1. Taking the Nations Pulse3 7 3 7

2. GDP
– A Measure of Output

3. 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.

4. GDP – A Measure of Output
What Counts Toward GDP?
Only final goods and services count
Sales at intermediate stages of production are not counted as their value is embodied within the final-user good. Including them would result in double counting.
Stage of production
Value added to the product
(equals income created)
Sales Receipts
(at each stage of production)
Stage 1: farmer’s wheat
$.30
by farmer
$.30
Stage 2: miller’s flour
$.65
by miller
$.35
Stage 3: baker’s bread
(wholesale)
$.90
by baker
$.25
Stage 4: grocer’s bread
(retail) $1
by grocer
$.10
Total consumer expenditure = $1
Total value added = $1

5. GDP – A Measure of Output
What Counts Toward GDP? (cont.)
Financial transactions and income transfers are excluded as they do reflect production.
Only production within the geographic borders of the country is counted.
Only those goods produced during the current period are counted.
GDP is measured in dollars
Each good produced increases output by the amount the purchaser pays for the good.
GDP is the sum of total spending on all goods and services produced during the year.

6. Questions for Thought:
1. Indicate how each of the following activities will affect GDP:
a. You pay $600 per month to lease an apartment while attending school.
b. You pay $8,000 to purchase a four-year-old car.
c. You have car trouble and have to pay a repair shop $1,500 to fix the transmission of your car.
d. You pay $5,100 to purchase 100 shares of Microsoft stock ($50 per share for the stock plus a $100 brokerage fee).
e. You sell your 100 shares of Microsoft stock (purchased for $5,000) for $6000 minus a $100 brokerage fee.
(continued on next slide)

7. Questions for Thought:
1. Indicate how each of the following activities will affect GDP: (cont.)
f. Your aunt sends you $500 to help with your college expenses.
g. You earn $500 providing computer services for a faculty member.
h. You win $500 playing cards with classmates in the dormitory.
2. Why aren’t the purchases of intermediate goods like steel and automobile motors and the purchase of final market goods like new automobiles both included in GDP?

8. Two Ways
of Measuring GDP

9. Two Ways of Measuring GDP
Dollar flow of expenditures on final goods =
Dollar flow of income (and indirect cost) of final goods =
Expenditure Approach:
GDP is the sum of expenditures on final user goods and services purchased by households, investors, governments, and foreigners.
There are four components of GDP:
personal consumption purchases
gross private investment (including inventories)
government purchases (consumption and investment)
net exports ( exports minus imports )

10. Two Ways of Measuring GDP
Resource Cost - Income Approach
GDP is the sum of costs incurred and income (including profits) generated by production of goods and services during the period.
The direct cost income components of GDP:
employee compensation
self-employment income
rents
interest
corporate profit
Sum of these = national income

11. Two Ways of Measuring GDP
Resource Cost - Income Approach: (cont.)
Not all cost components of GDP result in an income payment to a resource supplier. To get GDP, we need to account for 3 other factors:
Indirect business taxes: Taxes that increase the firm’s production costs and therefore final prices.
Depreciation: The cost of wear and tear on the machines and other capital assets used to produce goods and services.
Net Income of Foreigners: The income that foreigners earn producing goods within the borders of a country minus the income Americans earn abroad.

12. Two Ways of Measuring GDP
When derived by Resource Cost - Income Approach, GDP is equal to:
national income (employee compensation, self-employment income, rents, interest, corporate profit)
indirect business taxes
depreciation
net income of foreigners

13. Two Ways of Measuring GDP
There are two methods of calculating GDP:
Summing the expenditures of “final user” goods and services of consumers, investors, governments, and foreigners (net exports), or,
Summing income payments and indirect cost items that accompany the production of goods and services.
Expenditure Approach
Resource Cost-Income Approach
Personal consumption expenditures
Aggregate income:
Employee Compensation
Income of self-employed
Rents
Profits
Interest +
Gross private domestic investment +
Government consumption
and gross investment +
Non-income cost items:
Indirect business taxes and depreciation +
Net exports of goods and services
= GDP
Net income of foreigners +
= GDP

14. Employee compensation
Relative Size of
U.S. GDP Components:
(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 9%
profits
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.
The relative sizes of the major components of GDP usually fluctuate within a fairly narrow range.
The average proportion of each U.S. component during period is shown above for both the expenditure and resource cost-income approach.

