Download The Three Macroeconomic Ills

GDP and the
Standard of living
Outline:
1. Functions of National Income Accounting
2. Gross Domestic Product (GDP)
3. The Expenditure Approach to GDP
4. The Income Approach to GDP
5. Value added
6. Real versus Nominal GDP
7. Limitations of GDP as a measure of the standard of
living
National income accounting (NIA) is the
measurement of aggregate or total economic activity.
NIA is useful for assessing the
performance of the
macroeconomy. NIA is also
helpful in evaluating the
effectiveness of policy initiatives
such as the Bush tax cuts.
Stocks vs. Flows
We measure stock
variables at a
specific point in
time; whereas
flows are measured
per unit of time.
Stocks include:
•Checking account
balance
•Balance owed on
student loans
•Inventories
Flows include:
•Income
•Sales revenue
•Output
We measure
economic
activity as a
flow.
Gross Domestic Product (GDP)
GDP is the market value final goods and
services produced within a country in a given
time period.
GDP is our basic
measure of economic
activity
Three approaches to measuring GDP



The value-added
approach
The expenditure
approach
The income approach
Value-added is the increase
in the market value of a good
that takes place
at each stage of the production
-distribution process.
$1.00
Wood
Chips
Lumber
Mill
$1.50
Raw
Paper
Paper
Mill
$2.25
Notebook
Paper
Office Supplies
Manufacturer
$3.50
Notebook
Paper
Wholesaler
$5.00
Notebook
Paper
Retailer
Summing the value-added at each stage
Stage
Lumber milling
Value Added
$1.00
Paper processing
.50
Office Supply
Manufacturing
.75
Wholesaling
1.25
Retailing
1.50
Total
$5.00
To count the notebook in GDP, we count
the final transaction only. Otherwise, we
would be counting value added twice.
We count only final goods—that
is, a good or service produced for
a final user—in GDP. The value of
intermediate goods and services
are automatically included when
the count the value of the final
good or service.
The expenditure approach
Total Expenditure = C + I + G + NX
Here we simply
add up all
expenditures for
final goods
and services in one
year
Where,
C is personal consumption expenditure;
I is gross private domestic investment;
G is government expenditure (local, state, and federal);
and
NX is net exports, or Exports minus Imports
Consumption
Household spending for newlyproduced goods and services is
defined as consumption. We
distinguish between 3 categories
or types:
Spending for consumer
durables
Spending for consumer nondurables
Spending for consumer services.
Consumer Spending by Type, 2002
(in billions)
Category
Durables
Spending in
2002
Percent
(billions) of Total
$872.4
12
Nondurables
2,113.9
29
Services
4,314.5
59
Source:Bureau of Economic Analysis
Total consumption
by U.S. households
in 2002 was
$7.3
trillion
What is investment?
All spending by business firms for
newly built equipment and business
structures.
All changes in business inventories of
raw materials, semifinished articles, and
finished goods.
All spending by households for newly
constructed residential housing
Components of Business Fixed Investment, 2002
(billions/percent of total)
Hous ing
269. 30 / 17.0%
Equip. & Software
470. 90 / 29.7%
Business St ructures
847. 60 / 53.4%
Source: www.bea.gov
Investment does NOT include
•The purchase of stocks, bonds, or
other financial assets.
•Secondhand sales
Remember that
investment only happens
when there is production
of new tangible capital
goods
Business investment
has been slumping
lately
GDP: The Expenditure Approach
Amount in
2002
Percentage
Symbol
(billions)
of GDP
Consumption expenditure
C
7,255
69.9
Investment
I
1,588
15.3
Government purchases
G
1960
18.9
NX
-426
-4.1
Y
10,377
100
Item
Net exports
GDP
Source: U.S. Bureau of Commerce, Bureau of Economic Analysis
The income Approach
GDP =
This mainly involves
summing up income
earned in factor
markets
Employee compensation
+ net interest
+ rent
+ profits
+ proprietors’ income
+ Capital consumption
+ (indirect business taxes –
subsidies)
Definitions
Capital consumption (CC):A monetary measure of the
depreciation of the capital stock in a year due to normal
wear and tear, fires, or other accidents.
Net Investment: Gross Investment minus CC.
