Ch:21 Gross Domestic Product

1. Ch:21Gross Domestic Product Gross domestic product (GDP) is the value of the aggregate production of goods and services in a country during a given time period.

2. Gross Domestic Product Flows and Stocks 1) A flow is the quantities per unit of time. 2) A stock is a quantity that exists at a point in time.

3. Gross Domestic Product Flows and Stocks (cont.) Capital is the key macroeconomic stock. Capital The plant, equipment, buildings, and inventories of raw materials and semifinished goods that are used to produce other goods and services.

4. Gross Domestic Product Depreciation The decrease in the stock of capital that results from wear and tear and obsolescence. Otherwise known as capital consumption.

5. Gross Domestic Product Gross Investment The total amount spent on adding to the stock of capital and on replacing depreciated capital. Net Investment The amount spent on adding to the stock of capital. Gross Investment minus depreciation.

6. Capital and Investment

7. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

8. Gross Domestic Product Wealth Another macroeconomic stock. The value of all the things that people own. Related to their earnings (a flow).

9. Gross Domestic Product Consumption Expenditure The amount spent on consumption goods and services. Saving The amount of an income after meeting consumption expenditures.

10. Gross Domestic Product Income, Expenditure, and the Value of Production 1) Households sell their labor, capital, land, and entrepreneurship to firms. 2) Firms sell consumer goods and services. 3) Firms buy and sell capital goods. 4) Firms borrow to finance investment.

11. Gross Domestic Product Government Government purchases are purchases of goods and services by governments. • Paid for with tax revenue. Net taxes are taxes paid to governments minus transfer payments received from governments and minus interest payments from the government on its debt.

12. Gross Domestic Product Rest of World Sector Net exports is the value of exports minus the value of imports. Gross Domestic Product Production can be valued by what: • Buyers pay for it. • It costs producers to make it.

13. The Circular Flow ofIncome and Expenditure

14. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

15. Gross Domestic Product Expenditure Equals Income: Y = C + I + G + NX

16. Gross Domestic Product How Investment is Financed 1) National saving is the amount of saving by households and businesses plus government saving National saving = S + (T – G) 2) Borrowing from the rest of the world

17. Gross Domestic Product Measuring U.S. GDP 1) Expenditure Approach 2) Income Approach

18. Gross Domestic Product Expenditure Approach Uses data on consumption expenditure, investment, government purchases, and net exports

19. Gross Domestic Product Expenditure Approach (cont.) Personal consumption expenditures are the expenditures by households on goods and services produced in the United States and the rest of the world

20. Gross Domestic Product Expenditure Approach (cont.) Gross domestic investment is expenditure on capital equipment and buildings by firms and expenditure on new homes by households. Also, it includes the change in inventories.

21. Gross Domestic Product Expenditure Approach (cont.) Government purchases of goods and services are the purchases of goods and services by all levels of government. Does not include transfer payments

22. Gross Domestic Product Expenditure Approach (cont.) Net exports of goods and services are the value of exports minus the value of imports

23. GDP: The Expenditure Approach Amount in 1996 (billions of Percentage Item Symbol dollars of GDP Personal consumption expenditures C 5, 152 68.0 Gross private domestic investment I 1,116 14.7 Government purchase of goods and services G 1,407 18.6 Net exports of good and services NX –99 – 1.3 Gross domestic product Y 7,576 100.0

24. Gross Domestic Product Expenditures Not in GDP 1) Intermediate goods and services 2) Used goods 3) Financial assets

25. Gross Domestic Product Income Approach • Measures GDP by summing the incomes that firms pay households for the resources they hire. • Compensation of employees is the payment for labor services. • Includes net wages and salaries plus taxes withheld on earnings plus fringe benefits such as social security and pension fund contributions.

26. Gross Domestic Product Income Approach (cont.) • Net interest is the interest households receive on loans they make minus the interest households pay on their own borrowing. • Rental income is the payment for the use of land and other rented inputs.

27. Gross Domestic Product Income Approach (cont.) • Corporate profits are the profits of corporations. • Proprietors’ income is a combination of all of these.

28. Gross Domestic Product Net Domestic Income at Factor Cost The sum of the five categories of income We must convert factor cost to market prices.

29. Gross Domestic Product Income Approach (cont.) Indirect taxes are taxes paid by consumers when they buy goods and services Due to this additional cost, the market price is greater than the factor cost value for measuring GDP.

30. Gross Domestic Product Income Approach (cont.) Subsidies are payments by the government to a producer. • Due to this payment, the factor cost is greater than the market price for measuring GDP. We must convert from Net Domestic Product to Gross Domestic Product.