15. Questions for Thought:
1. What is the difference between Gross Domestic Product (GDP) and Gross National Product (GNP)?
2. Can net investment ever be negative? What would negative net investment imply?
3. What is the largest component of GDP when it is derived by the expenditure approach? What is the largest component of GDP when it is derived by the income-cost approach?

16. Real and Nominal GDP

17. Real and Nominal GDP The term "real" means adjusted for inflation.
Price indexes are use to adjust income and output data for the effects of inflation.
A price index measures the cost of purchasing a market basket (or “bundle”) of goods at a point in time relative to the cost of purchasing the identical market basket during an earlier reference (or base) period.

18. Two Key Price Indexes: - Consumer Price Index - GDP Deflator

19. Two Key Price Indexes:
Consumer Price Index (CPI): measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households.
GDP Deflator: designed to measure the change in the average price of the market basket of goods included in GDP (a broader price index than the CPI).

20. CPI and GDP Deflator:
CPI
Inflation rate
GDP deflator
Inflation rate
Year
( = 100)
(percent)
(1996 = 100)
(percent)
1991
136.2
4.2
89.7
3.6
1992
140.3
3.0
91.8
2.4
1993
144.5
3.0
94.1
2.4
1994
148.2
2.6
96.0
2.1
1995
152.4
2.8
98.1
2.2
1996
156.9
3.0
100.0
1.9
1997
160.5
2.3
102.0
2.0
1998
163.0
1.5
103.2
1.2
1999
166.6
2.2
104.7
1.5
2000
172.2
3.4
107.0
2.2
2001
177.1
2.8
109.4
2.2
Source: Economic Report of the President, 2001.
Even though the CPI and the GDP deflator are based on different market baskets and procedures, they yield similar estimates of the rate of inflation.

21. Using the GDP Deflator
to Derive Real GDP

22. Using the GDP Deflator to Derive Real GDP
The formula for converting the nominal GDP into real GDP is:
Real GDP2 =
GDP Deflator1
GDP Deflator2
Nominal GDP2 *
Data on both money GDP and price changes are essential for meaningful comparisons of output between two time periods.

23. Using the GDP Deflator to Derive Real GDP
Between 1996 and 2001, nominal GDP increased by 30.7%.
But, when the 2001 GDP is deflated to account for price increases, we see that real GDP increased by only 19.4%.
Source: U.S. Department of Commerce.
Nominal GDP
(billions of U.S. $)
Price index
(GDP deflator, 1996 = 100)
100.0
109.4
9.4%
Real GDP
(billions of 1996 $)
1996
$7,813
$7,813
2001
$10,208
$9,331
% increase
30.7%
19.4%

24. Converting Earlier Figures to Current Dollars
In order to make comparisons across time periods, we must use current dollars.
This can be done by “inflating” the earlier data for the increase in the price level.
The formula for converting the figures for the earlier year into current dollars is:
Figurecurrent $ =
price indexcurrent year
price indexearlier year
Figureearlier $ *
If prices have risen, this will “inflate” the data for earlier years and bring it into line with the current purchasing power of the dollar.

25. Questions for Thought:
1. What do price indexes measure?
2. What is the difference between the CPI and the GDP deflator? Which would you use if you wanted to measure whether your own earnings this year were higher than they were last year?
3. The CPI was 177 in 2001 compared to 100 in Suppose that the price of a ticket at a local movie theater rose from $4 to $8 between 1983 and Did the real ticket price increase or decrease? Calculate the 1983 ticket price measured in 2001 dollars.