Indirect business taxes: taxes collected by businesses for
government units, such as taxes on entertainment, motels,
groceries, liquor, cigarettes, or gasoline taxes. Also called
excise taxes.
GDP: The Income Approach
Amount in
2002
Percentage
(billions)
of GDP
5,964
57.5
Rental income of persons
153
1.5
Net interest
678
6.5
Corporate profits
785
7.6
Proprietors' income
747
7.2
8,327
80.3
660
6.4
Capital Consumption
1,390
13.3
GDP
10,377
100
Item
Compensation of employees
Net domestic product at factor cost
Indirect taxes less subsidies
Source: U.S. Bureau of Commerce, Bureau of Economic Analysis
Real versus Nominal GDP
•We use money to measure the market value of new
goods and services produced produced in the economy.
•The value (or purchasing power) of money is subject to
change over time.
•Hence we need to adjust nominal GDP (that is, GDP
measured at current prices) for changes in the value of
money.
•GDP adjusted for changes in the value of money is called
real GDP.
Nominal GDP Calculation
To calculate nominal GDP in 2002, sum the
expenditures on apples and oranges in 2002
as follows:
Expenditure on apples = 100 × $1
Expenditure on oranges = 200 × $0.50
Nominal GDP = $100 + $200
= $100
= $100
= $200
Now we will calculate nominal GDP for 2003
and compare
Expenditure on apples = 160 × $0.50
Expenditure on oranges = 220 × $2.25
Nominal GDP = $80 + $495
Our problem is that the nominal
GDP figures do not give us an
accurate read of period-to-period
changes in actual production.
Notice that a part of the change in
nominal GDP from 2002 to 2003
resulted from a change in prices.
= $80
= $495
= $575
“Traditional” Real GDP calculation
The traditional method converts nominal GDP to real GDP
by measuring GDP in all periods at “base period prices”
To correct for changes in the
value of money , we will
establish 2002 as our base
year. That is, we will
measure 2003 output at
2002 prices.
Traditional method: measuring 2003 GDP
at 2002 prices
Expenditure on apples = 160 × $1.00
Expenditure on oranges = 220 × $0.50
Nominal GDP = $80 + $495
Thus, real GDP increased from 2002 to
2003—but not by as much as nominal
GDP
= $160
= $110
= $270
To compute Real GDP (GDP expressed in
constant dollars):
No min alGDP
Re alGDP 
100
GDPDeflator
Year
1990
1991
Nominal GDP
(billions)
$5,748.30
5,916.70
GDP Deflator
1996 = 100
86.51
89.66
Real GDP
(billions of
1996 dollars)
$6,644.67
$6,599.04
New Method of Calculating Real
use this method, we must value 2002 output at 2003
GDPToprices
and 2003 output at 2002 prices.
2003 Quantities and 2002 Prices
Item
Quantity
Price
Apples
160
$1.00
Oranges
220
$0.50
2002Quantities and 2003 Prices
Item
Quantity
Price
Apples
100
$0.50
Oranges
200
$2.25
•Measured at 2002 prices, Real GDP increased by 35%
from 2002 to 2003 [($70/$200) × 100]
•Measured at 2003 prices, real GDP increased by 15%
from 2002 to 2003 [($75/$500) × 100]
The next step is to average
together the percentage increases
for 2002 and 2003. Thus we have:
35%  15%
 Re alGDP 
 25%
2
Therefore, since real GDP in
2002 is $200, this chain-weighted
method of converting nominal to
real GDP gives us real GDP in
2003 of $250.
GDP in the United States (in millions)
8000
www.bea.gov
6000
4000
2000
0
60
65
70
75
80
Nominal GDP
85
90
95
Chained 1996 dollars
GDP per Person in the United States
35000
www.economagic.com
30000
25000
20000
15000
10000
5000
0
60
65
70
75
80
Nominal
85
90
95
Chained 1996 dollars
GDP in the U.S. (millions of chained 1996 dollars)
7000
Recessions are shaded
www.bea.gov
6000
Notice that real GDP
decreased in 1991
5000
4000
3000
2000
70
75
80
85
90
95
Limitations of (real) GDP as a
measure of the standard of living
•Household production
•The underground economy
•Leisure time
•Environment quality