Gross Domestic Product Measures Total Production

1. Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year. Gross Domestic Product Measures Total Production GDP Is Measured Using Market Values, Not Quantities The worth of a thing is the price it will bring. • Final good or service A good or service purchased by a final user: • Household consumption—C • Business investment, including all residential construction—I • Government purchases—G • Exports to foreigners—X Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. vs GDP Includes Only Current Production

2. Production, Income, and the Circular Flow Diagram

3. Total GDP = $7,800

4. Measuring GDP by the Value-Added Method Value added The market value a firm adds to a product.

5. Components of GDP Personal Consumption Expenditures, or “Consumption” Consumption (C) Spending by households on goods and services, not including spending on new houses. Gross Private Domestic Investment, or “Investment” Investment (I) Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses. Government Consumption and Gross Investment, or “Government Purchases” Government purchases(G)Spending by federal, state, and local governments on goods and services. Net Exports of Goods and Services, or “Net Exports” (NX) The mantra: Y = C + I + G + NX

6. Components of GDP in 2006

7. GDP Facts • Consumer spending on services is greater than the sum of spending on durable and nondurable goods. • • Business fixed investment is the largest component of investment. Gross private domestic investment includes • New plant and equipment • New residential construction • Net additions to business inventories • Purchases made by state and local governments are greater than purchases made by the federal government. • Imports are greater than exports net exports are negative.

8. Transfer payments are not included in GDP: Payments by the government to individuals for which the government does not receive a new good or service in return. • Unemployment benefits paid to someone not working. • Social security benefits paid to someone who is retired. • Interest income paid to a government bondholder Since the government doesn’t produce anything for the market, the interest payment can’t be for any productive service. “Underground economy” activities are not included in GDP • Production “off-the-books” • Illegal activities…a matter of the law • Legalize prostitution GDP up • Household production is not included in GDP • Marry your gardener  GDP down

9. Does GDP Measure What We Want It to Measure? GDP Not a Measure of Well-Being…but pretty close The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

10. GDP Accounting Conventions Which component of GDP will be affected by each of these transaction? You buy a ticket to fly to Seattle. American Airlines buys a new jetliner from Boeing. AA buys new seats for a jetliner it already owns. AA buys 100 million gallons of jet fuel. A resident of France buys a ticket to fly from Paris to NY. Clark County extends a runway at McCarran so AA can land larger jets. In recent years, the BEA has classified government purchases into gov’t consumption and gross gov’t investment expenditures. How would you classify Homeland Security expenditures? Which of the following would increase measured GDP and which would reduce it? The fraction of women working outside the home increases. There is a sharp increase in the crime rate. Higher tax rates cause some people to hide more of the income they earn. What would you expect to happen to household production as unemployment rises during a recession? Would you therefore expect fluctuation in actual production—GDP plus household production—to be greater or less than fluctuation in GDP?

11. Real GDP The value of this year’s final goods and services evaluated at base-year prices. Nominal GDP The value of this year’s final goods and services evaluated at this year’s prices. Real GDP versus Nominal GDP vs $Y2009 = Nominal GDP = GDP in current year prices = $7,800 Y2009 = Real GDP = GDP in base year prices = $6,680

12. Comparing Real GDP and Nominal GDP Nominal GDP and Real GDP, 1990–2006 Base year prices > Current year prices  Y > $Y Base year prices < Current year prices  Y < $Y

13. The GDP Deflator GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. $ GDP = Price Level x Real Output $Y = P x Y P = $Y/Y In practice,, the GDP deflator is estimated first: Deflatorthis yr = (Cost of outputthis yr /Cost of same stufflast yr) x Deflatorlast yr Then, Real GDPthis yr = $GDPthis yr/(GDP Deflator)this yr

14. Other Measures of Total Production and Total Income • Gross National Product (GNP) • =GDP + Net Foreign Earnings of US Residents • Compensation of employees earned abroad • Interest and profits earned abroad Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation) National Income (NI) = NNP - Indirect Business Taxes + Statistical discrepancy = Income earned from production of national product Personal Income (PI) = NI + Net Transfer Payments – Corporate Retained Earnings Disposable Income (DI) = PI - Income Taxes Disposable Income is split between consumption and saving YD = C + S

15. Other Measures of Total Production and Total Income FIGURE 7-4 Measures of Total Production and Total Income, 2006

16. Other Measures of Total Production and Total Income FIGURE 7-5 The Division of Income

17. Real GDP—NI/PI/DI • If the quantity of final goods and services produced decreased, • Could real GDP increase? • Could nominal GDP increase? • Suppose the amount the federal government collects in personal income taxes increases, while the level of GDP remains the same. What will happen to the values of • National income • Personal income • Personal disposable income

18. K e y T e r m s Macroeconomics Microeconomics Net exports Nominal GDP Price levelReal GDP Recession Transfer payments Underground economy Value added Business cycle Consumption Economic growth Expansion Final good or service GDP deflator Government purchases Gross domestic product (GDP) Inflation rate Intermediate good or serviceInvestment