1. Production, Income, and Employment Chapter 6 Part 1

2. Aggregate Production is Measured by Gross Domestic Product (GDP)
Gross Domestic Product (GDP) is the:
total value of all final goods and services produced for the marketplace during a given period, within the nation’s borders.
Total value…
GDP is measured in dollar values (P x Q)

3. Production and GDP side note- Intermediate goods …of all final…
final means goods and services sold to their final user
side note- Intermediate goods
Goods that are inputs for the production of final goods
Value of intermediate goods is included in the value of final products
…goods and services…
Goods: tangibles
Services: intangibles

4. Production and GDP …produced… …for the marketplace…
Not included: land, stocks and bonds used goods … are not produced
…for the marketplace…
With the intention of being sold
…during a given period…
A specific period of time (annual/quarter)
…within a nation’s borders
Regardless of who owns the resources

5. Intermediate and Final Good
Tires taken from that pile and mounted on the wheels of the new car before it is sold are considered intermediate goods.
Tires taken from that pile to replace tires on your old car are considered final goods.
If we included the value of the tires (an intermediate good) on new cars and the value of new cars (including the tires), we would be double counting.

6. Example: Production of Notebook Paper
Stages of Production – Intermediate Goods
Intermediate Goods
Example: Production of Notebook Paper
$5.00 is the final sale included in GDP

7. Tracking and Reporting GDP
GDP is a flow variable
Flow variable: measures a rate of production
$40 billion worth of output each day
$1.2 trillion each month
$14.5 trillion for the year
In general, flow variables are measured per unit of time

8. Tracking and Reporting GDP
Annualization
The government reports GDP as an annual rate
But, it is measured and reported (as an annual rate) each quarter

9. Tracking and Reporting GDP
Nominal variable
A variable measured without adjustment for price changes
Nominal GDP
Real variable
A variable adjusted for changes in prices
Real GDP

10. Tracking and Reporting GDP
Comparing variables measured in dollars over time
It is important to translate nominal values to real values
Annual growth rate of real GDP
Reported quarterly
Annualized

11. Annualized data for GDP, real GDP, and growth rate, by quarters
Self test - How do we calculate the 3.8% real GDP growth rate for 2010-II?

12. What’s Not Included in GDP
Non-market goods and services such as chores performed at home by family members.
Underground activities, both legal and illegal such as legal unrecorded activities paid for in cash or illegal gambling
Sales of used goods (no production)
Financial transactions such as trading of stocks and bonds (no production)
Government transfer payments: a payment to a person that is not for goods and services currently supplied such as social security (no production)

13. How to Calculate GDP The Expenditure Approach
Four types of final users in the economy:
Household Sector – Consumption (C)
Business Sector – Investment (I)
Government Sector – Government Purchases (G)
Foreign Sector – Net Exports (NX)
Expenditure approach: GDP = C+I+G+NX
Adding the value of goods and services purchased by each type of final user

14. The Expenditure Approach to GDP
Consumption spending (C)
Part of GDP purchased by households as final users
represents about 70% of total GDP
Items not included:
Imported consumption goods and components
New home construction

15. The Expenditure Approach to GDP
Consumption spending (C)
Items included even though households don’t actually buy them
Total value of food products produced on farms that are consumed by the farmers and their families themselves
Total value of housing services provided by owner-occupied homes

16. The Expenditure Approach to GDP
Private investment (I)
Business purchases of plant, equipment, and software
New home construction
Changes in inventories

17. The Expenditure Approach to GDP
Private investment (I)
Adds to the nation’s capital stock
Excludes
Government investment
Consumer durables
Human capital
Ignores depreciation
Net investment
Investment minus depreciation

18. The Expenditure Approach to GDP
Government purchases (G )
Spending by federal, state, and local governments on goods and services and government investment in bridges, highways, etc.

19. The Expenditure Approach to GDP
Government outlays
Government purchases plus transfer payments
Transfer payments
Money redistributed from one group of citizens (taxpayers) to another (the poor, the unemployed, the elderly)
not associated with production of goods and services
included in government budgets as outlays
not included in the government purchase component of GDP

20. The Expenditure Approach to GDP
Net exports (NX)
Total exports minus total imports
Total exports (EX)
U.S. production that is purchased by foreigners
Total imports (IM)
Americans’ purchases of goods produced outside of the United States

21. GDP in 2010: The Expenditure Approach
2013: C I G + (EX IM)
GDP = 11, (2321 – 2778)
GDP = 17,089

22. Factor Payment (Income) Approach to GDP
Factor payments
Payments to the owners of resources that are used in production
Factor payments approach: Called The Income Approach
GDP = sum the factor payments earned by all households in the economy (wages and salaries, rent, interest, and profit)
Total output of the economy (GDP) = total income earned in the economy
Total expenditure (GDP) = total income earned in the economy

23. Why does expenditure = income
In every transaction, the buyer’s expenditure becomes the seller’s income.
Thus, the sum of all expenditure equals the sum of all income.

24. Simple Circular Flow
The circular flow diagram shows the income received and payments made by each sector of the economy.

