Production, Income , and Employment Chapter 6

1. CHAPTER Production, Income, and Employment Chapter 6

2. Production and GDP • Gross domestic product (GDP) • Total value • Of all final goods and services • Produced for the marketplace • During a given year • Within the nation’s borders • The total value… • GDP is measured in dollar values (P x Q)

3. Production and GDP • …of all final… • Final goods and services: sold to their final user • Intermediate goods • Goods used up in producing final goods • Value of all intermediate goods • Included in the value of final products • …goods and services… • Goods: tangibles • Services: intangibles

4. Production and GDP • …produced… • Not included: land, stocks and bonds used goods … • …for the marketplace… • With the intention of being sold • …during a given period… • Specific period of time • …within a nation’s borders • Regardless of who owns the resources

5. GROSS DOMESTIC PRODUCT (GDP) Intermediate and final good Tires taken from that pile and mounted on the wheels of the new car before it is sold are considered intermediate goods to the auto producer. Tires from that pile to replace tires on your old car are considered final goods. If we included the value of the tires (an intermediate good) on new cars and the value of new cars (including the tires), we would be double counting.

6. Example: Production of Notebook Paper • Stages of Production

7. Tracking and Reporting GDP • GDP is a flow variable • Flow variable: measures a rate of production • $40 billion worth of output each day • $1.2 trillion each month • $14.5 trillion for the year • In general, flow variables are measured per unit of time

8. Tracking and Reporting GDP • Annualization • The government reports GDP as an annual rate • But, it is measured and reported (as an annual rate) each quarter

9. Tracking and Reporting GDP • Nominal variable • A variable measured without adjustment for price changes • Nominal GDP • Real variable • A variable adjusted for changes in prices • Real GDP

10. Tracking and Reporting GDP • Comparing variables measured in dollars over time • It is important to translate nominal values to real values • Annual growth rate of real GDP • Reported quarterly • Annualized

11. How to we get 3.8%? • Annualized data for GDP, real GDP, and growth rate, by quarters

12. The Expenditure Approach to GDP • Expenditure approach: GDP=C+I+G+NX • Adding the value of goods and services purchased by each type of final user • Consumption goods and services (C) purchased by households • Private investment goods and services (I) purchased by businesses • Government goods and services (G) purchased by government agencies • Net exports (NX) purchased by foreigners

13. The Expenditure Approach to GDP • Consumption spending (C) • Part of GDP purchased by households as final users • 70% of total production • Not included: • Imported consumption goods and components • New home construction

14. The Expenditure Approach to GDP • Consumption spending (C) • Included - even though households don’t actually buy them • Total value of food products produced on farms that are consumed by the farmers and their families themselves • Total value of housing services provided by owner-occupied homes

15. The Expenditure Approach to GDP • Private investment (I) • Business purchases of plant, equipment, and software • New home construction • Changes in inventories

16. The Expenditure Approach to GDP • Private investment (I) • Adds to the nation’s capital stock • Excludes • Government investment • Consumer durables • Human capital • Ignores depreciation • Net investment • Investment minus depreciation

17. The Expenditure Approach to GDP • Government purchases (G ) • Spending by federal, state, and local governments on goods and services • Government consumption and investment purchases • Goods and services • Government outlays • Government purchases • Transfer payments

18. The Expenditure Approach to GDP • Transfer payments • Payment that is not compensation for supplying goods, services, or resources • Money redistributed from one group of citizens (taxpayers) to another (the poor, the unemployed, the elderly) • Included in government budgets as outlays • Not included in the government purchases component of GDP

19. The Expenditure Approach to GDP • Net exports (NX) • Total exports minus total imports • Total exports • U.S. production that is purchased by foreigners • Total imports • Americans’ purchases of goods produced outside of the United States

20. GDP in 2010: The Expenditure Approach About $17 trillion in 2013

21. Other Approaches to GDP • Factor payments • Payments to the owners of resources that are used in production • Factor payments approach (Income Approach) GDP = sum the factor payments earned by all households in the economy (wages and salaries, rent, interest, and profit) • Total output of the economy (GDP) = total income earned in the economy • Total expenditure (GDP) = total income earned in the economy

22. Why does expenditure = income • In every transaction, the buyer’s expenditure becomes the seller’s income. • Thus, the sum of all expenditure equals the sum of all income.

