Download Nominal GDP - McGraw Hill Higher Education

Chapter 14: Spending,
Income, and GDP
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1
Learning Objectives
1. Explain how economist define and
measure an economy's output
2. Use the expenditure method for
measuring GDP to analyze economic
activity
3. Define and compute nominal GDP and real
GDP
4. Discuss the relationships between GDP
and economic well-being
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Macroeconomics
Data on output, employment, prices
 Vital



signs of the economy
Employment, unemployment, average work hours
Stock values and trends
Prices and inflation
 Reported
often in the news
Systematic measurement of economic
output developed during World War II
 Common
systems and measured used virtually
worldwide
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Measuring Output
Gross Domestic Product (GDP) is
The market value of
Final goods and services
Produced in a country in a given
period of time
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Market Value
 A modern economy produces many different
goods and services
 Macroeconomists’ goal is to understand the
behavior of the economy as a whole
 This
is done through answers to the following
questions:


Has the overall capacity of the economy to produce
goods and services increased over time?
If so, by how much?
 Economists aggregate the quantities of the
many different goods and services into a single
number
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Market Value
 Aggregate measure of quantities produced
 Weighs more expensive items more
 Willingness
good
Orchardia
Price
Quantity
GDP contribution
to pay is an indication of benefit from the
Apples
Bananas
Shoes
$0.25
$0.50
$20.00
4
6
3
$1.00
$3.00
$60.00
 Orchardia's GDP = (4 apples$0.25/apple) + (6
bananas$0.50/banana) + (3 pairs of
shoes$20.00/pair) = $64
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Market Value
 Suppose now:
Orchardia
Price
Quantity
GDP contribution
Apples
Bananas
Shoes
$0.25
$0.50
$20.00
3
3
4
$0.75
$1.50
$80.00
 Orchardia's GDP (3 apples$0.25/apple) + (3
bananas$0.50/banana)
+ (4 pairs of shoes$20.00/pair) = $82.25 > $64
 The
good whose production has increased (shoes) is
much more valuable than the goods whose production
has decreased (apples and bananas)
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Female Labor Force Participation
 The percentage of adult women working
outside the home has increased dramatically
over the past three decades in the Middle East
and North Africa
 Women’s


labor force participation:
Egypt: 7% in 1980 to about 26% in 2005
Morocco: 15% in 1982 to about 30% in 2007
 Still it remains very low relative to other
industrialized nations such as the US and the
UK (60% and 70%)

If more women join the workforce, how is this change
expected to affect measured GDP?
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Female Labor Force Participation
 The entry of more women into the labor market
can raise measured GDP in two ways:

The goods and services that women produce in their
new jobs contribute directly to increasing GDP


Represents a genuine increase in economic activity
The fact that paid workers take over previously unpaid
housework and childcare duties increases measured
GDP by the amount paid to those workers

Reflects a transfer of existing economic activities from the
unpaid sector to the market sector
 Measured change in GDP overstates actual change
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Increasing Efficiency
 Principle of Comparative Advantage applies to
household tasks
 Produce
at lowest opportunity cost
 Women with high opportunity cost of household
tasks find other ways to get the tasks completed
 Feminist movement, civil rights concerns,
increasing educational attainment, and
loosening social constraints moved women
into the work force
 Household
tasks performed by paid specialists
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Some Non-Market Goods Included
Government goods and services are not
sold in the market

Protection by the army / transportation / education
 These
goods have value
 Increase overall output
 Quantities are known
 Prices cannot be established
Government production is valued at cost
 Overstates
inefficiency
GDP if there is waste and
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Final Goods and Services
 Final goods are consumed by the ultimate user
 End
products of production
 Included in GDP
 Intermediate goods are used up in the
production of final goods
 Not

included in GDP
Avoids double counting
 A barber's assistant earns $2 per haircut for
providing services such as shampooing and
sweeping up
 Barber
charges $10 per haircut
 Haircut's contribution to GDP is $10
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Goods Can Be Final and Intermediate
 Milk can be sold as:


A final product: milk in the grocery store sold to
households
An intermediate good: milk sold to restaurants
 Count
only the final goods
 A capital good, difficult to classify, is a longlived good used in the production of other
goods and services
 Houses,
apartments, and motels
 Stoves in restaurants, cooking schools
 Delivery vehicles and taxis
 Money is not a capital good
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Produced in a Country in a Period of Time
"Domestic" in GDP means the activity is
measured within a country's borders
 Nationality
relevant
of owners or company is not
Value must be produced in the year
considered
 Sell
a 20-year old house for $200,000
• House was not produced in the period of time studied

