Gross Domestic Product Measures Total Production

Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year.GDP Is Measured Using Market Values, Not Quantities

The worth of a thing is the price it will bring.Final good or service A good or service purchased by a final user:

• Household consumption

• Business investment, including all residential construction

• Government purchases

• Exports to foreigners

vs

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

PRODUCTION AND PRICE STATISTICS FOR 2011

(1)PRODUCT

(2)QUANTITY

(3)PRICE PER UNIT

Eye examinations 100 $50.00Pizzas 80 10.00Textbooks 20 100.00Paper (for textbooks) 2,000 0.10

PRODUCT(1)

QUANTITY(2)

PRICE PER UNIT(3)

VALUE

Eye examinations 100 $50 $5,000

Pizzas 80 10 800

Textbooks 20 100 2,000Total GDP = $7,800

Production, Income, and the Circular Flow Diagram

SprivateIm

X

C T

T

G + Tr

G

DeficitNX = X - Im

I = Sprivate

- NX - Deficit

Y: Components of GDP = $16.0 trillion (2013:Q1)

Consumption Spending by households on goods and services, not including spending on new houses.

C: Personal Consumption Expenditures = “Consumption” = 71.0% of Y

Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses.

I: Gross Private Domestic Investment, or “Investment” = 13.4% of Y

G: Government Consumption and Gross Investment,or “Government Purchases” = 19.0 % of Y

Government purchases Spending by federal, state, and local governments on goods and services.

NX: Net Exports of Goods and Services, or “Net Exports” = -3.4% of Y

X = 13.7 % of Y Im = 17.1% of Y

Transfer payments are not included in GDP: Payments by the government to individuals for which the government does not receive a new good or service in return.

• Unemployment benefits paid to someone not working.

• Social security benefits paid to someone who is retired.

• Interest income paid to a government bondholder

Since the government doesn’t produce anything for the market, the interest payment can’t be for anyproductive service.

“Underground economy” activities are not included in GDP• Production “off-the-books”• Illegal activities

Household production is not included in GDP

Does GDP Measure What We Want It to Measure?

Shortcomings of GDP as a Measure of Well-Being

The Value of Leisure Is Not Included in GDP

GDP Is Not Adjusted for Pollution or Other Negative Effects of Production

GDP Is Not Adjusted for Changes in Crime and Other Social Problems

GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

Per Capita Real GDP and Life Satisfaction

• Consumer spending on services is greater than the sum of spending on durable and nondurable goods.

• Business fixed investment is the largest component of investment. Gross private domestic investment includes

New plant and equipment

New residential construction

Net additions to business inventories

• Purchases made by state and local governments are greater than purchases made by the federal government.

• Imports are greater than exports

net exports are negative.

Consider the data above (in billions of dollars) for an economy: Gross domestic product (in billions of dollars) for this economy equals A) $2,200.B) $1,600.C) $1,400.D) $1,200.

Consumption expenditures $800

Investment expenditures 200

Government purchases 300

Exports 100

Imports 200

Wages 800

Measuring GDP by the Value-Added Method

Value added The market value a firm adds to a product.

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $1

Value added by cotton farmer = 1

Textile Mill

Value of raw cotton woven into cotton fabric = $3

Value added by cotton textile mill = ($3 – $1) = 2

Shirt Company Value of cotton fabric made

into a shirt = $15Value added by shirt manufacturer = ($15 –$3) = 12

L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35

Value added by L.L. Bean = ($35 – $15) = 20

Total Value Added = $35

PRODUCT2009

QUANTITY2000

PRICE VALUE

Eye examinations 100 $40 $4,000

Pizzas 80 11 880

Textbooks 20 90 1,800

2000 2009

PRODUCT QUANTITY PRICE QUANTITY PRICE

Eye examinations 80 $40 100 $50

Pizzas 90 11 80 10

Textbooks 15 90 20 100

Real GDP versus Nominal GDPReal GDP The value of this year’s final goods and services evaluated at base-year prices.

Nominal GDP The value of this year’s final goods and services evaluated at this year’s prices.

vs

Comparing Real GDP and Nominal GDPNominal GDP and Real GDP, 1990–2006

The GDP Deflator GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.

100Nominal GDPGDP deflatorReal GDP

$ GDP = Price Level x Real Output$Y = P x Y

P = $Y/Y

If the GDP deflator is greater than 100, real GDP is greater than nominal GDP.

a) True

b) False

c) The GDP deflator measures the general price level and has nothing to do with GDP, nominal or real, which measure output.

Increase in real GDP would overstate the increase of well-being in a country over time if

a) average hours worked per week increasedb) the amount of pollution increasedc) the crime rate increasedd) All of the abovee) None of the above

Other Measures of Total Production and Total Income

Gross National Product (GNP)=GDP + Net Foreign Earnings of US Residents

• Compensation of employees earned abroad• Interest and profits earned abroad

Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation)

National Income (NI) = NNP - Indirect Business Taxes

Personal Income (PI) = NI + Net Transfer Payments

= Income earned from production of national product

Disposable Income (DI) = PI - Income Taxes• Disposable Income is split between consumption and saving

Other Measures of Total Production and Total Income

FIGURE 7-4Measures of Total Production and Total Income, 2006

Other Measures of Total Production and Total Income

The Division of Income

FIGURE 7-5The Division of Income

Business cycleConsumptionEconomic growthExpansionFinal good or service GDP deflatorGovernment purchasesGross domestic product (GDP)Inflation rate

Intermediate good or service

Investment

K e y T e r m s

MacroeconomicsMicroeconomicsNet exportsNominal GDP

Price level

Real GDPRecessionTransfer paymentsUnderground economyValue added