1. GDP and Economic Growth
Chapter 10
GDP and Economic Growth
We will be calculating how economists estimate a country’s output and income for a year. The importance of these figures will be discussed, as well as the differences between the various ways that we can measure income. Lastly we will discuss how we can adjust the figures that we have calculated for inflation effects and analyze some of the issues associated with the various accounts.
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved

2. Gross Domestic Product
Measure of aggregate output
Monetary measure
Avoid multiple counting
Market value of final goods
Ignore intermediate goods
Count value added
The primary measure of the economy’s performance as a whole is its aggregate output. This is most commonly calculated as gross domestic product, or GDP. GDP is a monetary measure in that everything is valued in dollars. All goods and services produced must be converted into dollar values for GDP to work. To avoid multiple counting of goods, GDP includes only the market value of final goods and ignores intermediate goods, which are goods purchased either for resale or for further processing into final goods. GDP could also avoid multiple counting by counting only the value added at each stage. Value added is the market value of a firm’s output less the value of the inputs that the firm purchased from others.
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3. Gross Domestic Product
Comparing Heterogeneous Output by Using Money Prices
Year
Annual Output
Market Value 1
3 sofas and 2 computers
3 at $ at $2000 = $5500 2
2 sofas and 3 computers
2 at $ at $2000 = $7000
This table illustrates comparing heterogeneous output by using money prices. By converting the quantity of goods into a monetary measure, we are able to compare the relative value of the vast number of goods and services produced in different years.
LO1
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4. Gross Domestic Product
Exclude financial transactions
Public transfer payments
Private transfer payments
Stock (and bond) market transactions
Exclude secondhand sales
Sell used car to a friend
Nonproduction transactions must be excluded from GDP since they have nothing to do with the production of final goods. There are two types: purely financial transactions and secondhand sales. Purely financial transactions include such items as public transfer payments like Social Security, private transfer payments (Christmas gifts), and stock market transactions. Secondhand sales contribute nothing to current production so they are ignored in calculating GDP.
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5. Count sum of money spent buying the final goods
Measuring GDP
Expenditure approach
Count sum of money spent buying the final goods
The simplest way to measure GDP is to use the expenditures approach. The expenditures approach measures GDP as the sum of all of the money spent in buying the output. In theory, either method should yield equal results.
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6. Expenditures Approach
Personal consumption expenditures (C)
Durable consumer goods
Nondurable consumer goods
Consumer expenditures for services
Domestic plus foreign goods produced
Personal consumption expenditures, indicated by a “C” notation, covers all expenditures by households on goods and services during a year. In any given year, approximately 10 percent of those expenditures are for durable consumer goods, which are defined as having a life of three years or more. Another 30 percent go to nondurable goods such as food, clothing, and gasoline. The other 60 percent are for services leading to the U.S. economy, frequently being referred to as a service economy.
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7. Expenditures Approach
Gross private domestic investment (Ig)
Machinery, equipment, and tools
All construction
Changes in inventories
Creation of new capital assets
Noninvestment transactions excluded
The second component of the expenditures approach is gross private investment, which includes all final purchases of machinery, equipment, and tools by businesses; all construction; and changes in inventories. All of these items represent ways businesses invest in themselves. Construction also includes residential construction because homes could be rented to produce income.
LO1
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8. Expenditures Approach
Government purchases (G)
Expenditures for goods and services
Expenditures for publicly owned capital
Excludes transfer payments
Net exports (Xn)
Add exported goods and subtract imported goods
Xn = Exports – Imports
GDP = C + Ig + G + Xn
The last two components of the expenditures approach are government purchases and net exports. Government purchases are officially labeled “government consumption expenditures and gross investment.” It includes expenditures for goods and services that the government uses in providing public services and expenditures for publicly owned capital such as for schools or roads. It excludes government transfer payments such as Social Security because it merely transfers government receipts to certain households and does not generate any sort of production.
Net exports are calculated by subtracting the value of imported goods from the value of exported goods.
Adding up all four components provides a measure of GDP, a measure of the market value of a specific year’s total output. For the United States in 2009, GDP equaled $14,256 billion.
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9. Comparative GDP
In this table comparing GDPs for selected nations, the United States, China, and Japan have the world’s highest GDPs. Note that all data have been converted to U.S. dollars via international exchange rates.
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10. Nominal versus Real GDP
GDP is a dollar measure of production
Using dollar values creates problems
Nominal GDP
Use prevailing price
Real GDP
Reflect changes in price
Use base year price
GDP measures production at current dollar values, which creates problems because the value of a dollar changes over time. One hundred years ago, the purchasing power of one dollar was much different than it is today. To get around that problem, there are two different GDPs. Nominal GDP is based upon the prices that were in effect when the output was produced. A GDP that has been deflated or inflated to reflect changes in price levels is referred to as real GDP. In order to calculate real GDP, a base year must be selected and then the current year’s prices adjusted accordingly.
