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CHAPTER CHAPTER 77 Chapter 7: GDP: Measuring Total Production and Income GDP: Measuring Total Production and Income Prepared by: Fernando Quijano Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 1 of 33 GDP: Measuring Total Production and Income Chapter 7: GDP: Measuring Total Production and Income Microeconomics The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Business cycle Alternating periods of economic expansion and economic recession. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 2 of 33 GDP: Measuring Total Production and Income Chapter 7: GDP: Measuring Total Production and Income Expansion The period of a business cycle during which total production and total employment are increasing. Recession The period of a business cycle during which total production and total employment are decreasing. Economic growth The ability of an economy to produce increasing quantities of goods and services. Inflation rate The percentage increase in the price level from one year to the next. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 3 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Measuring Total Production: Gross Domestic Product Gross domestic product (GDP): Chapter 7: GDP: Measuring Total Production and Income The market value of all final goods and services newly produced within a country during a specified period of time, typically one year. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 4 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Measuring Total Production: Gross Domestic Product GDP Includes the Market Value of all Final Goods Chapter 7: GDP: Measuring Total Production and Income Final good or service A good or service purchased by a final user. Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. GDP Includes Only Newly Produced Items GDP includes only production that takes place during the indicated time period. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 5 of 33 7.1 LEARNING OBJECTIVE Solved Problem 7-1 Explain how total production is measured. Calculating GDP PRODUCTION AND PRICE STATISTICS FOR 2013 (1) PRODUCT (2) QUANTITY (3) PRICE PER UNIT 100 $50.00 Pizzas 80 10.00 Textbooks 20 100.00 2,000 0.10 Chapter 7: GDP: Measuring Total Production and Income Eye examinations Paper (1) QUANTITY (2) PRICE PER UNIT 100 $50 $5,000 Pizzas 80 10 800 Textbooks 20 100 2,000 PRODUCT Eye examinations (3) VALUE Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 6 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Production, Income, and the Circular-Flow Diagram FIGURE 7-1 Chapter 7: GDP: Measuring Total Production and Income The Circular Flow and the Measurement of GDP Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 7 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Chapter 7: GDP: Measuring Total Production and Income Production, Income, and the Circular-Flow Diagram Transfer payments (TR) Payments by the government to individuals for which the government does not receive a new good or service in return. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 8 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Components of GDP Consumption Expenditure or Consumption (C) Chapter 7: GDP: Measuring Total Production and Income Consumption Spending by households on goods and services, not including spending on new houses. Private Domestic Investment or Investment (I) Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households and firms on new houses. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 9 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Components of GDP Chapter 7: GDP: Measuring Total Production and Income Gov’t [Consumption plus Investment] or Government Purchases (G) Government purchases Spending by federal, state, and local governments on goods and services. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 10 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Components of GDP Net Exports of Goods and Services or Net Exports (NX) Chapter 7: GDP: Measuring Total Production and Income Net exports Exports minus imports. An Equation for GDP and Some Actual Values Y C I G NX Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 11 of 33 Chapter 7: GDP: Measuring Total Production and Income An Equation for GDP and Some Actual Values Components of GDP in 2012 Consumption is the largest component of GDP; within that, services are the largest component—almost half of GDP. © 2015 Pearson©Education, Inc. Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Copyright 2010 Pearson 12ofof 33 41 12 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. An Equation for GDP and Some Actual Values • Consumer spending on services is greater than the sum of spending on durable and nondurable goods. Chapter 7: GDP: Measuring Total Production and Income • Business fixed investment is the largest component of investment. • Purchases made by state and local governments are greater than purchases made by the federal government. • Imports are greater than exports, so net exports are negative. