1. Chapter 9 Gross Domestic Product 9-1 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives What is GDP? How is GDP measured? What are the national income accounts? What is the difference between GDP and real GDP? How does our GDP compare to those of other nations? How is per capita GDP calculated? What are the shortcomings of GDP as a measure of national economic well-being? 9-2 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

3. GDP is the nation’s expenditures on all FINAL goods and services produced during the year at market prices. An alternate definition of GDP is –the value of all goods and services produced within a nation’s boundaries during the year What Is GDP? 9-3 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

4. 9-4 Consumption –Durable goods …………$ 872 –Nondurable goods …….. 2,115 –Services ……………….. 4,317 –Total C …………………………….$7,304 Investment –Plant & Equipment …….$ 1,117 –Residential Housing …… 472 –Inventory change ………. 4 –Total I ……………………………….1,593 Government Purchases –Federal ………………….$ 694 –State and Local …………..1,279 –Total G ……………………………..$1,973 Net Exports (Xn) –Exports ………………….$ 1,015 –Imports …………………..- 1,439 –Xn …………………………………$ - 424 GDP …… …………………………$1,446 The Components of GDP, 2002 (in $ billions) Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

5. 9-5 Consumption –Durable goods …………$ 872 –Nondurable goods …….. 2,115 –Services ……………….. 4,317 –Total C …………………………….$7,304 Investment –Plant & Equipment …….$ 1,117 –Residential Housing …… 472 –Inventory change ………. 4 –Total I ……………………………….1,593 Government Purchases –Federal ………………….$ 694 –State and Local …………..1,279 –Total G ……………………………..$1,973 Net Exports (Xn) –Exports ………………….$ 1,015 –Imports …………………..- 1,439 –Xn …………………………………$ - 424 GDP …… …………………………$10,446 The Components of GDP, 2002 (in $ billions) Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved. GDP = C + I + G + X n GDP =7,304+1,593+1,973+(-424) GDP = 10,446

6. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-6 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

7. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-7 Same As Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

8. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-8 Same As Value of what is produced Value of what is spent Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

9. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-9 Same As Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

10. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-10 Same As Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach (GDP = C + I + G + Xn ) Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

11. The Flow of Income Approach (Most Complex) 9-11 Consumption +Investment + Government Spending +Net Exports GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

12. The Flow of Income Approach 9-12 GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) Why is NDP better than GDP Country North Atlantis South Atlantis GDP 500 500 - Depreciation 50 100 NDP 450 400 North Atlantis is better off because it had a higher NDP! South Atlantis had a lower NDP because it had to devote more of its resources to replacing worn out and obsolete equipment. These resources could not go toward additional plant and equipment nor could they even be used for more consumer goods. Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

13. The Flow of Income Approach 9-13 GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) Indirect business taxes and subsidies are mainly general sales taxes on specific items such as gasoline, liquor and cigarettes, and subsidies (such as government payments to farmers). Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

14. GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) 9-14 The Flow of Income Approach Distribution of Domestic Income (2002) Wages, salaries & fringes ……….71.6% Net Interest ……………………… 8.2% Proprietor’s Income …………….. 9.1% Corporate Profits ……………….. 9.4% Rent …………………………….. 1.7% Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

15. 9-15

16. GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) 9-16 The Flow of Income Approach Earnings not received are almost all Social Security taxes and corporate profits that were not paid out as dividends Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17. GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) 9-17 The Flow of Income Approach Receipts not earned are mainly Social Security benefits and other government transfer payments, and interest income Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

18. 9-18 The Flow of Income Approach GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) - Personal taxes DPI (Disposable Personal Income) Personal taxes are chiefly personal income taxes Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

19. 9-19 The Flow of Income Approach GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) - Personal taxes DPI (Disposable Personal Income) Disposable Personal Income is ours to dispose of, to spend and save as we see fit Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

20. 9-20 The Flow of Income Approach GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) - Personal taxes DPI (Disposable Personal Income) The “red” indicates the three main parts of the “Flow of Income” approach to GDP Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

21. 9-21 The Flow of Income Approach GDP (Gross Domestic Product) (+) - Depreciation NDP (Net Domestic Product) (+) - Indirect business taxes and subsidies DI (Domestic Income) (+) - Earnings not received (-) + Receipts not earned PI (Personal Income) (+) - Personal taxes DPI (Disposable Personal Income) If we start with “DPI” and work up - the signs have to be changed! Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

22. Two Things to Avoid When Compiling GDP Multiple counting –Only expenditures on final products – what consumers, businesses, and government units buy for their own use belong in GDP Intermediate goods are not counted Used goods are not counted Transfer payments –Transfer payments are not payments for currently produced goods and services When they are spent for final goods and services they will go into GDP as consumer spending Financial transactions do not go into GDP 9-22 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

23. 9-23 The Value-added Approach to Measuring GDP Production Generated Added Farmer harvest wheat $100 $100 Miller makes into flour 200 100 Baker makes into bread 300 100 $600 $300 GDP counts only the $ value of the final good This is the same as the “value-added.” Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

24. GDP versus Real GDP (RGDP) $8 $9 $10 $11 1998 1999 2000 2001 GDP is the Price RGDP is the pie GDP is measured in current dollars. Therefore it appears as if GDP was larger in 2001 than in previous years. To make year-to-year GDP comparisons, we have to get rid of inflation 9-24 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

