Understanding GDP: Measure of Economic Well-Being

1. Gross Domestic Product [GDP]

2. GDP and Economic Well-Being • GDP is the best single measure of the economic well-being of a society. • GDP per persontells us the income and expenditure of the average person in the economy.

3. GDP • IS THE MARKET VALUE OF ALL FINAL GOODS AND SERVICES PRODUCED WITHIN A COUNTRY IN A GIVEN PERIOD OF TIME • ( IN OTHER WORDS IT PUTS A DOLLAR VALUE FOR AN ECONOMIES PRODUCTION) • Example-Fords made in Michigan go towards GDP • Hondas made in Michigan go towards GDP-even though the company is from Japan. • As long as it is in our borders it counts towards GDP

4. INVENTORY IS A FINAL GOOD • Goods that are placed into inventory are considered to be “final” and included in GDP as a firm’s inventory investment.

5. GDP-FINAL AND INTERMEDIATE GOODS • MEASURES THE FINAL GOOD • IF A PAPER COMPANY MAKES PAPER AND SELLS IT TO HALLMARK WHICH THEN SELLS THE GREETING CARD ONLY THE FINAL PRICE OF THE GREETING CARDS IS MEASURED BY GDP • INTERMIDIATE GOOD-THE PAPER • FINAL GOOD-THE CARD.

6. GOODS AND SERVICES ARE MEASURED WITH GDP • GOOD-CD OF MIKE JONES YOU BUY • SERVICE- CONCERT OF MIKE JONES

7. WITHIN THE COUNTRY • IF TOYOTA MAKES A CAR IN THE US THAT GOES TOWARDS THE US GDP • IF EXXON SELLS GAS IN CHINA DOES NOT COUNT TOWARDS GDP

8. IN A GIVEN PERIOD OF TIME • THE GOVT WILL TAKE THE GDP DATA AND AJUST IT FOR SEASONALITY • FOR EXAMPLE XMAS IS A BIG BOOST TO GDP

9. If a Canadian citizen works temporarily in the United States, the value of his output is included in GDP for the United States. If an American owns a firm in Haiti, the value of the production of that firm is not included in U.S. GDP.

10. GDP • GDP-GROSS DOMESTIC PRODUCT • GDP MEASURES TWO THINGS AT ONCE • TOTAL INCOME OF EVERYONE IN ECONOMY • AND • TOTAL EXPENDITURE ON THE ECONOMY’S OUTPUT OF GOODS AND SERVICES

11. GDP • IT CAN MEASURE BOTH AT ONCE BECAUSE INCOME MUST EQUAL EXPENDITURES • BECAUSE IF SOMEONE BUYS SOMETHING FOR 10 DOLLARS THEN THEY HAVE SPENT 10 DOLLARS(EXPENDITURE) AND SOMEONE HAS RECEIVED 10 DOLLARS(INCOME)

12. What is the difference between GDP and GNP? [GNP was used until 1991] GDP measures production in the U.S. GNP measures production by Americans.

13. GDP v. GNP GNP – Ownership All goods/services produced legally for paybycitizens of a country. [Citizenship mattered, not geography] China Europe Nike in Indonesia Plano, TX in Chicago GDP - Location All goods/services produced legally for pay ina country’s borders. [Geography matters, not citizenship] Provo,UT BMW in Waco Honda in Ohio Products born in the USA The difference between GDP & GNP is about 2/10 of 1%.

14. PROBLEMS WITH CALCULATING GDP • NONMARKET TRANSACTIONS-SERVICES OF STAY AT HOME MOMS OR A MECHANIC WHO FIXES THEIR OWN CAR NEVER GET COUNTED IN GDP

15. PROBLEMS WITH CALCULATING GDP • DISTRIBUTION-DOESN’T SHOW THAT 90 PERCENT OF THE WEALTH IN THIS COUNTRY IS WITH LESS THEN 10 PERCENT OF THE PEOPLE

16. PROBLEMS WITH CALCULATING GDP • KIND AND QUALITY OF PRODUCTS- A CRAPPY PRODUCT IS COUNTED JUST A MUCH AS ONE THAT LAST A LONG TIME.

