Download Inflation October 18

A CASE STUDY
Gross Domestic Product
The Fourth Quarter, 2005
Date of Announcement
Dates of Next Announcement
January 27, 2006
February 28, 2006 (The “preliminary”
estimate of the 2005 fourth quarter)
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.
Announcement
Real Gross Domestic Product (GDP) during the fourth quarter (October, November,
and December) of 2005 increased at an annual rate of 1.1 percent. This is the first
estimate of the rate of change in the fourth quarter.
This is also the first estimate of the growth in real gross domestic product for the
entire year of 2005. Real GDP for the entire year increased at a rate of 3.5 percent.
Is this rate of increase in the last quarter of 2005 high, low, or about the same as the
increases in the last few years?
Higher
Pop-up –
About
the same
Lower
Yes, correct.
Lower
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If another choice is made, this should pop-up –
No. Try again. Think about
what has happened over the last
year.
This quarter’s increase compares to annual rates of 3.3 and 4.1 percent in each of the
first two previous quarters. For the entire 2005 year, real GDP increased at a rate of 3.5
percent. During all of 2005, real GDP increased by 3.5 percent. Annual growth rates in
2002, 2003, and 2004 were 1.6, 2.7, and 4.2 percent.
Attention Teachers
Material that appears in italics is included in the teacher version only. All other
material appears in the student version. Throughout the semester, the GDP cases will
become progressively more comprehensive and advanced.
Quarterly growth at annual rates
Rates of change in GDP figures are reported for years and quarters. When the
quarterly rates are reported they are at annual rates. That means that real GDP did not
grow at 1.1 percent during the fourth quarter. It grew at a rate that if it had continued
for an entire year, real GDP would have been 1.1 percent higher. (The actual growth
rate during the quarter was approximately one-fourth of 1.1 percent or .275 of one
percent.) Reporting at annual rates makes it easier to compare the change of a quarter
to the change over an entire year.
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.
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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.
There are often a number of different measures of GDP reported. Nominal GDP, or
simply GDP, is total output in current prices. Real GDP is total output with prices held
constant. Real GDP per capita is the real GDP per person in the economy and is the best
measure of well-being of all the other measures.
One approximate means of calculating real GDP per capita is to identify the increase
in nominal GDP and then subtract the percentage increase in prices and the percentage
increase in population. That would leave the percentage increase in real GDP per capita.
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 policies, our investment and saving patterns, the
quality of our technological advances, and our material well-being. Changes in real GDP
per capita provide our best measures of changes in our material standards of living.
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 increase in
real GDP will be discussed in news reports as a positive sign of the strength of the current
economy.
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 decreases 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.
Data Trends
During 2000 and 2001, the rate of growth of real gross domestic product slowed
significantly. A recession was declared for March 2001 to November 2001. Growth
increased in 2002, 2003, and 2004, reaching 4.2 percent in 2004. The most recent
quarter’s growth rate is relatively small. All of the quarterly growth rates in the previous
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10 quarters were above 3 percent annual rates. We would have to go back to the fourth
quarter of 2002 to find slower growth than in this quarter.
Figure 1
Long-run Trends
The rate of increase in real GDP was not only higher in the last part of the 1990s than
in the first half of the 1990s, but also when compared with 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 of the 1990s
being at or over 4.1 percent per year.
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. Figure 2 shows the history of growth since the 1970s. Figure 2 also
shows the average annual rate of growth of 3.1 percent since 1970.
Figure 2
Prices
The price index for GDP increased at an annual rate of 3.0 percent during the fourth
quarter of 2005, compared to an increase of 3,3 percent during the third quarter of 2005.
It increased at an annual rate of 2.8 percent for all of 2005. See the latest inflation case
study for a discussion of the recent increases in price levels.
Details of the Third-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 1.1 percent, a slowdown in growth. The
major contributors to the decrease in the growth rate of real GDP in the fourth quarter
were a significant slowing in the growth of in personal consumption and a fall in
government spending, with a decrease in national defense spending. Those factors
slowing growth were partially offset by an increase in investment.
A Hint about News Reports
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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.
