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A CASE STUDY
Gross Domestic Product
First Quarter, 2002
Date Of Announcement
April 26, 2002
Dates of Future Announcements
May 24, 2002
Announcement
Real Gross Domestic Product (GDP) during the first quarter (January through March)
of 2002 increased at an annual rate of 5.8 percent. This is the advance estimate for the
first quarter and will be revised in the preliminary and final estimates over the next 2
months. During 2001, real GDP changed at annual rates of +1.3 percent, +0.3 percent,
-1.3 percent and +1.7 percent for each quarter respectively.
This is the fastest rate of growth of GDP since the fourth quarter of 1999. The growth
rate in real GDP for all of 2001 was 1.2 percent. That compares to a 4.1 percent annual
growth rate in both 1999 and in 2000.
Why are Changes in Real Gross Domestic Product Important?
The measurement of the production of goods and services produced each year permits
us to evaluate our monetary and fiscal polices, our investment and saving patterns, the
quality of our technological advances, and our material well-being. While rates of
inflation and unemployment and changes in our income distribution provide us additional
measures of the successes and weaknesses of our economy, none is a more important
indicator of our economy's health than rates of change in real GDP.
Changes in real GDP are discussed in the press and on the nightly news after every
monthly announcement of the latest quarter's data or revision. This current rather high
increase in real GDP will be discussed in news reports as a sign that the economy may
have already come out of the recession that began in March of last year.
Real GDP trends are prominently included in discussions of potential slowdowns and
economic booms. They are featured in many discussions of trends in stock prices.
Economic commentators use falls in real GDP as indicators of recessions. The most
popular (although inaccurate) definition of a recession is at least two consecutive quarters
of declining real GDP. See below for a discussion of the current recession.
Most important, changes in real GDP per capita provide our best measures of changes
in our material standards of living.
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Goals of Case Study
The goals of the GDP Case Studies are to provide teachers and students:
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access to easily understood, timely interpretations of monthly announcements of
rates of change in real GDP and the accompanying related data in the U.S.
economy;
descriptions of major issues surrounding the data announcements;
brief analyses of historical perspectives;
questions and activities to use to reinforce and develop understanding of relevant
concepts; and
a list of publications and resources that may benefit classroom teachers and
students interested in exploring inflation.
Definition of Gross Domestic Product
Gross Domestic Product (GDP) is one measure of economic activity, the total amount
of goods and services produced in the United States in a year. It is calculated by adding
together the market values of all of the final goods and services produced in a year.
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It is a gross measurement because it includes the total amount of goods and
services produced, some of which are simply replacing goods that have
depreciated or have worn out.
It is domestic production because it includes only goods and services produced
within the U.S.
It measures current production because it includes only what was produced during
the year.
It is a measurement of the final goods produced because it does not include the
value of a good when sold by a producer, again when sold by the distributor, and
once more when sold by the retailer to the final customer. We count only the
final sale.
Changes in GDP from one year to the next reflect changes in the output of goods and
services and changes in their prices. To provide a better understanding of what actually
is occurring in the economy, real GDP is also calculated. In fact, these changes are more
meaningful, as the changes in real GDP show what has actually happened to the
quantities of goods and services, independent of changes in prices.
Data Trends
The growth in real GDP at the end of the 1990s has been relatively high when
compared with the early part of the 1990s. However, during the last two quarters of 2000
and the first three quarters of 2001, the rate of growth of real gross domestic product
slowed significantly. During the third quarter of 2001, real GDP was actually negative
for the first time since 1993.
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The Federal Reserve has responded to slowing growth and the recession, beginning in
March 2001, by reducing the target federal funds rate by 475 basis points (4.75%) from
January 2001 to December 2001. (See the January 30, Federal Reserve System and
Monetary Policy Case). The effects of stimulative monetary policy and the resulting low
interest rates helped increase consumer spending over the past two quarters, partially
responsible for the increase in real GDP in the fourth quarter of 2001 and the first quarter
of 2002.
The price index for GDP increased at a rate of 0.8 percent during the first quarter of
2002, compared to a decline of 0.1 percent during the fourth quarter of 2001. It increased
at an annual rate of 2.2 percent for 2001, compared to 2.3 percent for 2000.
