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A CASE STUDY
Gross Domestic Product
First Quarter, 2005
Date of Announcement
June 29, 2005
Date of Next Announcement
July 29, 2005
Announcement
Real gross domestic product (GDP) during the first quarter (January through March)
of 2005 increased at an annual rate of 3.8 percent. This is the final estimate of the change
in real GDP for the first quarter. It is a revision of the preliminary estimate of a 3.5
percent increase in real GDP in the first quarter that was announced one month ago.
The increase in real GDP during the quarter was primarily due to increases in
consumption, inventory, software, equipment, and residential housing investment, and
exports. Imports also increased during the quarter.
Real GDP has never fallen
during a quarter.
Interactive question.
When was the last time real gross domestic
product fell during a quarter?
2004
2003
2001
The great depression
Answer.
(This should pop up.)
2001
Real GDP has been increasing since the second quarter of 2001 during the recession
of 2001. Quarterly changes that were negative actually occurred during two quarters of
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2000 and one quarter of 2001. The normal path for real GDP is to gradually increase
over time. During recessions, real GDP will normally fall during one or more quarters.
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
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.
Meaning of the Announcement
Real gross domestic product increased during the first quarter (January through
March) of 2005 increased at an annual rate of 3.8 percent. This is the third release of the
estimate and is described as the final estimate. This increase compares to rates of 4.0 and
3.8 percent in the previous two quarters. The growth rates in 2001, 2002, 2003, and 2004
were .8 percent, 1.9 percent, 3.0 percent, and 4.4.
The U.S. economy experienced a recession in 2001 and had only modest growth in
real GDP in 2002. Employment fell and unemployment increased for much of that time.
Growth increased significantly beginning in the second quarter of 2003 and has continued
to grow at a relatively rapid pace.
The current announcement along with improving employment reports continues the
good news. The major causes of the 3.8 percent increase in real GDP were the increases
in consumption, investment, and exports. The effects of those increases in spending were
somewhat offset by a 9.6 percent (at an annual rate) increase in imports.
The price index for all of GDP increased at an annual rate of 2.9 percent during the
quarter. It increased at a rate of 2.1 percent for all of 2004.
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Figure 1
Interactive question
If we know that real GDP increased at a rate of 3.8 percent and that the GDP price
index increased at an annual rate of 2.9 percent, what was the approximate annual rate of
increase in the GDP in the economy during the quarter?
Prices:
decreased by
.9 percent.
increased by
.9 percent.
Pop-up answer-
increased by
3.8 percent.
increased by
6.7 percent.
increased by
6.7 percent.
Correct answer. The reasoning is that if real GDP increased by 3.8 percent and prices
increased by 2.9 percent, GDP in current prices increased approximately by the sum
of the two figures. That is 6.7 percent at an annual rate.
For math classes and more advanced students, the more exact method of calculation
is to multiply 1.038 by 1.029 and then subtract 1.00 to get the percentage increase.
With relatively small percentage changes, the results will be the same.
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, the changes in real
GDP are more meaningful than the changes in GDP, 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 third quarter of 2000 and
the first and third quarters of 2001, the rate of growth of real gross domestic product was
actually negative as the U.S. economy entered a recession in March of 2001. The
changes in real GDP were actually negative for the first time since the 1991 recession.
The Federal Reserve responded to slowing growth and the recession by reducing the
target federal funds rate twelve times from January 2001 to January 2003. (See the
Federal Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy
and the resulting low interest rates helped increase investment and consumer spending
during and since the recession.
As the economy recovered, the growth of real GDP increased and beginning in June
2004, the Federal Reserve began to be concerned with potential inflationary pressures.
The target federal funds rate was raised eight times to a current level of 3.0 percent.
Figure 2
The rate of increase in real GDP has been not only higher in the last several years
than in the first part of the 1990s, but also when compared to 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 (3.1%), and the first half of the 1990s (2.3%).
In the last five years of the 1990s, the rate of growth in real GDP increased to 3.9
percent, with the last three years of the 1990s equaling an average of 4.4 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, somewhat offset by increases in imports. That pattern is identical to the results
for this quarter. Productivity increases, expansions in the labor force, decreases in
unemployment, and increases in the amount of capital have allowed real GDP to grow at
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the faster rates. The changes in productivity have had the most lasting effects on our
average incomes.
Details of the First-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 3.8 percent in the first quarter of 2005, the
same as the increase in the fourth quarter of 2004. The major contributors to the increase
in real GDP were the increase in overall investment of 10.9 percent, the increase in
consumption spending of 3.6 percent, and the rise in exports of 8.9 percent. Government
spending increased by .2 percent.
Increases in imports were 9.6 percent. This means that a portion of the increases in
investment and consumption were not spent on goods and services produced in the U.S.
and thus did not add to real GDP here.
The price index for GDP increased at an annual rate of 2.9 percent during the first
quarter of 2005, compared to increases at annual rates of 1.4 and 2.3 percent during the
third and fourth quarters of 2004. The price index for GDP for all of 2004 increased by
2.1 percent.
This gradually increasing rate of change in prices has been becoming of some
concern as the Federal Reserve continues to increase the target federal funds rate. (See
the most recent Federal Reserve case study.)
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.
Interactive question
If we know that GDP increased at a rate of 3 percent (not the actual this last quarter),
that the GDP price index increased at an annual rate of 2 percent, and the population
growth was 1.5 percent, what was the approximate annual rate of increase in the real
GDP per capita in the economy?
Real GDP per capita:
decreased by
.5 percent.
increased by
1 percent.
increased by
3.5 percent.
increased by
2.5 percent.
increased by
5 percent.
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Pop-up answer-
decreased by
.5 percent.