26. Nominal GDP (trillions of $)
Questions for Thought:
4. Use the following data to answer this question.
a. Calculate the real GDP in 1999, 2000, and measured in 1996 dollars.
b. What was the percent change in real GDP between 1999 and 2000? What was the percent change between 2000 and 2001?
c. What was the inflation rate as measured by the GDP deflator in 2000 and 2001?
Nominal GDP (trillions of $)
GDP deflator (1996=100)
1999
2000
2001
9.27
9.87
10.21
104.7
107.0
109.4

27. Shortcomings and Strengths
of GDP as a Measuring Rod

28. Shortcomings and Strengths of GDP as a Measuring Rod
Shortcomings of GDP:
It does not count non-market production.
It does not count the underground economy.
It makes no adjustment for leisure.
It probably understates output increases because of the problem of estimating improvements in the quality of products.
It does not adjust for harmful side effects.
Great contribution of GDP:
In spite of its shortcomings, real GDP is a reasonably accurate measure of short-term fluctuations in output.

29. GDP Comparisons
Across Time Periods
and Across Countries

30. Per capita GDP Across Time Periods
U.S. Per Capita GDP
$33,833
$26,834
$21,521
$17,446
$13,148
$11,119
$7,423
$6,101
1930
1940
1950
1960
1970
1980
1990
2000
Source: derived from U.S. Department of Commerce data.
Per capita GDP has steadily risen. In 2000, per capita GDP was 4.6 times the 1940 figure. What does this mean?

31. Per Capita GDP Comparisons Across Time Periods
As was seen in the previous exhibit, U.S. per capita GDP has increased substantially over the past 70 years.
Compared to earlier periods, current GDP is probably biased upward because more output now takes place in the market sector and less in the household sector.
However, it is also probably biased downward because of failure to adjust for increased leisure, improvements in the work environment, and the introduction of improved products and new technologies.
The direction of the overall bias is uncertain.

32. Per Capita GDP Comparisons Across Countries
GDP comparisons across countries may be biased because of differences in
leisure versus time worked,
size of the underground economy,
the share of output in the household rather than the business sector.
Small differences in per capita GDP should be interpreted with caution.
However, there is a strong relation between per capita GDP across countries and indicators of living standards such as life expectancy, infant mortality, and literacy.
(see exhibit 8 of this chapter for evidence)

33. Related Income Measures

34. Related Income Measures
Gross National Product (GNP): Output produced by the “nationals” – citizens of the country, regardless of whether that output is produced domestically or abroad.
National income: Income earned by the nationals (citizens) during a period. It is the sum of employee compensation, self-employment income, rents, interest, and corporate profits.
Personal income: Income received by domestic households and non-corporate businesses. It is available for consumption, saving, and personal taxes.
Disposable income: Income available to individuals after personal taxes. Can be spent on consumption or saved.

35. 2001 U.S. Income Measures (in billions of $)
5 Measures of National Income
2001 U.S. Income Measures (in billions of $)
Net income of foreigners
Net exports
Depreciation
Personal
consumer
expenditures
Indirect business
taxes
– Minus –
Corporate
profits and
social
insurance
taxes
Personal
taxes
Employee
compensation
Gross private
domestic
investment
Proprietors’
income
– Plus –
Transfer payments, net interest,
and
dividends
Government
consumption
and investment
Interest
Rents
Corporate profits
GDP
GNP
National Income
Personal income
Disposable income
$10,208
$10,203
$8,218
$8,724
$7,417
Above are 5 alternative measures of national income.
These range from GDP (broadest) to Disposable Income (that available to households for saving or consumption).

36. Link Between Output and Income
GDP is a measure of both output & income.
This highlights a very important point: Expansion in output (additional production of goods and services that people value) is the source of higher income levels.
If we want to achieve higher income levels and living standards, we must figure out how to expand output (productivity) per person. We cannot have one without the other.

37. Questions for Thought:
1. When making income and GDP comparisons across time periods, why is it important to adjust for changes in the level of prices?
2. If nominal GDP during a year increased by 7% while the GDP deflator rose by 10 %, what happened to real GDP?
3. Why might per capita GDP be a misleading indicator of living standards across countries?
4. GDP does not count services such as child care, food preparation, cleaning, and laundry within the household. Why not? Is GDP a sexist measure? Does it understate the productive contributions of women relative to men?

38. Questions for Thought:
5. Which of the following are included in GDP?
a. the value of goods produced in the underground economy
b. the value of leisure
c. increases in the value of housing and financial assets
d. depreciation in the value of real assets such as equipment and buildings
e. the value of services such as food preparation and house cleaning that we provide for ourselves

39. End Chapter 7