Introduction to Gross Domestic Product

1
Introduction to Gross Domestic Product
2
Learning Objectives

• Define gross domestic product and explain how it
  is measured using the expenditure approach.
• Explain the difference between nominal and real
  GDP.

3
(No Transcript)
4
(No Transcript)
5
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?

6
Expansion and ContractionThe 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.

7
Real GDP, 1900-2002
8
Real GDP, 1970 I-2003 II
9
Macroeconomic Concerns

• Three of the major concerns of macroeconomics
  are
• Inflation
• Unemployment
• Output growth

10
Output GrowthShort Run and Long Run

• The business cycle is the cycle of short-term 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.

11
Output GrowthShort 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.

12
The Components ofthe Macroeconomy

• Everyones expenditure is someone elses receipt.
  Every transaction must have two sides.

13
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

14
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

15
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

16
Calculating GDP

• 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

17
The Expenditure Approach

• The expenditure approach calculates GDP by adding
  together the four components of spending. In
  equation form

18
The Circular Flow of Income and Expenditure
19
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)

20
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.

21
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.

22
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.

23
Government Consumptionand Gross Investment

• Government consumption and gross investment (G)
  counts expenditures by federal, state, and local
  governments for final goods and services.

24
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).

25
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

26

Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach Components of GDP, 2002 The Expenditure Approach
BILLIONS OFDOLLARS BILLIONS OFDOLLARS PERCENTAGEOF GDP PERCENTAGEOF GDP
Personal consumption expenditures (C) Personal consumption expenditures (C) Personal consumption expenditures (C) 7303.7 69.9
Durable goods Durable goods 871.9 8.3
Nondurable goods Nondurable goods 2115.0 20.2
Services Services 4316.8 41.3
Gross private domestic investment (l) Gross private domestic investment (l) Gross private domestic investment (l) 1543.2 14.8
Nonresidential Nonresidential 1117.4 10.7
Residential Residential 471.9 4.5
Change in business inventories Change in business inventories 3.9 0
Government consumption and gross investment (G) Government consumption and gross investment (G) Government consumption and gross investment (G) 1972.9 18.9
Federal Federal 693.7 6.6
State and local State and local 1279.2 12.2
Net exports (EX IM) Net exports (EX IM) Net exports (EX IM) - 423.6 - 4.1
Exports (EX) Exports (EX) 1014.9 9.8
Imports (IM) Imports (IM) 1438.5 13.8
Total gross domestic product (GDP) Total gross domestic product (GDP) Total gross domestic product (GDP) 10446.2 100.0
Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis. Note Numbers may not add exactly because of rounding.Source U.S. Department of Commerce, Bureau of Economic Analysis.
27
Current and Historical Data

• US data (BEA)
• http//www.bea.doc.gov/bea/newsrel/gdp499p.htm
• Historical US Data
• http//eh.net/hmit/gdp/
• International
• http//www.stls.frb.org/publications/iet/
• http//www.odci.gov/cia/publications/factbook/

28
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.

29
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.

30
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.

31
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.

32
Per Capita Gross National Income for Selected Countries, 2002 Per Capita Gross National Income for Selected Countries, 2002 Per Capita Gross National Income for Selected Countries, 2002 Per Capita Gross National Income for Selected Countries, 2002 Per Capita Gross National Income for Selected Countries, 2002
COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS
Switzerland 36,970 Portugal 10,670
Japan 35,990 South Korea 9,400
Norway 35,530 Argentina 6,860
United States 34,870 Mexico 5,540
Denmark 31,090 Czech Republic 5,270
Ireland 28,880 Brazil 3,060
Sweden 25,400 South Africa 2,900
United Kingdom 24,230 Turkey 2,540
Netherlands 24,040 Colombia 1,910
Austria 23,940 Jordan 1,750
Finland 23,840 Romania 1,710
Germany 23,700 Philippines 1,050
Belgium 23,340 China 890
France 22,640 Indonesia 680
Canada 21,340 India 460
Australia 18,770 Pakistan 420
Italy 18,470 Nepal 250
Spain 14,860 Rwanda 220
Greece 11,780 Ethiopia 100
Source The World Bank Atlas, 2002. Source The World Bank Atlas, 2002. Source The World Bank Atlas, 2002. Source The World Bank Atlas, 2002. Source The World Bank Atlas, 2002.
33
Accounting for Price Changes
34
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.

35
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

36
The Simplest Example of a Price Index (One
Product)
37
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

38
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.

