1. Chapter 7 The First Step into Macroeconomics McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives Define gross domestic product (GDP) and distinguish between final goods and services and intermediate inputs. List and discuss the components of GDP. Explain what GDP does not include. Compare GDP and GDP per capita across countries. 7-2

3. Macroeconomics Macroeconomics studies the economy as a whole. Core concepts include the issues of output, growth, inflation, and unemployment. Questions raised include: –Is the economy heating up or slowing down? –Are prices rising too quickly? –Are there jobs available for students graduating from college? –What will happen to interest rates for car loans and mortgages? 7-3

4. Measuring the Economy Measuring the size of the economy is done in order to identify economic problems, diagnose the causes, and figure out what the right policy might be to fix them. But measuring the size and growth of the economy is not an easy task. In the 1930s, Simon Kuznets developed a framework for measuring the economy. 7-4

5. Measuring the Economy Today, the Bureau of Economic Analysis (BEA), the Bureau of Labor Statistics (BLS), the Census Bureau, and the Federal Reserve are the main statistical agencies in Washington. They conduct surveys, collect data, and regularly publish reports on the key economic statistics. These include production, unemployment, inflation, productivity, and foreign trade. 7-5

6. The Basics of Gross Domestic Product Gross Domestic Product (GDP) is the dollar value of the output of the national economy. All the statistics that feed into the process of measuring GDP are known as the system of national accounts. The process requires measuring the output and price of over a million goods and services. 7-6

7. The Basics of Gross Domestic Product The problem in measuring GDP is that different types of goods and services are each measured in different units. –For example, how do we compare automobiles with haircuts or aquariums? There is no easy way to add them all up. The key is to express the output of each good and service as a dollar amount and then add these dollar amounts up. 7-7

8. Components of GDP GDP is made up of the following components: –personal consumption, which includes goods and services bought by households. –nonresidential investment, which includes the buildings, equipment, and software that businesses purchase to use in production. –residential investment, which includes the construction of new homes and the renovation of existing homes. 7-8

9. Components of GDP –government consumption and investment, which are goods and services purchased by the government. –inventory investment, or goods produced by businesses that are not immediately purchased. –net exports, which includes the difference between exports and imports. GDP is the sum of these components. 7-9

10. Components of GDP, 2010 CategoryBillions of Dollars Personal consumption10,349 Nonresidential investment1,415 Residential investment341 Change in private inventories72 Government consumption and investment 3,000 Net exports of goods and services -516 Gross Domestic Product14,660 The following table shows the value of the different components of GDP for 2010. 7-10

11. No Double-Counting Only final goods and services count in GDP; that is, goods and services purchased by the final user. Purchases of intermediate inputs are left out of GDP to avoid double-counting. –Intermediate inputs are any goods and services used or bought by a business as an input in the production process. For example, a printing company uses paper and ink to produce a book. 7-11

12. Consumption Expenditures The largest category of GDP is personal consumption expenditures, or consumer spending. This category includes all sorts of goods and services that households spend money on, including food, telephone services, personal computers, automobiles, and gasoline. Medical spending is part of consumer spending. 7-12

13. Nonresidential Investment Nonresidential investment is the total spending by businesses on the structures, equipment, and software they need to run their operations. The biggest category of business investment spending today is software. A new factory in the United States, even if built by a foreign-owned company, is counted as part of US GDP. –It is location, not ownership, that counts for GDP. 7-13

14. Information Technology’s Share of Nonresidential Investment 7-14

15. Residential Investment Residential investment is the spending on the building of new homes and the renovation of existing ones. In contrast, if you buy an existing home, the spending does not count as part of residential investment because no actual production or construction occurred. –Remember, GDP is about production of new goods and services. Residential investment is highly volatile over time. 7-15

16. Ups and Downs of Residential Investment 7-16

17. Government Consumption and Investment The federal, state, and local governments in the United States are an important part of the economy, spending a total of $5.6 trillion in 2010. There are two types of government spending: –The first type is called government consumption and investment, which includes all of the government’s purchases of goods and services, such as salaries paid to government employees. 7-17

18. Government Consumption and Investment –The other type of government spending is money which is sent out by the government, but the actual spending is done by the private sector. For example, government programs such as Medicare and Medicaid spend enormous sums of money, but most of the actual healthcare is done by private hospitals and doctors. Social Security checks are sent out by the federal government, but spent by individuals. These expenditures are not counted as part of government spending. 7-18

19. Nondefense versus Defense Government Spending 7-19

20. Change in Inventories The change in inventories is a rather small but important category. When companies add to their inventories, it contributes positively to GDP. This is because it counts as production, even if no one has bought the goods. In contrast, when companies reduce their inventories by selling goods, the change gets subtracted from GDP. 7-20

21. Net Exports Net exports equals exports minus imports. Exports are goods and services produced in the United States and sold outside the country, so they add positively to GDP. Imports are goods and services produced outside the United States and consumed within this country. They enter the GDP calculation with a negative sign. 7-21

22. What GDP Does Not Include GDP focuses on the market economy. Thus, non-market transactions are not included. –All the work put in by volunteers at hospitals, schools, and religious organizations is not counted as part of GDP. –All the time and effort that goes into raising children, cleaning house, and cooking food by a stay-at-home parent is not counted as part of GDP. 7-22

23. What GDP Does Not Include GDP also does not include the underground economy. The underground economy includes illegal activities such as drug dealing and off-the- book activities such as the babysitter or landscaper who gets paid in cash and does not report it to the Internal Revenue Service. –The underground economy could be as large as 10% of GDP. 7-23

24. International Comparisons of GDP Other countries calculate their own GDP using roughly the same methods as the U.S. This allows us to make an international comparison of GDP. GDP per capita is the economic output of a country divided by the size of its population. –If we want to determine which countries have the highest living standards, we use GDP per capita. 7-24

25. GDP per Capita Across Countries (2010). 7-25