Introduction to Gross Domestic Product
Learning Objectives • Define gross domestic product and explain how it is measured using the expenditure approach. • Explain the difference between nominal and real GDP.
Real GDP 13, 000 11, 000 9, 000 7, 000 5, 000 3, 000 1947: 11952: 11957: 11962: 11967: 11972: 11977: 11982: 11987: 11992: 11997: 12002: 12007: 1
4. 2 Log Real GDP 4. 1 4 3. 9 3. 8 3. 7 3. 6 3. 5 3. 4 3. 3 3. 2 Jan-47 Jan-52 Jan-57 Jan-62 Jan-67 Jan-72 Jan-77 Jan-82 Jan-87 Jan-92 Jan-97 Jan-02 Jan-07
GDP Dating Exercise • Describe the empirical facts before you (ie. GDP generally increases). • Identify peaks, valleys what happened. • Is there regularity in the frequency of changes?
Expansion and Contraction: The Business Cycle • An expansion, or boom, is the period in the business cycle from a trough up to a peak, during which output and employment rise. • A contraction, recession, or slump is the period in the business cycle from a peak down to a trough, during which output and employment fall.
Real GDP, 1900 -2002
Real GDP, 1970 I-2003 II
Macroeconomic Concerns • Three of the major concerns of macroeconomics are: – Inflation – Unemployment – Output growth
Output Growth: Short Run and Long Run • The business cycle is the cycle of shortterm ups and downs in the economy. • The main measure of how an economy is doing is aggregate output: – Aggregate output is the total quantity of goods and services produced in an economy in a given period.
Output Growth: Short Run and Long Run • A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession. • A prolonged and deep recession becomes a depression. • Policy makers attempt not only to smooth fluctuations in output during a business cycle but also to increase the growth rate of output in the long-run.
The Components of the Macroeconomy • Everyone’s expenditure is someone else’s receipt. Every transaction must have two sides.
An Overview of National Income and Product Accounting (NIPA) • • • Detailed calculations were first worked out by Simon Kuznets during the Great Depression Large quantities of data collected and organized from a variety of sources around the country These data are summarized, assembled into a coherent framework, and reported by the government
Gross Domestic Product and Gross National Product • GDP is the market value of all newly produced final goods and services produced by resources located in the United States, regardless of who owns those resources
Final and Intermediate Goods and Services • Final goods and services sold to ultimate, users – Cotton shirts are a final good • Intermediate goods and services are purchased for further reprocessing and resale – Cotton is intermediate good • Keeping final goods and intermediate goods separate in our thinking allows us to avoid double counting
Calculating GDP can be computed in two ways: • The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. • The income approach:
The Expenditure Approach • The expenditure approach calculates GDP by adding together the four components of spending. In equation form:
The Circular Flow of Income and Expenditure X-M consumption (C) S Financial markets Investment (I) Gov’t (G) transfer payments Disposable income taxes C+I+G+X-M aggregate income = GDP
Categories of Expenditures • Consumption (C) – All household purchases (blue jeans, twinkies, etc. ) • Investment (I) – Purchases not used for current consumption (newly built homes, plant, new inventories) • Government Purchases (G) – Examples include missile systems and paper clips • Net Exports (X - M) – Net exports = exports (X) - imports (M)
Personal Consumption Expenditures • Personal consumption expenditures (C) are expenditures by consumers on the following: – Durable goods: Goods that last a relatively long time, such as cars and appliances. – Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. – Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.
Gross Private Domestic Investment • Investment refers to the purchase of new capital. • Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector.
Gross Private Domestic Investment • Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. • Residential investment includes expenditures by households and firms on new houses and apartment buildings. • Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.
Government Consumption and Gross Investment • Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.
Net Exports • Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative. – Exports (EX) are sales to foreigners of U. S. produced goods and services. – Imports (IM) are U. S. purchases of goods and services from abroad).
Classify each of these scenarios • • You buy an old house You buy some marijuana from a friend You buy stock in GM A Japanese firm buys City Brewery The government makes a welfare payment You buy a used car A business fails to sell some of its inventory A business buys a new truck
Components of GDP, 2002: The Expenditure Approach BILLIONS OF DOLLARS Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories Government consumption and gross investment (G) Federal State and local Net exports (EX – IM) Exports (EX) Imports (IM) Total gross domestic product (GDP) Note: Numbers may not add exactly because of rounding. Source: U. S. Department of Commerce, Bureau of Economic Analysis. PERCENTAGE OF GDP 7303. 7 871. 9 2115. 0 4316. 8 1543. 2 1117. 4 471. 9 3. 9 1972. 9 69. 9 8. 3 20. 2 41. 3 14. 8 10. 7 4. 5 0 18. 9 693. 7 1279. 2 - 423. 6 1014. 9 1438. 5 10446. 2 6. 6 12. 2 - 4. 1 9. 8 13. 8 100. 0
Current and Historical Data • US data (BEA) – http: //www. bea. doc. gov/bea/newsrel/gdp 499 p. htm • Historical US Data – http: //eh. net/hmit/gdp/ • International – http: //www. stls. frb. org/publications/iet/ – http: //www. odci. gov/cia/publications/factbook/
GDP and Social Welfare • Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP. • An increase in leisure is an increase in social welfare, but not counted in GDP. • Nonmarket and household activities are not counted in GDP even though they amount to real production.
