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GDP and the Standard of Living

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Title: GDP and the Standard of Living


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14
GDP and the Standard of Living
CHAPTER
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C H A P T E R C H E C K L I S T
  • When you have completed your study of this
    chapter, you will be able to
  • 1 Define GDP and explain why the value of
    production, income, and expenditure are the same
    for an economy.
  • 2 Describe how economic statisticians measure
    GDP an distinguish between nominal GDP and real
    GDP.
  • 3 Describe and explain the limitations of real
    GDP as a measure of the standard of living.

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14.1 GDP, INCOME, AND EXPENDITURE
  • GDP Defined
  • Gross domestic product or GDP
  • The market value of all the final goods and
    services produced within a country in a given
    time period.
  • Value Produced
  • Use market prices to value production.

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14.1 GDP, INCOME, AND EXPENDITURE
  • What Produced
  • Final good or service is a good or service that
    is produced for its final user and not as a
    component of another good or service.
  • Intermediate good or service is a good or service
    that is produced by one firm, bought by another
    firm, and used as a component of a final good or
    service.
  • GDP includes only those items that are traded in
    markets.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Where Produced
  • Within a country
  • When Produced
  • During a given time period.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Circular Flows in the U.S. Economy
  • Consumption expenditure is the expenditure by
    households on consumption goods and services.
  • Investment is the purchase of new capital goods
    (tools, instruments, machines, buildings, and
    other constructions) and additions to inventories.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Government expenditure on goods and services is
    the expenditure by all levels of government on
    goods and services.
  • Net exports of goods and services is the value of
    exports of goods and services minus the value of
    imports of goods and services.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Exports of goods and services are the items that
    firms in in the United States produce and sell to
    the rest of the world.
  • Imports of goods and services are the items that
    households, firms, and governments in the United
    States buy from the rest of the world.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Total expenditure is the total amount received by
    producers of final goods and services.
  • Consumption expenditure C
  • Investment I
  • Government expenditure on goods and services G
  • Net exports NX
  • Total expenditure C I G NX

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14.1 GDP, INCOME, AND EXPENDITURE
  • Income
  • Labor earns wages.
  • Capital earns interest.
  • Land earns rent.
  • Entrepreneurship earns profits.
  • Households receive these incomes.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Expenditure Equals Income
  • Because firms pay out everything they receive as
    incomes to the factors of production, total
    expenditure equals total income.
  • That is
  • Y C I G NX
  • The value of production equals income equals
    expenditure.

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14.1 GDP, INCOME, AND EXPENDITURE
  • Figure 14.1 shows the circular flow of income and
    expenditure.
  • The table shows the U.S. data for 2007.

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14.2 MEASURING U.S. GDP
  • The Expenditure Approach
  • Measures GDP by using data on consumption
    expenditure, investment, government expenditure
    on goods and services, and net exports.
  • Table 14.1 on the next slide shows the
    calculation for 2007.

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14.2 MEASURING U.S. GDP
  • Expenditures Not in GDP
  • Used Goods
  • Expenditure on used goods is not part of GDP
    because these goods were part of GDP in the
    period in which they were produced and during
    which time they were new goods.
  • Financial Assets
  • When households buy financial assets such as
    bonds and stocks, they are making loans, not
    buying goods and services.

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14.2 MEASURING U.S. GDP
  • The Income Approach
  • Measures GDP by summing the incomes that firms
    pay households for the factors of production they
    hire.
  • The U.S. National Income and Product Account
    divide incomes into two big categories
  • Wages
  • Interest, rent, and profits

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14.2 MEASURING U.S. GDP
  • Wages
  • Wages, called compensation of employees in the
    national accounts, is the payment for labor
    services.
  • It includes net wages and salaries plus fringe
    benefits paid by employers such health care
    insurance, social security contributions, and
    pension fund contributions.

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14.2 MEASURING U.S. GDP
  • Interest, Rent, and Profit
  • Interest, rent, and profit, called net operating
    surplus in the national account, is the sum of
    the incomes earned by capital, land, and
    entrepreneurship.
  • Interest is the income households receive on
    loans they make minus the interest they pay on
    their borrowing.
  • Rent includes payments for the use of land and
    other rented inputs.
  • Profit includes the profits of corporations and
    small businesses.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP
  • Net domestic product at factor cost is the sum of
    wages, interest, rent, and profit.
  • Net domestic product at factor cost is not GDP.
  • We need to make two adjustments to arrive at GDP
  • One from factor cost to market prices
  • One from net product to gross product

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14.2 MEASURING U.S. GDP
  • From Factor Cost to Market Price
  • The expenditure approach values goods at market
    prices the income approach values them at factor
    cost.
  • Indirect taxes (such as sales taxes) make market
    prices exceed factor cost.
  • Subsidies (payments by government to firms) make
    factor cost exceed market prices.
  • To convert the value at factor cost to the value
    at market prices, we must
  • Add indirect taxes and subtract subsidies

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP
  • From Gross to Net
  • The expenditure approach measures gross product
    the income approach measures net product.
  • Gross profit is a firms profit before
    subtracting the depreciation of capital.
  • Net profit is a firms profit after subtracting
    the depreciation of capital.
  • Depreciation is the decrease in the value of
    capital that results from its use and from
    obsolescence.