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11. Calculating Real GDP (Base year = Yr 1)
GDP Price Index
Calculating Real GDP (Base year = Yr 1)
Year
(1)
Units of
Output
(2)
Price of
Pizza
per Unit
(3)
Price Index
(Year 1 = 100)
(4)
Unadjusted,
or Nominal,
GDP (1) × (2)
(5)
Adjusted, or
Real, GDP 1 5
$10
100
$ 50
$50 2 7 20
200
140 70 3 8 25
250 80 4 10 30
___ 11 28
In this table, nominal GDP and real GDP are calculated based upon the formula. Years 1 to 3 have been calculated. Complete the table for years 4 and 5.
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12. Annual percentage rate
Economic Growth
Increase in real GDP or real GDP per capita over some time period
Percentage rate of growth
Growth as a goal
Arithmetic of growth: Rule of 70
Economists define and measure economic growth two different ways. The first is as an increase in real GDP over some time period and the second is as an increase in real GDP per capita over some time period. It typically is measured as a percentage rate of growth on either a quarterly or yearly basis.
During periods of recession, the growth rate will be negative instead of positive. Whether the first or second measure of determining growth is used depends on the circumstances. Looking at GDP per capita allows one to compare countries of different sizes. For country-to-country comparisons, real GDP is more useful. Generally speaking, growth in GDP is considered an economic goal. The expansion of total output relative to population results in higher standards of living. It lessens the burden of scarcity.
Approximate
number of years
required to double
real GDP 70 =
Annual percentage rate
of growth
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13. Economic Growth Growth in U.S. real GDP 1950–2009
Increased sixfold
3.2 percent per year
Growth in U.S. real GDP per capita
Increased more than threefold
2 percent per year
Qualifications
Improved products and services
Added leisure
Other impacts
While both real GDP and real GDP per capita have increased over the past 60 years, this must be qualified in several ways. Because the numbers do not fully account for improvements in products and services, they tend to understate the growth of economic well-being. They also do not take into account that growth has occurred at the same time as there has been an increase in the amount of leisure time, so economic well-being is even further understated. The numbers fail to account for any environmental or quality of life impacts as well.
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14. Real GDP and Real GDP per Capita
Economic Growth
Real GDP and Real GDP per Capita
(1)
Year
(2)
Real GDP,
Billions of 2005 $
(3)
Population,
Millions
(4)
Real GDP, per Capita,
2005 $ (2) ÷ (3)
1950
$ 2,006
152
$13,197
1960
2,831
181
15,640
1970
4,270
205
20,829
1980
5,839
228
25,610
1990
8,034
250
32,136
2000
11,226
282
39,809
2010
13,248
309
43,456
This table presents the growth in real GDP and real GDP per capita in the United States since Due to the population increase, real GDP per capita has increased at a slower pace than real GDP. Since the population has doubled, the rate of increase in real GDP per capita has been about half that of real GDP.
Source: Bureau of Economic Analysis, and U.S. Census Bureau,
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15. Average Annual Growth Rates
Between 2000 and 2010, the U.S. economic growth exceeded that of several other major countries. Most countries experienced slow growth in the early 2000s and then recession in 2008–2009.
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16. Determinants of Growth
Supply factors
Increases in quantity and quality of natural resources
Increases in quality and quantity of human resources
Increases in the supply (or stock) of capital goods
Improvements in technology
Four of the determinants of growth relate to the physical ability of the economy to expand. These supply factors or changes in the physical and technical agents of production enable an economy to expand its potential GDP.
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17. Determinants of Growth
Demand factor
Households, businesses, and government must purchase the economy’s expanding output
Efficiency factor
Must achieve economic efficiency and full employment
The fifth determinant of economic growth is the demand factor. To achieve the higher production potential created by the supply factors, households, businesses, and government must purchase the economy’s expanding output. The sixth factor, efficiency, involves the issue that the economy must achieve economic efficiency as well as full employment. It must use its resources in the least costly way to provide the specific mix of goods and services that maximizes people’s well-being.
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18. Production PossibilitiesA
Economic
growth
Capital goods c b
Economic growth is made possible by the four supply factors that shift the production possibilities curve outward, as from AB to CD. Economic growth is realized when the demand factor and the efficiency factor move the economy from point a to b. Point c represents situations in which real output falls below what it should have been if the economy was operating at full employment. This situation occurred during the severe recession of 2007–2009. a B D
Consumer goods
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19. Inputs and Productivity
Real GDP = Hours of work × labor productivity
Size of employed labor force
Average hours of work
Labor
inputs
(hours of
work) = x
Real
GDP
Technological advance
Quantity of capital
Education and training
Allocative efficiency
Other
Labor
productivity
(average output per hour)
Society can increase its real output and income in one of two ways: (1) by increasing its inputs of resources and (2) by raising the productivity of those inputs. By focusing on the labor input, we can build a framework for discussing the role of supply factors in growth. In this illustration, a nation’s economic growth from one year to the next depends on its increase in labor inputs and its increase in labor productivity.