Figure 1
The rate of increase in real GDP has been higher in the last several years than in the
first part of the 1990s and much of the 1970s and 1980s. Economic growth, as measured
by average annual changes in real GDP, was 4.4 percent in the 1960s. Average rates of
growth decreased during the 1970s (3.3%), the 1980s (3.0%), and the first half of the
1990s (2.2%). In the last five years of the 1990s, the rate of growth in real GDP
increased to 3.8 percent, with the last three years being at or over 4.1 percent per year.
Figure 2
The upward trend in economic growth over the past decade has been accompanied by
increases in the rates of growth of consumption spending, investment spending, and
exports. Productivity increases, expansions in the labor force, decreases in
unemployment, and increases in the amount of capital have allowed real GDP to grow at
the faster rates. During this same time period, consumers have reduced their savings.
Personal savings as a percentage of disposable income had fallen to one-half of one
percent during the last several quarters before it rose this quarter to 2.1 percent.
Details of the Fourth-Quarter Changes in Real GDP
Real GDP increased by 5.8 percent in the first quarter of 2002 compared to a decline
of 1.7 percent in the fourth quarter of 2001. Consumption continued to increase during
the quarter, but at a slower rate than in the fourth quarter. Government spending also
increased at a slower rate than the fourth quarter, but included a quite large increase in
federal spending on national defense. Exports increased, but imports increased by an
even larger amount with the net effect being a reduction in real GDP.
The increase in consumption spending was primarily due increases in nondurable
goods and services. For 2001, consumption spending increased at a rate of 3.1 percent,
compared to 4.8 percent in 2000 and 5.0 percent in 1999.
Real investment increased at an annual rate of 22.6 percent during the first quarter of
2002, compared to a decrease of 23.5 percent in the fourth quarter of 2001. The most
important causes of that increase were the rise in residential investment and the
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significantly smaller reduction in inventories. For all of 2001, investment spending
decreased 8.0 percent. The 15.7 percent increase in residential investment, but this was
slightly offset by continued declines in non-residential fixed investment.
The effects of the changes in inventories are not always easy to interpret. The
previous quarter included a reduction in inventories of almost $120 billion. This quarter
saw a reduction in inventories of only $36 billion. Inventory reductions are counted as a
negative investment - a reduction in the capital stock. As a much smaller amount was
subtracted from the total amount of fixed investment, total investment actually increased
during the quarter. (Investment in the fourth quarter was equal to $1,622 billion minus
$120 billion, that is $1,502 billion. Investment in the first quarter of 2002 was equal to
$1,621 billion minus $36 billion, which is $1,595 billion.)
Exports increased by 6.8 percent (compared to a decrease of 10.9 percent in the fourth
quarter) and imports increased by 15.5 percent (compared to a decrease of 7.5 percent in
the fourth quarter). Thus net exports fell slightly during the quarter.
Monetary policy has been used to encourage consumers to increase spending and
businesses to increase investment. The short-run effects of both the monetary policy and
the increase in government spending should be some stimulus to spending. In the fourth
quarter of 2001, the effects of low interest rates (and zero-percent financing by many car
dealerships) are seen in the increased purchases of durable goods such as automobiles
and appliances. In the first quarter of 2002, the effects of monetary policy are
contributing to inventory expansion.
Recessions
On November 26, The National Bureau of Economic Research announced though its
Business Cycle Dating Committee that it had determined that a peak in business activity
occurred in March of 2001. That signals the official beginning of a recession.
The NBER defines a recession as a "significant decline in activity spread across the
economy, lasting more than a few months, visible in industrial production, employment,
real income, and wholesale-retail trade." The current data show a decline in employment,
but not as large as in the previous recession. Real income growth has slowed but not
declined. Manufacturing and trade sales and industrial production have both declined
and have been doing so for some time. As seen during this quarter, consumers are
increasing their spending and businesses are increasing their inventories, contributing to
speculation that we are currently coming out of the recession.
The last recession began in July of 1990 and ended in March of 1991, a period of
eight months. However, the beginning of the recession was not announced until April of
1991 (after the recession had actually ended). The end of the recession was announced in
December of 1992, almost 21 months later. One of the reasons the end of the recession
was so difficult to determine was the economy did not grow very rapidly even after it
came out a period of falling output and income.
