Gross Domestic Product and Gross National Product

1
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

2
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

3
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

4
The Expenditure Approach

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

5
The Circular Flow of Income and Expenditure
6
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)

7
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.

8
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.

9
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.

10
Government Consumptionand Gross Investment

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

11
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).

12
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

13

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.
14
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/

15
The Keynesian Framework and the ISLM Model
16
Determination of Output

• Keynesian ISLM Model assumes price level is fixed
• Aggregate Expenditures
• AE C I G NX
• Equilibrium
• Y AE
• Consumption Function
• C a (mpc ? YD)
• Investment
• 1. Fixed investment
• 2. Inventory investment
• Only planned investment is included in AE
• NOTE In many of the Slides Yd in place of AE
  they are the same thing.

17
Consumption Function
18
Keynesian Cross Diagram
AE
YAE
AE

• Assume G 0, NX 0, T 0
• AE C I 200 .5Y 300 500 .5Y
• Equilibrium
• 1. When Y gt Y, Iu gt 0 ? Y ? to Y
• 2. When Y lt Y, Iu lt 0 ? Y ? to Y

19
Expenditure Multiplier
20
Analysis of Figure 3 Expenditure Multiplier

• ?I 100 ? ?Y/?I 200/100 2
• 1
• Y (a I) ?
• 1 mpc
• A a I autonomous spending
• Conclusions
• 1. Expenditure multiplier ?Y/?A 1/(1
  mpc) whether change in A is due to change in a
  or I
• 2. Animal spirits change A

21
The Great Depression and the Collapse of
Investment
22
Role of Government
23
Analysis of Figure 5 Role of Government

• ?G 400, ? T 400
• 1. With no G and T, Yd C I 500 mpc ??Y
  500 .5Y, Y1 1000
• 2. With G, Y C I G 900 .5Y, Y2 1800
• 3. With G and T, Yd 900 mpc ? Y mpc ??T
  700 .5Y, Y3 1400
• Conclusions
• 1. G ? Y ? T ? Y ?
• 2. ?G ?T 400, Y ? 400

24
Role of International Trade

• ?NX 100,
• ?Y/?NX 200/100 2 1/(1 mpc) 1/(1 .5)

25
Summary Factors that Affect Y
26
IS Curve

• IS curve
• 1. i ? I ? NX ?, Yad ?, Y ?
• Points 1, 2, 3 in figure
• 2. Right of IS Y gt Yad ? Y ? to IS
• Left of IS Y lt Yad ? Y ? to IS

27
LM Curve

• LM curve
• 1. Y ?, Md ?, i ? Points 1, 2, 3 in figure
• 2. Right of LM excess Md, i ? to LM Left of LM
  excess Ms, i ? to LM

28
ISLM Model

• Point E, equilibrium where Y Yad (IS) and Md
  M s (LM )
• At other points like A, B, C, D, one of two
  markets is not in equilibrium and arrows mark
  movement towards point E

29
Monetary and Fiscal Policy in the ISLM Model
30
Shift in the IS Curve

• 1. C ? at given iA, Yad ?, Y ? ? IS shifts right
• 2. Same reasoning when I ?, G ?, NX ?, T ?

31
Shift in the LM Curve from a Rise in Ms

• 1. Ms ? at given YA, i ? in panel (b) and (a) ?
  LM shifts to the right

32
Shift in the LM Curve from a Rise in M d

• 1. M d ? at given YA, i ? in panel (b) and (a) ?
  LM shifts to the left

33
Response to an Increase in Ms

• 1. M s ? i ?, LM shifts right ? Y ? i ?

34
Response to Expansionary Fiscal Policy

• 1. G ? or T ? Yad ?, IS shifts right ? Y ? i ?

35
Summary Factors that Shift IS and LM Curves
36
Effectiveness of Monetary and Fiscal Policy

• 1. M d is unrelated to i ? i ?, M d M s at same
  Y ? LM vertical
• 2. Panel (a) G ?, IS shifts right ? i ?, Y stays
  same (complete crowding out)
• 3. Panel (b) M s ?, Y? so M d ?, LM shifts right
  ? i ? Y ?
• Conclusion Less interest sensitive is M d, more
  effective is monetary policy relative to fiscal
  policy

37
Ms vs. i Targets When IS Unstable

• 1. IS unstable fluctuates from IS' to IS''
• 2. i target at i Y fluctuates from YI' to YI''
• 3. M target, LM LM Y fluctuates from YM' to
  YM''
• 4. Y fluctuation is less with M target
• Conclusion If IS curve is more unstable than LM
  curve, M target is preferred

38
Ms vs. i Targets When LM Unstable

• 1. LM unstable fluctuates from LM' to LM''
• 2. i target at i Y Y
• 3. M target Y fluctuates from YM' to YM''
• 4. Y fluctuation is less with i target
• Conclusion If LM curve is more unstable than IS
  curve, i target is preferred

39
The ISLM Model in the Long Run

• Panel (a)
• 1. Ms ?, LM right to LM2, go to point 2, i to i2,
  Y to Y2
• 2. Because Y2 gt Yn, P ?, M/P ?, LM back to LM1,
  go back to point 1
• Panel (b)
• 1. G ?, IS right to IS2, go to point 2 where i
  i2 and Y Y2
• 2. Because Y2 gt Yn, P ?, M/P ?, LM left to LM2,
  go to point 2', i i2 and Y Yn.