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20. (average percentage changes)
Accounting for Growth
Accounting for the Growth of U.S. Real GDP, 1953–2007, Plus Projection from 2009–2021
Item
1953 Q2
to 1973 Q4
1973 Q4
to 1995 Q4
1995 Q4
to 2001 Q1
2001 Q1
to 2007 Q3
Projected
2010 Q1
to 2021 Q4
Increase in real GDP
3.6
2.8
3.8
2.6
2.5
Increase in quantity of labor
1.1
1.3
1.4
-0.1
0.2
Increase in labor productivity
1.5
2.4
2.7
2.3
By looking at these numbers, it is clear that both increases in the quantity of labor and increases in labor productivity are important sources of economic growth. Between 1953 and 2009, the labor force increased from 63 million to 154 million workers. Productivity growth has usually been the more significant factor.
(average percentage changes)
Source: Derived from Economic Report of the President, 2008, p. 45; and Economic Report of the President, 2011, p. 82
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21. Factors affecting productivity growth
Accounting for Growth
Factors affecting productivity growth
Technological advance (40 percent)
Quantity of capital (30 percent)
Education and training (15 percent)
Economies of scale and resource allocation (15 percent)
There are five factors that, when combined, appear to explain changes in productivity growth rates. The largest contributor is technological advance, which accounts for approximately 40 percent of productivity growth. It is generated by the discovery of new knowledge. The quantity of capital explains roughly 30 percent of productivity growth. More and better plant and equipment make workers more productive. Education and training, economies of scale, and resource allocation account for the remaining productivity growth. Investment in human capital is an important means of increasing labor productivity.
By 2009, 87 percent of the U.S. population had at least a high school education and 29 percent had a college or post-secondary education, both representing substantial increases over the past several decades. Economies of scale are the reductions in per-unit production costs that result from increases in output levels. Improved resource allocation means workers over time have moved from low-productivity employment to high-productivity employment. The long-run movement toward liberalized international trade through international agreements has improved the allocation of resources, increased labor productivity, and expanded real output, both here and abroad.
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22. Education and Training
The percentage of the U.S. adult population, age 25 or more, completing high school and college has been rising over recent decades. However, many observers feel that the quality of education in the United States has declined. U.S. students perform poorly on tests in math and science areas compared to students in many nations. The United States has been producing fewer native-born engineers and scientists. Much discussion in recent years has been focused on improving the quality of the U.S. education and training system.
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23. Institutional Structures
Strong property rights
Patents and copyrights
Efficient financial institutions
Free trade
A competitive market system
Institutional structures are also important in promoting and sustaining economic growth. Some of these structures promote the development of new technologies while others act to ensure that resources flow efficiently to their most productive uses.
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24. Productivity Growth Microchip/information technology
New firms and increasing returns
Sources of increasing returns
More specialized inputs
Spreading of development costs
Simultaneous consumption
Network effects
Learning by doing
Global competition
So what are some of the reasons for the increased productivity growth? A core element was the explosion of entrepreneurship and innovation based on the development of the microchip. Microchips have found their way into thousands of products and changed the way business is conducted. Hundreds of new start-up firms aided in the advancement of the new information technology. These new firms took advantage of increasing returns and economies of scale as they helped to increase labor productivity. Global competition fueled by the collapse of the socialist economies was another key factor in the increasing rate of labor productivity growth.
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25. Productivity Growth
This graph reflects the growth in U.S. productivity between 1973 and Average productivity was 1.5 percent until 1995, but after 1995 the average productivity growth rate increased to 2.8 percent.
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26. Is economic growth desirable and sustainable? The antigrowth view
Environmental and resource issues
In defense of economic growth
Higher standard of living
Human imagination can solve environmental and resource issues
While most economists usually agree that economic growth is both desirable and sustainable, not everyone agrees. Critics say industrialization and growth come with pollution, climate changes, ozone depletion, and other environmental problems. They also argue that there is little compelling evidence that economic growth has solved sociological problems such as poverty, homelessness, and discrimination. While growth has led to higher standards of living, it does not necessarily translate to a better life. There is also concern about whether the growth is sustainable. The earth only has a limited number of resources, which are being consumed at alarming rates.
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27. Growth is the path to greater material abundance
Economic Growth
Growth is the path to greater material abundance
Results in higher standards of living
Increases leisure time
Allows for the expansion and application of human knowledge
Proponents of growth meet all of the arguments of critics with the upside of the situation. They point to the higher education levels, increased recreation, better access to medical care, and other benefits of modern society. They feel that the concerns about the environment can be dealt with as technology advances. The automobile industry illustrates that very issue with the movement towards vehicles that use alternative fuels rather than the limited fossil fuels.
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28. Global Competitiveness Ranking, 2011-2012
Global Snapshot
Country
Global Competitiveness Ranking,
Switzerland 1
Singapore 2
Sweden 3
Finland 4
United States 5
Germany 6
Netherlands 7
Denmark 8
Japan 9
United Kingdom 10
The Global Snapshot lists the top 10 countries based on the global competitiveness index. The index uses factors like innovativeness, the capability to transfer technology among sectors, efficiency of the financial system, rates of investment, and the degree of integration with the rest of the world.
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