Download Economics R. Glenn Hubbard, Anthony Patrick O`Brien, 2e.

Increases in GDP
Help Revive
American Airlines
The business cycle does not
affect all industries in the same
way. For example, some
trucking firms experienced
slow sales during 2006 while
airlines were prospering.
Learning Objectives
7.1
Explain how total production
is measured.
7.2
Discuss whether GDP is a good
measure of well-being.
7.3
Discuss the difference between
real GDP and nominal GDP.
7.4
Become familiar with other
measures of total production
and total income.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
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.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
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.
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Chapter 7: GDP: Measuring Total Production and Income
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Chapter 7: GDP: Measuring Total Production and Income
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Learning Objective 7.1
Chapter 7: GDP: Measuring Total Production and Income
Gross Domestic Product Measures Total Production
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: We want dollar
value!
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
Chapter 7: GDP: Measuring Total Production and Income
Gross Domestic Product Measures Total Production
GDP Includes Only the Market Value of Final Goods
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.
Only goods and services produced within the year (not
sold in that year)
Only production within the geographic boundaries of
the United States.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
Measuring Total Production: Gross Domestic Product
GDP = sum of the money values of all final goods and
services produced in the domestic economy within a
specified period of time. (such as a year).
Suppose in country A there are a total of n goods and
services produced; then in year t:
Nominal GDPt = P1,t *Q 1,t + P 2,t *Q 2,t + … + Pn,t *Q n,t
Nominal GDP may change if prices change and the
quantities are constant.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
Solved Problem
7-1
Chapter 7: GDP: Measuring Total Production and Income
Calculating GDP
PRODUCTION AND PRICE STATISTICS FOR 2007
(1)
PRODUCT
(2)
QUANTITY
(3)
PRICE PER UNIT
100
$50.00
Pizzas
80
10.00
Textbooks
20
100.00
2,000
0.10
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
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
How to calculate GDP?
• Expenditure Approach
• Income Approach
• Value Added Approach
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
Chapter 7: GDP: Measuring Total Production and Income
Expenditure Approach: GDP as the Sum of Final Goods and
Services
GDP  C  I  G  ( X  IM )
C:Personal Consumption Expenditures, or “Consumption”
Consumption Spending by households on goods
and services, not including spending on new houses.
I: Gross Private Domestic Investment, or “Investment”
Investment Spending by firms on new factories, office
buildings, machinery, and additions to inventories, and
spending by households on new houses.
Don’t Let This Happen to YOU!
Remember What Economists Mean by Investment
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
Chapter 7: GDP: Measuring Total Production and Income
Expenditure Approach: GDP as the Sum of Final Goods and
Services
G: Government Consumption and Gross Investment, or
“Government Purchases”
Government purchases
Spending by federal, state, and local governments
on goods and services.
(X-IM) or NX: Net Exports of Goods and Services, or “Net
Exports”
(X-IM): Net exports Exports minus imports.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
Learning Objective 7.1
Expenditure Approach: GDP as the Sum of Final Goods
and Services
Some Actual Values
FIGURE 7-2
Components of GDP in 2006
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
Chapter 7: GDP: Measuring Total Production and Income
Expenditure Approach: GDP as the Sum of Final Goods
and Services
Some Actual Values
• Consumer spending on services is greater than the sum
of spending on durable and nondurable goods.
• 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.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.1
VA Approach: GDP as the Sum of Values Added
Chapter 7: GDP: Measuring Total Production and Income
GDP = sum of values added to goods in all firms
Value added = firm’s revenue from selling a product minus
the amount paid for goods and services purchased from
other firms
Table 7-1
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
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Chapter 7: GDP: Measuring Total Production and Income
VA Approach: GDP as the Sum of Values Added
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Chapter 7: GDP: Measuring Total Production and Income
VA Approach: GDP as the Sum of Values Added
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Chapter 7: GDP: Measuring Total Production and Income
Income Approach: GDP as the Sum of All Income

The income approach to measuring GDP is to add up all the
income earned by households and firms in a single year.

The rationale behind the income approach is that total
expenditures on final goods and services are eventually
received by households and firms in the form of wage, profit,
rent, and interest income.

Therefore, by adding together wage, profit, rent, and interest
income, one should obtain the same value of GDP as is
obtained using the expenditure approach.