25. Deflating GDP to Get RGDP RGDP cy = GDP cy X -------------------------- GDP DEFLATOR cy GDP DEFLATOR by 9-25 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

26. Deflating GDP to Get RGDP RGDPcy = GDPcy X -------------------------- GDP DEFLATOR cy GDP DEFLATOR by 9-26 RGDP 86 = 4422.2 X ------------------------------------ 100 80.6 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

27. Deflating GDP to Get RGDP RGDPcy = GDPcy X -------------------------- GDP DEFLATOR cy GDP DEFLATOR by 9-27 RGDP 86 = 4422.2 X ------------------------------------ 100 80.6 RGDP 86 = 4422.2 X 1.2406948 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

28. Deflating GDP to Get RGDP RGDPcy = GDPcy X -------------------------- GDP DEFLATOR cy GDP DEFLATOR by 9-28 RGDP 86 = 4422.2 X ------------------------------------ 100 80.6 RGDP 86 = 4422.2 X 1.2406948 RGDP 86 = 5486.6 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

29. 9-29 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X -------------------------- GDP DEFLATOR by GDP DEFLATOR 97 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

30. 9-30 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X -------------------------- GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = 8083.4 X ---------------------------------------- 100 115.2 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

31. 9-31 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X -------------------------- GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = 8083.4 X ---------------------------------------- 100 115.2 RGDP 97 = 8083.4 X.8680556 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

32. 9-32 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X -------------------------- GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = 8083.4 X ----------------------------------------` 100 115.2 RGDP 97 = 8083.4 X 8680556 RGDP 97 = 7016.8 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

33. 9-33 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved. GDP and Real GDP(in 1992Dollars), 1960-2002 Survey of Current Business, May 2003

34. Calculating Percentage Changes 9-34 % change = ------------------------------------ Change Original Number Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

35. Calculating Percentage Changes 9-35 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

36. Calculating Percentage Changes 9-36 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

37. Calculating Percentage Changes 9-37 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = -------------------- 226.7 2557.5 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

38. Calculating Percentage Changes 9-38 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = -------------------- 226.7 2557.5 % change =.0886413 = 8.8% Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

39. Calculating Percentage Changes 9-39 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = --------------------- 226.7 2557.5 % change =.0886413 = 8.8% 1980 RGDP = 4611.9 1979 RGDP = 4624.0 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

40. Calculating Percentage Changes 9-40 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = --------------------- 226.7 2557.5 % change =.0886413 = 8.8% 1980 RGDP = 4611.9 1979 RGDP = 4624.0 Change ------> 12.9 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

41. Calculating Percentage Changes 9-41 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = --------------------- 226.7 2557.5 % change =.0886413 = 8.8% 1980 RGDP = 4611.9 1979 RGDP = 4624.0 Change ------> 12.9 % change = ------------------------- 12.9 4624.0 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

42. Calculating Percentage Changes 9-42 % change = ------------------------------------ Change Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 % change = --------------------- 226.7 2557.5 % change =.0886413 = 8.8% 1980 RGDP = 4611.9 1979 RGDP = 4624.0 Change ------> 12.9 % change = ------------------------- 12.1 4624.0 % change =.0026168 =.26 % Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

43. Per Capita GDP 9-43 Per capita GDP = --------------------------------- GDP Population Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

44. Per Capita GDP 9-44 Per capita GDP = -------------------------------- GDP Population 20000 2000 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

45. Per Capita GDP 9-45 Per capita GDP = -------------------------------- GDP Population 20000 2000 Per capita GDP = -------------------------------- $9,965,700,000,000 281,000,000 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

46. Per Capita GDP 9-46 Per capita GDP = -------------------------------- GDP Population 20000 2000 Per capita GDP = -------------------------------- $9,965,700,000,000 281,000,000 Per capita GDP = $35,465 20000 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

47. Per Capita Real GDP 9-47 Per capita real GDP = -------------------------------- Real GDP Population To compare per capita GDP in one year with that of another year we have to correct for inflation. In other words, we really need to revise our formula Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

48. 9-48 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

49. 9-49 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved. International comparisons for per capita GDP are at least somewhat suspect because of varying national income accounting systems as well as fluctuations of foreign exchange rates

50. Shortcomings of GDP as a Measure of National Economic Well-being Production that is excluded –Household production –Illegal production –The underground economy –Bartering (exchange of services) –Pirated CDs and Videos Treatment of leisure time –While the average workweek has declined, many more mothers with young children work –1960 79 percent of all families with children had one stay-at- home parent. Now this has fallen to just 28 percent Human cost and benefits GDP gives us a “ballpark” idea of how much we produce, not necessarily how well off we are 9-50 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

51. When a large part of our production goes toward national defense, police protection, pollution control devices, repair and replacement of poorly made cars and appliances, and cleanups of oil spills, a large GDP is not a good indicator of how we’re doing In general, the problem with using GDP as a measure of national economic well-being is that GDP is just one number, and no single number can possibly provide us with all of the information we need What Goes into GDP 9-51 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.

52. The Last Word on GDP GDP includes some things that really shouldn’t be counted GDP has excluded some things that should be counted Nevertheless, if we can accept GDP while acknowledging all of its limitations, it serves us well 9-52 Copyright  2005 by The McGraw-Hill Companies, Inc. All rights reserved.