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Measuring the Economy: GDP
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Newspaper headline…

“Real GDP, the value of goods and
services produced in the U.S., grew at
an annual rate of 1 percent in the
fourth quarter….”
Simon Kutznetz: Invented GDP in 1934
His idea was to calculate all economic
production by individuals, companies
and the government in a single
measure. According to him, GDP would
rise in good times and fall during any
crisis.
In 1944, the World Bank and the
International Monetary Fund accepted
GDP as a method to assess a nation's
economy.
The US Commerce Department
described GDP as 'one of the great
inventions of the 20th century.'
Gross Domestic Product: Measuring
the Nation’s Output

Gross Domestic Product (GDP)
– A measure of the market value of the final
goods and services produced in a country
during a given period, based on the prices
existing during the time of production.
What Good Is It?


The Fed uses GDP figures to
determine whether the economy is
growing too slowly or too quickly and
by how much, in order to plan
monetary adjustments
Economists at every level of
government and private industry use
GDP to help plan for the future
What is our GDP?




There are two ways of stating U.S. GDP for 2010 (4th
Quarter, seasonally adjusted, as of 1/28/2011)
– Current GDP, $14, 870.4 billion (nominal dollars)
– Real GDP, chained (chain-weighting) to 2005
dollars: $13, 382.6 billion
Or about 14.9 trillion dollars in current (nominal)
dollars / 13.4 trillion in real dollars
(one trillion is a thousand times a billion in the U.S.
system of counting)
GDP is measured by the U.S. Bureau of Economic
Analysis (BEA), a research arm of the Commerce
Department
Gross Domestic Product: Measuring
the Nation’s Output

Market Value
– Market value is used to aggregate the
quantities of different goods and services
into one measurement
Gross Domestic Product: Measuring
the Nation’s Output

Market Value
– Calculating GDP for Kerfluffistan

Total production = 4 apples, 6 bananas, and 3
pairs of shoes
– Price of apples = $0.25
– Price of bananas = $0.50
– Price of shoes = $20
Gross Domestic Product: Measuring
the Nation’s Output

K’stan’s GDP, measured in market value
– Nominal GDP, measured in current dollars …
– (4 x $0.25) + (6 x $0.50) + (3 x $20) = $64.00
– Real GDP, adjusted to account for inflation, the
changing value of K’stan’s dollars (amounts are
rounded to nearest whole cent)…
– (4 x 0.24) + (6 x $0.47) + (3 x $19.80) = $63.18
Gross Domestic Product: Measuring
the Nation’s Output

Final Goods or Services
– Goods or services consumed by the
ultimate user; because they are the end
products of the production process, they
are counted as part of GDP
Gross Domestic Product: Measuring the
Nation’s Output

Intermediate Goods or Services
– Goods or services used up in the
production of final goods and services and
therefore not counted as part of GDP
Gross Domestic Product: Measuring
the Nation’s Output

Final Goods and Services
– Bread Production
Milling Co. pays $0.50 for wheat
 Bakery pays $1.20 for flour
 Bakery sells bread for $2.00
 Contribution to GDP = $2.00

Gross Domestic Product: Measuring
the Nation’s Output

Final Goods and Services
– Getting a haircut
Barber charges $10 for a
haircut
 Barber pays his assistant $2
 Contribution to GDP = $10

Gross Domestic Product: Measuring
the Nation’s Output

Example: A good that can be either
intermediate or final:
– Capital Good

A long-lived good, which is itself produced and
used to produce other goods and services
Gross Domestic Product: Measuring
the Nation’s Output

Example: A good that can be either
intermediate or final:
– Capital Good

Newly produced capital goods are classified as
final goods.
Gross Domestic Product: Measuring
the Nation’s Output

Value Added
– For any firm, the market value of its
product or service minus the cost of inputs
purchased from other firms
Gross Domestic Product: Measuring
the Nation’s Output
Company
Revenues – Cost of purchased inputs = Value added
ABC Grain
$0.50
$0.00
$0.50
General Flour
$1.20
$0.50
$0.70
Hot’n’Fresh
$2.00
$1.20
$0.80
Total
•The grain and flour are produced in 2005
•Bread is produced in 2006
•$1.20 is added to 2005 GDP
•$0.80 is added to 2006 GDP
$2.00
Gross Domestic Product: Measuring
the Nation’s Output

Produced Within a Country During a
Given Period
– Domestic
Only production that takes place within a
country’s border
 Examples

– Cars produced in the U.S. by foreign owned
companies are counted.
– Cars produced in Mexico by U.S. owned
companies are not counted.
Gross Domestic Product: Measuring the
Nation’s Output

Produced within a country during a
given Period
– Given Period
Counts only goods and services produced
during the defined period such as a calendar
year
 Examples

– The sale of used goods is not counted.
– Real estate commissions are counted.
How many Ways to Measure Are There?

