1. SPENDING, INCOME, & GDP
Chapter 4

2. GDP Accounting
GDP (Gross Domestic Product)—the market value of all final goods and services produced in a country during a given period of time.

3. GDP Breakdown
1) Only consider the market value 2) We wish to include only final goods and services. 3) Must avoid double accounting—counting the same production twice. 4) All output should be included in GDP. 5) GDP includes only currently produced goods and services. 6) GDP includes only goods and services produced within a nation’s border

4. 1) Market Value Approach to GDP
Measure in terms of market value, not in terms of solely output or solely price

5. Market Value Example:
Suppose a country’s total production is 4 purses ($20 each), 2 cookies ($1 each), and 1 television ($600).
Three possibilities of measurement:
Just in terms of output: = 7 units of total output
Does this make sense?
In terms of price only: = $621
Really?
Or in terms of market value:
(4 purses*20)+(2 cookies*1)+(1 television *600)=$682
Allows for all goods to be on an equal playing field

6. 2) We wish to include only final goods and services.
Final goods—consumed by the ultimate user.
Intermediate goods—used up in the production of final goods (not counted as part of GDP).

7. 3) Must avoid double accounting—counting the same production twice.
To avoid double accounting, we use value added
Value added, for any firm, is the market value of its product minus the cost of inputs purchased.
Example: Suppose the following market values:
Grain: $.50
Flour: $1.20
French Bread: $2.00
So GDP must be $3.70…WRONG!
GDP is $2.00

8. 4) All output should be included in GDP, but it’s not
Some output is not sold through markets and is difficult to value.
GDP does not include the volunteer services, housework, and do-it-yourself activities.
Underground economy

9. Drawback of Market Value
Non-market goods not counted in GDP
Fails to account for household activities, volunteer services, and do-it yourself activities
Example is female labor force participation
Since 1960 female LFP has increased, so did GDP.
However prior many females stay at home as mothers, whose production was not counted in GDP
Note: some non-market goods are still included, e.g. defense spending

10. 5) GDP includes only currently produced goods and services
GDP only includes production that takes place during the indicated time period.
For example GDP in 2011 includes only goods and services in 2011.
Transactions in existing assets are not included.
Eg. If you buy a DVD of star Trek from Amazon, the purchase is included in GDP. If 6 months later you resell the DVD on ebay, that transaction is not included in GDP.

11. 6) Produced within a nation’s borders
Key: GDP = Gross Domestic Product
GDP includes any goods produced within the nation’s borders regardless of a company’s home country
If Toyota (a Japanese Multinational Corp.) makes cars in Kentucky, is that part of U.S. GDP?
If Apple ( a California based Corp.) makes ipods in Canada, is that part of U.S. GDP?

12. GNP
GNP (Gross National Product)—the market value of all final goods and services produced by resources supplied by a country during a given period of time, regardless of where they are located.

13. Main Difference
GDP measures the production of resources located in the U.S., regardless of who owns them. GNP measures the production of resources owned by U.S. residents, regardless of where the resources are located.

14. Nominal GDP

15. Expenditure Approach to GDP
GDP = consumption + investment + government purchases + net exports

16. Consumption
Consumption—spending by households on goods and services except the purchase of homes.

17. Types of Consumption Consumer Durables – long-lived consumer goods
Consumer Nondurables – short-lived consumer goods
Services – Largest component of consumption

18. Consumption

19. Investment
Investment—spending by firms on final goods and services—primarily capital goods and housing.

20. Types of Investment
Business Fixed Investment – purchase by firms of new capital goods such as machinery factories, and office buildings
Residential Investment – construction of new homes and apartment buildings. (treated as investment by business sector)
Inventory Investment – addition of unsold goods to company inventories
CAUTION: Do not confuse with financial investment

21. Investment

22. Government Spending
Government purchases—government purchases of final goods and services.

23. Exclusions of Government Spending
Government Spending does not include transfer payments
What are transfer payments?
Payments made by the government in return for which no current goods or services are received
Examples: Social Security benefits, unemployment benefits, pensions to government workers, and welfare payments
Why do we exclude them?