17. What Eight Things Do Not Count In GDP? 1. Intermediate Goods – components of the final good. A. Ford buys batteries or tires for its cars. B. KFC buys chickens to eventually sell to customers.

18. Value Added – increase in the market value at each stage Only Final Sales($20)Count[to prevent “multiple counting”($38)] $20 “Wife-beater” Shirt from Kohls Final Good Retail Shirt $20 $8 Intermediate Good 8 Wholesale Shirt $12 $7 $7 Value Added ($) Value of Output($) 7 Cloth $5 $4 $4 $4 4 Cotton $1 $1 $1 1 $1 $1 0 Shirt Manufacturer Cotton Farmer Textile Mill Retail Store $20 = sum Sum = $38 So, to avoid“multiple counting”, we count the$20final price, not$38.

19. GDP - what is not counted [#2] 2. 2nd Hand Sales – no current production. A. 1957 Chevy bought in 2007 This falls under the rule of “Do Not Double Count”. 57 Chevy [Gas was 30¢ gallon.] Salesman [It has not been produced again in 1963 & would not count.] The salesman is doing productive work. His commission would count. B. Boots produced in 1980 are bought in a Thrift Store in 09. They also have not been produced again. Salesman’s commission would count. You are buying his services. Shoe salesman

20. The salesman’s commission does count. So again, second hand sales, let’s say from Salvation Army, do not count.

21. GDP - what is not counted [#3] 3. Purely Financial Transactions – stocks, bonds, CDs. There is no current production. Ex: If 100 shares of Dell stock is bought Buying stock is not buying a product but buying ownership of the firm. Buying bonds is making a loan. I’m not buying a Dell computer but part ownership of Dell. Exchanging one financial asset for another [swapping bits of paper]

22. “Now that I’ve gotten my welfare check, I can get an iPhone 3G” GDP – what is not counted [#4]. 4. A. Public Transfer Payments–welfare, unemployment, social security. [There is nocontribution to final production] B. Private Transfer Payments, like your parents giving you $250 cash for Christmas, or - $100 for making an “A” in economics. [Just transferring funds from one private individual to another private individual]

23. 5. Unreported “Legal” Business Activity Unreported“legal”business activity [tax avoidance[does not count. This is two-thirds of the “underground economy.” Before LASIK Surgery And what if the dentist doesn’t report $400 for teeth whitening? Then he has LASIK but the surgeon doesn’t report $500 of his $3,400 bill? And what if this waitress doesn’t report all tips?

24. 6. Illegal business activity is also not counted. Illegal business activity, becauseit goes unreported, also does not count. Making up 1/3 of the “underground economy,” also called the [“black market”] it includes murder for hire, gambling, drugs, prostitution, and money laundering. “Give me the money in your purse, but at least it will not count in GDP.” Money Laundering Making money illegally (drug money) and making it look like it was legally earned (like buying a laundry mat or car wash that deal in cash) and report it as legally earned.

25. U.S. Underground Economy Illegal $300 B Legal $600 B Drugs $120 Self Employed$255 Bribery $35 Gambling and Loan Sharking $10 Other Legal $25 Rents & Royalties $30 Pornography $20 Fraud $30 Corporate Profits $50 Other Illegal $20 Prostitution $30 Interest $55 Stolen Goods $35 Wages and Salaries $185 What gets reported is the “Above Ground” What doesn’t get reported is the “Underground”

26. U.S. Underground Economy Underground Economy[compared to “above ground”] Unreported exchanges that take place - legal and Illegal [Hidden – “off the books”] Total illegal activities - $300 billion Totallegalactivities - $600 billion Totallegal and illegal -$900 billion Underground Economy 1. Illegal business activities (1/3) – gambling, narcotics trade, prostitution, loan sharking, etc. 2. Unreported legal business activities (2/3) a. waitresses not reporting all of her tips b. Cabdriver not reporting all of his income c. Self employed cheat the most. Off-the-books cash transactions d. $300 billion *IRS estimates that about $300 billion in income taxes from the underground economy escapes federal taxes each year. $300 B

27. Underground Economy [as a Percentage of GDP for Select Nations] Percentage of GDP 0 5 10 15 20 25 30 Mexico S. Korea India Italy Spain China Sweden Germany France United Kingdom Japan Switzerland United States Source: Journal of Economic Literature

28. 7. Non-market Transactions Are Not Counted Work in your own household or volunteer workin the community does not count because there was no payment. You need to do some of this housework.