Pay $12,000 commission  value added is $12,000
• Since the service was provided during the current year,
the agent’s fee is counted in current-year GDP
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The Value Added Method for Measuring GDP
 Value added is the market value of the
product minus the cost of inputs purchased
from other firms
 Count
value added in the year it is produced
 Suppose that the bread is the ultimate product of
three corporations
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
$2.00
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The Expenditure Method for Measuring GDP
 Users of final goods can be divided into 4
groups
 Households(C)
 Government
(G)
■ Firms
(I)
■ Foreigners (NX)
 All goods produced are purchased by one of
these groups in a given year
 Amount spent = market value
 GDP can be measured two ways
 Market
value
 Total spending for final goods less value of imports
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The Expenditure Method for Measuring GDP
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Consumption Expenditure
 Spending by households for goods and
services is divided into three subcategories
 Consumer
 Cars
 Consumer
goods
 Clothing
durables are long-lived consumer goods
 Furniture
 Appliances
non-durable goods are shorter-lived
 Food
 Bedding
 Services
are the largest component of consumer
spending
 Education
 Taxi rides
 Haircuts
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Investment
 Investment can be divided into three
subcategories
 Business
goods
fixed investment is purchases of new capital
 Plant
 Property
 Equipment
 Residential
investment is construction of new homes
and apartment buildings
 Inventory investment is the change in unsold goods
to the company's inventory



These goods are produced but not yet sold
This entry can be positive or negative
Negative inventory investment means less in inventory
at year-end than at the beginning
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Economic Investment and Financial
Investment
 The purchase of stocks and bonds do not represent an
investment, as defined in this chapter. Rather, they are
referred to as financial investments.
 Financial investments include purchases of stocks,
bonds, and other financial assets
Purchase generally transfers ownership of a portion of the
firm's existing capital stock
 Does not correspond to any increase in physical capital or
production capacity, in most cases


New stock issues can be an exception
 Economic investment refers to the increase in the
capital goods used to produce other goods

This value is based on purchase price of the capital goods,
not on stock value
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Government Purchases
 Federal, state, and local government purchase
final goods and services
 Fighter jets
 Teaching
 Office supplies
 Excludes transfer payments
 Transfer
payments are made by government but
the government receives no current goods or
services


Pension benefits, unemployment
No purchases of final goods and services involved in
transfer payments
• Spending by recipients is included in GDP
 Excludes interest paid on government debt
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Net Exports
 Net exports are exports (X) minus imports
(M)
 Exports
are goods and services produced
domestically and sold abroad

Exports reduce the amount available to the domestic
economy
 Imports
are purchases of goods and services
produced abroad


Imports can be consumption, investment, or
government spending
Imports increase the amount available to the domestic
economy
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GDP Expenditures Equation
 Terminology
Y
C
I
G
NX
Gross Domestic Product or output
Consumption Expenditure
Investment
Government Purchases
Net Exports
 Expenditure approach to measuring GDP
Y = C + I + G + NX
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GDP Example
 Total production is 1 million cars valued at $15,000 each
 Total Production value is 1 million × $15,000 = $15
billion
Sector
GDP Contribution
Consumers
700,000
$10.500 billion
Investment
Businesses
225,000
200,000
$3.375
$3.000 billion
Government
50,000
$0.750 billion
Net exports
25,000
$0.375 billion
Total

# Cars Purchased
1,000,000
975,000
$15.000
$14.625 billion
25,000 cars are unsold

Investment in inventories increases by $0.375 billion
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Expenditure Components of GDP
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The Income Method for Measuring GDP
There are three ways to measure GDP
 Measure
of total production
 Measure of total expenditure
 Measure of incomes of capital and labor
All three methods should give the same
final answer
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The Income Method for Measuring GDP
 When a good is sold, its proceeds are
distributed to workers or business owners
 GDP = labor income + capital income
 Labor income is wages, salaries, benefits, and
incomes of the self-employed
 About
71 percent of GDP in the UAE (2008)
 Capital income pays for physical capital and
intangibles
 Profits for business owners
 Interest for bond holders
 Measured
 Rent for land
 Royalties
before taxes
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The Three GDP Approaches
Production
Market
Value of
Final Goods
and
Services
Expenditure
Consumption
Income
Labor
Income
Investment
Government
purchases
Net exports
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Capital
Income
28
Nominal GDP versus Real GDP
Compare GDP for different years to see
how much output has changed
GDP changes over time because
 Prices
change
AND / OR
 Quantity
of output changes
To see how much output has grown, use
only the changes in quantities
 Hold
prices constant
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The Shirts and Skirts Economy
 GDP in 2009 is $175; GDP in 2013 is $420
 Only
twice as many goods were produced in 2013
 Comparing the GDP for the year 2009 to the GDP
for the year 2013, we might conclude that it is 2.4
times greater: 2.4 = ($420/$175)
 Because of the increase in prices, the market value of
production grew more than the physical volume of
production
Number
of Shirts
Price of
Shirts
Number
of Skirts
Price of
Skirts
Nominal
GDP
2009
10
$10
15
$5
$175
2013
20
$12
30
$6
$420
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Real GDP and Nominal GDP
 Real GDP (RGDP) values output in the
current year using the prices from the base
year
 The
base year is a reference year that changes
infrequently
 Real GDP measures the physical volume of
production
 Nominal GDP (NGDP) values output in
the current year using prices from the current
year
 Nominal
GDP is the current dollar value of
production
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Calculating Real GDP for 2013
Use 2009 as the base year
Nominal GDP for 2009 is $175 and for
2013, $420
Calculate real GDP using current year
quantities and base year prices
Number of
Shirt
Price of
Shirts
Number of
Skirts
Price of
Skirts
2009
10
$10
15
$5
2013
20
$12
30
$6
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Calculating Real GDP for 2013
 Now we can determine how much real production
has actually grown over the four-year period
 By using RGDP, we have eliminated the effects of
price changes and obtained a reasonable measure of
the actual change in physical production over the
four-year span
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Chain Weighting
 Another method to calculate RGDP
 RGDP