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14.2 MEASURING U.S. GDP
  • Income includes net profit, so the income
    approach gives a net measure.
  • Expenditure includes investment. Because some new
    capital is purchased to replace depreciated
    capital, the expenditure approach gives a gross
    measure.
  • To get gross domestic product from the income
    approach, we must add depreciation to total
    income.
  • After making these two adjustments the income
    approach almost gives the same estimate of GDP as
    the expenditure approach.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP
  • Statistical Discrepancy
  • The income approach and the expenditure approach
    do not deliver exactly the same estimate of
    GDPthere is a statistical discrepancy.
  • Statistical discrepancy is the discrepancy
    between the expenditure approach and income
    approach estimates of GDP, calculated as the GDP
    expenditure total minus the GDP income total.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP
  • GDP and Related Measures of Production and Income
  • Gross national product or GNP is the market value
    of all the final goods and services produced
    anywhere in the world in a given time period by
    the factors of production supplied by residents
    of the country.
  • U.S. GNP U.S. GDP Net factor income from
    abroad

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14.2 MEASURING U.S. GDP
  • Disposable Personal Income
  • Consumption expenditure is one of the largest
    components of aggregate expenditure and one of
    the main influences on it is disposable personal
    income.
  • Disposable personal income is the income
    received by households minus personal income
    taxes paid.

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14.2 MEASURING U.S. GDP
  • Figure 14.2 shows the relationship between GDP,
    GNP, and disposable personal income.

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14.2 MEASURING U.S. GDP
  • Real GDP and Nominal GDP
  • Real GDP is the value of the final goods and
    services produced in a given year expressed in
    the prices of the base year.
  • Nominal GDP is the value of the final goods and
    services produced in a given year expressed in
    the prices of that same year.
  • The method of calculating real GDP changed in
    recent years. Here we describe the essence of the
    calculation. The appendix gives the technical
    details.

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14.2 MEASURING U.S. GDP
  • Calculating Real GDP
  • The goal of calculating real GDP is to measure
    the extent to which total production has
    increased
  • Real GDP removes the influence of price changes
    from the nominal GDP numbers.
  • To focus on the principles and keep the numbers
    easy to work with, well calculate real GDP for
    an economy that produces only one consumption
    good, one capital good, and one government
    service.

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14.2 MEASURING U.S. GDP
  • Table 14.3 shows the calculation with 2000 (base
    year) and 2008.
  • To find the total expenditure in 2000 multiply
    the quantity of each item produced in 2000 by its
    price in 2000.
  • Then sum the expenditures to find nominal GDP in
    2000.
  • The next slide shows the data.

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Nominal GDP in 2000 is 100 million. Because
2000 is the base year, real GDP in 2000 is also
100 million.
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14.2 MEASURING U.S. GDP
  • In part (b) of Table 14.3, we calculate nominal
    GDP in 2008.
  • Again, we calculate nominal GDP by multiplying
    the quantity of each item produced by its price
    and then sum the expenditures to find nominal GDP
    in 2008.

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Nominal GDP in 2000 is 100 million. Nominal GDP
in 2008 is 300 million.
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14.2 MEASURING U.S. GDP
Nominal GDP in 2000 is 100 million and in 2008
it is 300 million.
  • Nominal GDP in 2008 is three times its value in
    2000.
  • But by how much has the quantity of final goods
    and services produced increased?

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14.2 MEASURING U.S. GDP
  • The increase in real GDP will tell by how much
    the quantity of good and services has increased.
  • Real GDP in 2008 is what the total expenditure
    would have been in 2008 if prices had remained
    the same as they were in 2000.
  • To calculate real GDP in 2008 multiply the
    quantities produced in 2008 by the price in 2000
    and the sum these expenditures to find real GDP
    in 2008.
  • Part (c) of Table 14.3 shows the details.

