Download GDP and the Standard of Living C H A P T E R C H E C K L I S T

GDP and the Standard
of Living
CHAPTER
5
CHAPTER CHECKLIST
When you have completed your study of this
chapter, you will be able to
1
Define GDP and explain why the value of production,
income, and expenditure are the same for an economy.
2
Describe how economic statisticians measure GDP an
distinguish between nominal GDP and real GDP.
3
Describe and explain the limitations of real GDP as a
measure of the standard of living.
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5.1 GDP, INCOME, AND EXPENDITURE
GDP Defined
Gross domestic product or GDP
The market value of all the final goods and services
produced within a country in a given time period.
Value Produced
• Use market prices to value production.
5.1 GDP, INCOME, AND EXPENDITURE
What Produced
Final good or service is a good or service that is
produced for its final user and not as a component of
another good or service.
Intermediate good or service is a good or service
that is produced by one firm, bought by another firm,
and used as a component of a final good or service.
GDP includes only those items that are traded in
markets.
5.1 GDP, INCOME, AND EXPENDITURE
Where Produced
• Within a country
When Produced
• During a given time period.
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5.1 GDP, INCOME, AND EXPENDITURE
Circular Flows in the U.S. Economy
Consumption expenditure is the expenditure by
households on consumption goods and services.
Investment is the purchase of new capital goods
(tools, instruments, machines, buildings, and other
constructions) and additions to inventories.
5.1 GDP, INCOME, AND EXPENDITURE
Government expenditure on goods and services
is the expenditure by all levels of government on goods
and services.
Net exports of goods and services is the value of
exports of goods and services minus the value of
imports of goods and services.
5.1 GDP, INCOME, AND EXPENDITURE
Exports of goods and services are the items that
firms in in the United States produce and sell to the rest
of the world.
Imports of goods and services are the items that
households, firms, and governments in the United
States buy from the rest of the world.
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5.1 GDP, INCOME, AND EXPENDITURE
Total expenditure is the total amount received by
producers of final goods and services.
Consumption expenditure: C
Investment: I
Government expenditure on goods and services: G
Net exports: NX
Total expenditure = C + I + G + NX
5.1 GDP, INCOME, AND EXPENDITURE
Income
• Labor earns wages.
• Capital earns interest.
• Land earns rent.
• Entrepreneurship earns profits.
Households receive these incomes.
5.1 GDP, INCOME, AND EXPENDITURE
Expenditure Equals Income
Because firms pay out everything they receive as
incomes to the factors of production, total expenditure
equals total income.
That is:
Y = C + I + G + NX
The value of production equals income equals
expenditure.
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5.1 GDP, INCOME, AND EXPENDITURE
Figure 5.1
shows the
circular flow
of income
and
expenditure.
The table
shows the
U.S. data
for 2007.
5.2 MEASURING U.S. GDP
The Expenditure Approach
Measures GDP by using data on consumption
expenditure, investment, government expenditure on
goods and services, and net exports.
Table 5.1 on the next slide shows the calculation for
2007.
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5.2 MEASURING U.S. GDP
Expenditures Not in GDP
Used Goods
Expenditure on used goods is not part of GDP because
these goods were part of GDP in the period in which
they were produced and during which time they were
new goods.
Financial Assets
When households buy financial assets such as bonds
and stocks, they are making loans, not buying goods
and services.
5.2 MEASURING U.S. GDP
The Income Approach
Measures GDP by summing the incomes that firms pay
households for the factors of production they hire.
The U.S. National Income and Product Account divide
incomes into two big categories:
• Wages
• Interest, rent, and profits
5.2 MEASURING U.S. GDP
Wages
Wages, called compensation of employees in the
national accounts, is the payment for labor services.
It includes net wages and salaries plus fringe
benefits paid by employers such health care
insurance, social security contributions, and pension
fund contributions.
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5.2 MEASURING U.S. GDP
Interest, Rent, and Profit
Interest, rent, and profit, called net operating surplus in
the national account, is the sum of the incomes earned
by capital, land, and entrepreneurship.
Interest is the income households receive on loans they
make minus the interest they pay on their borrowing.
Rent includes payments for the use of land and other
rented inputs.
Profit includes the profits of corporations and small
businesses.
5.2 MEASURING U.S. GDP
5.2 MEASURING U.S. GDP
Net domestic product at factor cost is the sum of
wages, interest, rent, and profit.
Net domestic product at factor cost is not GDP.
We need to make two adjustments to arrive at GDP:
• One from factor cost to market prices
• One from net product to gross product
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5.2 MEASURING U.S. GDP
From Factor Cost to Market Price
The expenditure approach values goods at market
prices; the income approach values them at factor cost.