GDP = wages + interest + rents + profits + statistical adjustment
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.4
Chapter 7: GDP: Measuring Total Production and Income
Income Approach: GDP as the Sum of All Income
The Division of Income: Total: $13,247 bil.
FIGURE 7-5
The Division of Income
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
Other Measures of Total Production and Total Income
Gross National Product (GNP)
is the total income acquired by Americans both within the
U.S. and elsewhere.
includes foreign production by U.S. firms but excludes
U.S. production by foreign firms.
GNP= GDP + net foreign factor income
National Income = GNP – depreciation – indirect
business taxes
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Chapter 7: GDP: Measuring Total Production and Income
Income-expenditure identity: Expenditure = Income
Y=C+I+G+NX
Net foreign
factor income
Net exports
Government
expenditures
Depreciation
Indirect business taxes
Rents
Interest
Investment
Profits
Consumption
GNP
GDP
National
Income
Employee
compensation
(1)
Expenditures
=
(2)
Output
=
(3)
Income
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.2
Chapter 7: GDP: Measuring Total Production and Income
Does GDP Measure What We Want It to Measure?
Shortcomings in GDP as a Measure of Total Production
Household Production
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.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.2
Chapter 7: GDP: Measuring Total Production and Income
Does GDP Measure What We Want It to Measure?
Shortcomings of GDP as a Measure of Well-Being
The Value of Leisure Is Not Included in GDP
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
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.2
Making
Chapter 7: GDP: Measuring Total Production and Income
the
Did World War II Bring Prosperity?
Connection
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Chapter 7: GDP: Measuring Total Production and Income
An Inside LOOK
Trucking Industry Depends on the
Goods—Not Services—Component of GDP
Economic Slowdown Slams Breaks on Trucking Sector
As goods decline as a percentage of GDP, so does the demand for ground-freight transportation
services. (The goods and services shares of GDP do not sum to 100 percent because GDP is
composed of goods, services, and structures.)
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.3
Chapter 7: GDP: Measuring Total Production and Income
Real GDP versus Nominal GDP
Calculating Real GDP
Real GDP The value of final
goods and services evaluated at
base-year prices.
Nominal GDP The value of final
goods and services evaluated
at current-year prices.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.3
Solved Problem
7-3
Chapter 7: GDP: Measuring Total Production and Income
Calculating Real GDP
2000
PRODUCT
2009
QUANTITY
PRICE
QUANTITY
PRICE
Eye examinations
80
$40
100
$50
Pizzas
90
11
80
10
Textbooks
15
90
20
100
2009
QUANTITY
2000
PRICE
100
$40
$4,000
Pizzas
80
11
880
Textbooks
20
90
1,800
PRODUCT
Eye examinations
VALUE
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.3
Chapter 7: GDP: Measuring Total Production and Income
Real GDP versus Nominal GDP
Comparing Real GDP and Nominal GDP
FIGURE 7-3
Nominal GDP and
Real GDP, 1990–2006
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Chapter 7: GDP: Measuring Total Production and Income
Real GDP in the U.S.
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Learning Objective 7.3
Chapter 7: GDP: Measuring Total Production and Income
Real GDP versus Nominal GDP
The GDP Deflator
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
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.3
Chapter 7: GDP: Measuring Total Production and Income
Real GDP versus Nominal GDP
The GDP Deflator
2005
2006
NOMINAL GDP
$12,456 billion
$13,247 billion
REAL GDP
$11,049 billion
$11,415 billion
FORMULA
APPLIED TO 2005
APPLIED TO 2006
GDP  Nominal GDP 100
Deflator Real GDP
 $12,456 billion 

 100  113
 $11,049 billion 
 $13,247 billion 

 100  116
 $11,415 billion 
116  113
The increase of price level 
 2.7%
113
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 7.3
Chapter 7: GDP: Measuring Total Production and Income
Real GDP versus Nominal GDP
Growth Rate of Nominal GDP and Real GDP
2005
2006
NOMINAL GDP
$12,456 billion
$13,247 billion
REAL GDP
$11,049 billion
$11,415 billion
Growth rate of GDP from year t to t+1:
Nominal GDP:
Real GDP
Nominal GDP in year t+1 - Nominal GDP in year t
Nominal GDP in year t
Real GDP in year t+1 - Real GDP in year t
Real GDP in year t
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