31. Gross Domestic Product Income Approach (cont.) • Net profit of businesses--profit after subtracting depreciation—is a component of aggregate incomes. • To get gross domestic product, we must add depreciation to aggregate income.

32. GDP: The Income Approach Amount in 1996 Percentage Item (billions ofdollars of GDP Compensation of employees 4,449 58.7 Net Interest 405 5.4 Rental Income 127 1.7 Corporate Profits 650 8.6 Proprietors’ income 518 6.8 Indirect taxes less subsidies 569 7.5 Capital consumption (depreciation) 858 11.3 Gross domestic 7,576 100.0 product

33. Gross Domestic Product Valuing the Output of Industries Value added is the value of a firm's production minus the value of the intermediate goods that the firm buys from other firms.

34. Farmer’s value added Value of wheat Miller’s value added Value of flour Bakers value added Wholesale value of bread Grocer’s value added Retail value of bread; Final Expenditure on bread Value Added andFinal Expenditure Value added Farmer Intermediate expenditure Miller Final expenditure Baker Grocer Consumer

35. GDP Aggregate Expenditure,Output, and Income 100 NX G Depreciation Indirect taxes less subsidies I 80 Proprietor’s incomes Interest C Profits 60 Rent Percentage of GDP Wages and other labor income 40 20 0 Aggregate income Aggregate expenditure GDP

36. Learning Objectives (cont.) • Explain how the Consumer Price Index (CPI) and GDP deflator are measured • Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

37. The Price Level and Inflation The inflation rate is the percentage change in the price level from one year to the next. Two Main Price Indexes • Consumer Price Index • GDP Deflator

38. The Price Level and Inflation Consumer Price Index • Measures the average level of prices of the goods and services that a typical urban family buys. • Published monthly by the Bureau of Labor Statistics • Must use a base period (1982-1984)

39. $210.00 $210.00 $231.00 $210.00  100 = 100 100 = 110 CPI = The CPI: A Simplified Calculation Base Period Current period Base-period basket Price Expenditure Price Expenditure 5 pounds of oranges $0.80/pound $4 $1.20/pound $6 6 haircuts $11.00 each $66 $12.50 each $75 100 bus rides $1.40 each $140 $1.50 $150 Total expenditure $210 $231

40. Nominal GDP Real GDP  100 GDP deflator = The Price Level and Inflation The GDP Deflator Measures the average level of prices of all the goods and services that are included in GDP

41. Learning Objectives (cont.) • Explain how real GDP is measured • Explain the shortcomings of real GDP growth as a measure of improvements in living standards

42. The Price Level and Inflation Nominal GDP is GDP valued in the current year’s prices. Real GDP is GDP in a base year (1992) scaled up by the growth rate of real GDP since the base year.

43. The Price Level and Inflation Real GDP Growth: A Chain-Weighted Measure The chain-weighted output index is an index number that measures the growth rate of real GDP.

44. Calculating a Chain-Weighted Output Index Oranges 50 $1.00 $50 $2.00 $100 Video games 5 $10.00 $50 $8.00 $40 A = $100 D = $140 1992 quantities 1992 quantities valued at 1992 valued at 1993 Item 1992 quantities 1992 prices prices 1993 prices prices

45. Calculating a Chain-Weighted Output Index Oranges 45 $1.00 $45 $2.00 $90 Video games 7 $10.00 $70 $8.00 $56 B = $115 E = $146 1993 quantities 1993 quantities valued at 1992 valued at 1993 Item 1993 quantities 1992 prices prices 1993 prices prices

46. Calculating a Chain-Weighted Output Index Oranges 45 $1.00 $45 $2.00 $90 Video games 7 $10.00 $70 $8.00 $56 B = $115 E = $146 Output index C = B/A = 1.150 F = E/D = 1.043 Chain-weighted output index(geometric mean of C and F = )= 1.095 1993 quantities 1993 quantities valued at 1992 valued at 1993 Item 1993 quantities 1992 prices prices 1993 prices prices

47. Calculating a Chain-Weighted Output Index Oranges 45 $1.00 $45 $2.00 $90 Video games 7 $10.00 $70 $8.00 $56 B = $115 E = $146 Output index C = B/A = 1.150 F = E/D = 1.043 Chain-weighted output index(geometric mean of C and F = )= 1.095 Growth rate in 1993 using chain-weighted output index 9.5 percent 1993 quantities 1993 quantities valued at 1992 valued at 1993 Item 1993 quantities 1992 prices prices 1993 prices prices

48. $146 $109.5  100 = 133.33 GDP deflator = The Price Level and Inflation The GDP Deflator can now be calculated.

49. The U.S. GDP Balloon GDP deflator 1992 1998

50. Learning Objectives (cont.) • Explain how the Consumer Price Index (CPI) and GDP deflator are measured • Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation