Macroeconomics: Measuring Total Production and Income Chapter 8

Important issues in macroeconomics Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? Why are there recessions? Can the government do anything to combat recessions? Should it??

GDP – A Measure of Output Gross Domestic Product (GDP): The market value of final goods and services produced within a country during a specific time period, usually a year. GDP is the most widely used indicator of economic performance.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. GDP is measured in dollars. Each good produced increases output by the amount the purchaser pays for the good. The total spending on all final-user goods and services produced during the year is summed, in dollar terms, to obtain the annual GDP.

U.S. Gross Domestic Product in billions of chained 2000 dollars long-run upward trend… 6

U.S. Gross Domestic Product in billions of chained 2005 dollars longest economic expansion on record Recessions

There are three methods for calculating GDP: Market Value Adding up total value of all final goods and services produced in an economy during a given time period Expenditure approach Total spending on US production Adds up the aggregate expenditure on all final goods and services produced during that year Income approach Total income received from that production Adds up the aggregate income earned during the year by those who produce that output

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: Year Price of Cars Quantity of Cars Price of CDs Q of CDs $10,000 5 $20 4 Market Value = (value of Cars) + (value of CDs) ($10,000 x 5) + ($20 x 4) ($50,000) + ($80) Market Value = $50,080

Value added definition:

Aggregate Spending $9,000 (steel) $21,500 (car) 4,200 (ore) 9,000 (steel) 3,700 600 300 10,000 1,000 500 $15,700 2,600 1,000 2,200 Total Payments to Factors = $21,500 200 1,000 9,000 21,500 4,800 12,500 Sum of Value Added = $21,500 4,800 12,500

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. GDP = Sum of value added at all stages of production The value of the final goods already includes the value of the intermediate goods, so including intermediate goods in GDP would be double-counting.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. No Financial transactions No Income Transfers

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time.

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time.

The Expenditure Method of Measuring GDP Expenditure Approach: GDP is the sum of expenditures on final-user goods and services purchased by households, investors, governments, & foreigners. When calculated by this method, there are 4 components of GDP: personal CONSUMPTION purchases gross private INVESTMENT GOVERNMENT purchases NET EXPORTS GDP in 2013: $15.94 trillion dollars 16

Consumption (C) def: the value of all goods and services bought by households. Includes: durable goods last a long time ex: cars, home appliances non-durable goods last a short time ex: food, clothing services work done for consumers ex: dry cleaning, air travel. 17

U.S. Consumption, 2013 GDP in 2013: $15.94 trillion dollars source: Bureau of Economic Analysis, U.S. Department of Commerce http://www.bea.doc.gov 18

Investment (I) Def. 1: spending on [the factor of production] capital. Def. 2: spending on goods bought for future use. Includes: business fixed investment spending on plant and equipment that firms will use to produce other goods & services residential fixed investment spending on housing units by consumers and landlords inventory investment the change in the value of all firms’ inventories 19

Note on Inventory Investment: American Motors Inc. produces 5,000 cars in 2011 and sells 4,500 cars in 2011. The average price per car is $10,000. In 2012 AMI produces 5,000 cars and sells 5,100 cars in 2012. The average price per car is $12,000.

Inventories Net changes in inventories Net increase in inventories counts as investment because it represents current production not used for current consumption Net decrease in inventories counts as negative investment, or disinvestment, because it represents the sale of output already credited to a prior year’s GDP 21

U.S. Gross Private Domestic Investment, 2013 GDP in 2013: $15.94 trillion dollars U.S. Gross Private Domestic Investment, 2013 source: Bureau of Economic Analysis, U.S. Department of Commerce http://www.bea.doc.gov 22

Government spending (G) G includes all government spending on goods and services by local, state, and federal governments. Includes the salaries of government workers and spending on public works. Government spending excludes transfer payments. 23

Government spending, 2013 GDP in 2013: $15.94 trillion dollars source: Bureau of Economic Analysis, U.S. Department of Commerce http://www.bea.doc.gov 24

Net exports Def.: the value of total exports (X) minus the value of total imports (M) (NX = X - M) GDP is the value of spending on our country’s output of goods & services. Exports represent foreign spending on our country’s output, so we include exports. Imports represent the portion of domestic spending (C, I, and G) that goes to foreign goods and services, so we subtract off imports. NX, therefore, equals net spending by the foreign sector on domestically produced goods & services. 25

2013 Net exports = –$424 billion

GDP: The Expenditure Approach Item Symbol Personal CONSUMPTION Expenditures C Gross Private Domestic INVESTMENT I GOVERNMENT Purchases G NET EXPORTS NX Gross Domestic Product Y Amount in 2013 Percentage of GDP $10,832 68.0% $2,643 16.6% $2,939 18.4% -$424 -2.7% $15,942 100% Aggregate Expenditures = Total Output = Real GDP = Y = C + I + G + (X – M)