29. 7. Non-market Transactions Are Not Counted Work in your own household or volunteer workin the community does not count because there was no payment. So, don’t marry your maid, yardman, or fitness instructor, or you will hurt GDP.

30. 8. U.S. Corporations Producing Goods Overseas Nike in Indonesia GM in France IfU. S. corporationsproduce goods overseas, it does not count in GDP, but would count in GNP. Remember, we are measuring production inside the U.S. Imports represent production outside of the U.S.

31. Eight Things Not Counted in GDP [no production] • Second Hand Sales[no production] • Public/Private Transfer Payments • Purely Financial Transactions • Intermediate Goods 5. U.S. Corporations producing overseas 6. Non-market transactions [household or volunteer work] Underground Economy 7. Illegal business activity 8. Unreported legal business activity

32. - When Outback buys potatoes for baked potatoes When a tattoo business buys ink for tattoos When Tom Thumb buys spam to sell it to you When the popsicle maker buys the sticks Dell buys a computer monitor frame Ice cream that Braum’s buys for sundaes A bakery buys an apple to put in its pies When Ford buys a windshield wiperfor a car When hooker, J-Lo Ho, is paid $200.00 Do These Count in GDP?

33. Is It Counted In GDP? On the next slide, read each sentence and determine, “To Be or Not To Be Counted?” That is the question. If “Yes”, put “Y” and tell if it is “C”, “Ig”, “G”, or “X”. If “No”, put “N” and give the number from below on why it is not counted in GDP. GDP DOES NOT INCLUDE 1. Second hand sales [no current production] [but the salesman’s commission counts] 2. Public/Private transfer payments [no current production] 3. Purely financial transactions [no current production] [broker’s fees do count] 4. Intermediate goods [component of final good] 5. U.S. corporations producing overseas. 6. Non-market transactions [ household or volunteer work. Underground Economy [not reported] 7. Illegal business activity [prostitution, murder-for-hire, illegal drugs, etc.] 8. Unreported legal business activity [“off the books”] Example: C Y ___ ___ 1. New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacherthe year it was produced. ___ ___ 2. You buy a new Wii at GameStop in 2009. Does it count if you resell it on eBay in March of 2010? 1 N

34. Is It Counted In GDP? ___ ___ 1. You buy a purple “TinkyWinky” from Wal-Mart. ___ ___ 2. You and your family paint your house. [labor involved] ___ ___ 3. You marry your housemaid. [“working-for-love”] [her services] ___ ___ 4. You buy 100 shares of Microsoft Corporation. ___ ___ 5. You volunteer to babysit your little sister to help your parents while they work. ___ ___ 6. Bob buys a 1965 ford Mustang convertible, in 2010, which is in mint condition. ___ ___ 7. The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010. ___ ___ 8. You and your friend volunteer to cook at the senior class picnic. ___ ___ 9. Dr. Payne does $1,000 worth of dental work but reports only $500 of it. Does the $500 the dentist keeps and doesn’t report count? ___ ___ 10. You are given s suitcase full of $100 bills from the sale of smuggled drugs. ___ ___ 11. Your mother is teaching you to read [& not having much success]. ___ ___ 12. Your dad bakes you a home-baked loaf of bread. [his labor] ___ ___ 13. You buy a loaf of bread from Kroger’s Grocery Store. ___ ___ 14. The U.S. government purchases 5 B-2 Bombers for $2 B each. ___ ___ 15. Ford buys a ton of sheet metal used in making car doors. ___ ___ 16. You buy a new “iPad” from the Apple store. ___ ___ 17. You send in a $90 check to your dentist for cleaning your teeth. ___ ___ 18. Your family buys a new house next to the mansion of Bill Gates. ___ ___ 19. 100 additional teachers are hired by the Frisco ISD. ___ ___ 20. GM invest in $500 million worth of robotsto assemble their cars. ___ ___ 21. You volunteer 10 hours a week of your time to work for senior citizens. ___ ___ 22. Ford produces 25,000 F150s in Denver which are not sold by the end of the year. ___ ___ 23. Russia buys 3,000Dell computers, produced in NY, as they become Rusky Dell Dudes. ___ ___ 24. A man’s wife does all his cooking and sewing, working for him 16 hours per day. ___ ___ 25. Nike produces $10 million worth of Nike Air Jordan’s in Vietnam. C Y 6 N N 6 3 N 6 N 1 N C Y 6 N 8 N 7 N N 6 N 6 • 2ndHd sales • Transfers • Financial • Intermediate • Overseas • Non-market • Illegal • Unreported C Y G Y 4 N Y C C Y Ig Y G Y Ig Y 6 N Ig Y X Y 6 N 5 N

