1. C H A P T E R O U T L I N E Chapter 6 Measuring National Output and National Income Gross Domestic Product Final Goods and Services Calculating GDP The Expenditure Approach The Income Approach Nominal versus Real GDP Calculating Real GDP Calculating the GDP Deflator Limitations of the GDP Concept GDP and Social Welfare

2. national income and product accounts Data collected and published by the government describing the various components of national income and output in the economy. http://www.bea.gov/http://www.bea.gov/ While there are literally thousands of variables in the national income and product accounts, in this chapter we discuss only the most important. Measuring National Output and National Income

3. 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

4. Production and GDP …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

5. Production and GDP …produced… – 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

6. 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.

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. 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?

10. 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

11. 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

12. value added The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. Value Added In calculating GDP, we can sum up the value added at each stage of production or we can take the value of final sales. We do not use the value of total sales in an economy to measure how much output has been produced. TABLE 6.1 Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) Stage of ProductionValue of SalesValue Added (1)Oil drilling$3.00 (2)Refining3.300.30 (3)Shipping3.600.30 (4)Retail sale4.000.40 Total value added$4.00

13. What’s Not Included in GDP 13 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)

14. Exclusion of Output Produced Abroad by Domestically Owned Factors of Production GDP is the value of output produced by factors of production located within a country. Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP).

15. GNP versus GDP Gross National Product (GNP): total income earned by the nation’s factors of production, regardless of where located Gross Domestic Product (GDP): total income earned by domestically- located factors of production, regardless of nationality.

16. GNP versus GDP GNP = GDP + (payments received by U.S owned factors of production from abroad) less (payments made to foreign ownd factors of production) (GNP - GDP) = (factor payments from abroad) less (factor payments to abroad)

17. GNP versus GDP Payments received by U.S. factors of production from abroad include: - wages earned by U.S. citizens working abroad - profits earned by U.S.-owned businesses located abroad - income (interest, dividends, rent) generated from the foreign assets owned by U.S. citizens Payments to foreign factors of production include: - wages earned by foreign workers in the U.S. - profits earned by foreign-owned businesses located in the U.S. - income (interest, dividends, rent) that foreigners earn on U.S. assets

18. (GNP – GDP) as a percentage of GDP for selected countries, 1997.

19. expenditure approach A method of computing GDP that measures the total amount spent on all final goods and services during a given period. income approach A method of computing GDP that measures the income—wages, rents, interest, and profits— received by all factors of production in producing final goods and services. Calculating GDP

20. There are four main categories of expenditure: Personal consumption expenditures (C): household spending on consumer goods Gross private domestic investment (I): spending by firms and households on new capital, that is, plant, equipment, inventory, and new residential structures Government consumption and gross investment (G) Net exports (EX − IM): net spending by the rest of the world, or exports (EX) minus imports (IM) GDP = C + I + G + (EX − IM) The Expenditure Approach

21. TABLE 6.2 Components of U.S. GDP, 2012: The Expenditure Approach Billions of DollarsPercentage of GDP Personal consumption expenditures (C)11,119.570.9 Durable goods1,218.87.8 Nondurable goods2,563.016.3 Services7,337.746.8 Gross private domestic investment (l)2,059.513.1 Nonresidential1,616.610.3 Residential382.42.4 Change in business inventories60.60.4 Government consumption and gross investment (G) 3,063.619.5 Federal1,214.27.7 State and local1,849.411.8 Net exports (EX – IM)−566.7−3.6 Exports (EX)2,179.713.9 Imports (IM)2,746.317.5 Gross domestic product15,676.0100.0 Note: Numbers may not add exactly because of rounding.

22. Personal Consumption Expenditures (C) personal consumption expenditures (C) Expenditures by consumers on goods and services. durable goods Goods that last a relatively long time, such as cars and household appliances. nondurable goods Goods that are used up fairly quickly, such as food and clothing. services The things we buy that do not involve the production of physical things, such as legal and medical services and education. Items not included in C: Imported consumption goods and components New home construction

23. Items included in C 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

24. eBay’s business is to provide a marketplace for exchange. In doing so, it uses labor and capital and creates value. In return for creating this value, eBay charges fees to the sellers that use its site. The value of these fees enter into GDP. Items that people sell on eBay do not contribute to current GDP. The cost of finding an interested buyer for those goods, however, does get counted. E C O N O M I C S I N P R A C T I C E Where Does eBay Get Counted? THINKING PRACTICALLY 1.John has a 2009 Honda Civic. In 2013, he sells it to Mary for $10,000. Is that $10,000 counted in the GDP for 2013? 2.If John is an automobile dealer, does that change your answer to Question 1 at all?

