Chapter 12

Gross Domestic Product (GDP)

http://en.wikipedia.org/wiki/Gross_domestic_product

Table of Contents

What is GDP? Other Vocabulary / Approaches to GDP Measurements of Macroeconomics The Business Cycle

“Stuff”

How much money you have does not measure your economic well-being. Money, by itself, has no intrinsic value. It will not make you live longer. It does not entertain you. It does not make it easier to get around town, and so on. The only reason to have money is so you can exchange it for something that does have intrinsic value, like a car or a stereo or a sandwich or an doctor’s services or a macroeconomics tutor or what not.

“Stuff”

How much stuff you have does measure your economic well-being. Your car makes getting around town easier. Sandwiches keep you from starving and if they taste good, you enjoy eating them. Stereos entertain you. Doctors' services help you live longer.

Gross Domestic Product (GDP)

The dollar value of all final goods and services produced within a country’s borders in a given year

Signals the health of the economy Basically, you want GDP to increase

Example

If a person from China comes to the U.S. and produces items in the U.S., those items are part of the U.S.’s GDP

If a person from the U.S. goes to Italy and produces items in Italy, those items are part of Italy’s GDP

U.S. GDP excludes "American" goods produced on foreign soil, such as a Ford built in England.

U.S. GDP includes "foreign" goods produced in American soil, such as a Toyota built in Kentucky.

GDP does NOT include:

(Limitations)

Intermediate goods Used Products Non-market activities Black market Externality Quality of life

Intermediate Goods

Goods that are used in the production of a final good and services

Examples: Raw materials

Intermediate Example: Apples

If the purpose of the apples to sell the apples as is, then the apples ARE included in GDP

However, if the purpose of the apple is to make applesauce, then the apple is an intermediate good and is NOT counted in GDP. The applesauce would be counted in GDP

Examples

The steel used to make cars.

The bread used in sandwiches that are sold in delis.

The gas used in the cars of taxicabs.

We do this to prevent double counting

Example: counting the steel in its raw form and second in its final form, as the automobile

Example: Paper is the intermediategood; the book is the final good. The book is counted in GDP

Used Products

Products can ONLY be counted ONE time—the year they were FINISHED being made

A product does NOT have to be SOLD.

It only has to finish being made.

Example

GDP is for 2005

If you finish building a house in 2005. It is counted in GDP for 2005

If you resell the house in 2006, it does NOT count in 2006’s GDP.

Example

GDP is for 2005

A 2006 Volkswagon Jetta is made in 2005. Therefore, the car is considered part of 2005’s GDP

Example

Additions to houses sometimes are considered part of the year the addition was made

It all depends on several factors, such as the size, and who constructed it.

Non-market activities

Goods that people do themselves

Example: Childcare, mowing lawn

Example

If a farmer grows tomatoes and sells them to me at the farmer's market, the tomatoes are included in GDP.

But if I grow tomatoes and eat them myself, the tomatoes are NOTincluded in GDP.

Loophole

If the business (childcare, mowing lawn) is by the books—legitimate—then, it may be considered part of GDP

Black Market

The market for illegal goods

Examples: Drugs, weapons, babies

Externality

Unintended economic side effects have a monetary value that is often NOT reflected in GDP

Examples: Building a pool causes changes in ecology

However,

If you pay someone to fix up the ecology that was destroyed, that person’s income is part of GDP

Quality of life

Additional goods do NOT necessarily make people happier

Examples: Pleasant surroundings, personal safety, leisure time

Other Vocabulary

Durable goods

Goods that last for more than ONE year

Examples: Refrigerator,

Washer, Dryer

Nondurable goods

Goods that last for less than ONE year

Examples: Light bulbs,

food, sneakers

Price level

Average of all prices in an economy

Expenditure

Amounts spent

National Income Accounting

Collects statistics to define and measure GDP

The Great Crash (1929)

The stock market fell rapidly, causing people to lose much of their money

Caused a severe economic decline

The government found a way to predict and prevent economic downturns

Approaches to GDP

Output Approach

Expenditure Approach

Income Approach

(sometimes people combine the Output and Expenditure approach)

Output Approach

Adding up the market value (the market price) of all final goods and services produced domestically (within the borders of the country)

Expenditure Approach

Estimate the annual expenditures on four final goods and services.

Expenditure Approach

Y = GDP

Y = C + I + G + Nx

Nx = (X - M)

Expenditure Approach

C = Consumption (household items; ex: food, cars)

I = Investments (business; ex: factories, equipment, houses)

G = Government(ex: navy purchases, tanks, guns)

Nx = Net ExportsX = Exports (going OUT of country)M = Imports (coming INTO country)

Expenditure Approach

Y = GDP

Y = C + I + G + Nx

Nx = (X - M)

Income Approach

The total income of everyone in the economy compromises all payments to the factors of production—land, labor, and capital—in the form of rent, wages, interest, and profits

MOST accurate

Income Approach

Is problematic in the sense that it takes into consideration the suppliers of the resources, which is difficult to define. Moreover it is problematic to calculate Interest and Profit.

