Taking the Nation’s Economic Pulse Chapter 7

Chapter 7 Objectives Define gross domestic product. Calculate gross domestic product. Differentiate between GDP and GNP Differentiate between real GDP and nominal GDP.

GDP Gross Domestic Product – The market value of final goods and services produced within a country during a specific time period. Performance measure Announced quarterly, at annual rate

GDP Do include final goods and services Gross Domestic Product – The market value of final goods and services produced within a country during a specific time period, usually a year. Do include final goods and services Don’t include intermediate goods Intermediate goods – goods purchased for resale or for use in producing another good or service Final goods and services – items purchased by their ultimate end-user

GDP Do include services rendered and sales commissions Gross Domestic Product – The market value of final goods and services produced within a country during a specific time period, usually a year. Do include services rendered and sales commissions Don’t include income transfers, financial transactions, welfare, Social Security

GDP Gross Domestic Product – The market value of final goods and services produced within a country during a specific time period, usually a year. Do include production by individuals of any citizenship within U.S. Don’t include count production by U.S. citizens working outside the U.S. Citizenship doesn’t matter Location does!

GDP Gross Domestic Product – The market value of final goods and services produced within a country during a specific time period, usually a year. Do include value of services provided by realtor, car dealer, clothing reseller, etc Don’t include value of the used goods

Dollars are the Common Denominator for GDP + + + Each good/service counted increases GDP by its market price 22oz of Bud Light at pro baseball game: $7 22oz of Bud Light from the gas station: $2

GDP Measures Output and Income 1) Add up all expenditures on goods and services produced during the year OR 2) Add up all the income payments to the resource suppliers of the things used to produce the goods and services Dollar flow of expenditures on final goods = Dollar flow of income (and indirect cost) from final goods

Two Ways of Measuring GDP Expenditure Approach Personal consumption expenditures + Gross private domestic investment + Government consumption and gross investment + Net exports of goods and services = GDP

GDP Expenditure Approach Personal consumption expenditures – Household spending on consumer goods and services 71% of GDP Private investment Production of capital goods that provide a flow of future services 14% of GDP

GDP Expenditure Approach Government consumption and gross investment Expenditures on goods, services consumed Purchases of capital goods 20% of GDP Net Exports – exports minus imports Exports – goods and services produced domestically and sold to foreigners Imports – goods and services produced abroad but purchased by domestic consumers, businesses, and governments -4% of GDP

Expenditure Approach, 2013 data (billions) Personal Consumption $11,484 Durable Goods $1,249 Non Durable Goods $2,601 Services $7,633 Gross Private Investment $2,648 Fixed Investment $2,574 Inventories $74 Government Consumption and Gross Investment $3,144 Federal $1,232 State and Local $1,912 Net Exports -$508 Gross Domestic Product $16,768

Two Ways of Measuring GDP Resource Cost-Income Approach Aggregate income: Employee Compensation Income of self-employed Rents Profits Interest + Non-income cost items: Indirect business taxes depreciation Net income of foreigners + = GDP

GDP Resource Cost-Income Approach Indirect business taxes Taxes that increase a business firm’s cost of production Examples: sales, excise, property taxes Depreciation Estimated based on expected life of the asset Capital consumption

Resource Cost-Income Approach, 2013 data (billions) Employee Compensation $8,606 Proprietors’ Income $1,260 Rents $533 Corporate Profits $2,023 Interest Income $492 Indirect Business Taxes $1,074 Depreciation (Capital Consumption) $2,627 Net Income of Foreigners -$224 Gross Domestic Product $16,768

GNP Gross National Product – Total market value of all final goods and services produced by the citizens of a country Equal to GDP minus the net income of foreigners

Adjusting for Price Changes Nominal GDP may rise because (1) More goods/services (2) Higher prices Nominal values (money values) Expressed in current (Now) dollars Not adjusted for inflation Real values Expressed in constant dollars (base year) Adjusted for inflation

Adjusting for Price Changes Imagine a country that only produces kibbles and Frisbees. In 2013 10 bags of kibble, $5 each 3 Frisbees, $4 each Nominal GDP = $62 Scenario 1: in 2014 10 bags of kibble cost $6 each, 3 Frisbees, $5 each Nominal GDP = $75 Real GDP (base year 2013) = $62

Adjusting for Price Changes Imagine a country that only produces kibbles and Frisbees. In 2013 10 bags of kibble, $5 each 3 Frisbees, $4 each Nominal GDP = $62 Scenario 2: in 2014 11 bags of kibble cost $6 each, 5 Frisbees, $5 each Nominal GDP = $91 Real GDP (base year 2013) = $75

Real GDP If real GDP increases If real GDP decreases output is increasing Incomes are rising Economy is growing  If real GDP decreases output is decreasing Incomes are falling Two quarters falling real GDP  recession 

Adjusting for Price Changes Inflation – increase in the general level of prices over time Purchasing power of money is falling If unexpected, borrowers win, savers lose Deflation – decrease in the general level of prices over time Purchasing power of money is rising If unexpected, savers win, borrowers lose

Adjusting for Price Changes Consumer price index (CPI) – measures the impact of price changes on the cost of the typical bundle of goods purchased by households, 1982-84=100 GDP deflator – measures the change in the average price of the market basket of goods included in GDP, 2009 = 100 Both help us measure inflation!

Adjusting for Price Changes Example: The CPI in 2012 was 229.6. The CPI in 2013 was 233.0. Calculate the inflation rate. Answer: 1.5%

Adjusting for Price Changes Example: I earned $5.15 per hour in 1997. The CPI in 1997 was 160.5. The CPI in 2013 was 233.0. Find the wage rate in 2013 dollars Answer: $7.48

Adjusting for Price Changes Percent change in real GDP equals the percent change in nominal GDP minus the inflation rate %∆Real GDP = %∆Nominal GDP – inflation

Nobody’s Perfect, Not Even GDP GDP does not include or take into account Nonmarket or household production Underground or black market economy Leisure and human costs Quality variation, introduction of new goods Harmful side effects, economic “bads”

Chapter 7 Objectives Define gross domestic product. Calculate gross domestic product. Differentiate between GDP and GNP Differentiate between real GDP and nominal GDP.