Download Lecture 1: GDP: Measuring Total Production and Income

Chapter 7: GDP: Measuring Total Production and Income
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
1 of 33
Chapter 7: GDP: Measuring Total Production and Income
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
2 of 33
CHAPTER
CHAPTER
77
Chapter 7: GDP: Measuring Total Production and Income
GDP: Measuring
Total Production
and Income
In the more than 100
years that Ford
Motor Company has
been in business, its
experiences have
often mirrored those
of the U.S economy.
Prepared by:
Fernando Quijano
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
3 of 33
CHAPTER
CHAPTER
77
Chapter 7: GDP: Measuring Total Production and Income
GDP: Measuring
Total Production
and Income
Chapter Outline and
Learning Objectives
7.1 Gross Domestic Product Measures
Total Production
Explain how total production is
measured.
7.2 Does GDP Measure What We Want It
to Measure?
Discuss whether GDP is a good
measure of well-being.
7.3 Real GDP versus Nominal GDP
Discuss the difference between real
GDP and nominal GDP.
7.4 Other Measures of Total Production
and Total Income
Become familiar with other
measures of total production and
total income.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
4 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.
5 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.
6 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
Measuring Total Production: Gross Domestic Product
Gross domestic product (GDP)
The market value of all final goods
and services produced in a country
during a period of time, typically one
year.
GDP Is Measured Using Market Values, Not Quantities
The word value is important in the
definition 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.
Measuring Total Production: Gross Domestic Product
GDP Includes Only the Market Value of 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 Current Production
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.
8 of 33
7.1 LEARNING OBJECTIVE
Solved Problem
7-1
Explain how total production is
measured.
Calculating GDP
PRODUCTION AND PRICE STATISTICS FOR 2011
(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
YOUR TURN: For more practice, do related problem 1.12 at the end of this
chapter.
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.
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
The circular-flow diagram illustrates
the flow of spending and money in the
economy.
Firms sell goods and services to three
groups: domestic households, foreign
firms and households, and the
government.
To produce goods and services, firms
use factors of production: labor,
capital, natural resources, and
entrepreneurship. Households supply
the factors of production to firms in
exchange for income in the form of
wages, interest, profit, and rent.
Firms make payments of wages and
interest to households in exchange for
hiring workers and other factors of
production.
The sum of wages, interest, rent, and
profit is total income in the economy.
We can measure GDP as the total
income received by households.
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.
Production, Income, and the Circular-Flow Diagram
FIGURE 7-1 (continued)
Chapter 7: GDP: Measuring Total Production and Income
The Circular Flow and the
Measurement of GDP
The diagram also shows that
households use their income to
purchase goods and services, pay
taxes, and save. Firms and the
government borrow the funds that
flow from households into the
financial system.
We can measure GDP either by
calculating the total value of
expenditures on final goods and
services or by calculating the value
of total income.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
11 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 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.
12 of 33
Gross Domestic Product
Measures Total Production
7.1 LEARNING OBJECTIVE
Explain how total production is
measured.
Components of GDP
Personal Consumption Expenditures, or “Consumption”
Chapter 7: GDP: Measuring Total Production and Income
Consumption Spending by
households on goods and services,
not including spending on new houses.
Gross Private Domestic Investment, or “Investment”
Investment Spending by firms on new
factories, office buildings, machinery, and
additions to inventories, and spending by
households and firms on new houses.
Don’t Let This Happen to YOU!
Remember What Economists Mean by Investment
YOUR TURN: Test your understanding by doing related problem 1.8 at the end of this
chapter.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
13 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
Government Consumption and Gross Investment, or
“Government Purchases”
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.
14 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”
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.
15 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
An Equation for GDP and Some Actual Values
FIGURE 7-2
Components of GDP in 2008
Consumption accounts for 70 percent of GDP, far more than any of the other components. In recent years,
net exports typically have been negative, which reduces GDP.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
16 of 33
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.
17 of 33
7.1 LEARNING OBJECTIVE
Making
Will U.S. Consumers
Connection Be Spending Less?
Chapter 7: GDP: Measuring Total Production and Income
the
Explain how total production is
measured.
YOUR TURN: Test your understanding by doing related problem 1.11 at the end
of this chapter.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
18 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.
19 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.
Shortcomings in GDP as a Measure of Total
Production
Household Production
Chapter 7: GDP: Measuring Total Production and Income
Household production refers to goods and
services people produce for themselves.
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.
20 of 33
7.2 LEARNING OBJECTIVE
Making
the
Connection
Why Do Many Developing Countries
Have Such Large Underground
Economies?
Discuss whether GDP is a good
measure of well-being.
Chapter 7: GDP: Measuring Total Production and Income
A large informal sector can be a
sign of government policies that
are retarding economic growth.
In some developing countries, more than half the
workers may be in the underground economy.
YOUR TURN: Test your understanding by doing related problem 2.6 at the end of
this chapter.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
21 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.
Shortcomings of 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 of Production
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.
22 of 33
7.2 LEARNING OBJECTIVE
Making
the
Did World War II Bring Prosperity?
Discuss whether GDP is a good
measure of well-being.
Chapter 7: GDP: Measuring Total Production and Income
Connection
World War II was a period of extraordinary sacrifice and achievement by
the “greatest generation.” But statistics on GDP may give a misleading
indication of whether it was also a period of prosperity.
YOUR TURN: Test your understanding by doing related problem 2.8 at the end of
this chapter.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
23 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 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.
24 of 33
Solved Problem
7.3 LEARNING OBJECTIVE
7-3
Discuss the difference between
real GDP and nominal GDP.
Calculating Real GDP
2005
Chapter 7: GDP: Measuring Total Production and Income
PRODUCT
2011
QUANTITY
PRICE
QUANTITY
PRICE
Eye examinations
80
$40
100
$50
Pizzas
90
11
80
10
Textbooks
15
90
20
100
2011
QUANTITY
2005
PRICE
100
$40
$4,000
Pizzas
80
11
880
Textbooks
20
90
1,800
PRODUCT
Eye examinations
VALUE
YOUR TURN: For more practice, do related problem 3.3 at the end of this
chapter.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
25 of 33
7.3 LEARNING OBJECTIVE
Real GDP versus Nominal GDP
Discuss the difference between
real GDP and nominal GDP.
Comparing Real GDP and Nominal GDP
FIGURE 7-3
Chapter 7: GDP: Measuring Total Production and Income
Nominal GDP and
Real GDP, 1990–2008
Currently, the base year for
calculating GDP is 2005. In
the years before 2005,
prices were, on average,
lower than in 2005, so
nominal GDP was lower
than real GDP. In 2005,
nominal and real GDP were
equal. After 2005, prices
have been, on average,
higher than in 2005, so
nominal GDP is higher than
real GDP.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
26 of 33
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 A measure of the average
prices of goods and services in the
economy.
GDP deflator 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.
27 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
2007
2008
NOMINAL GDP
$14,078 billion
$14,441 billion
REAL GDP
$13,254 billion
$13,312 billion
FORMULA
GDP
Deflator
APPLIED TO 2007