from a chain weighting approach is
Less sensitive to the choice of the base year
 Chain
weighting is similar to the simpler process
 Geometric average (where the subscript is the
price year)
2013 RGDP
2013 RGDP2009
=
2009 RGDP
2009 RGDP2009
2013 RGDP2013
2009 RGDP2013
2013 RGDP
350 420
=
=2
2009 RGDP
175 210
 Consistent
with the income method, RGDP
doubles between 2009 and 2013.
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Observations on Real and Nominal GDP
 Usually, nominal and real GDP increase each year
 Nominal GDP can go up and real GDP go down


Fewer goods and services produced AND
Prices increase faster than output decreased
 Nominal GDP will be smaller than real GDP if the
prices in the current year are less than in the base
year

Usually true for years before the base year
 Real GDP could rise and nominal GDP fall, but this
is rare

Prices are falling faster than output is increasing
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Calculating the Price Level
RGDP measures the change in output by
constant prices.
In a world of rising prices, nominal GDP is
deflated by a factor, that we call GDP
Deflator.
 The
GDP deflator captures output prices in a
particular year relative to a selected base year.
NGDP
RGDP =
GDP Deflator
GDP Deflator =
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NGDP
´100
RGDP
36
GDP Deflator
The GDP deflator represents a measure of
the overall price level of produced goods
and services.
The GDP deflator is equal to 100 in the
base year.
It is greater than 100 when the current
year’s prices exceed the base year’s prices.
It is less than 100 when the current year’s
prices are lower than the base year’s
prices.
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Calculating Inflation
Following the previous example we have
The percent change column shows that
prices have increased by 20%
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Real GDP and Economic Well-Being
Real GDP is a flawed measure of well-being
 It

values only market transactions
Omits illegal transactions, volunteer work, and
household production
Maximizing GDP will not necessarily
maximize national well-being
 Whether
increases in output increase welfare
is a case-by-case issue
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GDP Does Not Value Leisure
 Amount of leisure time has increased in the
past 100 years
 Work
weeks are shorter
 People enter the labor force at an older age
 People retire earlier
 Leisure produces no goods for market
 GDP
places a value of zero on all leisure time
 Opportunity cost of an hour of leisure is your
hourly wage
 Omission of the value of leisure time makes GDP
seem smaller
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Nonmarket Economic Activities
 GDP omits services that are not traded in
markets
 Household

production
This is of particular importance to developing countries
where services are commonly traded for others
 Volunteer
services
 Valuing these services would be difficult
 Nonmarket activities are important in poor
countries
 Self-sufficient
services
households and bartered goods and
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Underground economy
 Underground economy is all unreported
transactions, legal and illegal
 Casual labor is often paid in cash
 Failure
to report transaction reduces taxes
 Includes baby sitters, lawn care, home repair, etc.
 Some underground activity is illegal
A
service of value is provided
 Drug dealers, etc
 Estimates suggest the underground economy
is large regardless of national income level
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Environmental Quality
Suppose a factory is built in your town
 People

are employed and output is produced
Productive activity is included in GDP
Suppose further that the factory creates
pollution
 Your
city hires a company to restore the
environment to its initial condition
 Clean-up activities are included in GDP

Gets environment back to its starting point, not
better
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Resource Depletion
No adjustment is made for the decline in
resource availability when mining or other
harvesting is done
 One
more barrel of oil on the market means
one less barrel for future use
Environmental quality and resource
depletion are difficult to value
 They
have value and that value is omitted from
GDP
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Other Quality of Life Considerations
GDP does not account for intangibles
people value
 Crime
rates
 Traffic congestion
 Civic organizations
 Open space
 Sense of community
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Poverty and Economic Inequality
 GDP measures the total quantity of goods and
services produced and sold in an economy,
but it conveys no information about who gets
to enjoy those goods and services
 Two countries may have identical GDPs but
differ radically in the distribution of economic
welfare across the population
 GDP does not capture the effects of income
inequality
 Most
would prefer living in a relatively equal
society to one with a few wealthy and many poor
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GDP as a Welfare Measure
 GDP omits and undervalues some goods and
services
 GDP per capita is positively associated with
several measures of well-being
 Material
standard of living: more goods and
services
 Health and life expectancy

Residents of industrialized countries fare better than
residents of developing countries in a range of health
measures
 Education

Literacy and school enrollment rates are higher in highincome countries
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GDP as a Welfare Measure
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