25. gross private domestic investment (I) Total investment in capital—that is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector. nonresidential investment Expenditures by firms for machines, tools, plants, and so on. residential investment Expenditures by households and firms on new houses and apartment buildings. Gross Private Domestic Investment (I) change in business inventories The amount by which firms’ inventories change during a period. Inventories are the goods that firms produce now but intend to sell later. GDP = Final sales + Change in business inventories Change in Business Inventories

26. depreciation The amount by which an asset’s value falls in a given period. gross investment The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. net investment Gross investment minus depreciation. capital end of period = capital beginning of period + net investment Gross Investment versus Net Investment

27. government purchases (G) Spending by federal, state, and local governments on goods and services and government investment in bridges, highways, etc. Government Expenditures (G) 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

28. Net Exports (EX − IM) net exports (EX − IM) The difference between exports (sales to foreigners of U.S.-produced goods and services) and imports (U.S. purchases of goods and services from abroad). The figure can be positive or negative.

29. 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 29

30. 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. In every transaction, the buyer’s expenditure becomes the seller’s income. Thus, the sum of all expenditure equals the sum of all income.

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

32. current dollars The current prices that we pay for goods and services. nominal GDP Gross domestic product measured in current dollars. weight The importance attached to an item within a group of items. Nominal versus Real GDP

33. TABLE 6.6 A Three-Good Economy (1) (2) (3)(4)(5)(6)(7)(8) GDP in Year 1 inYear 2 inYear 1 inYear 2 in ProductionPrice per UnitYear 1 Year 2 Year 1Year 2Year 1Year 2Prices Q1Q1 Q2Q2 P1P1 P2P2 P1 × Q1P1 × Q1 P1 × Q2P1 × Q2 P2 × Q1P2 × Q1 P 2 × Q 2 Good A611$0.50$0.40$3.00$5.50$2.40$4.40 Good B740.301.002.101.207.004.00 Good C10120.700.907.008.409.0010.80 Total$12.10$15.10$18.40$19.20 Nominal GDP in year 1 Nominal GDP in year 2 Calculating Real GDP base year The year chosen for the weights in a fixed-weight procedure. fixed-weight procedure A procedure that uses weights from a given base year.

34. 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.

35. 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

36. 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) 201120102009 205$100200$102192$100good B 1,050$361,000$31900$30good A QPQPQP Compute nominal GDP in each year Compute real GDP in each year using 2009 as the base year.

37. Example - Calculation of Real GDP Nominal GDP multiply P & Q from same year 2009: $46,200 = $30  900 + $100  192 2010: $51,400 = $31 x 1000 + $102 x 200 2011: $58,300 = $36 x 1050 + $100 x 205 Real GDP multiply each year’s Q by 2009 P 2009: $46,200 = $30 x 900 + $100 x 192 2010: $50,000 = $30 x 1000 + $100 x 200 2011: $52,000 = $30  1050 + $100  205

38. 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

39. Self Test 52,000 50,000 $46,200 Real GDP GDP deflator 58,3002011 51,4002010 n.a.$46,2002009 inflation rate Nominal GDP Compute the GDP deflator in each year. Use GDP deflator to compute the inflation rate from 2009 to 2010, and from 2010 to 2011.

40. Answers 52,000 50,000 $46,200 Real GDP 112.1 102.8 100.0 GDP deflator 9.05%58,3002011 2.8%51,4002010 n.a.$46,2002009 inflation rate Nom. GDP Calculate the growth rate in NGDP for 2011. Calculate the Growth rate in RGDP for 2011.

41. Inflation rate and growth rate is a percent change

42. Inflation rate and growth rate in 2011 -

43. Policy makers not only need good measures of how real output is changing but also good measures of how the overall price level is changing. The GDP deflator is one measure of the overall price level. Calculating the GDP Deflator However, the fixed-weight procedure has flaws such as it ignores the substitution away from goods whose prices are increasing and toward goods whose prices are decreasing or increasing less rapidly.

44. How GDP Is Used Short-run – Business cycle recession expansion Long-run – Trend growth Measure the long-run growth rate of the economy’s output 44

45. The Business Cycle peak trough +3% +4% -2% 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.

46. 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.

47. LIMITATIONS OF THE GDP CONCEPT Underground (informal) 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.

48. Looking Ahead This chapter has introduced many key variables in which macroeconomists are interested, including GDP and its components. There is much more to be learned about the data that macroeconomists use. In the next chapter, we will discuss the data on employment, unemployment, and the labor force. In later chapters, we will discuss the data on money and interest rates. Finally, we will discuss in more detail the data on the relationship between the United States and the rest of the world.

49. base year change in business inventories compensation of employees corporate profits current dollars depreciation disposable personal income, or after-tax income durable goods expenditure approach final goods and services fixed-weight procedure government consumption and gross investment (G) R E V I E W T E R M S A N D C O N C E P T S GDP GDP deflator gross investment gross national product (GNP) gross private domestic investment (I) income approach indirect taxes minus subsidies informal economy intermediate goods national income national income and product accounts

50. net exports (EX − IM) net investment net national product (NNP) nominal GDP nondurable goods nonresidential investment personal consumption expenditures (C) personal income personal saving personal saving rate R E V I E W T E R M S A N D C O N C E P T S real GDP rental income residential investment services value added Expenditure approach to GDP: GDP = C + I + G + (EX − IM) GDP = Final sales + Change in business inventories capital end of period = capital beginning of period + net investment