1. Chapter 5 GDP & Economic Growth

2. Learning Objectives How GDP is Defined and Measured.
How economists distinguish between nominal GDP & real GDP.
Long-term trend of U.S. economic growth.
General ingredients of economic growth & how they relate to production possibilities analysis.
“Growth Accounting” & the specific sources of U.S. economic growth.
Why U.S. productivity growth has accelerated since the mid-1990’s.
About differing perspectives on whether growth is desirable & sustainable.

3. Gross Domestic Product (GDP)
The total market value of all final goods and services produced in a given year.
This includes all goods and services provided by citizens or foreigners working in the U.S.
It is a monetary measure and one way for us to determine how our economy is doing compared to previous years. The more goods and services we produce the ‘healthier’ we are.

4. Avoiding multiple counting
If GDP is going to be effective, we must avoid counting goods and services multiple times.
Therefore, only final goods are counted, and not intermediate goods.
Example : wool suits
Instead of adding up the sales value of each transaction in the making of the suit, we only count the final cost of the suit.
Another term for this: value added

5. Other exclusions
Non-production transactions: Financial & second-hand sales
Financial:
Public transfer payments: Social security, veteran’s benefits, welfare
Private transfer payments: Christmas gifts from grandma, allowance
Stock market transactions: buying and selling of stocks
Second-hand sales: yard sales, person-to-person sales of stuff

6. 2 ways to compute GDP
Expenditures Approach – the sum of all money spent to buy GDP
Income Approach – the sum of all the income created from producing GDP
Technically, both approaches should give you the same answer.

7. + + + + + + + G D P = = Expenditure Approach Income Approach
Consumption by
Households
Wages + +
Rents
Investment by
Businesses + G D P + = =
Interest +
Government
Purchases +
Profits +
Expenditures
By Foreigners
Statistical
Adjustments

8. Household/personal consumption (C)
This includes everything….
Durable goods (cars, fridge – lives of more than 3 yrs)
non-durable goods (food, clothes, gas – lives of less than 3 yrs)
services (haircuts, doctor bills, lawyers, etc.)

9. Investment by businesses (Ig)
This is also called Gross private domestic investment.
Includes:
Purchases of machinery, tools, etc
Construction costs (including residential)
Changes in inventories (unsold goods)
Noninvestment transactions

10. Constructions costs (incl. residential)
Why include owner-occupied residential construction in the ‘investment by businesses’ category????
Because the house/apartment could be rented or leased

11. Changes in inventories
It is hard to sell everything that was produced in a year by the end of the year. You almost always have some left over that was produced in this year but didn’t sell.
Before we can compute how this affects GDP, we need to figure out how the level of inventories at the end of last year compare to the inventories at the end of this year.

12. Changes in inventories, cont.
If there are more inventories now than last year, then inventories increased.
So when this happens, what is left over is considered ‘investment’ for that year and must be added to the ‘investment’ figure
If there are less inventories, then that means we sold inventories this year that were counted in last year’s GDP, so we subtract them from the ‘investment’ figure

13. Noninvestment transactions
Investment DOES NOT include the transfer of paper assets (stocks, etc)
Investment DOES NOT include the sale of existing tangible assets (houses, boats, etc.)

14. Gross vs Net Investment
Gross investment means we are referring to ‘all’ investment during the year
When an asset gets ‘worn out’ during the year, that is called ‘depreciation’.
To find Net investment, you subtract depreciation from Gross investment
If more stuff ‘depreciates’ during the year than you produce new stuff, that is ‘disinvesting’.

15. Household/personal consumption (C) Investment by businesses (Ig)
So far…
Household/personal consumption (C) Investment by businesses (Ig)

16. Government purchases (G)
The goods and services that it consumes in providing public services
Expenditures for social capital like schools, highways
It DOES NOT include transfer payments, which only transfer assets from one to another and don’t generate any new assets.

