Unit 1 – Macroeconomic Measurement and Basics Concepts Chapter 25 – Measuring Domestic Output and National Income

Essential Questions How do we measure the nation’s economic output? How do we compare the nation’s economic output from year to year in the face of changing prices?

National Income Accounting measures the economy’s overall performance. The most commonly used measure is Gross Domestic Product (GDP). GDP is the total market value of all final goods and services in a given year produced by resources employed within this country. - Must avoid multiple counting: - Count only final goods or - Count only value added at each step.

Avoiding multiple counting (example): Marc has a sheep farm. He produces a bushel of wool. Amelia has a textile mill, she buys the wool from Marc for $100 and produces cloth. Evelyn is a tailor. She buys the cloth from Amelia for $200 and makes a suit that she sells to Gaige for $300. How much do we count toward GDP? 1. Either count just the final good – the $300 suit. 2. Or count the value that each person added: - Marc produced $100 worth of wool. - Amelia added $100 of value to that wool to make $200 worth of cloth. - Evelyn added $100 of value to that cloth to make a $300 suit. $100 + $100 + $100 = $300

GDP excludes “non-production” transactions: 1. Financial transactions a. Public transfer payments b. Private transfer payments c. Stock market transactions (brokers fees are included). 2. Second-hand sales. (anything “used”) There are two methods of computing GDP: Spending and Income. We’re going to look at the spending, or Expenditures Approach. But, and this is very important, the income approach gives you the same result. GDP = National Income.

The Expenditures Approach - Add together all of these: 1. Personal Consumption Expenditures (C) 2. Gross Private Domestic Investment (Ig) a. Final purchases of machinery, equipment and tools by businesses. b. All construction. c. Changes in inventories (can be positive or negative). 3. Government Purchases (G) 4. Net Exports (Xn) (Exports – Imports) (example of the Toyota factory in Kentucky) GDP = C + Ig + G + Xn

Nominal GDP vs. Real GDP Year 2000 – We produced 1 car with a final price tag of $25,000. So GDP for 2000= $25,000 Year 2013 - We produced the same kind of car with a final price tag of $30,000 So GDP for 2013 = $30,000 But we know that doesn’t really reflect reality. Output did not actually grow. We call these figures nominal GDP. Nominal GDP increased but Real GDP did not.

Nominal GDP vs. Real GDP Year 2000 – We produce 10 cars ($15,000 each) and 40 computers ($500 each). (10 x 15,000) + (40 x 500) = $170,000 So GDP for 2000 = $170,000 Year 2013 - We produce 10 cars ($20,000 each) and 40 computers ($625 each) (10 x 20,000) + (40 x 625) = $225,000 So GDP for 2013 = $225,000 Again, output did not actually grow. Only nominal GDP increased.

Nominal GDP vs. Real GDP Year 2000: Nominal GDP = $170,000 Year 2013: Nominal GDP = $225,000 Real GDP is how we adjust these numbers to show actual growth. First, choose a base year. We’ll use 2000. Then we calculate a price index for that year. Price Index = Value of market basket in a given year x 100 Value of market basket in base year So the Price Index for the base year is always 100.

Nominal GDP vs. Real GDP Year 2000: Nominal GDP = $170,000 Year 2013: Nominal GDP = $225,000 Price Index for 2000 is 100. Price Index for 2013 = Value of market basket in 2013 x 100 Value of market basket in 2000 Let’s say our market basket is 1 car and 1 computer. Price Index for 2013 = 20,625 x 100 = 133 15,500

Nominal GDP vs. Real GDP Year 2000: Nominal GDP = $170,000 Year 2013: Nominal GDP = $225,000 Price Index for 2013 = 20,625 x 100 = 133 15,500 Now we can calculate Real GDP for 2013: __Nominal GDP__ = $225,000 = $225,000 = $169,172 (Price Index ÷ 100) (133/100) 1.33 OK, this is close, but shouldn’t they be exact if we produced the exact same amount of goods? Anybody have any explanations for this?

Nominal GDP vs. Real GDP To summarize: To find Real GDP: Divide Nominal GDP by (Price Index/100). Price Index is also called the GDP Deflator because you use it to deflate inflated Nominal GDP figures back to Real GDP figures. And one last thought: the Price Index (GDP Deflator) can sometimes actually be an inflator if the price index is less than 100.

