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Measuring U.S. GDP

GDP data compiled by The Bureau of

Economic Analysis

Two approaches -

The expenditure approach

The income approach

Expenditure = Income

In every transaction, one

person’s expenditure is

another person’s income.

The Expenditure Approach

GDP is measured as the sum of consumption

expenditure, business investment expenditure,

government expenditure on goods and services,

and net exports.

GDP = C + I + G + (X M)

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The Income Approach to GDP • GDP is measured as the sum of factor payments

earned by all households in the economy (wages

and salaries, rent, interest, and profit)

• Factor payments

– Payments to the owners of resources that are

used in production

• Total output of the economy (GDP) = total

income earned in the economy = total

expenditure.

• This is all you need to know.

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Simple Circular Flow

Incom e ($)

Labor

Goods (bread)

Expenditure ($)

Households Firms

The circular flow diagram shows

the income received and

payments made by each

sector of the economy.

Value Added Approach to GDP

Important Concept - Not in the Book

• Value added

– Revenue a firm receives minus amount paid for

goods and services purchased from other firms

(intermediate goods)

• Value-added approach to GDP

– GDP = sum the values added by all firms in

the economy

– Value added = Wages + Interest + Rents + Profits

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Value Added at Different Stages of Production

Notebook Example:

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$5.00 is the value of the final expenditure

Value Added at Different Stages of Production

Notebook Example:

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$5.00 is the value of the final expenditure

Intermediate

transactions

The Factor Payments Approach – Using the

Notebook Paper Example

Value Added goes to the factors of production

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Measuring U.S. GDP

GDP: Is it Nominal or Real?

Nominal GDP is the value of goods and services

produced during a given year valued at the prices

that prevailed in that same year.

Real GDP is the value of final goods and services

produced in a given year when valued at the

prices of a reference base year.

- Currently, the reference base year is 2009

- We describe real GDP as measured in 2009

dollars.

Calculating Real GDP

This table shows the

quantities produced and

the prices in 2009 (the

base year).

Nominal GDP in 2009 is

$100 million.

Because 2009 is the base

year, real GDP equals

nominal GDP and is $100

million.

Measuring U.S. GDP

Table (b) shows the

quantities produced and

the prices in 2014.

Nominal GDP in 2014 is

$300 million.

Nominal GDP in 2014 is

three times its value in

2009.

Measuring U.S. GDP

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In Table (c), we calculate

real GDP in 2014.

The quantities are those

of 2014, as in part (b).

The prices are those in

the base year (2009), as

in part (a).

The sum of these

expenditures is real GDP

in 2014, which is $160

million.

Measuring U.S. GDP

How Real GDP Is Used

• Short-run

• Measure fluctuations in economic activity.

- recession or

- too-rapid expansion that can overheat

the economy

• Long-run

– Measure the long-run growth rate of the

economy’s output

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How Real GDP is Used

Measure the Standard of Living Over

Time

Real GDP per person is real GDP divided by the

population.

Real GDP per person tells us the value of goods

and services that the average person can enjoy.

By using real GDP, we remove any influence that

rising prices and rising cost of living might have

on our comparison.

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How Real GDP is Used

How Real GDP is Used

Two features of expanding living standard are

The growth of potential GDP per person

Fluctuations of actual real GDP around potential GDP

Potential GDP - The value of real GDP when all the

economy’s labor, capital, land, and entrepreneurial ability

are fully employed. Its an estimate of the economy's

potential

Actual GDP – What actually happened.

This figure shows U.S.

real GDP per person.

Potential GDP grows at a

steady pace because the

quantities of the factors of

production and their

productivity grow at a

steady pace.

Real GDP fluctuates

around potential GDP.

How Real GDP is Used

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Real GDP per person in

the United States:

Doubled between 1960

and 1987.

Was 3 times its 1960 level

in 2013.

How Real GDP is Used

How Real GDP is Used

Productivity Growth Slowdown

The growth rate of real GDP per person slowed after 1970.

How costly was that slowdown?

The answer is provided by a number that we’ll call the

Lucas wedge.

The Lucas wedge is the dollar value of the accumulated

gap between what real GDP per person would have been

if the 1960s growth rate had persisted and what real GDP

per person turned out to be.

Figure 21.3 illustrates the

Lucas wedge.

The red line is actual real

GDP per person.

The thin black line is the

trend that real GDP per

person would have followed

if the 1960s growth rate of

potential GDP had

persisted.

The shaded area is the

Lucas wedge.

How Real GDP is Used

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How Real GDP is Used

The Business Cycle - Real GDP Fluctuations

A business cycle is a periodic but irregular up-and-down

movement of total production and other measures of

economic activity.

Every cycle has two phases:

1. Expansion

2. Recession

and two turning points:

1. Peak

2. Trough

business cycle The cycle of short-term ups and downs in

the economy.

aggregate output The total quantity of goods and services

produced in an economy in a given period – called GDP

recession A period during which aggregate output

declines. Conventionally, a period in which aggregate

output declines for two consecutive quarters.

depression A prolonged and deep recession.

Output and Growth – Important Concepts

expansion or boom The period in the business cycle from

a trough up to a peak during which output and employment

grow.

contraction, recession, or slump The period in the

business cycle from a peak down to a trough during which

output and employment fall.

The Business Cycle

peak

trough

+3%

+4%

-2%

Three growth rates presented:

(1) the long-run upward trend is 3%;

(2) in a recession, output falls (growth is negative);

(3) in the expansion phase of the cycle, growth rate is higher than the trend.

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• What drives trend growth?

• What causes expansions and recessions?

• What macroeconomic policies can be used to

offset recessions or to sustain expansions?

• What has caused the recent/current

recession - often referred to as the “Great

Recession”?

Economic Growth Questions

This figure illustrates the

current business cycle.

An expansion is a period

during which real GDP

increases—from a trough

to a peak.

Recession is a period

during which real GDP

decreases—its growth

rate is negative for at least

two successive quarters.

How Real GDP is Used

http://cafehayek.com/2012/09/the-numbers-game.html

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.

Environmental quality.

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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.

Mathematical Note:

SKIP Chained-Dollar Real GDP

The BLS uses a measure of real GDP called chained-

dollar real GDP.

Three steps are needed to calculate this measure:

Value production in the prices of adjacent years

Find the average of two percentage changes

Link (chain) back to the reference year

A time-series graph

measures

Time on the x-axis

The variable in which

we are interested on

the y-axis.

Graphs:

The Graph on the Previous Slide is a Time-Series Graph

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Figure in the appendix

shows the average prices

paid by consumers 1974 to

2014.

In 1974, the price is set at

100.

The price in other years is

measured as a percentage

of the 1974 level.

Prices look as if they rose at

a fairly constant rate.

Time-Series Graph – Ratio Scale

On the y-axis of a normal

graph, the gap between 100

and 200 is the same as that

between 300 and 400.

On a graph with a ratio

scale, the gap between 100

and 200 is same as that

between 200 and 400.

The ratio of 200 to 100

equals the ratio of 400 to

200 - a constant ratio gap.

Time-Series Graph - Using a Ratio

Scale

Graphing data on a ratio

scale reveals the trend.

The steeper the line, the

faster is the growth rate of

prices.

Prices rose rapidly in the

1970s and early 1980s

and more slowly in the

later 1980s, 1990s, and

2000s.

Time-Series Graph - Using a Ratio Scale