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Real GDP in 2000 is 100 million. Real GDP in
2008 is 160 milliononly 1.6 times real GDP in
2000.
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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • We use estimates of real GDP for two main
    purposes
  • To compare the standard of living over time
  • To compare the standard of living among countries
  • The Standard of Living Over Time
  • To compare living standards we calculate real GDP
    per personreal GDP divided by the population.
  • Table 14.4 shows two calculations

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • In 1967, real GDP in the United States was
    3,485 billion and the population of the United
    States was 198.7 million.
  • Real GDP per person 3,485 billion 198.7
    million
  • Real GDP per person 17,536
  • In most years, real GDP per person increases,
    but sometimes it doesnt change.

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Long-Term Trend
  • Figure 14.3 shows the long-term trend in U.S.
    real GDP per person.

Real GDP per person doubled in the 36 years from
1967 to 2002.
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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Short-Term Fluctuations
  • Fluctuations in the pace of expansion of real GDP
    is called the business cycle.
  • The business cycle is a periodic irregular up-and
    down movement of total production and other
    measure of economic activity.
  • The four stages of a business cycle are
    expansion, peak, recession, and trough.

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • The shaded periods show the recessionsperiods of
    falling production that lasts for at least six
    months.

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Standard of Living Across Countries
  • To compare living standards across countries, we
    must convert real GDP into a common currency and
    common set of prices, called purchasing power
    parity.
  • Goods and Services Omitted from GDP
  • Household production
  • Underground production
  • Leisure time
  • Environment quality

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Household Production
  • Real GDP omits household production, it
    underestimates the value of the production of
    many people, most of them women.
  • Underground Production
  • Hidden from government to avoid taxes and
    regulations or illegal.
  • Because underground economic activity is
    unreported, it is omitted from GDP.

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Leisure Time
  • Our working time is valued as part of GDP, but
    our leisure time is not.
  • Environment Quality
  • Pollution is not subtracted from GDP.
  • We do not count the deteriorating atmosphere as a
    negative part of GDP.
  • If our standard of living is adversely affected
    by pollution, our GDP measure does not show this
    fact.

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14.3 THE USE AND LIMITATIONS OF REAL GDP
  • Other Influences on the Standard of Living
  • Health and Life Expectancy
  • Good health and a long life do not show up
    directly in real GDP.
  • Political Freedom and Social Justice
  • A country might have a very large real GDP per
    person but have limited political freedom and
    social justice.
  • A lower standard of living than one that had the
    same amount of real GDP but in which everyone
    enjoyed political freedom.

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APPENDIX MEASURING REAL GDP
  • The Problem with Base-Year Prices
  • Well calculate real GDP in 2008 using 2000 as
    the base year and found that real GDP in 2008 was
    1.6 percent greater than in 2000an increase of
    60.
  • But if we had used 2008 prices rather than 2000,
    real GDP would have increased from 150 million
    (2008 dollars) in 2000 to 300 million in 2008an
    increase of 100.
  • So did real GDP increase by 60 or 100?

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APPENDIX MEASURING REAL GDP
  • The BEA method uses the prices of both years.
  • The three steps in the method are
  • Value production in the prices of adjacent
    years.
  • Find the average of the two percentage changes.
  • Link (chain) back to the base year.

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APPENDIX MEASURING REAL GDP
  • Value Production in the Prices of Adjacent Years
  • Lets take as the two adjacent years 2008 and its
    preceding year 2007.
  • Value the quantities produced in 2007 and 2008 at
    both the prices of 2007 and the prices of 2008.
  • Table A14.1 shows the calculations.

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APPENDIX MEASURING REAL GDP
  • The table gives
  • Value of production in 2007 at 2007 prices is
    145.
  • Value of production in 2008 at 2007 prices is
    160.
  • Value of production in 2007 at 2008 prices is
    158.
  • Value of production in 2008 at 2008 prices is
    172.
  • The next step is the find the percentage
    increases using 2007 prices and 2008 prices and
    then average these two percentages.

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APPENDIX MEASURING REAL GDP
  • Find the Average of Two Percentage Changes
  • Table A14.1 sets out the calculation
  • Value of production in 2007 at 2007 prices is
    145.
  • Value of production in 2008 at 2007 prices is
    160.
  • Using 2007 prices, production increased by 10.3.
  • Value of production in 2007 at 2008 prices is
    158.
  • Value of production in 2008 at 2008 prices is
    172.
  • Using 2008 prices, production increased by 8.9.
  • The average percentage increase in production is
    9.6.

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APPENDIX MEASURING REAL GDP
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APPENDIX MEASURING REAL GDP
  • Link (Chain) Back to the Base Year
  • Starting in the base year, apply the calculated
    average percentage increase each year to obtain
    the chained-dollar real GDP.
  • Figure A14.1 illustrates the calculation with
    assumed data.

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