For the full press release from the National Bureau of Economic Research see:
http://cycles-www.nber.org/cycles/november2001/recessnov.html
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Changes in Nominal Gross Domestic Product
Nominal GDP – that is, GDP measured in current prices – increased at annual rate of
6.7 percent in the first quarter of 2001 to a level of $10,431.3 billion. The rate of change
in nominal GDP (6.7%) equals the change in real GDP (5.8%) plus the change in prices
of goods included in nominal GDP (0.8%). The latter is represented by the GDP deflator,
sometimes described as the GDP price index. (The numbers do not add up exactly due to
errors in rounding).
A Hint About News Reports
Many news reports simply use "gross domestic product" as a term to describe this
announcement. The actual announcement focuses on the REAL gross domestic product,
and that is the meaningful part of the report. In addition, newspapers will often refer to
the rate of growth during the most recent quarter and will not always refer to the fact that
it is reported at annual rates of change. This is contrasted to the reports of the consumer
price index, which are reported at actual percentage changes in the index for a single
month, and not at annual rates.
HOW CAN WE INCREASE ECONOMIC GROWTH IN THE FUTURE?
Economic growth is a function of the technological innovation and the amount and
quality of labor and capital in the economy:
As more people are employed, the amount of capital increases, education levels increase,
the quality of capital changes, or the technology increases, the productive capacity of the
economy increases. Therefore, the economy can increase its output giving consumers
more disposable income, promoting an increase in consumption spending, and providing
resources for business to use for further investment and government to use to provide
public goods and services.
Increased labor force participation increases output. Expanded, improved education
creates more productive workers. Business and government spending on research and
development enhance our abilities to produce and allow each worker to become more
productive, increasing incomes for all. Finally, to achieve a higher level of GDP in the
future, consumers need to limit consumption spending and increase savings today,
permitting businesses to invest more in capital goods. If resources are invested into
building an economy now, future generations will enjoy a higher level of economic
growth; our businesses will produce more goods and consumers can purchase more
goods. Expansion of output at rates faster than our population growth is what gives us
the opportunity to enjoy higher standards of living.
Explanations of GDP and its Components
It is common to see the following equation in economics textbooks:
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GDP = C + I + G + NX
Consumption spending (C) consists of consumer spending on goods and services. It
is often divided into spending on durable goods, non-durable goods, and services. These
purchases accounted for 70 percent of GDP in the first quarter.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years (11%).
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period (20%).
Services include rent paid on apartments (or estimated values for owner-occupied
housing), airplane tickets, legal and medical advice or treatment, electricity and other
utilities. Services are the fastest growing part of consumption spending (39%).
Investment spending (I) consists of non-residential fixed investment, residential
investment, and inventory changes. Investment spending accounts for 17 percent of GDP,
but varies significantly from year to year.
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Non-residential fixed investment is the creation of tools and equipment to use in the
production of other goods and services. Examples are the building of factories, the
production of new machines, and the manufacturing of computers for business use
(17%).
Residential investment is the building of a new homes or apartments (4%).
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold (<-1%).
Government spending (G) consists of federal, state, and local government spending
on goods and services such as research, roads, defense, schools, and police and fire
departments. This spending does not include transfer payments such as Social Security,
unemployment compensation, and welfare payments, which do not represent production
of goods and services (18%).
Net Exports (NX) is equal to exports minus imports. Exports are items produced in
the U.S. and purchased by foreigners (11%). Imports are items produced by foreigners
and purchased by U.S. consumers (16%). Thus, net exports (exports minus imports) are
negative, about – 5% of the GDP. (For more information on the balance of trade, see the
Trade Report case study.)
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Saving and GDP
During the first quarter of 2002, personal saving as percentage of disposable income
increased to 2.1 percent from 0.4 percent in the fourth quarter of 2001. Other
industrialized nations such as France, Germany, Italy, Spain and Japan all have saving
rates of over 10 percent. A low saving rate means that there are fewer resources to
finance investment in the economy and, as a result, the growth rate in investment may be
subdued. Over the past several years, foreign capital has funded investment in the U.S.
However, as the global economy strengthens, foreign investors have a wider range of
options for investing and this source of investment capital may weaken, hurting
investment unless the U.S. saving rate increases.
