GDP and the Standard of living

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GDP and the Standard of living

• Outline
• Functions of National Income Accounting
• Gross Domestic Product (GDP)
• The Expenditure Approach to GDP
• The Income Approach to GDP
• Value added
• Real versus Nominal GDP
• Limitations of GDP as a measure of the standard
  of living

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National income accounting (NIA) is the
measurement of aggregate or total economic
activity.
NIA is useful for assessing the performance of
the macroeconomy. NIA is also helpful in
evaluating the effectiveness of policy
initiatives such as the Bush tax cuts.
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Stocks vs. Flows
Flows include

• Income
• Sales revenue
• Output

We measure stockvariables at a specific point
intime whereasflows are measuredper unit of
time.
We measure economicactivity as aflow.
Stocks include

• Checking account balance
• Balance owed on student loans
• Inventories

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Gross Domestic Product (GDP)
GDP is the market value final goods and
services produced within a country in a given
time period.
GDP is our basicmeasure of economicactivity
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Three approaches to measuring GDP

• The value-added approach
• The expenditure approach
• The income approach

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Value-added is the increase in the market value
of a good that takes place at each stage of the
production -distribution process.
Value-Added
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Stages of Production
5.00NotebookPaper
3.50NotebookPaper
2.25NotebookPaper
1.50Raw Paper
1.00Wood Chips
Office SuppliesManufacturer
Lumber Mill
Paper Mill
Wholesaler
Retailer
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Summing the value-added at each stage
Stage Value Added
Lumber milling 1.00
Paper processing .50
Office Supply Manufacturing .75
Wholesaling 1.25
Retailing 1.50
Total 5.00
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Don't double count!
To count the notebook in GDP, we count the
final transaction only. Otherwise, we would be
counting value added twice.
We count only final goodsthat is, a good or
service produced for a final userin GDP. The
value of intermediate goods and services are
automatically included when the count the value
of the final good or service.
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Here we simplyadd up allexpenditures forfinal
goods and services in oneyear
The expenditure approach
Total Expenditure C I G NX
Where, C is personal consumption expenditureI
is gross private domestic investmentG is
government expenditure (local, state, and
federal) andNX is net exports, or Exports minus
Imports
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Consumption

• Household spending for newly-produced goods and
  services is defined as consumption. We
  distinguish between 3 categories or types
• Spending for consumer durables
• Spending for consumer non-durables
• Spending for consumer services.

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Consumer Spending by Type, 2002 (in billions)
Total consumptionby U.S. householdsin 2002 was
7.3trillion
SourceBureau of Economic Analysis
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What is investment?

• All spending by business firms for newly built
  equipment and business structures.
• All changes in business inventories of raw
  materials, semifinished articles, and finished
  goods.
• All spending by households for newly constructed
  residential housing

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Investment does NOT include

• The purchase of stocks, bonds, or other financial
  assets.
• Secondhand sales

Remember that investment only happens when there
is production of new tangible capital goods
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Business investment has been slumping lately
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GDP The Expenditure Approach
Amount in 2002 Percentage
Item Symbol (billions) of GDP
Consumption expenditure C 7,255 69.9
Investment I 1,588 15.3
Government purchases G 1960 18.9
Net exports NX -426 -4.1
GDP Y 10,377 100
Source U.S. Bureau of Commerce, Bureau of
Economic Analysis
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The income Approach
GDP Employee compensation net interest
rent profits proprietors income Capital
consumption (indirect business taxes
subsidies)
This mainly involves summing up incomeearned in
factor markets
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Definitions

• Capital consumption (CC)A monetary measure of
  the depreciation of the capital stock in a year
  due to normal wear and tear, fires, or other
  accidents.
• Net Investment Gross Investment minus CC.
• Indirect business taxes taxes collected by
  businesses for government units, such as taxes on
  entertainment, motels, groceries, liquor,
  cigarettes, or gasoline taxes. Also called excise
  taxes.

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GDP The Income Approach
Amount in 2002 Percentage
Item (billions) of GDP
Compensation of employees 5,964 57.5
Rental income of persons 153 1.5
Net interest 678 6.5
Corporate profits 785 7.6
Proprietors' income 747 7.2
Net domestic product at factor cost 8,327 80.3
Indirect taxes less subsidies 660 6.4
Capital Consumption 1,390 13.3
GDP 10,377 100
Source U.S. Bureau of Commerce, Bureau of
Economic Analysis
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Real versus Nominal GDP

• We use money to measure the market value of new
  goods and services produced produced in the
  economy.
• The value (or purchasing power) of money is
  subject to change over time.
• Hence we need to adjust nominal GDP (that is, GDP
  measured at current prices) for changes in the
  value of money.
• GDP adjusted for changes in the value of money is
  called real GDP.

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Nominal GDP Calculation
To calculate nominal GDP in 2002, sum the
expenditures on apples and oranges in 2002 as
follows
Expenditure on apples 100 1
100Expenditure on
oranges 200 0.50
100Nominal GDP 100 200
200

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Now we will calculate nominal GDP for 2003 and
compare
Expenditure on apples 160 0.50
80Expenditure on
oranges 220 2.25
495Nominal GDP 80 495
575

Our problem is that the nominal GDP figures do
not give us an accurate read of period-to-period
changes in actual production. Notice that a part
of the change in nominal GDP from 2002 to 2003
resulted from a change in prices.
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Traditional Real GDP calculation
The traditional method converts nominal GDP to
real GDP by measuring GDP in all periods at base
period prices
To correct for changes in the value of money , we
will establish 2002 as our base year. That is, we
will measure 2003 output at 2002 prices.
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Traditional method measuring 2003 GDP at 2002
prices
Expenditure on apples 160 1.00
160Expenditure on
oranges 220 0.50
110Nominal GDP 80 495
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Thus, real GDP increased from 2002 to 2003but
not by as much as nominal GDP
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To compute Real GDP (GDP expressed in constant
dollars)
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New Method of Calculating Real GDP
To use this method, we must value 2002 output at
2003 prices and 2003 output at 2002 prices.
2002Quantities and 2003 Prices
2003 Quantities and 2002 Prices
Item Quantity Price
Apples 100 0.50
Oranges 200 2.25
Item Quantity Price
Apples 160 1.00
Oranges 220 0.50

• Measured at 2002 prices, Real GDP increased by
  35 from 2002 to 2003 (70/200) 100
• Measured at 2003 prices, real GDP increased by
  15 from 2002 to 2003 (75/500) 100

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The next step is to average together the
percentage increases for 2002 and 2003. Thus we
have
Therefore, since real GDP in 2002 is 200,
this chain-weighted method of converting nominal
to real GDP gives us real GDP in 2003 of 250.
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GDP in the United States (in millions)
www.bea.gov
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GDP per Person in the United States
www.economagic.com
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GDP in the U.S. (millions of chained 1996 dollars)
Recessions are shaded
www.bea.gov
Notice that real GDP decreased in 1991
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Limitations of (real) GDP as a measure of the
standard of living

• Household production
• The underground economy
• Leisure time
• Environment quality