39
Calculating Real GDP
A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy A Three-Good Economy
(1) (1) (1) (2) (2) (3) (3) (3) (4) (4) (5) (5) (6) (6) (7) (7) (8) (8)
GDP IN GDP IN GDP IN GDP IN GDP IN GDP IN GDP IN GDP IN
YEAR 1 YEAR 1 YEAR 2 YEAR 2 YEAR 1 YEAR 1 YEAR 2 YEAR 2
IN IN IN IN IN IN IN IN
PRODUCTION PRODUCTION PRODUCTION PRODUCTION PRODUCTION PRICE PER UNIT PRICE PER UNIT PRICE PER UNIT PRICE PER UNIT PRICE PER UNIT YEAR 1 YEAR 1 YEAR 1 YEAR 1 YEAR 2 YEAR 2 YEAR 2 YEAR 2
YEAR 1 YEAR 1 YEAR 2 YEAR 2 YEAR 2 YEAR 1 YEAR 1 YEAR 2 YEAR 2 YEAR 2 PRICES PRICES PRICES PRICES PRICES PRICES PRICES PRICES
Q1 Q1 Q2 Q2 Q2 P1 P1 P2 P2 P2 P1 x Q1 P1 x Q1 P1 x Q2 P1 x Q2 P2 x Q1 P2 x Q1 P2 X Q2 P2 X Q2
Good A 6 11 11 .50 .40 .40 3.00 5.50 2.40 4.40
Good B 7 4 4 .30 1.00 1.00 2.10 1.20 7.00 4.00
Good C 10 12 12 .70 .90 .90 7.00 8.40 9.00 10.80
Total 12.10 15.10 18.40 19.20
Nominal GDPin year 1 Nominal GDPin year 1 Nominal GDPin year 2 Nominal GDPin year 2
40
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.

41
Hypothetical Data Used to Develop Chain-Weighted
Indexes
42
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.

43
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 Ive used in the past,
  or slides I just dont want to delete as I may
  use them in the future.

44
Introduction to Macroeconomics

• Macroeconomists often reflect on the
  microeconomic principles underlying macroeconomic
  analysis, or the microeconomic foundations of
  macroeconomics.

45
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.

46
The Components ofthe Macroeconomy

• The circular flow diagram shows the income
  received and payments made by each sector of the
  economy.

47
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.

48
Measuring Economic Aggregates
49
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

50
Calculating GDP

• 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 incomewages, rents, interest,
  and profitsreceived by all factors of production
  in producing final goods.

51
Gross Private Domestic Investment

• Remember that GDP is not the market value of
  total sales during a periodit is the market
  value of total production.
• The relationship between total production and
  total sales is

GDP final sales change in business inventories
52
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

53
Review Terms and Concepts
base year change in business inventories compensat
ion 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) gross domestic product (GDP) gross
investment gross national income (GNI) gross
national product (GNP) gross private domestic
investment (I) income approach indirect
taxes intermediate goods national income national
income and product accounts
54
Review Terms and Concepts
personal saving personal saving rate proprietors
income rental income residential
investment services subsidies underground
economy value added weight
net exports (EX IM) net factor payments to the
rest of the world net interest net investment net
national product (NNP) nominal GDP nondurable
goods nonresidential investment personal
consumption expenditures (C) personal income
55
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.

56
The Components ofthe Macroeconomy

• Transfer payments are payments made by the
  government to people who do not supply goods,
  services, or labor in exchange for these payments.

57
The Three Market Arenas

• Households, firms, the government, and the rest
  of the world all interact in three different
  market arenas
• Goods-and-services market
• Labor market
• Money (financial) market

58
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.

59
The Three Market Arenas

• In the money marketsometimes called the
  financial markethouseholds 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.

60
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.

61
Financial Instruments

• Shares of stock are financial instruments that
  give to the holder a share in the firms
  ownership and therefore the right to share in the
  firms profits.
• Dividends are the portion of a corporations
  profits that the firm pays out each period to its
  shareholders.

62
Review Terms and Concepts
aggregate behavior aggregate demand aggregate
output aggregate supply business cycle circular
flow contraction, recession, or slump corporate
bonds deflation depression
microeconomics monetary policy recession shares
of stock stagflation sticky prices supply-side
policies transfer payments Treasury bonds, notes,
bills unemployment rate
dividends expansion or boom fine tuning fiscal
policy Great Depression hyperinflation inflation m
acroeconomics microeconomic foundations of
macroeconomics
63
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.

64
Unemployment

• The unemployment rate is the percentage of the
  labor force that is unemployed.
• The unemployment rate is a key indicator of the
  economys 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?

65
Unemployment Rate, 1970 I-2003 II
66
Percentage Change in the GDP Deflator
(Four-Quarter Average), 1970 I-2003 II
67
Introduction to Macroeconomics

• Microeconomics examines the behavior of
  individual decision-making unitsbusiness 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.

68
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.

69
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 1930s.

70
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.

71
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.

72
Recent Macroeconomic History

• Fine-tuning was the phrase used by Walter Heller
  to refer to the governments role in regulating
  inflation and unemployment.
• The use of Keynesian policy to fine-tune the
  economy in the 1960s, led to disillusionment in
  the 1970s and early 1980s.

73
Recent Macroeconomic History

• Stagflation occurs when the overall price level
  rises rapidly (inflation) during periods of
  recession or high and persistent unemployment
  (stagnation).

74
Aggregate Supply andAggregate 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.

75
Government in the Macroeconomy

• There are three kinds of policy that the
  government has used to influence the
  macroeconomy
• Fiscal policy
• Monetary policy
• Growth or supply-side policies