Nominal GDP
100
Real GDP
 $14,078 billion 

 100  106
 $13,254 billion 
APPLIED TO 2008
 $14,441 billion 

 100  108
 $13,312 billion 
From these values for the deflator, we can calculate that the price level
increased by 1.9 percent between 2007 and 2008:
 108  106 

 100  1.9%
 106 
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
28 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
Disposable personal income is equal to personal income minus
personal tax payments.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
29 of 33
Chapter 7: GDP: Measuring Total Production and Income
Other Measures of Total
Production and Total Income
7.4 LEARNING OBJECTIVE
Become familiar with other
measures of total production and
total income.
FIGURE 7-4
Measures of Total Production
and Total Income, 2008
The most important measure of total production and total income is gross domestic product (GDP). As we will see in
later chapters, for some purposes, the other measures of total production and total income shown in the figure turn
out to be more useful than GDP.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
30 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.
Chapter 7: GDP: Measuring Total Production and Income
The Division of Income
FIGURE 7-5
The Division of Income
We can measure GDP in terms of total expenditure or as the total income received by households. The
largest component of income received by households is wages, which are more than three times as large
as the profits received by sole proprietors and the profits received by corporations combined.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
31 of 33
AN INSIDE
LOOK
>> Falling Auto Purchases Lead to
Lower GDP
Chapter 7: GDP: Measuring Total Production and Income
A Slowing Descent: Auto Sales
Fell 37Percent, but Improved Slightly
Real GDP declined for three consecutive quarters beginning in the third quarter of
2008.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
32 of 33
Chapter 7: GDP: Measuring Total Production and Income
KEY TERMS
Business cycle
Macroeconomics
Consumption
Microeconomics
Economic growth
Net exports
Expansion
Nominal GDP
Final good or service
Price level
GDP deflator
Real GDP
Government purchases
Recession
Gross domestic product (GDP)
Transfer payments
Inflation rate
Underground economy
Intermediate good or service
Value added
Investment
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
33 of 33