GDP and Social Welfare • GDP accounting rules do not adjust for production that pollutes the environment. • GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. • GDP is neutral to the kinds of goods an economy produces.
The Underground Economy • The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.
Gross National Income per Capita • To make comparisons of GNP between countries, currency exchange rates must be taken into account. • Gross National Income (GNI) is a measure used to make international comparisons of output. GNI is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation. • GNI divided by population equals gross national income per capita.
Per Capita Gross National Income for Selected Countries, 2002 COUNTRY Switzerland Japan Norway United States Denmark Ireland Sweden United Kingdom Netherlands Austria Finland Germany Belgium France Canada Australia Italy Spain Greece U. S. DOLLARS 36, 970 35, 990 35, 530 34, 870 31, 090 28, 880 25, 400 24, 230 COUNTRY Portugal South Korea Argentina Mexico Czech Republic Brazil South Africa Turkey 24, 040 23, 940 23, 840 23, 700 23, 340 22, 640 21, 340 18, 770 18, 470 14, 860 11, 780 Colombia Jordan Romania Philippines China Indonesia India Pakistan Nepal Rwanda Ethiopia Source: The World Bank Atlas, 2002. U. S. DOLLARS 10, 670 9, 400 6, 860 5, 540 5, 270 3, 060 2, 900 2, 540 1, 910 1, 750 1, 710 1, 050 890 680 460 420 250 220 100
Accounting for Price Changes
Nominal Versus Real GDP • Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. • When a variable is measured in current dollars, it is described in nominal terms.
Real GDP • Real GDP is the value of GDP measure in terms of dollars of fixed purchasing power • Real GDP is measured in the dollars of the base year • The base year is a reference year against which other years are measured
The Simplest Example of a Price Index (One Product)
The GDP Price Index, Nominal GDP, and Real GDP • The GDP price index is a comprehensive price index of all goods and services included in the gross domestic product
Calculating Real GDP • A weight is the importance attached to an item within a group of items. • A base year is the year chosen for the weights in a fixed-weight procedure. • A fixed-weight procedure uses weights from a given base year.
Calculating Real GDP A Three-Good Economy (1) (2) PRODUCTION YEAR 1 YEAR 2 Q 1 Q 2 (3) (4) PRICE PER UNIT YEAR 1 YEAR 2 P 1 P 2 (5) (6) (7) (8) GDP IN YEAR 1 PRICES P 1 x Q 1 GDP IN YEAR 2 IN YEAR 1 PRICES P 1 x Q 2 GDP IN YEAR 1 IN YEAR 2 PRICES P 2 x Q 1 GDP IN YEAR 2 PRICES P 2 X Q 2 Good A 6 11 $. 50 $. 40 $3. 00 $5. 50 $2. 40 $4. 40 Good B 7 4 . 30 1. 00 2. 10 1. 20 7. 00 4. 00 Good C 10 12 . 70 . 90 7. 00 8. 40 9. 00 10. 80 $12. 10 $15. 10 $18. 40 $19. 20 Total Nominal GDP in year 1 Nominal GDP in year 2
The Problems of Fixed Weights The use of fixed price weights to estimate real GDP leads to problems because it ignores: 1. Structural changes in the economy. 2. Supply shifts, which cause large decreases in price and large increases in quantity supplied. 3. The substitution effect of price increases.
Hypothetical Data Used to Develop Chain-Weighted Indexes
Calculating the GDP Deflator • The GDP deflator is one measure of the overall price level. The GDP deflator is computed by the Bureau of Economic Analysis (BEA). • Overall price increases can be sensitive to the choice of the base year. For this reason, using fixed-price weights to compute real GDP has some problems.
Appendix • Slides after this point will most likely not be covered in class. However they may contain useful definitions, or further elaborate on important concepts, particularly materials covered in the text book. • They may contain examples I’ve used in the past, or slides I just don’t want to delete as I may use them in the future.
Introduction to Macroeconomics • Macroeconomists often reflect on the microeconomic principles underlying macroeconomic analysis, or the microeconomic foundations of macroeconomics.
Government in the Macroeconomy • Fiscal policy refers to government policies concerning taxes and spending. • Monetary policy consists of tools used by the Federal Reserve to control the quantity of money in the economy. • Growth policies are government policies that focus on stimulating aggregate supply instead of aggregate demand.
The Components of the Macroeconomy • The circular flow diagram shows the income received and payments made by each sector of the economy.
The Methodology of Macroeconomics • Connections to microeconomics: – Macroeconomic behavior is the sum of all the microeconomic decisions made by individual households and firms. We cannot understand the former without some knowledge of the factors that influence the latter.