23. Simple Circular Flow The circular flow diagram shows the income received and payments made by each sector of the economy.

24. The Factor Payments Approach

25. Other Approaches to GDP • Value added • Revenue a firm receives • Minus the cost of the intermediate goods it buys • Value-added approach • GDP = sum the values added by all firms in the economy

26. Value Added at Different Stages of Production • Back to the notebook example

27. Exercise • A farmer grows a bushel of wheat and sells it to a miller for $1.00. • The miller turns the wheat into flour and sells it to a baker for $3.00. • The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00. • The engineer eats the bread. • Compute: • value added at each stage of production • GDP

28. Exercise • Value added - farmer = ? • Value added - miller = ? • Value added - baker = ? • Total Value added = ? = GDP

29. Measuring GDP: A Summary

30. Calculating Real GDP • Nominal GDP measures the value of all final goods and services using current prices. • Real GDPmeasures the value of all final goods and services using the prices of a base year.

31. Real GDP controls for inflation • Changes in nominal GDP can be due to: • changes in prices (P) • changes in quantities of output produced (Q) • Remember: total sales = P x Q • Changes in real GDP can only be due to changes in quantities (Q), because real GDP is constructed using constant base-year prices. P is held constant

32. 2009 2010 2011 P Q P Q P Q good A $30 900 $31 1,000 $36 1,050 good B $100 192 $102 200 $100 205 Example - Calculation of Real GDP(NOTE: Numerical Calculation of Real GDP presented in this and the next 4 slides is not covered in the text) • Compute nominal GDP in each year • Compute real GDP in each year using 2009 as the base year.

33. Example - Calculation of Real GDP • Nominal GDP multiply Ps & Qs from same year2009: $46,200 = $30  900 + $100  192 2010: $51,400 = $31 x 1000 + $102 x 2002011: $58,300 = $36 x 1050 + $100 x 205 • Real GDP multiply each year’s Qs by 2005 Ps2009: $46,200 = $30 x 900 + $100 x 192 2010: $50,000 = $30 x 1000 + $100 x 200 2011: $52,000 = $30  1050 + $100  205

34. GDP Deflator • The inflation rate is the percentage increase in the overall level of prices. • One measure of the price level is the GDP Deflator, defined as

35. Nominal GDP Real GDP GDP deflator inflationrate 2009 $46,200 $46,200 n.a. 2010 51,400 50,000 2011 58,300 52,000 Exercise • Use your previous answers to compute the GDP deflator in each year. • Use GDP deflator to compute the inflation rate from 2009 to 2010, and from 2010 to 2011.

36. Nom. GDP Real GDP GDP deflator inflationrate 2005 $46,200 $46,200 100.0 n.a. 2006 51,400 50,000 102.8 2.8% 2007 58,300 52,000 112.1 9.1% Answers

37. How GDP Is Used • Short-run • Onset of a recession or a too-rapid expansion that can overheat the economy • Long-run • Measure the long-run growth rate of the economy’s output • Real GDP needed to grow by about 3% per year to provide enough jobs for a workforce that is growing in number and becoming more productive every year

38. Real GDP Growth Rate, 1970–2011 http://bea.gov/newsreleases/national/gdp/gdp_glance.htm

39. Although the growth rate of real GDP has fluctuated over time, it has on average been well above the 1 percent rate needed to maintain output per person, so real GDP per capita has risen over time. • And for most of the period, the average growth rate was high enough to create the jobs needed by a growing and more productive workforce. During some years (e.g., 2008– 2011), growth slowed, and an insufficient number of jobs were created • Real GDP Growth Rate, 1970–2011 • Things to note:

40. LIMITATIONS OF THE GDP CONCEPT GDP AND SOCIAL WELFARE If crime levels went down, society would be better off, but a decrease in crime is not an increase in output and is not reflected in GDP. An increase in leisure is also an increase in social welfare, but sometimes associated with a decrease in GDP. Most nonmarket and domestic activities, such as housework and child care, are not counted in GDP even though they amount to real production. GDP also has nothing to say about the distribution of output among individuals in a society.

41. LIMITATIONS OF THE GDP CONCEPT underground economy The part of the economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.