structural.

RECESSION  A period when economic growth is negative (real GDP falls) for two consecutive quarters  A quarter is three consecutive months during the year  A recession is a period when real GDP falls for at least six months  A period when economic growth is negative (real GDP falls) for two consecutive quarters  A quarter is three consecutive months during the year  A recession is a period when real GDP falls for at least six months

RECESSION Peak  The date at which a recession starts Trough  The date at which output starts to increase again Since World War II, the United States has experienced nine recessions. Peak  The date at which a recession starts Trough  The date at which output starts to increase again Since World War II, the United States has experienced nine recessions.

NINE POSTWAR RECESSIONS PeakTroughPercent Decline in real GDP November 1948October July 1953May August 1957April April 1960February December 1969November November 1973March January 1980July July 1981November July 1990March PeakTroughPercent Decline in real GDP November 1948October July 1953May August 1957April April 1960February December 1969November November 1973March January 1980July July 1981November July 1990March

 A common term for a severe recession  In the United States, the Great Depression refers to the period, in which real GDP fell by over 33%  It created the most severe economic dislocations that the United States has experienced in the twentieth century  Banks closed, businesses failed, and many people lost their life savings  Unemployment rose sharply  In 1933, over 25% of the people looking for work failed to find jobs  A common term for a severe recession  In the United States, the Great Depression refers to the period, in which real GDP fell by over 33%  It created the most severe economic dislocations that the United States has experienced in the twentieth century  Banks closed, businesses failed, and many people lost their life savings  Unemployment rose sharply  In 1933, over 25% of the people looking for work failed to find jobs DEPRESSION

CAUSES OF RECESSION  Changes in technology  Disruptions to the financial system  Increases in prices of key commodities  (Deliberate or inadvertent) government policies  Changes in technology  Disruptions to the financial system  Increases in prices of key commodities  (Deliberate or inadvertent) government policies

 An index that measures the average of the prices of the goods and services that are contained in the GDP  Starting in 1996, a chain-type price index for GDP replaced the GDP deflator as the principle index reported by the U.S. Department of Commerce  An index that measures the average of the prices of the goods and services that are contained in the GDP  Starting in 1996, a chain-type price index for GDP replaced the GDP deflator as the principle index reported by the U.S. Department of Commerce CHAIN-TYPE PRICE INDEX FOR GDP

CHAIN-TYPE PRICE INDEX  It has a value of 100 in a given year, called the base year  The important information in the value of the index for any other year is contained in its relation to the base year  If a chin-type price index for GDP in one year is 105, it means that prices have increased by 5% since the base year: [ ( ) / 100 ]  By using a chain price index, we see how the overall level of prices changes from one year to the next over a long period of time  It has a value of 100 in a given year, called the base year  The important information in the value of the index for any other year is contained in its relation to the base year  If a chin-type price index for GDP in one year is 105, it means that prices have increased by 5% since the base year: [ ( ) / 100 ]  By using a chain price index, we see how the overall level of prices changes from one year to the next over a long period of time

CHAIN PRICE INDEX EXAMPLE YEAROUTPUTPRICE 1 10$1, $1,100  If year 1 is chosen as the base year, the price index for GDP will be 100  The price of the single good in the economy, computers, rose by a factor of 1.1: ( $1,100 / $1,000 = 1.1 )  The price index for year 2 is equal to the value of the index in year 1 (100) times the factor by which prices increased (1.1): 100 * 1.1 = 110 YEAROUTPUTPRICE 1 10$1, $1,100  If year 1 is chosen as the base year, the price index for GDP will be 100  The price of the single good in the economy, computers, rose by a factor of 1.1: ( $1,100 / $1,000 = 1.1 )  The price index for year 2 is equal to the value of the index in year 1 (100) times the factor by which prices increased (1.1): 100 * 1.1 = 110

Sources: R.J. Gordon, Macroeconomics, New York, (Harper Collins, 1993); U.S. Department of Commerce

INFLATION The percentage rate of change in price level increase  If GDP in year 1 is 100 and GDP in year 2 is 110, inflation rate is 10% The percentage rate of change in price level increase  If GDP in year 1 is 100 and GDP in year 2 is 110, inflation rate is 10%

Source: U.S. Department of Commerce Based on Chain-type Price Index

CLASSICAL ECONOMICS The study of the economy when it operates at or near full employment.

KEYNESIAN ECONOMICS The study of business cycles and economic fluctuations that we develop.