AP Exam Registration: Beginning on January 16th, 2015, this year’s AP exam registration will start online with a Google Form.  Students are instructed to select the courses for which they would like to take the AP exam using the link below.  AP Registration Link Students will have until January 23rd, 2015 to finalize their selections.  Students should not submit multiple entries.  There will be an opportunity to correct errors.  It is imperative students properly enter Student ID number.  The information submitted in this registration process will be used to generate an invoice for final exam ordering and payment in February 2015. 

I need each teacher to identify one or two students to be present at the AP Showcase. Last year, 66% of students who attended the showcase enrolled in an AP course.  If you could find some students who potentially utilized information or connections made at the showcase to help confirm or make their decision to enroll in AP that would be great! I would like to have these names by Friday, January 16th, 2015.

Each year we show a short video at the AP showcase Each year we show a short video at the AP showcase.  I would like to update the student portions of the video for this year.  If you could email Bob Gilmer any students who would be able to talk on camera about the benefits, challenges of AP and attended last year’s AP showcase, that would be appreciated. 

Year Nominal GDP (In Billions of $) Price Index (GDP Deflator) Real GDP 1980 2795.6 57.05 1985 4213.0 73.69 1990 5803.2 6707.9 1995 7400.5 7543.8 1996 7813.2 2002 10,446.2 110.66 Complete this table. Given that the base year is one of these years, which one is it? How do you know?

Year Nominal GDP (In Billions of $) Price Index (GDP Deflator) Real GDP 1980 2795.6 57.05 4900.3 1985 4213.0 73.69 5717.2 1990 5803.2 86.51 6707.9 1995 7400.5 98.10 7543.8 1996 7813.2 100 2002 10,446.2 110.66 9439.9 Complete this table. Given that the base year is one of these years, which one is it? How do you know?

Homework: Read 557 (start with Nominal GDP v. Real GDP) - 564.  Do Discussion Questions 2, 4, 5, 7, & 10 on p. 565. Do Problems 1, 2, 6, & 7 on p 566 - 567.

Last night’s homework: Discussion Questions: 2. Why do national income accountants compare the market value of the total outputs in various years rather than actual physical volumes of production? What problem is posed by any comparison over time of the market values of various total outputs? How is this problem resolved? 4. Why do economists include only final goods and services when measuring GDP for a particular year? Why don’t they include the value of the stocks and bonds bought and sold? Why don’t they include the value of the used furniture bought and sold?  

Last night’s homework: Discussion Questions: 5. Explain why an economy’s output, in essence, is also its income. 7.  Why are changes in inventories included as part of investment spending? Suppose inventories declined by $1 billion during 2014. How would this affect the size of gross private domestic investment and gross domestic product in 2014? Explain. 10. Define net exports. Explain how U.S. exports and imports each affects domestic production. How are net exports determined? Explain how net exports might be a negative amount.

Nominal Value of Goods Year 1 Nominal Value of Goods Year 2 Last night’s homework: Problems: 1. Good Price Year 1 Quantity of Goods Year 1 Nominal Value of Goods Year 1 Price Year 2 Quantity of Goods Year 2 Nominal Value of Goods Year 2 Quarts of ice cream $4.00 3 $12.00 5 $20.00 Bottles of shampoo   3.00 1     3.00 2     6.00 Jars of peanut butter   2.00     4.00   — $21.00 $30.00

Last night’s homework: Problems: 2. These two transactions would add $160,000 to personal consumption expenditures and thus to GDP during the year. The reason that we do not count the $70,000 is that this first sale is an intermediate step toward the final sale and value of the flower bulbs sold to consumers. This final price includes the cost of the bulbs purchased by the Internet retailer.

Last night’s homework: Problems: 6. Suppose that in 1984 the total output in a single-good economy was 7,000 buckets of chicken. Also suppose that in 1984 each bucket of chicken was priced at $10. Finally, assume that in 2005 the price per bucket of chicken was $16 and that 22,000 buckets were produced. a. What is the GDP price index for 1984, using 2005 as the base year?  62.5   b. By what percentage did the price level, as measured by this index, rise between 1984 and 2005?  60%   c. What were the amounts of real GDP in 1984 and 2005?        In 1984, real GDP = $112,000.        In 2005, real GDP = $352,000.  

Last night’s homework: Problems: 7. Year Nominal GDP Price Index 7.   Year Nominal GDP Price Index (2005 = 100) Real GDP 1968 909.8 22.01 4,133.58 inflating 1978 2293.8 40.4 5,677.72 1988 5100.4 66.98 7,614.81 1998 8793.5 85.51 10,283.59 2008 14,441.4 108.48 13,312.50 deflating