17. Net Exports (Xn)
GDP includes the spending on goods and services produced in this country, and that doesn’t matter if American’s buy them or foreigners buy them.
So products that are exported get counted
Money that we spend on products that are imported are included in the GDP of other countries

18. Net Exports (Xn) , cont.
To figure it, we simply take exports – imports, which gives us Net Exports.

19. Expenditures Approach summary:
GDP = C + Ig + G + Xn

20. GDP in Trillions of Dollars, 2005
United States
Japan
Germany
China
United Kingdom
France
Italy
Spain
Canada
Brazil
Korea, Rep.
India
Mexico
Russian Fed.
Australia
$12.4
$4.5
$2.8
$2.2
$2.2
$2.1
$1.7
$1.1
$1.1
$.79
$.79
$.78
$.77
$.76
$.70

21. + + + + + + + G D P = = Expenditure Approach Income Approach
Consumption by
Households
Wages + +
Rents
Investment by
Businesses + G D P + = =
Interest +
Government
Purchases +
Profits +
Expenditures
By Foreigners
Statistical
Adjustments

22. Measuring GDP GDP = C + Ig + G + Xn
The simplest way to measure GDP is to add up all that was spent to buy total output in a certain year.
Four categories of spending are added up:
Personal
Consumption
Expenditures (C):
Expenditures by
households for
durable goods,
nondurable goods,
and services.
Gross Private
Domestic
Investment (Ig):
Expenditures for newly
produced capital goods
(such as plant and
equipment) and for
additions to inventories.
Government
Purchases (G):
expenditures on
final goods,
services, and
publicly owned
capital.
Net Exports (Xn):
Exports
minus
Imports
The simplest way to measure GDP is to add up all that was spent to buy total output in a certain year. There are four categories of spending that are added up to obtain GDP: Personal Consumption Expenditures (or C) are expenditures by households for durable goods, nondurable goods, and services; Gross Private Domestic Investment (or Ig) are expenditures for newly produced capital goods (such as plant and
equipment) and for additions to inventories; Government Purchases (or G) are government expenditures on final goods, services, and
publicly owned capital; finally Net Exports (or Xn) are exports minus imports. Thus, GDP can be computed as C plus Ig plus G plus Xn.
LO: 5-1

23. #2: Income Approach To compute the National Income, we add up:
Wages of Employees
Rents
Interest
Profits (Proprietor’s & corporate)

24. Adjustments Taxes on production and imports
Why would we add taxes that are paid on products?
Example: you buy a $1 item, and pay $.08 in taxes.
In the Expenditures approach, that tax was included in the cost of the item, so we have to add that same amount of tax to the Income approach to balance everything out.

25. Adjustments….cont.
GDP is a measure of total ‘domestic’ output produced in the U.S. regardless of the nationality of those who provide the resources
Some Americans earn income by supplying resources in other countries, but that activity is not ‘domestic’ activity. However, the money they make is included in their income.
Some foreigners earn income by supplying resources here.

26. Net Foreign Factor Income
Adjustments….cont.
So if we take the difference between what Americans earn abroad and subtract what foreigners make here, we call that….
Net Foreign Factor Income
We add that figure to the total of all the incomes that we just added.

27. Adjustments….cont.
Consumption of Fixed Capital – also known as ‘depreciation’.
This amount of capital that is ‘used up’ during the year must be added to the income figures because depreciation was added to the cost of Expenditures in the other approach. We must balance the equation.

28. Adjustments….cont.
Statistical Discrepancy – oops, we didn’t exactly come out the same in both approaches, so let’s just call this a ‘statistical discrepancy!
The government can do this in figuring GDP, but you better not try this on your taxes!

29. Other national accounts
Net Domestic Product (NDP) – simply take GDP and remove depreciation.
National Income – take the NDP, add the Net Foreign Factor Income, and subtract the Statistical discrepancy

30. Other national accounts…cont.
Personal Income – includes all income received, whether earned or unearned
Simply remove income items that don’t apply to households (SS contributions, corp. income taxes)
Disposable Income – personal income minus personal taxes.