There are three ways to measure
GDP; all three yield similar results:
– The Expenditure method
– The Income method
– The Production method
Expenditure Components of
U.S. GDP, 2004 (billions of dollars)
Consumption
Durable goods
8,214.3
987.8
Nondurable goods
2,368.3
Services
4,858.2
Investment
Business fixed investment
Residential investment
Inventory investment
1,928.1
1,198.8
673.8
55.4
Government purchases
2,215.9
Net exports
-624.0
Exports
1,173.8
Imports
1,797.8
Total: Gross domestic product
11,734.3
The Expenditure Method for
Measuring GDP

Consumption Expenditure, or simply
Consumption
– Spending by households on goods and
services, such as food, clothing, and
entertainment
Consumer durables
 Consumer nondurables
 Services

The Expenditure Method for
Measuring GDP

Investment
– Spending by firms on final goods and
services, primarily capital goods and
housing
Business fixed investment
 Residential investment
 Inventory investment

The Expenditure Method for
Measuring GDP

Government Purchases
– Purchases by federal, state,
and local governments of
final goods and services
– Does not include transfer
payments
– Does not include interest paid
on government debt
The Expenditure Method for
Measuring GDP

Net Exports
– Exports minus imports
The Expenditure Method for
Measuring GDP





Y = gross domestic product, or output
C = consumption expenditure
I = investment
G = government purchases
NX = net exports
The Expenditure Method for
Measuring GDP

GDP
Y  C  I  G  NX
The Expenditure Method for
Measuring GDP

Example
– An economy produces 1 million cars valued
at $15,000 each.
The Expenditure Method for
Measuring GDP

Production
– GDP = 1 million x $15,000 = $15 billion
The Expenditure Method for
Measuring GDP

Expenditure
– 700,000 sold to consumers

C = 700,000 x $15,000 = $10.5 billion
– 200,000 sold to businesses

I = 200,000 x $15,000 = $3.0 billion
– 50,000 sold to government

G = 50,000 x $15,000 = $.75 billion
– 25,000 exported (no imports)

NX = 25,000 x $15,000 = $.375 billion
The Expenditure Method for
Measuring GDP

Expenditure
– 975,000 sold
– 25,000 inventory


I = 25,000 x $15,000 = $.375 billion
GDP = C + I + G + NX
– $10.5 + (3.0 +.375) + .75 + .375 = $15.0
billion
GDP and the Incomes of Capital and Labor

GDP = Labor Income + Capital Income
– Labor income
Equals 2/3 of GDP
 Includes:

– Wages
– Salaries
– Income of the self-employed
GDP and the Incomes of Capital and
Labor

GDP = Labor Income + Capital Income
– Capital income
Equals 1/3 of GDP
 Includes:

–
–
–
–
Profits
Rents
Interest
Royalties
The Three Faces of GDP
Production
Market
value of
final
goods
and
services
Expenditure
Income
Consumption
Labor Income
=
=
Investment
Government
purchases
Net exports
Capital
Income
Prices and Quantities in 2004 and 2008
Quantity of
pizzas
Price of
pizzas
Quantity of
calzones
2004
10
$10
15
$5
2008
20
$12
30
$6
GDP
•2004 = (10)($10) + (15)($5) = $175
•2008 = (20)($12) + (30)($6) = $420
Price of
calzones
Observations
•Output doubled
•GDP increased by 2.4 times
•Prices also rose
•GDP overstates economic growth
Nominal GDP versus Real GDP

Real GDP
– A measure of GDP in which the quantities
produced are valued at the prices in a base
year rather than at current prices
– Real GDP measures the actual physical
volume of production
Nominal GDP versus Real GDP

Nominal GDP
– A measure of GDP in which the quantities
produced are valued at current-year prices
– Nominal GDP measures the current dollar
value of production
Prices and Quantities in 2004 and 2008
Quantity of
pizzas
Price of
pizzas
Quantity of
calzones
Price of
calzones
2004
10
$10
15
$5
2008
20
$12
30
$6
•2004 = base year
•2008 Real GDP = (20)($10) + (30)($5) = $350
•2004 Real GDP = (10)($10) + (15)($5) = $175
Real GDP = Nominal GDP in the base year
Real GDP is not the Same as
Economic Well-Being

Leisure Time
– Shorter work week
– Start working later
– Retire earlier
Real GDP is not the Same as
Economic Well-Being

Thinking
economically
– Why do people
work fewer hours
today than their
great-grandparents
did?

Hint: Use the
concept of
opportunity cost
Real GDP is not the Same as
Economic Well-Being

Nonmarket Economic Activities
– Household production
– Volunteer services
– Nonmarket activities are more important in
poor countries
– Underground economy
Real GDP is not the Same as Economic
Well-Being

Environmental Quality and Resource Depletion
– Benefits of environment quality are not measured.
– GDP is not adjusted for resource depletion.
Real GDP is not the Same as Economic
Well-Being

Quality of Life
– Crime rates
– Traffic congestion
– Civic organizations
– Open space
Real GDP is not the Same as Economic
Well-Being

Poverty and Economic Inequality
– GDP does not capture the effects of
income inequality
But GDP is Related to Economic WellBeing But GDP is Related to Economic
Well-Being

Thinking Economically
– Why do far fewer children complete high
school in poor countries than in rich
countries?
?
Alternatives to GDP
Gross National Happiness
(GNH) is the main index for
defining the quality of life in a
more holistic manner in Bhutan.
Works Cited
Rediff.com. GDP: Interesting Facts You Must Know.” 9 Feb.
2010. Web. 8 Feb. 2011.
Measuring the Economy: Principles of Economics. New York:
2007, McGraw-Hill. Presentation.
Various photographs. Wikipedia.com. Images.