25. Value Added Approache to GDP
Revenue a firm receives
Minus the cost of the intermediate goods it buys
Value-added approach
GDP = sum the values added by all firms in the economy

26. Back to the notebook example
Value Added at Different Stages of Production
Back to the notebook example

27. Value Added goes to the factors of production
The Factor Payments Approach – Using the Notebook Paper Example
Value Added goes to the factors of production

28. Exercise
A farmer grows a bushel of wheat and sells it to a miller for $1.00.
The miller turns the wheat into flour and sells it to a baker for $3.00.
The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00.
The engineer eats the bread.
Compute:
value added at each stage of production
GDP

29. Exercise Value added - farmer = ? Value added - miller = ?
Value added - baker = ?
Total Value added = ? = GDP

30. Measuring GDP: A Summary

31. Calculating Real GDP
Nominal GDP measures the value of all final goods and services using current prices.
Real GDP measures the value of all final goods and services using the prices of a base year.

32. Real GDP controls for inflation
Changes in nominal GDP can be due to:
changes in prices (P)
changes in quantities of output produced (Q)
Remember: total sales = P x Q
Changes in real GDP can only be due to changes in quantities (Q), because real GDP is constructed using constant base-year prices. P is held constant

33. Example - Calculation of Real GDP (NOTE: Numerical Calculation of Real GDP presented in this and the next 4 slides is not covered in the text)
2011
2010
2009
205
$100
200
$102
192
good B
1,050
$36
1,000
$31
900
$30
good A Q P
Nominal GDP multiply Ps & Qs from same year 2009: $46,200 = $30  $100  : $51,400 = $31 x $102 x : $58,300 = $36 x $100 x 205
Real GDP multiply each year’s Qs by 2009 Ps 2009: $46,200 = $30 x $100 x 192
2010: $50,000 = $30 x $100 x : $52,000 = $30  $100  205
Compute nominal GDP in each year
Compute real GDP in each year using 2009 as the base year.

34. Example - Calculation of Real GDP
Nominal GDP multiply P & Q from same year 2009: $46,200 = $30  $100  : $51,400 = $31 x $102 x : $58,300 = $36 x $100 x 205
Real GDP multiply each year’s Q by 2009 P 2009: $46,200 = $30 x $100 x : $50,000 = $30 x $100 x : $52,000 = $30  $100  205

35. GDP Deflator
The inflation rate is the percentage increase in the overall level of prices.
One measure of the price level is the GDP Deflator, defined as

36. Self Test
52,000
50,000
$46,200
Real GDP
GDP deflator
58,300
2011
51,400
2010
n.a.
2009
inflation rate
Nominal GDP
Use your previous answers to compute the GDP deflator in each year.
Use GDP deflator to compute the inflation rate from 2009 to 2010, and from 2010 to 2011.

37. Calculate the growth rate in NGDP for 2011.
Answers
52,000
50,000
$46,200
Real GDP
112.1
102.8
100.0
GDP deflator
9.05%
58,300
2011
2.8%
51,400
2010
n.a.
2009
inflation rate
Nom. GDP
Calculate the growth rate in NGDP for 2011.
Calculate the Growth rate in RGDP for 2011.

38. Inflation rate and growth rate is a percent change
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃= 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝐿𝑎𝑡𝑒𝑟 𝑌𝑒𝑎𝑟 − 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑋 100
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃= 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝐿𝑎𝑡𝑒𝑟 𝑌𝑒𝑎𝑟 − 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑋 100
Inflation Rate
= 𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝐿𝑎𝑡𝑒𝑟 𝑌𝑒𝑎𝑟 − 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟 𝑋 100

39. Inflation rate and growth rate in 2011 -
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
= 58, − 51, , 𝑋 100 = 13.4%
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
= 52, − 50, , 𝑋 100 = 4.0%
Inflation Rate
= − 𝑋 100 = 9.05%

40. How GDP Is Used Short-run – Business cycle Long-run – Trend growth
recession
expansion
Long-run – Trend growth
Measure the long-run growth rate of the economy’s output

41. The Business Cycle peak trough +3% -2% +4%
Over time, real GDP fluctuates around an overall long-run upward trend. Such fluctuations are called business cycles. When output rises, we are in the expansion phase of the cycle; when output falls, we are in a recession.

42. How GDP Is Used
Real GDP needs to grow by about 3% per year to provide enough jobs for a workforce that is growing in number and becoming more productive every year
This is a big concern now because the economy have not been growing at 3% per year.

43. Real GDP Growth Rate, 1970–2011

44. Real GDP Growth Rate, 1970–2011
Things to note:
Although the growth rate of real GDP has fluctuated over time, it has been well above the 1 percent rate needed to maintain output per person, so real GDP per capita has risen over time.
For most of the period, the average growth rate was high enough to create the jobs needed by a growing and more productive workforce. During some years (e.g., 2008– 2011), growth slowed, and an insufficient number of jobs were created

45. LIMITATIONS OF THE GDP CONCEPT
GDP AND SOCIAL WELFARE
If crime levels went down, society would be better off, but a decrease in crime is not an increase in output and is not reflected in GDP.
An increase in leisure is also an increase in social welfare, but sometimes associated with a decrease in GDP.
Most nonmarket and domestic activities, such as housework and child care, are not counted in GDP even though they amount to real production.

46. LIMITATIONS OF THE GDP CONCEPT
underground economy - the part of the economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.
distribution of income - GDP also has nothing to say about the distribution of output among individuals in a society.
pollution – environmental deterioration is not subtracted out.