Explanations of GDP and its Components
Gross domestic product consists of goods and services produced for consumption, for
investment, for government, and for export. The GDP accounts are broken down into
consumption spending, investment spending, government spending, and spending on U.S.
exports. To arrive at the amount actually produced (that is, GDP) our spending on
imports is subtracted from those other amounts of spending. Thus,
GDP = Consumption spending + investment spending + government spending +
export spending – import spending
There is a slide that shows this equation.
Consumption spending consists of consumer spending on goods and services. It is
often divided into spending on durable goods, non-durable goods, and services. These
purchases currently account for 70 percent of GDP.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years.
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period.
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.
Investment spending 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.
Residential investment is the building of a new homes or apartments.
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold.
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Government spending 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 (19 percent) does not include transfer payments such as
Social Security, unemployment compensation, and welfare payments, which do not
represent production of goods and services. Federal defense spending now accounts for
approximately 5 percent of GDP. State and local spending on goods and services
accounts for 12 percent of GDP, while federal spending is 7 percent of GDP.
Exports are goods and services produced in the U.S. and purchased by foreigners –
currently about 10 percent of GDP.
Imports are items produced by foreigners and purchased by U.S. consumers are equal
to 16 percent of GDP. Net exports (exports minus imports) are negative and are about 6
percent of the GDP.
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 real 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. From 1983 to 2002, the advance estimates of the rate of growth in
real GDP have been revised an average of 0.5 percent in the next month's preliminary
estimate. The preliminary estimates have been revised by an average of an additional 0.3
percent.
Revisions in inventory investment and the international trade data are often the
causes of changes in the GDP figures. Those data for the last month of the quarter are
not available when the advance estimate of GDP is announced.
Interactive questions for students.
1. Given the following data (in billions of current dollars),
a.
what is the level of government spending in the calculation of GDP?
b.
what is the level of investment?
c.
what is the level of net exports?
d.
calculate the level of gross domestic product.
Social security payments
Income tax receipts
Exports
Wages
$1,000
1,500
2,100
9,000
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Consumption spending
Federal government spending on
goods and services
Construction of new homes
State and local spending on
goods and services
Changes in inventories
Imports
Business purchases of new factories
and equipment
8,000
750
400
1,250
- 500
2,500
2,000
2. If GDP has increased by 4 percent and inflation is 3 percent, what has happened to
real GDP?
3. If GDP increases by 5 percent and real GDP increased by 4 percent, what has
happened to the average price level?
4. If GDP increased by 4 percent, inflation is 3 percent, and population growth is 1
percent, what has happened to real GDP per capita?
Answers to interactive questions.
1. a. Government spending equals $2,000 ($750 plus $1,250).
Government spending is equal to the sum of federal spending on goods and services
and state and local spending on goods and services. Social security payments are
transfers of income from tax payers to social security recipients and do not represent
the production of goods and services.
b. Investment equals $1,900 ($2,000 + 400 - 500).
New factories and equipment and construction of new homes are included in
investment. However, since business inventories fell, we subtract $500 billion from
investment in structures, equipment, and residential housing to get the investment
portion of GDP.
c. Net exports equal a minus $500 ($2,000 - 2,500).
Net exports are exports minus imports. In this case, the economy has a balance of
trade deficit.
d. GDP equals $10,150 billion ($7,000 + 1,850 + 1,700 - 400).
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GDP equals consumption spending plus government spending on goods and
services plus investment spending plus net exports.
2. If nominal GDP has increased by 4 percent and inflation was 3 percent, the amount
of output has increased by 1 percent. The remaining (after inflation) increase in
nominal GDP must be due to real output increases.
3. If nominal GDP increases by 5 percent and the amount of output increases by 4
percent, then prices must have increased by 1 percent.
4. Real GDP has not changed. Nominal GDP increased by 4 percent. Real GDP
increased by 1 percent. So if population grew by 1 percent, per capita real GDP did
not change.
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
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it arbitrarily redistributes purchasing power. Inflation can reduce the rate
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)
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Lesson 6: Measuring How Our Economy is Doing
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.
Author:
Stephen Buckles
Vanderbilt University
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