Indirect taxes (such as sales taxes) make market prices
exceed factor cost.
Subsidies (payments by government to firms) make
factor cost exceed market prices.
To convert the value at factor cost to the value at
market prices, we must:
• Add indirect taxes and subtract subsidies
5.2 MEASURING U.S. GDP
5.2 MEASURING U.S. GDP
From Gross to Net
The expenditure approach measures gross product; the
income approach measures net product.
Gross profit is a firm’s profit before subtracting the
depreciation of capital.
Net profit is a firm’s profit after subtracting the
depreciation of capital.
Depreciation is the decrease in the value of capital
that results from its use and from obsolescence.
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5.2 MEASURING U.S. GDP
Income includes net profit, so the income approach
gives a net measure.
Expenditure includes investment. Because some new
capital is purchased to replace depreciated capital, the
expenditure approach gives a gross measure.
To get gross domestic product from the income
approach, we must add depreciation to total income.
After making these two adjustments the income
approach almost gives the same estimate of GDP as
the expenditure approach.
5.2 MEASURING U.S. GDP
5.2 MEASURING U.S. GDP
Statistical Discrepancy
The income approach and the expenditure approach do
not deliver exactly the same estimate of GDP—there is
a statistical discrepancy.
Statistical discrepancy is the discrepancy between
the expenditure approach and income approach
estimates of GDP, calculated as the GDP expenditure
total minus the GDP income total.
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5.2 MEASURING U.S. GDP
5.2 MEASURING U.S. GDP
GDP and Related Measures of Production
and Income
Gross national product or GNP is the market value
of all the final goods and services produced anywhere
in the world in a given time period by the factors of
production supplied by residents of the country.
U.S. GNP = U.S. GDP + Net factor income from abroad
5.2 MEASURING U.S. GDP
Disposable Personal Income
Consumption expenditure is one of the largest
components of aggregate expenditure and one of the
main influences on it is disposable personal income.
Disposable personal income is the income received
by households minus personal income taxes paid.
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5.2 MEASURING U.S. GDP
Figure 5.2 shows the
relationship between
GDP, GNP, and
disposable personal
income.
5.2 MEASURING U.S. GDP
Real GDP and Nominal GDP
Real GDP is the value of the final goods and services
produced in a given year expressed in the prices of the
base year.
Nominal GDP is the value of the final goods and
services produced in a given year expressed in the
prices of that same year.
The method of calculating real GDP changed in recent
years. Here we describe the essence of the calculation.
The appendix gives the technical details.
5.2 MEASURING U.S. GDP
Calculating Real GDP
The goal of calculating real GDP is to measure the
extent to which total production has increased
Real GDP removes the influence of price changes from
the nominal GDP numbers.
To focus on the principles and keep the numbers easy
to work with, we’ll calculate real GDP for an economy
that produces only one consumption good, one capital
good, and one government service.
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5.2 MEASURING U.S. GDP
Table 5.3 shows the calculation with 2000 (base year)
and 2008.
To find the total expenditure in 2000 multiply the
quantity of each item produced in 2000 by its price in
2000.
Then sum the expenditures to find nominal GDP in
2000.
The next slide shows the data.
Nominal
GDP in
2000 is
$100
million.
Because
2000 is the
base year,
real GDP
in 2000 is
also $100
million.
5.2 MEASURING U.S. GDP
In part (b) of Table 5.3, we calculate nominal GDP in
2008.
Again, we calculate nominal GDP by multiplying the
quantity of each item produced by its price and then
sum the expenditures to find nominal GDP in 2008.
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Nominal
GDP in
2000 is
$100
million.
Nominal
GDP in
2008 is
$300
million.
5.2 MEASURING U.S. GDP
Nominal GDP in 2000 is $100 million and in 2008 it is $300
million.
Nominal GDP in 2008 is three times its value in 2000.
But by how much has the quantity of final goods and
services produced increased?
5.2 MEASURING U.S. GDP
The increase in real GDP will tell by how much the
quantity of good and services has increased.
Real GDP in 2008 is what the total expenditure would
have been in 2008 if prices had remained the same as
they were in 2000.
To calculate real GDP in 2008 multiply the quantities
produced in 2008 by the price in 2000 and the sum
these expenditures to find real GDP in 2008.
Part (c) of Table 5.3 shows the details.
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Real GDP
in 2000 is
$100
million.
Real GDP
in 2008 is
$160
million—
only 1.6
times real
GDP in
2000.
5.3 THE USE AND LIMITATIONS OF REAL GDP
We use estimates of real GDP for two main purposes:
• To compare the standard of living over time
• To compare the standard of living among countries
The Standard of Living Over Time
To compare living standards we calculate real GDP per
person—real GDP divided by the population.