Correct answer. The reasoning is that if GDP increased by percent and prices increased
by 2 percent, real GDP increased approximately by one percent – the difference
between the increase in GDP and the price index. If the population growth was 1.5
percent, then actual real GDP per person or per capital decreased by approximately
one-half of one percent.
For math classes and more advanced students, the more exact method of calculation
is to multiply and divide. The change in real GDP would be found by dividing 1.03
by 1.02. Then to find the change in real GDP per capita, divide the result by 1.015.
The result should be .995. That is that real per capita GDP is 99.5 percent of what it
was or a decrease of .5 percent in real GDP per capita.
While inflation and unemployment rates and changes in our income distribution
provide us additional measures of the successes and weaknesses in our economy, none is
a more important indicator of our economy's health than the rate 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. The current increase in
real GDP is discussed in news reports as a sign that the economy is growing and may
well continue to do so. The upward revision in the growth rate may even receive some
special attention in the press. However, we should be careful in attaching too much
importance to any one month change in the data.
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. The most widely used definition by policy makers and
economists includes measures of changes in industrial production, retail trade,
employment, and real income.
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
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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.
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 2004.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years (8%).
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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 (41%).
Investment spending (I) consists of non-residential fixed investment, residential
investment, and inventory changes. Investment spending accounts for 16 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 (6%).
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold (less than 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 (19%) does not include transfer payments such as Social
Security, unemployment compensation, and welfare payments, which do not represent
production of goods and services.
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Federal spending now accounts for approximately 7 percent of GDP. Five percent of
GDP is federal spending on defense.
State and local spending on goods and services accounts for 12 percent of GDP.
Net Exports (NX) is equal to exports minus imports.
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Exports are items produced in the U.S. and purchased by individuals, businesses, and
governments abroad (10%).
Imports are items produced abroad and purchased by U.S. consumers (15%).
Thus, net exports (exports minus imports) are negative, about 5% of the GDP.
Revisions in GDP Announcements
Real GDP for each quarter is announced in each of three months and often the
revisions are significant. The month following the end of the quarter is described as the
advance GDP; the next is a revision described as the preliminary announcement; and the
third announcement is a revision labeled the final announcement. Even this final
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announcement will likely be revised again with year-end announcements and periodic
reexaminations of the accuracy of the data.
The causes of the changes are often changes in inventory and international trade data
– two particularly difficult estimates to make accurately in a quick fashion. This month is
the final estimate is .3 percent higher than the preliminary estimate of one month ago.
The preliminary estimate was .4 percent higher than the advance estimate. The current
revision occurred primarily due to an upward adjustment in the increase in exports and
an increase in housing investment.
Interactive questions –
1. Every dollar of gross domestic product becomes income to someone. True or
false?
True
False
2. Gross domestic product is larger, equal to, or smaller than total national income?
Larger
Equal to
Smaller
3. Which of the following components is the largest part of total national income?
Employee
income
Corporate
profits
Interest and
rent
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4. Which of the following should be included in the U.S. gross domestic product?
(Click on yes or no.)
Consumption
spending on
imports
Yes
No
Yes
No
Yes
No
Education
expenses for
U.S. elementary
schools
Yes
No
Housework done
by a father in his
own house in the
U.S.
Yes
No
Goods produced
in Kansas for
sale in China
Yes
No
Construction of
a new factory in
the U.S.
Yes
No
Production of
automobiles in
the U.S. but not
sold this year
Yes
No
Environmental
damage from
production in
the U.S.
Housework
done by an
employee in
the U.S.
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Answers –
1. It is true. Every dollar spent on gross domestic product has to become income to
someone.
2. It is basically “equal to”. Technically speaking, there are some parts of gross
domestic product that do not become income. The primary adjustment is for that
part of gross domestic product that is used up as part of depreciation of plant and
equipment of businesses. There are some other adjustments, with the largest
being the income earned from U.S. businesses producing abroad and income here
paid to those owners who might be abroad.
3. Employee income makes up almost 65 percent of total income. When combined
with small business owner income, it is 74 percent of total income. Corporate
profits make up an additional11 percent. Interest, rent, and taxes on production
make up all the remaining 15 percent.
All of the figures have to be adjusted by “capital consumption”. That is the
amount of machinery, equipment, and buildings that are depreciated or used up
during the year. See table 1 for approximate percentages after adjusting for
capital consumption.
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4. The following should pop-up, once a student has clicked on a button.
Consumption
spending on
imports
No is the
correct
answer.
Environmental
damage from
production in
the U.S.
Housework
done by an
employee in
the U.S.
Education
expenses for
U.S. elementary
schools
No is the
correct
answer.
Yes is the
correct
answer.
Yes is the
correct
answer.
Housework done
by a father in his
own house in the
U.S.
No is the
correct
answer.
Goods produced
in Kansas for
sale in China
Yes is the
correct
answer.
Construction of
a new factory in
the U.S.
Yes is the
correct
answer.
Production of
automobiles in
the U.S. but not
sold this year
Yes is the
correct
answer.
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Explanations of answers to question 4.
a. Imports are not part of total GDP. (They are included in consumption spending
and then subtracted out as imports.)
b. Environmental damage is not a good or service produced and counted as part of
GDP.
c. Housework done by a hired employee is a service that is counted.
d. Education is part of government production in GDP.
e. Housework done for oneself is not counted as part of GDP.
f. Those goods are produced in the U.S. and thus counted. They are included under
exports.
g. Construction of a new factory is part of investment.
h. Production of unsold automobiles is part of production and thus included in
GDP. Since they are not sold, they are counted as part of inventory and that is
part of investment.
Key Concepts
Consumption
Investment
Government expenditures
Net exports
Real GDP and nominal GDP
Real GDP per capita
Productivity
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.
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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.
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.gov/newsrel/gdpnewsrelease.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
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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
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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