40
Deriving AD Curve

• P ?, M/P ?, LM shifts in, Y ?
• Points 1, 2, 3

41
Shift in AD from Shift in IS

• At given PA, IS shifts right Y ? in panel (b) ?
  AD shifts right in panel (a)

42
Shift in AD from Shift in LM

• At given PA, LM shifts right Y ? in panel (b) ?
  AD shifts right in panel (a)

43
The Aggregate Supply Curve

• Aggregate supply is the total supply of all goods
  and services in the economy.

44
The Aggregate Supply Curve

• The aggregate supply (AS) curve is a graph that
  shows the relationship between the aggregate
  quantity of output supplied by all firms in an
  economy and the overall price level.

45
The Aggregate Supply CurveA Warning

• The aggregate supply curve is not a market supply
  curve or the sum of all the individual supply
  curves in the economy.

46
The Aggregate Supply CurveA Warning

• Firms do not simply respond to market-determined
  prices, but they actually set prices.
  Price-setting firms do not have individual supply
  curves because these firms are choosing both
  output and price at the same time.

47
The Aggregate Supply CurveA Warning

• When we draw a firms supply curve, we assume
  that input prices are constant. In
  macroeconomics, an increase in the overall price
  level means that at least some input prices will
  be rising as well.
• The outputs of some firms are the inputs of other
  firms.

48
The Aggregate Supply CurveA Warning

• Rather than an aggregate supply curve, what does
  exist is a price/output response curve a
  curve that traces out the price and output
  decisions of all the markets and firms in the
  economy under a given set of circumstances.

49
Aggregate Supply in the Short Run

• In the short run, the aggregate supply curve (the
  price/output response curve) has a positive slope.

50
Aggregate Supply in the Short Run

• At low levels of aggregate output, the curve is
  fairly flat. As the economy approaches capacity,
  the curve becomes nearly vertical. At capacity,
  the curve is vertical.

51
Aggregate Supply in the Short Run

• Macroeconomists focus on whether or not the
  economy as a whole is operating at full capacity.
• As the economy approaches maximum capacity, firms
  respond to further increases in demand only by
  raising prices.

52
Output Levels andPrice/Output Responses

• When the economy is operating at low levels of
  output, an increase in aggregate demand is likely
  to result in an increase in output with little or
  no increase in the overall price level.

53
The Response of Input Prices to Changes in the
Overall Price Level

• There must be a lag between changes in input
  prices and changes in output prices, otherwise
  the aggregate supply (price/output response)
  curve would be vertical.

54
The Response of Input Prices to Changes in the
Overall Price Level

• Wage rates may increase at exactly the same rate
  as the overall price level if the price-level
  increase is fully anticipated. Most input
  prices, however, tend to lag increases in output
  prices.

55
Shifts of the Short-RunAggregate Supply Curve

• A cost shock, or supply shock, is a change in
  costs that shifts the aggregate supply (AS) curve.

56
Shifts of the Short-RunAggregate Supply Curve
57
The Equilibrium Price Level

• The equilibrium price level is the point at which
  the aggregate demand and aggregate supply curves
  intersect.

58
The Equilibrium Price Level

• P0 and Y0 correspond to equilibrium in the goods
  market and the money market and a set of
  price/output decisions on the part of all the
  firms in the economy.

59
The Long-RunAggregate Supply Curve

• Costs lag behind price-level changes in the short
  run, resulting in an upward-sloping AS curve.

• Costs and the price level move in tandem in the
  long run, and the AS curve is vertical.

60
The Long-RunAggregate Supply Curve

• Output can be pushed above potential GDP by
  higher aggregate demand. The aggregate price
  level also rises.

61
The Long-RunAggregate Supply Curve

• When output is pushed above potential, there is
  upward pressure on costs, and this causes the
  short-run AS curve to the left.

• Costs ultimately increase by the same percentage
  as the price level, and the quantity supplied
  ends up back at Y0.

62
The Long-RunAggregate Supply Curve

• Y0 represents the level of output that can be
  sustained in the long run without inflation. It
  is also called potential output or potential GDP.

63
Aggregate Demand, AggregateSupply, and Monetary
and Fiscal Policy

• AD can shift to the right for a number of
  reasons, including an increase in the money
  supply, a tax cut, or an increase in government
  spending.

• Expansionary policy works well when the economy
  is on the flat portion of the AS curve, causing
  little change in P relative to the output
  increase.

64
Aggregate Demand, AggregateSupply, and Monetary
and Fiscal Policy

• On the steep portion of the AS curve,
  expansionary policy does not work well. The
  multiplier is close to zero.

• When the economy is operating near full capacity,
  an increase in AD will result in an increase in
  the price level with little increase in output.

65
Long-Run AggregateSupply and Policy Effects

• If the AS curve is vertical in the long run,
  neither monetary policy nor fiscal policy has any
  effect on aggregate output.

• In the long run, the multiplier effect of a
  change in government spending or taxes on
  aggregate output is zero.

66
The Simple KeynesianAggregate Supply Curve

• The output of the economy cannot exceed the
  maximum output of YF.
• The difference between planned aggregate
  expenditure and aggregate output at full capacity
  is sometimes referred to as an inflationary gap.

67
Causes of Inflation

• Inflation is an increase in the overall price
  level.
• Sustained inflation occurs when the overall price
  level continues to rise over some fairly long
  period of time.

68
Causes of Inflation

• Demand-pull inflation is inflation initiated by
  an increase in aggregate demand.

• Cost-push, or supply-side, inflation is inflation
  caused by an increase in costs.