GDP: The Expenditure Approach Symbol Percentage of GDP in 2011 C 71.1% I 12.7% G 20.1% NX -3.8% Y 100% Percentage of GDP in 2007 Percentage of GDP in 2000 69.7% 68.6% 16.4% 17.8% 19.1% 17.4% -5.1% -3.8% 100%

GDP: Income Approach Income approach sums, or aggregates, income arising from that production Recall that double-entry bookkeeping ensures that the value of aggregate output equals the aggregate income paid for resources used to produce that output Wages Interest Rent Profit arising from production

Employee compensation Relative Size of U.S. GDP Components: 1998-2001 (a) Expenditure approach (b) Resource cost-income approach a Private investment Net exports Rental income Indirect Net - 3% < 1% taxes interest 6% 17% Depreciation 7% Gov’t 13% 18% 58% Corporate profits 9% 68% 7% Employee compensation Self-employed Personal proprietor income consumption Source: Economic Report of the President, 2002. a The net income of foreigners was negligible.

Market value of final goods and services The Three Faces of GDP = Market value of final goods and services Production Expenditure Income Investment Consumption Government purchases Net exports Capital Income Labor Income Chapter 5: Measuring Economic Activity: GDP and Unemployment Slide 32

GNP vs. GDP Gross National Product (GNP): total income earned by the nation’s factors of production, regardless of where located Gross Domestic Product (GDP): total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad) From the perspective of the U.S., factor payments from abroad includes things like wages earned by U.S. citizens working abroad profits earned by U.S.-owned businesses located abroad income (interest, dividends, rent, etc) generated from the foreign assets owned by U.S. citizens Factor payments to abroad includes things like wages earned by foreign workers in the U.S. profits earned by foreign-owned businesses located in the U.S. income (interest, dividends, rent, etc) that foreigners earn on U.S. assets 33

In your country, which would you want to be bigger, GDP or GNP? Discussion Question: In your country, which would you want to be bigger, GDP or GNP? Why? 34

(GNP – GDP) as a percentage of GDP selected countries, 2002 For the U.S., GDP and GNP are very close. Thus, students may not realize why we bother teaching them the difference. The data on this slide makes clear that the difference is very important for many countries. Source: World Bank. 35

Real GDP Per Person: 1900 – 2000

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: Year Price of Cars Quantity of Cars Price of CDs Q of CDs $10,000 5 $20 4 Market Value = (value of Cars) + (value of CDs) ($10,000 x 5) + ($20 x 4) ($50,000) + ($80) Market Value = $50,080

Gross Domestic Product (GDP) is … …the market value of all final goods and services produced within a country in a given period of time. Calculating Market Value: Year Price of Cars Quantity of Cars Price of CDs Q of CDs $10,000 5 $20 4 Year Price of Cars Quantity of Cars Price of CDs Q of CDs 2 $15,000 5 $22 4 Market Value = (value of Cars) + (value of CDs) ($15,000 x 5) + ($22 x 4) ($75,000) + ($88) Market Value = $75,088 Market Value = $50,080

A Measure of the Economy’s Price Level – Consumer Price Index Source: The CPI Home page of the U.S. Bureau of Labor Statistics at http:\\ftp.bls.gov\pub\special requests.cpi\cpia.html 39

Real GDP controls for inflation Changes in Nominal GDP can be due to: Changes in Real GDP can only be due to: 40

Practice problem, part 1 Compute nominal GDP in each year 2002 2003 2004 P Q Toy cars $30 900 $31 1,000 $36 1,050 Toy dolls $10 850 $12 925 Plastic $100 192 $102 200 205 Compute nominal GDP in each year Compute real GDP in each year using 2002 as the base year. 41

Real GDP multiply each year’s Qs by 2002 Ps 2002: $ 2003: $ 2004: $ Toy cars $30 900 $31 1,000 $36 1,050 Toy dolls $10 850 $12 925 Plastic $100 192 $102 200 205 Nominal GDP multiply Ps & Qs from same year 2002: $ 2003: $ 2004: $ Real GDP multiply each year’s Qs by 2002 Ps 2002: $ 2003: $ 2004: $ 42

U.S. Real & Nominal GDP, 1970-2004 (base year = 2000) 43

GDP Deflator

GDP Deflator Example Using the values in the table below, we can compute GDP deflator for 2007 and 2008. What is the percentage increase in the price level from 2007 to 2008?