Table 5.4 shows two calculations
5.3 THE USE AND LIMITATIONS OF REAL GDP
In 1967, real GDP in the United States was $3,485 billion
and the population of the United States was 198.7
million.
Real GDP per person = $3,485 billion ÷ 198.7 million
Real GDP per person = $17,536
In most years, real GDP per person increases, but
sometimes it doesn’t change.
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5.3 THE USE AND LIMITATIONS OF REAL GDP
Long-Term Trend
Figure 5.3 shows the
long-term trend in
U.S. real GDP per
person.
Real GDP per person
doubled in the 36
years from 1967 to
2002.
5.3 THE USE AND LIMITATIONS OF REAL GDP
Short-Term Fluctuations
Fluctuations in the pace of expansion of real GDP is
called the business cycle.
The business cycle is a periodic irregular up-and down
movement of total production and other measure of
economic activity.
The four stages of a business cycle are expansion,
peak, recession, and trough.
5.3 THE USE AND LIMITATIONS OF REAL GDP
The shaded periods
show the
recessions—
periods of falling
production that
lasts for at least six
months.
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5.3 THE USE AND LIMITATIONS OF REAL GDP
Standard of Living Across Countries
To compare living standards across countries, we must
convert real GDP into a common currency and common
set of prices, called purchasing power parity.
Goods and Services Omitted from GDP
•
•
•
•
Household production
Underground production
Leisure time
Environment quality
5.3 THE USE AND LIMITATIONS OF REAL GDP
Household Production
• Real GDP omits household production, it
underestimates the value of the production of
many people, most of them women.
Underground Production
• Hidden from government to avoid taxes and
regulations or illegal.
• Because underground economic activity is
unreported, it is omitted from GDP.
5.3 THE USE AND LIMITATIONS OF REAL GDP
Leisure Time
• Our working time is valued as part of GDP, but our
leisure time is not.
Environment Quality
• Pollution is not subtracted from GDP.
• We do not count the deteriorating atmosphere as a
negative part of GDP.
• If our standard of living is adversely affected by
pollution, our GDP measure does not show this
fact.
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5.3 THE USE AND LIMITATIONS OF REAL GDP
Other Influences on the Standard of Living
Health and Life Expectancy
• Good health and a long life do not show up directly
in real GDP.
Political Freedom and Social Justice
• A country might have a very large real GDP per
person but have limited political freedom and
social justice.
• A lower standard of living than one that had the
same amount of real GDP but in which everyone
enjoyed political freedom.
APPENDIX: MEASURING REAL GDP
The Problem with Base-Year Prices
We’ll calculate real GDP in 2008 using 2000 as the
base year and found that real GDP in 2008 was 1.6
percent greater than in 2000—an increase of 60%.
But if we had used 2008 prices rather than 2000, real
GDP would have increased from $150 million (2008
dollars) in 2000 to $300 million in 2008—an increase of
100%.
So did real GDP increase by 60% or 100%?
APPENDIX: MEASURING REAL GDP
The BEA method uses the prices of both years.
The three steps in the method are
• Value production in the prices of adjacent years.
• Find the average of the two percentage changes.
• Link (chain) back to the base year.
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APPENDIX: MEASURING REAL GDP
Value Production in the Prices of Adjacent
Years
Let’s take as the two adjacent years 2008 and its
preceding year 2007.
Value the quantities produced in 2007 and 2008 at both
the prices of 2007 and the prices of 2008.
Table A5.1 shows the calculations.
APPENDIX: MEASURING REAL GDP
The table gives
• Value of production in 2007 at 2007 prices is $145.
• Value of production in 2008 at 2007 prices is $160.
• Value of production in 2007 at 2008 prices is $158.
• Value of production in 2008 at 2008 prices is $172.
The next step is the find the percentage increases using
2007 prices and 2008 prices and then average these
two percentages.
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APPENDIX: MEASURING REAL GDP
Find the Average of Two Percentage Changes
Table A5.1 sets out the calculation:
• Value of production in 2007 at 2007 prices is $145.
• Value of production in 2008 at 2007 prices is $160.
Using 2007 prices, production increased by 10.3%.
• Value of production in 2007 at 2008 prices is $158.
• Value of production in 2008 at 2008 prices is $172.
Using 2008 prices, production increased by 8.9%.
The average percentage increase in production is 9.6%.
APPENDIX: MEASURING REAL GDP
APPENDIX: MEASURING REAL GDP
Link (Chain) Back to the Base Year
Starting in the base year, apply the calculated average
percentage increase each year to obtain the chaineddollar real GDP.
Figure A5.1 illustrates the calculation with assumed
data.
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