Measuring GDP

1. Chapter 18Measuring the GDP

2. Measuring GDP GDP: a measure of value of all the final goods and services newly produced in a country during some period of time.

3. Measuring GDP (2) Prices of goods and services are used as weight. Convert quantities of goods and services produced to common monetary value so they can be added. Ex. Convert marginal utility to (monetary) value of good Prices reflect the cost and value of the goods and services produced. GDP includes only final goods. Final goods: a new good that undergoes no further processing before it is sold to consumers. Intermediate goods: a good that undergoes further processing before it is sold to consumers.

4. Three Ways to Measure GDP Spending approach: total amount that people spend on goods and services. Income approach: total income earned by all workers and businesses. Production approach: total amount of goods and services produced.

5. Circular Flow Model

6. Spending Approach Four components of spending Households� consumption (C) Firms� investment (I) Government purchase (G) Net export to foreigners (X) Y = C + I + G + X Y: GDP

7. Figure 18.4The Circular Flow of Income and Expenditure

8. Consumption Consumption: purchase of final goods and services by households. It does not include purchases of new houses. purchases of financial assets such as stocks and bonds. purchases of second-hand goods. It include purchases of foreign-made goods. Purchases of services provided by firms and governments.

9. Investment Investment: purchase of final goods and services by firms plus purchases of newly produced residences by households. Business fixed investment: purchase of new machines, factories, and other tools. Inventory investment: changes in inventory of final goods and services. Residential investment: purchase of new houses by households. Investment does not include purchases of intermediate goods.

10. Government Purchase Government purchase: spending by federal, state, and local governments on new goods and services. transfer payment is not included such as social security and welfare benefit (Chapter 14). Wage and salary paid to government workers who produce goods and services are included. Ex. Military, police, fire-fighters, teachers

11. Net Export Net export: the value of exports minus the value of imports. Exports: the total value of the goods and services that people in one country sell to people in other countries. People in the U.S. purchase made-in-China shoes. Imports: the total value of the goods and services that people in one country buy from people in other countries. Firms in China purchase made-in-USA jetliner. Trade balance Trade deficit: imports exceeds exports. Trade surplus: exports exceed imports.

12. Figure 18.3Government Purchases, Investment, and Consumption as a Share of GDP

13. Consumption, Investment, Government Purchase & Net Export Consumption is the largest component of GDP (about 68% of GDP). Investment tends to fluctuate from year to year. Government purchase has grown steadily during 1900s. Net export has been almost always negative.

14. Income Approach Income approach adds up the income of the people who produce the output of the firm. Labor income Capital income: interest payment on capital, rental payment on land, and profits Depreciation: the decrease in an asset�s value over time which reduce firms� profits Indirect business tax (sales tax) not included in firms� profits Net income to foreigners

15. Production Approach Value added: the value of the firm�s production minus the value of the intermediate goods used in production. Summing up value added along the production line is equal to the value of final product. ? Spending approach Value added is distributed to factors of production contributing to value added; wage to labor, interest to capital, rent to landlord, and profits to owners. ? Income approach

16. Figure 18.5Value Added in Coffee: From Beans to Espresso

17. Saving, Investment, and Net Export National saving (S) = Y � C � G Household saving (SH) = Y � C � T (Tax) Government saving (SG) = T � G S = SH + SG = (Y � C � T) + (T � G) Y = C + I + G + XY = C + G + S? X = S � I Trade deficit is a result of Households not saving enough as compared with business investment. Government runs deficits.

18. Real GDP vs. Nominal GDP A rise in the prices of goods and services will increase the (nominal) GDP even if there is no increase in the production. GDP measures the total monetary value of goods and services produced. Real GDP is a measure of production that corrects for the inflation. It uses prices of a certain year (base year) to compute the value of goods and services produced in each year. Because of inflation, the nominal GDP grows faster than real GDP.

19. Computing Nominal GDP Nominal GDP in 2001 = $15 x 1,000 + $5 x 2,000 = $25,000 Nominal GDP in 2002 = $20 x 1,200 + $10 x 2,200 = $46,000 From Year 2001 to Year 2002 the nominal GDP increases by 84%.

20. Computing Real GDP Use Year 2001 prices. Real GDP in 2001 = $15 x 1,000 + $5 x 2,000 = $25,000 Real GDP in 2002 = $15 x 1,200 + $5 x 2,200 = $29,000 Real GDP increases by 16% from 2001 to 2002.

21. Real GDP and Base Year The real GDP increases from 2001 to 2002 by 16% when Year 2001 prices are used. by 15% when Year 2002 prices are used. Averaging two numbers, the real GDP increases from 2001 to 2002 by 15.5%. Use real GDP growth rate to find real GDP in other year as compared with the base year. Real GDP = Nominal GDP in the base year. Choosing Year 2001 as a base year, the real GDP in 2002 is re-calculated by using 15.5% growth rate as $28,875 = $25,000 x (1+0.155).

22. Figure 18.6Real GDP versus Nominal GDP

23. GDP Deflator GDP deflator = Nominal GDP / Real GDP x 100 Measures the level of prices of goods and services included in real GDP relative to a given base year.

24. Computing Inflation Rate Inflation rate: the percentage change in the price level. Inflation rate from Year 0 to Year 1 (next year) = (P1 - P0)/P0 x 100 where P0 is the price level in Year 0 and P1 is the price level in Year 1.

25. Nominal GDP, Real GDP, and Inflation Rate The growth rate of nominal GDP is related with the growth rate of real GDP and the inflation rate.

26. Alternative Price Indices Consumer price index (CPI): a price index based on the price of a fixed collection (market basket) of consumer goods and services relative to a base year. Price level for typical consumers Producer price index (PPI): a price index based on the price of a fixed collection of raw materials, intermediate goods and some final goods sold by producers. Cost of production which eventually affects the prices of final goods and services.

27. Consumer Price Index CPI is the price level if consumers purchase the same amount of each good and service. It overestimates an inflation because it ignores the substitution effect of price changes.

28. Computing CPI If Year 2001 is the base year, then use quantities in Year 2001 to compute the price level in 2002.

29. Figure 18.7Comparison of Measures of Inflation

30. Shortcomings of GDP Measure Revisions in GDP Omissions from GDP Home work Leisure activity Underground economy Quality improvement Externalities