Measures of GDP

Nominal GDP

(“Current GDP”)

GDP measured in current year’s prices

Problem: A general increase in prices appears to make GDP rise—when it really didn’t

Real GDP Expressed in constant,

unchanging prices

MORE accurate

Measures of GDP

Year Nominal GDP Real GDP

2001 $1 x 1000 = $1,000 $1 x 1000 = $1,000

2002 $2 x 2000 = $4,000 $1 x 2000 = $2,000

2003 $3 x 3000 = $9,000 $1 x 3000 = $3,000

2004 $4 x 4000 = $16,000 $1 x 4000 = $4,000

2005 $5 x 5000 = $25,000 $1 x 5000 = $5,000

Measurements of Macroeconomics

Gross Domestic Product (GDP)

Gross National Product (GNP)

Net National Product (NNP)

National Income (NI)

Personal Income (PI)

Disposable Personal Income (DPI)

Gross National Product (GNP)

GDP + Income earned - Income earned

outside U.S. by by foreign firms

U.S. firms & & citizens in

citizens the U.S.

Means: Products produced by Americans Does NOT account for depreciation

Net National Product (NNP)

GNP - Cost of depreciation

Means: Reflects depreciation Does NOT reflect taxes

What is depreciation?

Decreases in value

Example: Car

What is Appreciation?

Increases in value

Example: House

National Income (NI)

NNP - (Sales tax + Excise tax)

Means: Reflects taxes

What is an excise tax?

A tax on items the government believes is “harmful” to people

Purpose: is to deter people from buying or using the product

Example: Cigarettes, alcohol, gas

Personal Income (PI)

NI - (firms reinvested profits + Other + firm’s income taxes household + social security taxes ) income

Means: What everyone in the household makes—before taxes AKA: Gross Income

Disposable Personal Income (DPI)

PI - Individual taxes

Means: Income to spend or put in the bank AKA: Net Income

Business Cycle

A period of Macroeconomic expansion followed by a period of contraction

Business Cycle

Peak

Contraction

Trough

Expansion

Business Cycle

Expansion: Recovery, growth. A period of economic growth as measured by a rise in Real GDP

Peak: The height of the economic expansion, when real GDP stops rising

Contraction: A period of economic decline marked by a falling real GDP

Trough: The lowest point in an economic contraction, when real GDP stops falling

Business Cycle(Levels of Severity)

Recession: A prolonged economic contraction, 2 consecutive quarter of decreased GDP

Depression: A recession that is especially long and severe

Stagflation: A decline in real GDP combined with a rise in the price level

Business Cycle(with Levels of Severity)

Business Cycle(with Levels of Severity)

Peak

ContractionExpansion

Trough

Recession

Depression

Business Cycle

Business Cycle

Peak

Expansion

Trough

Contraction

Leading Indicators(Economic Variables)

Key economic variables that economists use to predict a new phase of the business cycle

Business Investment

Explanation Positive Examples & Characteristics

Negative Examples & Characteristics

Expansion leads to sales and profits keep rising until a point when firms expand enough or demand for a product drops

Hire more workers

Increase Output

Lay off workers

Reduce output

Interest Rates & Credit

Explanation Positive Examples & Characteristics

Negative Examples & Characteristics

Consumers use credit to purchase “big ticket” items

Low interest rates

Businesses BORROW money

High interest rates

Businesses PAY back loans

Interest Rate Calculator

Low Interest Rates…

More money saved

Spend more money on other “things” Businesses stay operating People keep jobs People spend…

Consumer Expectations

Explanation Positive Examples & Characteristics

Negative Examples & Characteristics

Partially determined by consumer spending

Expectation of rapid growth

Fears of a weakening economy

External Shocks

Explanation Positive Examples & Characteristics

Negative Examples & Characteristics

Huge events occur—usually suddenly

Discovery of Oil or Mineral deposits

Wars

Droughts

Shortages

Disruption of oil supply

September 11, 2001

Positives Negatives

Bush says positives to boost consumer confidence

WAR—September 11th

Lower Interest Rates

Bush give money to families

“New Discoveries” advertized

September 11, 2001

“It’s often said that if you ask ten economists the same question you will get ten different answers.”

“Economists were virtually unanimous in their forecast that the horrific tragedy of September 11, 2001, would lead to a contraction of economic activity.”

--Naked Economics, page xii

Review

Are these positive factors, or negative factors?

Expansionary

Business Hire more workers.

Expansionary

Businesses borrow money from banks

Expansionary

People feel good about the economy

Contraction

The government increases interest rates

Expansionary

Businesses increase output

Contraction

The United States enters a war

Standards

6.1.12 CD 6.2.12 I 6.4.12 ABCDEFG 6.5.12 E