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A Case Study
Gross Domestic Product
First Quarter, 2004
Date of Announcement
April 29, 2004
Dates of Future Announcements
May 27, 2004
Announcement
Real Gross Domestic Product (GDP) during the first quarter (January through March)
of 2004 increased at an annual rate of 4.2 percent.
Interactive question.
High
Is this rate of increase high relative to recent
increases? Low? About the same?
Low
About the
same
Answer. (This should pop up.) This increase is almost the same as the previous
quarter, but relatively high compared to recent history. (An exception is the very high
2004 third quarter increase of 8.2 percent.) During 2003, real GDP increased by 3.1
percent. Annual growth rates in 2001 and 2002 were .5 percent and 2.2 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.
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 first quarter (January through March)
of 2004 increased at an annual rate of 4.2 percent. This is the first release of the estimate
and will be followed by two revisions over the next two months. This compares to rates
of 8.2 and 4.1 percent in the previous two quarters.
The growth rates in real GDP in 2001, 2002, and 2003 were .3, 2.2, and 3.1 percent.
Meaning of the Announcement
The U.S. economy was in a recession during most of 2001 and experienced only
modest growth in real GDP in 2002 and early 2003. The growth has increased
significantly beginning in the middle of 2003, as real GDP increased at an annual rate of
6.1 percent over the last six months of the year.
Employment fell and unemployment increased for much of the time since the
recession ended in November of 2001. Only in the last three months has employment
started to rise at a pace greater than a pace that would simply keep unemployment rates
steady.
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.
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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.
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. 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 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.
Data Trends
The growth in real GDP at the end of the 1990s was relatively high when compared
with the early part of the 1990s. However, during the last two quarters of 2000, the rate
of growth of real gross domestic product slowed significantly (with a decrease in the third
quarter of 2000). During the first three quarters of 2001, real gross domestic product fell
as the U.S. economy entered a recession in March of 2001 lasting through November of
2001. The negative changes in real GDP were the first since 1993.
The Federal Reserve responded to slowing growth and the recession by reducing the
target federal funds rate by 475 basis points (4.75%) from January 2001 to December
2001 and then two more times since. The most recent was in June of 2003. (See Federal
Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy and the
resulting low interest rates and a stimulative fiscal policy helped increase consumer and
investment spending during and since the recession.
Inflation remains low but is likely to be of more concern to policy makers as the
economy continues to grow. The price index for GDP increased at an annual rate of 2.5
percent during the first quarter of 2004, compared to an increase of 1.7 percent during
2003. It increased at an annual rate of 1.5 percent for 2002, compared to 2.4 percent for
2001.
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Figure 2
The rate of increase in real GDP, prior to the recession and over the last three quarters
has been not only higher than in the first part 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. Increases in productivity, that is, output per hour worked, are the key to
increases in real GDP per capita and therefore to increases in material standards of living.
Details of the First-Quarter Changes in Real GDP
The major contributors to the increase in real GDP were the increases in consumption
spending, business investment, and spending on national defense. There was also a small
increase in exports and a slower rate of growth in imports, together contributing to a more
rapid rise in real GDP.
Gross private domestic investment increased at an annual rate of 7.2 percent during
the first quarter of 2004, compared to an increase of 14.9 percent in the last quarter of
2003. For all of 2003, investment spending increased by 4.2 percent.
First quarter exports increased by 3.2 percent (compared to a increase of 20.5 percent
in the previous quarter) and imports increased by 2.0 percent (compared to an increase of
16.4 percent in the previous quarter). Net exports therefore rose slightly during the
quarter.
GDP, Productivity, and Unemployment
A major factor in the continued growth in the American economy, as seen in the
sound increase of 4.2% in real GDP in the first quarter, is the continued improvement in
productivity.
Productivity, defined as the amount of output per hour of work, increased at an annual
rate of 3.5% in the first quarter and 2.5% growth in the previous quarter. With rapid rates
of increase in productivity, businesses are able to gain more output from the same or only
a slight increase in the number of workers, boosting economic results. This explains how
the economy was able to grow strongly in 2003 even as the unemployment rate stayed
high and employment grew only slowly.
The Federal Reserve has stated in its recent releases that continued productivity
growth is a key component in the continued growth in the American economy.
Businesses are able to keep costs low by reducing the need to hire new employees to
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create growth. The most important cause of this productivity growth has been investment
in information technology and software. This growth allowed the Fed to cut rates more
than it would otherwise, as inflationary pressures are reduced. Alan Greenspan has
repeatedly cited productivity growth and was one of the first to view the 1990’s boom in
technology spending as a period of sustainable growth above historical levels.
Eventually, continued productivity and economic growth will spur new investment and
hiring.
Interactive question –
What happens to employment if GDP increases by 5 percent in a year, inflation is
equal to 2 percent, and productivity increases by 4 percent?
Employment is likely to:
Increase
Pop-up answer –
Decrease
Stay the same
Decrease
The reasoning is that real GDP increases by approximately 3 percent. That is
calculated by subtracting the rate of increase in prices from the rate of increase in
GDP. Then if productivity increases by 4 percent, the economy needs 1 percent fewer
workers to produce 3 percent more output. (Technically, 1 percent fewer hours of work
are needed.)