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 13 of 33 Making Will U.S. Consumers Connection Be Spending Less? Explain how total production is measured. Chapter 7: GDP: Measuring Total Production and Income the 7.1 LEARNING OBJECTIVE Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 14 of 33 Gross Domestic Product Measures Total Production 7.1 LEARNING OBJECTIVE Explain how total production is measured. Measuring GDP by the Value-Added Method Value-Added The market value a firm adds to a product. Table 7-1 Chapter 7: GDP: Measuring Total Production and Income Calculating Value Added FIRM VALUE OF PRODUCT VALUE ADDED Cotton farmer Value of raw cotton = $1 Value added by cotton farmer =1 Textile mill Value of raw cotton woven into cotton fabric = $3 Value added by cotton textile mill = ($3 – $1) =2 Value of cotton fabric made into a shirt = $15 Value added by shirt manufacturer = ($15 –$3) = 12 Value of shirt for sale on L.L. Bean’s Web site = $35 Value added by L.L. Bean = ($35 – $15) = 20 Shirt company L.L. Bean Total Value Added = $35 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 15 of 33 Does GDP Measure What We Want It to Measure? 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being. Why is GDP not a perfect measure of production? Excludes Household Production Chapter 7: GDP: Measuring Total Production and Income Household production refers to goods and services people produce for themselves. Excludes the Underground Economy Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 16 of 33 Does GDP Measure What We Want It to Measure? 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being. Other problems with using GDP as a measure of well-being The value of leisure is not included in GDP Chapter 7: GDP: Measuring Total Production and Income GDP is not adjusted for pollution or other negative effects GDP is not adjusted for changes in crime and other social problems GDP measures the “size of the pie” but not how the pie is “divided up” Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 17 of 33 7.3 LEARNING OBJECTIVE Real GDP versus Nominal GDP Discuss the difference between real GDP and nominal GDP. Calculating Real GDP Chapter 7: GDP: Measuring Total Production and Income Nominal GDP The value of final goods and services evaluated at current-year prices. Real GDP (Y) The value of final goods and services evaluated at base-year prices. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 18 of 33 Solved Problem 7.3 LEARNING OBJECTIVE 7-3 Discuss the difference between real GDP and nominal GDP. Calculating Real GDP 2009 Chapter 7: GDP: Measuring Total Production and Income PRODUCT 2015 QUANTITY PRICE QUANTITY PRICE Eye examinations 80 $40 100 $50 Pizzas 90 11 80 10 Textbooks 15 90 20 100 2015 QUANTITY 2009 PRICE 100 $40 $4,000 Pizzas 80 11 880 Textbooks 20 90 1,800 PRODUCT Eye examinations VALUE Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 19 of 33 Comparing Real GDP and Nominal GDP Chapter 7: GDP: Measuring Total Production and Income The current base year for calculating prices is 2009, so real and nominal GDP are equal in 2009. Growth figures reported in the media are the growth in real GDP. Since prices have generally increased since 2009, real GDP is less than nominal GDP, and the opposite is true before 2009. Nominal GDP and real GDP: 1990-2012 © 2015 Pearson©Education, Inc. Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Copyright 2010 Pearson 20ofof 33 41 20 7.3 LEARNING OBJECTIVE Real GDP versus Nominal GDP Discuss the difference between real GDP and nominal GDP. The GDP deflator Chapter 7: GDP: Measuring Total Production and Income Price level (P) A measure of the average prices of goods and services in the economy. GDP deflator (P) A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. Nominal GDP GDP deflator 100 Real GDP Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 21 of 33 7.3 LEARNING OBJECTIVE Real GDP versus Nominal GDP Discuss the difference between real GDP and nominal GDP. Chapter 7: GDP: Measuring Total Production and Income The GDP Deflator 2011 2012 NOMINAL GDP $15,534 billion $16,245 billion REAL GDP $15,052 billion $15,471 billion FORMULA GDP Deflator APPLIED TO 2011 Nominal GDP 100 Real GDP $15,534 billion 100 103 $15,052 billion APPLIED TO 2012 $16,245 billion 100 105 $15,471 billion From these values for the deflator, we can calculate that the price level increased by 1.9 percent between 2011 and 2012: 105 103 100 1.9% 103 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 22 of 33 Other Measures of Total Production and Total Income 7.4 LEARNING OBJECTIVE Become familiar with other measures of total production and total income. Gross National Product (GNP) Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. Chapter 7: GDP: Measuring Total Production and Income National Income National income is calculated as GDP minus the consumption of fixed capital, or depreciation. Personal Income Personal income is income received by households. Disposable Personal Income (YD) Disposable personal income is equal to personal income minus personal tax payments (Y – T). Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 23 of 33 Chapter 7: GDP: Measuring Total Production and Income KEY TERMS Business cycle Macroeconomics Consumption (C) Microeconomics Economic growth Net exports (NX) Expansion Nominal GDP Final good or service Price level (P) GDP deflator (P) Real GDP (Y) Government purchases (G) Recession Gross domestic product (GDP) Transfer payments (TR) Inflation rate Underground economy Intermediate good or service Value added Investment (I) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 24 of 33