Measuring Economic Aggregates
Gross Domestic Product and Gross National Product • GDP is the market value of all final goods and services produced by resources located in the United States, regardless of who owns those resources • GNP is the market value of all final goods and services produced by resources supplied by U. S. residents and firms, regardless of location
Calculating GDP can be computed in two ways: • The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. • The 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.
Gross Private Domestic Investment • Remember that GDP is not the market value of total sales during a period—it is the market value of total production. • The relationship between total production and total sales is: GDP = final sales + change in business inventories
Consumer Price Index • The consumer price index is a measure over time of the cost of a fixed “market basket” of consumer goods and services
Review Terms and Concepts base year change in business inventories compensation of employees corporate profits current dollars depreciation disposable personal income, or after-tax income government consumption and gross investment (G) gross domestic product (GDP) gross investment gross national income (GNI) gross national product (GNP) gross private domestic investment (I) income approach durable goods indirect taxes expenditure approach intermediate goods final goods and services national income fixed-weight procedure national income and product accounts
Review Terms and Concepts net exports (EX – IM) personal saving net factor payments to the rest of the world personal saving rate net interest net investment net national product (NNP) nominal GDP nondurable goods nonresidential investment personal consumption expenditures (C) personal income proprietors’ income rental income residential investment services subsidies underground economy value added weight
Skip The slides that follow • We skipped some of the slides for time consideration and some because it is material I do not care to cover.
The Components of the Macroeconomy • Transfer payments are payments made by the government to people who do not supply goods, services, or labor in exchange for these payments.
The Three Market Arenas • Households, firms, the government, and the rest of the world all interact in three different market arenas: 1. Goods-and-services market 2. Labor market 3. Money (financial) market
The Three Market Arenas • Households and the government purchase goods and services (demand) from firms in the goods-and services market, and firms supply to the goods and services market. • In the labor market, firms and government purchase (demand) labor from households (supply). – The total supply of labor in the economy depends on the sum of decisions made by households.
The Three Market Arenas • In the money market—sometimes called the financial market—households purchase stocks and bonds from firms. – Households supply funds to this market in the expectation of earning income, and also demand (borrow) funds from this market. – Firms, government, and the rest of the world also engage in borrowing and lending, coordinated by financial institutions.
Financial Instruments • Treasury bonds, notes, and bills are promissory notes issued by the federal government when it borrows money. • Corporate bonds are promissory notes issued by corporations when they borrow money.
Financial Instruments • Shares of stock are financial instruments that give to the holder a share in the firm’s ownership and therefore the right to share in the firm’s profits. – Dividends are the portion of a corporation’s profits that the firm pays out each period to its shareholders.
Review Terms and Concepts aggregate behavior dividends microeconomics aggregate demand expansion or boom monetary policy aggregate output fine tuning recession aggregate supply fiscal policy shares of stock business cycle Great Depression stagflation circular flow hyperinflation sticky prices contraction, recession, or slump inflation supply-side policies macroeconomics transfer payments microeconomic foundations of macroeconomics Treasury bonds, notes, bills corporate bonds deflation depression unemployment rate
Inflation and Deflation • Inflation is an increase in the overall price level. • Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations are rare, but have been used to study the costs and consequences of even moderate inflation. • Deflation is a decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation.
Unemployment • The unemployment rate is the percentage of the labor force that is unemployed. • The unemployment rate is a key indicator of the economy’s health. • The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium. Why do labor markets not clear when other markets do?
Unemployment Rate, 1970 I-2003 II
Percentage Change in the GDP Deflator (Four. Quarter Average), 1970 I-2003 II
Introduction to Macroeconomics • Microeconomics examines the behavior of individual decision-making units—business firms and households. • Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. – Aggregate behavior refers to the behavior of all households and firms together.
Introduction to Macroeconomics • Microeconomists generally conclude that markets work well. Macroeconomists, however, observe that some important prices often seem “sticky. ” • Sticky prices are prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded.
The Roots of Macroeconomics • The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930 s.
The Roots of Macroeconomics • Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems. • However, simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. This provided the impetus for the development of macroeconomics.
The Roots of Macroeconomics • In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. • Keynes believed governments could intervene in the economy and affect the level of output and employment. • During periods of low private demand, the government can stimulate aggregate demand to lift the economy out of recession.
Recent Macroeconomic History • Fine-tuning was the phrase used by Walter Heller to refer to the government’s role in regulating inflation and unemployment. • The use of Keynesian policy to fine-tune the economy in the 1960 s, led to disillusionment in the 1970 s and early 1980 s.
Recent Macroeconomic History • Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).
Aggregate Supply and Aggregate Demand • Aggregate demand is the total demand for goods and services in an economy. • Aggregate supply is the total supply of goods and services in an economy. • Aggregate supply and demand curves are more complex than simple market supply and demand curves.
Government in the Macroeconomy • There are three kinds of policy that the government has used to influence the macroeconomy: 1. Fiscal policy 2. Monetary policy 3. Growth or supply-side policies
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