GDP as a Measure of Well-Being
Changes in real GDP are a more accurate representation of meaningful economic
growth than changes in nominal GDP, because changes in real GDP represent changes in
quantities produced, while prices are held constant. Real GDP per capita is even more
relevant because it measures goods and services produced per person and thus
approximates the amount of goods and services each person can enjoy. If real GDP
grows, but the population grows faster, then each person, on average, is actually worse
off than the change in real GDP would indicate.
Consider the table below. While the mainland part of China has a GDP of $991
billion, its GDP per capita is only $791.30. Hong Kong has a much smaller GDP of $159
billion. However, its GDP per capita is much higher at $23,639.58. Other nations, such
as France and Germany, may have quite different GDPs, but GDPs per capita that are
very close.
Country
China (mainland)
China (Hong Kong)
France
Germany
United States
Population
GDP (billions)
1,262,460,000 $ 1,158.70
6,797,000 $
161.87
58,892,000 $ 1,307.06
82,150,000 $ 1,847.35
281,550,000 $ 10,208.13
Per Capita GDP
$
910.80
$ 23,879.50
$ 21,988.90
$ 22,427.10
$ 36,716.30
2001 GDP in billions of current US dollars
(International Monetary Fund, World Bank)
GDP per capita is not a perfect estimate of well-being. When individuals grow their
own food, build their own houses and sew their own clothes, they are not producing
goods and services to be sold in a marketplace and therefore GDP does not change. As a
result, many countries South America and Africa have a low GDP per capita that
underestimates their well-being.
(The comparisons in the above table are of nominal GDP per capita, not real GDP per
capita. As we are comparing per capita figures for the same year there is no need to
deflate the nominal figures into real figures.)
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The U.S. as a Wealthy Country
Worldwide Gross Domestic Product
Percentage
Country
of Global GDP
United States
32.9%
Japan
13.4%
Germany
6.0%
United Kingdom
4.6%
France
4.2%
China
3.7%
Italy
3.5%
Canada
2.3%
Mexico
2.0%
Spain
1.9%
Population
281,550,000
126,870,000
82,150,000
59,739,000
58,892,000
1,262,460,000
57,690,000
30,750,000
97,966,000
39,465,000
Percentage
of World Population
4.65%
2.09%
1.36%
0.99%
0.97%
20.84%
0.95%
0.51%
1.62%
0.65%
Estimates of 2001 GDP in billions of current US
dollars
(International Monetary Fund, World Bank)
An alternative way of comparing the size of world economies is to calculate the
percentage of the world GDP (approximately $32 trillion) produced in each country and
compare that to the percentage of the world's population living in each country. As seen
in the table above, the top ten countries in terms of gross domestic product comprise 75
percent of the global GDP with only 35 percent of the world’s population. The U.S.
alone produces a third of the goods bought and sold around the world with only 4.7
percent of the world’s population. There are significant differences in the wealth of
nations and the income of its citizens.
Revisions in GDP Announcements
Real GDP for each quarter is announced three times. The month following the end of
the quarter is described as the advance GDP; the second announcement or revision is
described as the preliminary announcement; and the third month is the final. While
labeled as the final version, even it will eventually be revised after the final data for the
year are published. Since 1978, the advance estimates have been revised an average
increase of 0.5 percent in the rate of growth of GDP and the preliminary estimates have
been revised by an average increase of 0.3 in the rate of growth of GDP.
Revisions in inventory investment and the international trade data are often the causes
of changes in the GDP figures. Because changes in inventories and international trade
data make up significant portions of the current report, one should be particularly
cautious in using the “advance” and “preliminary” figures.
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ARE ESTIMATES OF GDP ACCURATE MEASURES OF OUR WELL BEING?
GDP fails to account for many forms of production that improve a person’s well being.
For example, if you make a meal at home, the labor is not included. However, if you
were to go out to a restaurant and consume that same meal, the labor is included in
GDP. Unpaid work at home or for a friend and volunteer work is not included and thus
GDP does not reflect production of all we produce.
External effects of production, such as pollution, are not subtracted from the value of
GDP. Although two countries may have similar GDP growth rates, one country may
have significantly cleaner water and air, and therefore is truly better off than the other
country. If as economic growth accelerates, producers begin to employ production
techniques that create more pollution, the effects of the growth are overstated.
