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# Chapter 7 GDP: Measuring Total Production and Income

Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Business cycle Alternating periods of economic expansion and economic recession. Expansion The period of a business cycle during which total production and total employment are increasing. Recession The period of a business cycle during which total production and total employment are decreasing. Economic growth The ability of an economy to produce increasing quantities of goods and services. Inflation rate The percentage increase in the price level from one year to the next. Transfer payments Payments by the government to individuals for which the government does not receive a good or service in return.

Annual Changes in U.S. Economic Output
(Real GDP - Chainweighted 2000\$)
5%
4.4% 4.0% 4.3% 4.1% 3.8% 3.6% 3.4% 3.1% 2.9% 3.1% 2.7% 2.7% 2.7% 3.5% 3.6% 4.2%

4%

3.8%

3%

2%

1.8% 1.6%

1%
0.3%

0%
-0.5%

-1%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Source: Department of Commerce.

Domestic Production, Y =100

Foreign Production, M=17

Inventory

Sales, C + I + G + X 70 + 17 +19 +11

Equilibrium Condition
Q.S. = Q.D. Y+M=C+I+G+X 2006 \$ Trillion \$13.2 + \$2.2 = \$9.2 + \$2.2 + \$2.5 + \$1.5 Divide by Y (13.2 trillion) to get relative perspective 100% + 17% = 70% + 17% + 19% + 11% For heuristic reasons, multiply by 100 100 + 17 = 70 + 17 + 19 + 11 Or 100 = 70 + 17 + 19 + 11 – 17

Y=C+I+G+X-M

Measuring Total Production: Gross Domestic Product Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time.
• GDP IS MEASURED USING MARKET VALUES, NOT QUANTITIES GDP INCLUDES ONLY THE MARKET VALUE OF FINAL GOODS
Final good or service A good or service purchased by a final user. Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck.

GDP INCLUDES ONLY CURRENT PRODUCTION

The Circular Flow Diagram
\$13.2 Trillion \$1.5

\$2.2 \$2.5 \$9.2-2.2= \$7 \$0.7

\$2.2

Components of GDP
PERSONAL CONSUMPTION EXPENDITURES, OR “CONSUMPTION” Consumption Spending by households on goods and services, not including spending on new houses. GROSS PRIVATE DOMESTIC INVESTMENT, OR “INVESTMENT” Investment Spending by firms on new factories, office buildings, machinery, and inventories, and spending by households on new houses. GOVERNMENT CONSUMPTION AND GROSS INVESTMENT, OR “GOVERNMENT PURCHASES” Government purchases Spending by federal, state, and local governments on goods and services. NET EXPORTS OF GOODS AND SERVICES, OR “NET EXPORTS” Net exports Exports minus imports.

An Equation for GDP and Some Actual Values

Y = C + I + G + NX

Two Ways of Measuring GDP:
The two methods of calculating GDP are summarized below:
Expenditure Approach Personal consumption expenditures Resource Cost-Income Approach Aggregate income: Employee Compensation Income of self-employed Rents Profits Interest

+
Gross private domestic investment

+
Government consumption and gross investment

+
Net exports of goods and services

+

= GDP

Non-income cost items: Indirect business taxes and depreciation

+
Net income of foreigners

= GDP

The Expenditure Method of Measuring GDP Expenditure Approach:
GDP is the sum of expenditures on final-user goods and services purchased by households, investors, governments, and foreigners. There are four components of GDP: • personal consumption purchases • gross private investment (including inventories) • government purchases (consumption and investment) • net exports (exports minus imports)

Resource Cost-Income Method of Measuring GDP Resource Cost - Income Approach
GDP is the sum of costs incurred and income (including profits) generated by the production of goods and services during the period.

The direct cost income components of GDP:
employee compensation self-employment income rents interest corporate profits

Sum of these = national income
Not all cost components of GDP result in an income payment to a resource supplier. To get GDP, we need to account for 3 other factors:
Indirect business taxes: Taxes that increase the firm’s production costs and therefore final prices. Depreciation: The cost of wear and tear on the machines and other capital assets used to produce goods and services. Net Income of Foreigners: The income that foreigners earn producing goods within the borders of the U.S. minus the income Americans earn abroad.

Relative Size of U.S. GDP Components: 2000-2003
(a) Expenditure approach
Private investment Net exports - 4%

(b) Resource cost-income approach a
Indirect taxes Net interest 5% Depreciation 8% 12% Rental income 1%

16% Gov’t 18%

58% Corporate profits 70% Self-employed proprietor income 8% 7% Employee compensation
a The net income of foreigners was negligible.

Personal consumption
Source: http://www.economagic.com.

Calculating GDP
PRODUCTION AND PRICE STATISTICS FOR 2007
(1) PRODUCT (2) QUANTITY (3) PRICE PER UNIT

Eye examinations Pizzas Textbooks Paper
(1) QUANTITY

100 80 20 2,000
(2) PRICE PER UNIT

\$50.00 10.00 100.00 0.10
(3) VALUE

PRODUCT

Eye examinations Pizzas Textbooks

100 80 20

\$50 10 100

\$5,000 800 2,000

Measuring GDP by the Value Added Method

FIRM
Cotton Farmer Textile Mill Shirt Company L.L. Bean

VALUE OF PRODUCT
Value of raw cotton = \$1.00 Value of raw cotton woven into cotton fabric = \$3.00 Value of cotton fabric made into a shirt = \$15.00 Value of shirt for sale on L.L. Bean’s Web site = \$35.00

Value added by cotton farmer Value added by cotton textile mill = (\$3.00 – \$1.00) Value added by shirt manufacturer = (\$15.00 –\$3.00) Value added by L.L. Bean = (\$35.00 – \$15.00) = \$1.00 = \$2.00 = \$12.00 = \$20.00 = \$35.00

Real GDP versus Nominal GDP Calculating Real GDP
Real GDP The value of final goods and services evaluated at base year prices. Nominal GDP The value of final goods and services evaluated at current year prices.

The GDP Deflator
Price level A measure of the average prices of goods and services in the economy. GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP, and multiplying by 100.

Nominal GDP GDP deflator = x 100 Real GDP

Calculating Real GDP
2000 PRODUCT Eye examinations Pizzas Textbooks PRODUCT Eye examinations Pizzas Textbooks QUANTITY 80 90 15 QUANTITY 100 80 20 PRICE \$40 \$11 \$90 PRICE \$40 \$11 \$90 2005 QUANTITY 100 80 20 PRICE \$50 \$10 \$100 VALUE \$4,000 \$880 \$1,800

Other Measures of Total Production and Total Income Gross Domestic Product (GDP) \$13.197 Trillion
+ Foreign production of domestic firms \$0.661 Trillion - Domestic production of foreign firms \$0.638 Trillion

Gross National Product (GNP) \$13.220 Trillion
- Consumption of fixed capital (depreciation) \$1.573 Trillion

Net National Product (NNP) \$11.647 Trillion
- Indirect business taxes (sales tax) \$.914 Trillion

National Income \$10.733 Trillion
- Retained earnings \$0.963 Trillion + Transfer payments & government bond interest \$1.131 Trillion

Personal Income \$10.901 Trillion
- Personal tax payments (federal personal income tax) \$1.378 Trillion

Disposable Personal Income \$9,522 Trillion
- Personal outlays \$9.577 Trillion

Personal Savings \$-0.054 Trillion

Homework 7 Due Friday March 2 Problems and Applications,…. pages 225-226 Problems 6,7,8,13,20