35. Does Her Work Count? It depends on whether she is the maid or housewife.

36. And – What About This Work? It depends on whether he is the owner or hired mechanic.

37. Know How To Figure GDP & NDP.

38. THE MIX OF OUTPUT IN 1900 THE MIX OF OUTPUT IN 2000 Construction and Mining 6% Construction and Mining 9% Government 18% Manufacturing 22% Farming 2% Services 22% Farming 37% Manufacturing 20% Services 54% Government 10% A Century of GDP Changes

39. Lets’ take a look at some “Is It Included In GDP” questions on the 2007 FRQ.

40. 3. [8 pts] Indicate whether each of the following is counted in the U.S. GDP for the year 2006. Explaineach ofyour answers. (a) The value of used textbooksold through online auction in 2006. FRQ 2007 Answer: No, it was counted the year it was produced. Because it was not produced again, it would not be counted. That would be double counting. [2 pts: 1 pt for saying not included and 1 pt for saying not produced in 2006] b. Rent paid in 2006 by residents in an apartment building built in 2000 Answer: Yes, rents consist of the income received by the households and businesses that supply property resources. The properties have to be maintained or “serviced” each year. It is included in the income approach to GDP. [2 pts: 1 pt for “yes” and 1 pt for saying this is the payment for services] c. Commissions earned in 2006 by a stockbroker Answer: Yes, payment is being made for productive services of the broker. So the purchase of stocks would not count but his work would. [2 pts: 1 pt for “yes” and 1 pt for saying this is the payment for services] d. The value of autos produced in 2006 entirely in South Korea by a firm fully owned by U.S. citizens Answer: No, GDP measures production inside the U.S. regardless of ownership. These autos were produced in South Korea. [2 pts: 1 pt for “not included” and 1 pt for saying produced in Korea]

41. Components of Gross Domestic Product Y=[C + I + G + NX(X - M] Y= STANDS FOR GDP C=CONSUMPTION(CONSUMERS BUYING STUFF) I=INVESTMENT-FACTORIES/HOUSING G=GOVERNMENT SPENDING ON STUFF NX=NET EXPORTS(EXPORTS –IMPORTS)

42. THE EQUATION TO MEASURE GDP • Y=C+I+G+NX • WHAT IS THAT CRAP?

43. “Y.” in equilibrium GDP expenditures must be equal to income. The “Y” stands for income because the letter “I” is used for investment

44. Y=C+I+G+NX • Y=C+I+G+NX • OR • GDP=CONSUMPTION + INVESTMENT +GOVERNMENT PURCHASES + NET EXPORTS

45. Y=C+I+G+NX • CONSUMPTION-SPENDING BY HOUSEHOLDS ON GOODS AND SERVICES- YOU GOING TO JACK IN THE BOX OR PAYING ME TO TAKE YOU FISHING!

46. Definition of Consumption: spending by households on goods and services, with the exception of purchases of new housing.

47. Y=C+I+G+NX • INVESTMENT-PURCHASE OF CAPITLAL EQUIPMENT, INVENTORIES, AND STRUCTURES, SUCH AS THE GM FACTORY. ALSO INCLUDED IS BUYING OF NEW HOUSES.

48. Housing is Weird • The value of housing services is somewhat difficult to measure. • a. If housing is rented, the value of the rent is used to measure the value of the housing services. • b. For housing that is owned (or mortgaged), the government estimates the rental value and uses this figure to value the housing services.

49. Investment goods (such as structures and vehicles used in production) are not intermediate goods. Investment goods represent products purchased for final use by business firms.

50. Definition of Investment: spending on capital equipment, inventories, and structures, including household purchases of new housing.