24. Government Purchases

25. Net Exports
Net exports = exports – imports Why do we subtract imports?

26. Since imports are included in consumption, investment, and government purchases but do not represent spending on domestic production, they must be subtracted.

27. Net Exports

28. Formal Representation of GDP
Y = C + I + G + NX
Recall NX = EX - IM
What does each component represent?
Or more appropriately who?

29. How do we classify the following?
A haircut
A defense contractor buys a tank
The U.S. Army buys a tank
Financial services provided by domestic residents to foreigners on U.S. soil

30. Income Approach to GDP
When a good is sold, its proceeds are distributed to workers or business owners
Capital income pays for physical capital and intangibles
Profits for business owners
GDP = labor income + capital income
Rent for land
Interest for bond holders
Labor income is wages, salaries, benefits, and incomes of the self- employed
Royalties

31. Market Value of Final Goods and Services
Three GDP Approaches
Production
Market Value of Final Goods and Services
Expenditure
Investment
Consumption
Government purchases
Net exports
Income
Capital Income
Labor Income

32. Adjusting for Price Changes
Compare GDP for different years to see how much output has changed
GDP changes over time because
Prices change AND
Quantity of output changes
To see how much output has grown, use only the changes in quantities
Hold prices constant

33. The Pizza and Games Economy
GDP in 2009 is $175; GDP in 2013 is $420
GDP in 2013 is 2.4 times the GDP in 2009
Only twice as many pizzas and games were produced in 2013
Market value of output grew faster than the physical volume of output
Number of Pizzas
Price of Pizza
Number of Games
Price of Game
2009 10
$10 15 $5
2013 20
$12 30 $6

34. Real GDP and Nominal GDP
Real GDP values output in the current year using the prices from the base year
The base year is a reference year that changes infrequently
Real GDP measures the physical volume of production
Nominal GDP values output in the current year using prices from the current year
Nominal GDP is the current dollar value of production

35. Calculating Real GDP for 2013
Use 2009 as the base year
Nominal GDP for 2009 is $175 and for 2013, $420
Calculate real GDP using current year quantities and base year prices
Real GDP in 2013 is
(20 pizzas) ($10) + (30 games) (5) = $350
Real GDP doubled between 2009 and 2013
Number of Pizzas
Price of Pizza
Number of Games
Price of game
2009 10
$10 15 $5
2013 20
$12 30 $6

36. Observations on Real and Nominal GDP
Usually, nominal and real GDP increase each year
But can they move in opposite directions?
YES!
Nominal GDP can go up and real GDP go down
Fewer goods and services produced AND
Prices increase faster than output decreased
Nominal GDP will be smaller than real GDP if the prices in the current year are less than in the base year
Usually true for years before the base year
Real GDP could rise and nominal GDP fall, but this is rare
Prices are falling faster than output is increasing

37. Real GDP and Economic Well-Being
Real GDP is a flawed measure of well-being
It values only market transactions
Omits illegal transactions, volunteer work, and household production
Maximizing GDP will not necessarily maximize national well-being
Whether increases in output increase welfare is a case- by-case issue

38. Poverty and Economic Inequality
GDP does not capture the effects of income inequality
Most would prefer living in a relatively equal society to one with a few wealthy and many poor
US uses an absolute standard of poverty
In 2005, a family of four was poor if their income was less than $19,350
Inequality matters and it is increasing in the US
The case of the beat-up car

39. GDP as a Welfare Measure
GDP omits and undervalues some goods and services
GDP per capita is positively associated with several measures of well-being
Material standard of living: more goods and services
Health and life expectancy
Residents of industrialized countries fare better than residents of developing countries in a range of health measures
Education
Literacy and school enrollment rates are higher in high-income countries