Productivity increases are not undesirable. In fact, productivity changes make it
possible for per capita real GDP to increase. However, if spending is not rising faster
than productivity the short-run result will be falling employment.
Recessions
On November 26, 2001, the National Bureau of Economic Research (NBER)
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. More recently the NBER announced that the recession actually ended in
November of 2001.
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 previous 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
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in December of 1992, almost 21 months later. One of the reasons the ends of that
recession and the most recent one were so difficult to determine was that 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.html
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.
Explanations of GDP and its Components
It is common to see the following equation in economics textbooks:
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 (9%).
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period (21%).
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 (41%).
Investment spending (I) consists of non-residential fixed investment, residential
investment, and inventory changes. Investment spending accounts for 15 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
(10%).
Residential investment is the building of a new homes or apartments (5%).
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold (0%).
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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 (19%) 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.
Net Exports (NX) is equal to exports minus imports. Exports are items produced in
the U.S. and purchased by foreigners (10%). Imports are items produced by foreigners
and purchased by U.S. consumers (14%). Thus, net exports (exports minus imports) are
negative, about - 4% of the GDP.
Interactive questions –
1. What happens to real GDP as
Increases
Decreases
Stays the same
investment spending increases?
2. What happens to investment
Increases
Decreases
Stays the same
spending as real GDP increases?
3. What is the difference or the
similarity?
Answers –
1. Increases
2. Increases
3. The results are the same, but the difference is in causation. In the first case,
investment spending increases, and because it is part of GDP, real GDP
increases. In the second, an increase in real GDP causes income and
consumption to increase. Because sales and economic conditions are improving,
businesses are likely to increase investment spending.
A trade deficit
In the latest monthly announcement of U.S. international trade conditions, the
Department of Commerce reported that total March exports of $95 billion and imports of
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$141 billion resulted in a goods and services trade deficit of $46 billion, $4 billion more
than the $42 billion than the revised February amount.
If the trade deficit continues at this same pace for a year, the deficit in trade would be
almost $550 billion dollars or almost 5 percent of GDP. Such a deficit, particularly when
many are concerned about U.S. jobs, often results in political pressure to use tariffs and
quotas to reduce imports to protect American business and employment. The goal of
such a policy is to make imports more expensive and cause consumers and businesses to
switch to domestically produced goods. The intended final result then is to increase
employment and decrease unemployment in the U.S.
However, such a policy is counterproductive.
Interactive questions 1. What will happen to imports with the placing of tariffs on imported goods?
Increase
Decrease
Stay the same
2. What will likely happen to exports?
Increase
Decrease
Stay the same
3. What will likely happen to U.S. employment?
Increase
Decrease
Stay the same
Answers –
1. Decrease. Decrease as imports become more expensive for U.S. buyers.
2. Decrease. May decrease as other countries respond with tariffs on U.S. goods.
3. Stay approximately the same is the best answer. Some jobs will be saved and
others lost. U.S. employment rises in firms competing with the now more
expensive foreign imports and falls in U.S. export industries as exports fall.
Note to teachers. More advanced students may recognize that decreases in
imports will eventually raise the international value of the dollar and, as a result,
exports become more expensive and decrease.
Revisions in GDP Announcements
Real GDP for each quarter is announced three times and often the revisions are
significant. The month following the end of the quarter is described as the advance
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GDP; the second announcement or revision is described as the preliminary
announcement; and the third month is the final announcement. While labeled as the final
version, even it will eventually be revised after the final data for the year are published.
Revisions in inventory investment and the international trade data are often the causes of
changes in the real GDP figures. Since 1978, the advance estimates have been revised
an average of 0.5 percent in the rate of growth of real GDP and the preliminary
estimates have been revised by an average of 0.3 percent in the rate of growth of real
GDP.
Questions (All of these should be placed in an interactive mode.)
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 sound system produced and sold in the U.S. by a Chinese 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 jacket made in Mexico and sold in the U.S.
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 highway
Answers 1. Consumption – A stereo produced and purchased in the U.S. 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
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6. Imports and consumption – This is an import and part of consumption, 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 Class Discussions
1. If gross domestic product increases by three percent over a year, are we better off?
Why or why not?
2. If consumers begin to purchase more automobiles manufactured in the U.S. instead of
those manufactured abroad, what will happen to real GDP?
3. Why is income not included in gross domestic product?
Sample Answers for Additional Questions
1. It is not clear whether or not we are better off. The answer depends upon what is
happening to prices and what is happening to population growth. If prices and
population together are rising by more than three percent per year, than we, on
average, are worse off. We have fewer goods and services per person. An example
would be if we were experiencing three percent inflation and a one percent growth in
population, real GDP per capita would have fallen over the year by one percent.
2. Consumption spending will remain the same if the total spending on automobiles has
not changed; however, imports will decrease. Real GDP in the U.S. will increase.
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3. Gross domestic product includes all of the production of final goods and services in a
year. Production of consumption, investment, government, and export goods and
services are included.
Income is not added to the total amounts of production when calculating GDP.
However, wages, salaries, dividends, profits, and rents are part of the costs on
producing those goods and services and are thus indirectly included. An alternative
way of calculating GDP is to add all of the income payments together.
Key Concepts
Consumption
Economic growth
Government expenditures
Investment
Net exports
Real GDP and nominal GDP
Real GDP per capita
Trade deficit
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
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.
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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.
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
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
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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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