GDP includes police protection, new prisons, and national defense as goods and
services. It is not always clear that if we have to devote increased resources for such
purposes that we are better off as a result.
GDP includes the effects of price changes. An increase in GDP due solely to inflation
does not signal an improvement in living standards. Real GDP is a better measure. Nor
does GDP reflect population growth. Changes in the income distribution are not
measured. It is also difficult to compare rates of growth for different countries, as
countries use different means of estimating income and price levels in their economy.
There are a variety of other weaknesses and inaccuracies, but GDP accounting is the
best that we have. Real GDP does provide sound signals as to the direction of change of
a selected large part of what we produce each year. Government statisticians and
academics are constantly working to improve its accuracy and its ability to reflect our
well being.
Questions
Components of GDP
Determine if each of the items listed below should be included in GDP and under which
component or components: Consumption, Investment, Government, Exports or Imports.
1. A stereo produced and sold in the U.S. by a Japanese company
2. College tuition
3. Social Security payments
4. Microsoft stock purchased from Microsoft
5. A space shuttle launch
6. The purchase of a plane ticket to London on British Airways
7. The purchase of a U.S. Treasury Bond by an individual
8. A new factory
9. The sale of a previously occupied house
10. A bottle of French wine, sold in the U.S.
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11. A television produced, but not sold.
12. A home cooked meal
13. A dinner at a restaurant
14. A computer produced in the U.S. and sold in Canada
15. A new interstate
Answers:
1. Consumption – A stereo produced and purchased in the US is counted as a
consumption good and not an import, regardless of the ownership of the company.
2. Consumption
3. Not included – This is a type of transfer payment and is not included in GDP, because
it does not represent the production of goods and services.
4. Not included – The purchase of a stock is a transfer of money and does not represent
the production of goods and services.
5. Government
6. Imports and consumption – This is an import and a consumption good because it is
the consumption of a good produced outside the U.S by a consumer in the U.S.
7. Not included – The purchase of a U.S. Treasury Bond is a transfer of money from the
consumer to the Treasury and does represent the production of goods and services.
8. Investment
9. Not included – Only current construction is counted in GDP. The house was
accounted for in GDP when it was originally built. When resold later, it does not
represent the production of goods and services.
10. Imports and consumption – This is both an import and a consumption good, because
it was produced outside the U.S. and purchased by a consumer in the U.S. for
personal consumption.
11. Investment – A good that is produced but not sold is counted as an increase in
business inventories, a category of investment. They are counted in GDP because
they represent the current production of goods; they are a business investment to be
sold in the future.
12. Not included
13. Consumption
14. Export
15. Government
Other Questions for Students
1. Given the following data (in billions of current dollars), calculate the current level of
gross domestic product.
Consumption spending
Social security payments
Income tax receipts
$7,000
500
1,000
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Exports
Business purchases of new factories
and equipment and changes in inventories
Federal government spending on
goods and services
Construction of new homes
State and local spending on
goods and services
Imports
Wages
1,100
1,500
550
200
1,300
1,500
6,000
2. If gross domestic product increases by 10 percent over a year, are we better off? Why
or why not?
3. Increases in real GDP represent more production of goods and services. Why would
the Federal Reserve ever undertake a policy to slow down the rate of growth in
production?
4. If consumers begin to purchase automobiles manufactured abroad instead of those
manufactured in the U.S., what will happen to real GDP? Will the answer be
different if consumers are simply increasing their spending and those purchases are of
automobiles manufactured abroad?
5. Why are wages and profits not included in gross domestic product?
Sample Answers for Additional Questions
1. Gross domestic product will equal consumption spending ($7,000), plus investment
spending ($1,500 + 200), plus government spending on goods and services ($550 +
1,300), plus exports ($1,100), minus imports ($1,500). GDP = $10,150 billion, or
$10.150 trillion.
Social security payments are not included, as they are transferring income from one
set of individuals, taxpayers, to another, social security recipients. Goods and
services are not produced. For basically the same reasons, taxes are not included.
Construction of new homes is part of investment spending. Wages are not included.