31. Nominal GDP vs Real GDP
The market value of money changes every year because of inflation or deflation. So how can realistically compare dollar amounts from year to year?
We deflate GDP when prices are rising and inflate GDP when prices are falling
Whenever we adjust it, we call it Real GDP

32. Nominal and Real GDP
It is difficult to compare values over time without correcting them for inflation or deflation.
The monetary value of GDP changes from year to year due to changes in prices and output.
To distinguish the two, economists compute nominal GDP and real GDP.
Nominal GDP is measured in terms of the price level at the time of measurement (i.e., GDP that is unadjusted for inflation).
Real GDP is measured in terms of the price level in a base period (i.e., GDP that is adjusted for inflation).
It is difficult to compare values over time without correcting them for inflation or deflation. The monetary value of GDP changes from year to year due to changes in prices and output. To distinguish the two, economists compute nominal GDP and real GDP. Nominal GDP is measured in terms of the price level at the time of measurement (i.e., GDP that is unadjusted for inflation). Real GDP is measured in terms of the price level in a base period (i.e., GDP that is adjusted for inflation).
LO: 5-2

33. How we adjust it We use a ‘price index’. Formula: =
It is a measure of the price of a specific collection of goods & services called a ‘market basket’ in a given year as compared to that same thing in a previous year.
Formula:
Price of item in specific year
Price of item in base year
Price index in a given year =
X 100

34. Price index computation
Remember: in the real world it is much harder to figure GDP and reliable price indexes

35. Shortcomings of GDP
Nonmarket activities – plumber fixing his own house, activity of homemakers
Leisure – we work shorter weeks than 100 yrs ago and we have vacations, holidays, etc. We are happier and GDP doesn’t reflect that
Improved product quality – the same money today can buy a much better product

36. Shortcomings of GDP…cont.
The underground economy – not reporting tips, trading labor with your neighbor, etc
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United Kingdom
Japan
United States
Switzerland
Percentage of GDP

37. Shortcomings of GDP…cont.
Environmental damage – the cost to cleanup pollution and waste is not considered
Composition of output - To GDP, there’s no difference between books and hand grenades
Non-economic sources of well-being – a household’s income doesn’t measure happiness, and GDP won’t either!

39. Two Definitions of Economics Growth
Economic Growth
1. An increase in real GDP occurring over some time period.
2. An increase in real GDP per capita occurring over some time period (takes into account the size of the population).
(growth is calculated as a % rate of growth
per quarter (3 month) or per year)

40. Growth – An Economic Goal
Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem.
Growth lessens the burden of scarcity.
An economy that is experiencing economic growth is better able to meet people’s wants and resolve socioeconomic problems

41. The Rule of 70
Example: A 3 % annual rate of growth will double real GDP in about 23 years (70/3 = 23).

42. Main Sources of Growth – 2 ways
Increasing inputs of resources.
(About one-third of U.S. growth comes from more inputs)
2. Increasing productivity of existing inputs.
(About two-thirds of growth comes from improved productivity)

43. Economic Growth An increase in real GDP occurring over time. or
An increase in real GDP per capita occurring over time.
(both calculate economic growth as a percentage rate of growth per 3-month period or year)
Real GDP per capita (output per person)
Divide real GDP by the size of the population

44. Economic Growth Economic growth is an economic goal of government
it raises the standards of living in society
lessens the burden of scarcity.
Two fundamental ways society can increase its real output and income are:
by increasing its inputs of resources
by increasing the productivity of those inputs
Economic growth is an economic goal of government because it raises the standards of living in society and lessens the burden of scarcity. It is defined as the expansion of real GDP (or real GDP per capita) over time. Two fundamental ways society can increase its real output and income are: by increasing its inputs of resources and by increasing the productivity of those inputs.
Economic growth is the expansion of real GDP (or real GDP per capita) over time.
LO: 5-3

45. Rule of 70
Shows the effect of compounding of economic growth rates over time.
Number of years it will take for some measure to double, given its annual % increase.
Calculate by dividing the percentage increase into the # 70.