2. Perhaps we are better off. Part of the answer depends upon what is happening to
prices and what is happening to population. If prices and population together are
rising by more than 10 percent per year, than we, on average, are worse off. We have
fewer goods and services per person.
3. As more is produced, more labor is hired. Increasing demand for labor will
eventually cause wages to begin to rise. Although workers benefit, the increased
wages will eventually put upward pressure on the prices businesses have to charge to
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cover their new higher costs. If the Federal Reserve is concerned with rising
inflationary pressures, they will be concerned with the rapid rates of increase in GDP.
4. Consumption spending will remain the same; however, imports will increase. Real
GDP in the U.S. will decrease. In the second instance, consumption spending
increased, but imports increased by an equal amount. Real GDP does not change.
The components do change.
5. Gross domestic product includes all of the production of goods and services in a year.
Production of consumption, investment, government, and net export goods is
included. Therefore, wages are not added to the total amounts of production when
calculating GDP. But, production also generates income. Every dollar that is spent
on goods and services eventually becomes income to someone - the workers, the
owners, and the lenders. An alternative way of calculating GDP is to add all of the
incomes earned by all participants in the economy.
Key Concepts
Consumption
Investment
Government expenditures
Net exports
Real GDP and nominal GDP
Real GDP per capita
Economic growth
Relevant National Economic Standards
The relevant national economic standards are numbers 15, 18, 19, and 20.
15. Investment in factories, machinery, new technology and in the health,
education, and training of people can raise future standards of living.
Students will be able to use this knowledge to predict the consequences of
investment decisions made by individuals, businesses, and governments.
18. A nation's overall levels of income, employment, and prices are
determined by the interaction of spending and production decisions made
by all households, firms, government agencies, and others in the economy.
Students will be able to use this knowledge to interpret media reports
about current economic conditions and explain how these conditions can
influence decisions made by consumers, producers, and government policy
makers.
19. Unemployment imposes costs on individuals and nations. Unexpected
inflation imposes costs on many people and benefits some others because
it arbitrarily redistributes purchasing power. Inflation can reduce the rate
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of growth of national living standards because individuals and
organizations use resources to protect themselves against the uncertainty
of future prices. Students will be able to use this knowledge to make
informed decisions by anticipating the consequences of inflation and
unemployment.
20. Federal government budgetary policy and the Federal Reserve
System's monetary policy influence the overall levels of employment,
output, and prices. Students will be able to use this knowledge to
anticipate the impact of federal government and Federal Reserve System
macroeconomic policy decisions on themselves and others.
Original U.S. Bureau of Economic Analysis Announcement and Data
http://www.bea.doc.gov/bea/newsrel/gdp301p.htm
Sources of Additional Activities
Advanced Placement Economics: Macroeconomics. (National Council on
Economic Education)
Unit 2: Measuring Economic Performance
Focus on Economics: High School Economics (National Council on Economic
Education)
Lesson 18. Economics Ups and Downs
Economics USA: A Resource Guide for Teachers
Lesson 6: U.S. Economic Growth: What Is the Gross National Product?
Capstone: The Nation’s High School Economics Course
Unit 5: 2.
Unit 5: 3.
Unit 6: 2.
Unit 6: 3.
Unit 6: 4.
Unit 6: 5.
What Do We Want from Our Economy?
An Economy Never Sleeps
Making a Macro Model: Consumers
Making a Macro Model: Investment
Making a Macro Model: Government
Making a Macro Model: Imports and Exports
Handbook of Economic Lessons (California Council on Economic Education)
Lesson 6: Measuring How Our Economy is Doing
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Lesson 7: Measuring How Our Economy Is Doing: GNP
Lesson 20: Plotting the Ups and Downs of the U.S. Economy
Lesson 21: The Fluctuating Economy: A Look at Business Cycles
Learning from the Market: Integrating the Stock Market Across the Curriculum
Lesson 23. Business Cycles and Investment Choices
Geography: Focus on Economics
Lesson 4. International Interdependence
Lesson 7. Places and Production
Lesson 8. GDP and Life Expectancy
All are available in Virtual Economics, An Interactive Center for Economic Education
(National Council on Economic Education) or directly through the National Council on
Economic Education.
Authors: Stephen Buckles
Erin Kiehna
Vanderbilt University
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