46. Rule of 70
Examples:
A 3 % annual rate of growth will double real GDP in appx. 23 (= 70/3) years.
Growth of 8 % per year will double it in
appx. 9 (=70/8) years

47. Ingredients of Economic Growth
Six main ingredients of economic growth:
Supply factors:
Increases in the quantity and quality of natural resources
Increases in the quantity and quality of human resources
Increases in the supply or stock of capital goods
Improvements in technology
Demand factor: households, businesses, and government must purchase the expanding output
Efficiency factor: the economy must achieve economic efficiency and full employment
What are the determinants of economic growth? There are six main ingredients: The first four are supply factors: Increases in the quantity and quality of natural resources; Increases in the quantity and quality of human resources; Increases in the supply or stock of capital goods; Improvements in technology. There is also a demand factor: households, businesses, and government must purchase the expanding output; and an efficiency factor: the economy must achieve economic efficiency and full employment.
LO: 5-4

48. Economic Growth and Production Possibilities
Economic growth is an expansion of production possibilities. A
Economic
Growth
Capital Goods b
Recall the production possibilities model from Chapter 1. Suppose economy is initially in point a on the production possibilities curve. Economic growth allows the economy to move to point b, which lies on a higher production possibilities curve. Thus, we can think of economic growth as an expansion of production possibilities. a B D
LO: 5-4
Consumer Goods

49. Growth Accounting
Growth accounting measures the relative importance of supply factors contributing to growth:
Increases in hours of work (small factor in the U.S.)
Increases in labor productivity due to
Technological advance (40% of productivity growth)
Quantity of capital (30% of productivity growth)
Education and training (15% of productivity growth)
Economies of scale and resource allocation (15% of productivity growth)
Growth accounting measures the relative importance of supply factors contributing to growth. Two main factors can be identified: Increases in hours of work (which is a small factor in the U.S.), and increases in labor productivity. Labor productivity may increase due to technological advance (which contributes 40% to productivity growth in the U.S.), quantity of capital (30% of productivity growth), education and training (15% of productivity growth), and economies of scale and resource allocation (15% of productivity growth).
LO: 5-5

50. Labor Productivity Accelerated Since the Mid-90s
Labor productivity in the U.S. has accelerated since the 1990s. One can see that the trend rate of increase in productivity increased in the mid-1990s compared to prior years. What were the reasons?
LO: 5-6

51. Reasons for Productivity Acceleration
Microchip/information technology
New (start-up) firms
Increasing returns (firm’s output increases by a larger percentage than its inputs):
More specialized inputs
Spreading of development costs
Simultaneous consumption
Network effects
Learning by doing
Global competition
The following are the main reasons for recent productivity acceleration in the U.S.: introduction of microchip and information technology; a larger number of new start-up firms; increasing returns allow for output to increase by a larger percentage than inputs; and global competition. The main reasons for achieving increasing returns are more specialized inputs, the spreading of development costs, simultaneous consumption, network effects, and learning by doing.
LO: 5-6

52. Desirability and Sustainability of Growth
Is accelerated productivity growth sustainable?
Is economic growth desirable and sustainable?
The antigrowth view
Environmental problems and resource depletion
No evidence that growth solved sociological problems
Economic wealth ≠ good life
Fast economic growth is not sustainable
In defense of economic growth:
Growth increases standard of living
Growth is the only way to resolve the problem of poverty
Growth improved working conditions
Human imagination can solve environmental and resource issues, and therefore, growth is sustainable
Is accelerated productivity growth sustainable? Is economic growth desirable and sustainable? There are two competing views. The antigrowth view states that growth has negative impacts such as environmental problems and resource depletion; that there is no evidence that growth solved sociological problems, such as poverty; that economic wealth is not identical to a good life; and that fast economic growth is not sustainable, and slow sustainable growth would be better. In defense of economic growth, the following arguments are brought up: growth increases the standard of living; it is the only way to resolve the problem of poverty; growth improved working conditions; and human imagination can solve environmental and resource issues, and therefore, growth can be sustainable.
LO: 5-7

53. Economic Growth in China
Growth averages past 25 years:
9% annual growth output
8% annual growth output per capita
What were the sources of this growth?
Labor is more productive
More international trade
Transition to a market economy
Joined WTO 2001
What are the challenges?
Financial system remains weak
Income inequality across geographic areas
What were the sources of recent economic growth in China? The Chinese economy grew on average 9 percent, and 8 percent per capita in last 25 years. This impressive growth can be attributed to labor becoming more productive, an increase in international trade, transition to a market economy, and joining WTO in Two main challenges remain: the financial system in China remains weak, and income inequality across geographic areas of China is growing.
LO: 5-8

54. End