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

Chapter 6
Measure Domestic Output, National
Income, and the price level
Table 1. GCC Countries: Selected Economic Indicators, 2002
Nominal
Central
Nominal
GDP
Overall
Total
Bank
Current
GDP
(Per
Fiscal Government Proven
Foreign
Account
Assets
(Millions of capita
Balance Gross Debt
Oil
Balance
U.S.
in U.S. Population (Percent (Percentof Reserves (Months of (Percent of
dollars) dollars)1 (Millions)1 of GDP)2
GDP)
(Years)3 Imports)4
GDP)
Country
Bahrain
8,506
Kuwait
33,215
Oman
20,290
Qatar
17,321
Saudi
188,960
Arabia
U.A.E.
71,187
GCC
339,479
11,619
15,098
7,515
28,362
0.7
2.2
2.7
0.6
0.8
20.6
3.7
5.1
30.3
32.9
16.0
58.2
15.0
134.0
16.0
15.0
2.7
10.7
4.8
2.7
0.3
20.9
10.0
13.8
8,567
22.1
–5.3
93.8
85.0
12.9
4.7
19,613
11,9795
3.6
31.9
–9.3
–2.75
4.5
66.65
124.0
83.75
4.7
7.6
5.5
6.95
Assessing the Economy’s
Performance
National income accounts enable us to:
a. Measure the economy’s overall performance by
measuring the flows of income and expenditures over
a period of time (Assess the health of the economy)
a. Track the long run course of the economy: growing,
declining, or constant (compare conditions over time
and across countries)
b. Provide a basis for appropriate public policies to
improve economic performance (improve the
economy’s health)
GROSS DOMESTIC PRODUCT
• The total market value of all final goods and
services produced within a country in a given
year produced by residents (nationals or
foreigners) in the economy
Note:
• GDP is a monetary measure:
Quantities x prices
Money valuation allows the summing of apples
and oranges; money acts as the common
denominator
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.
Gross Domestic Product Measures Total Production
Measuring Total Production: Gross Domestic Product
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. NOT ICLUDED IN
GDP
GDP Includes Only Current Production
GDP includes only production that
takes place during the indicated
time period.
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
Gross Domestic Product Measures Total Production
Production, Income, and the Circular Flow Diagram
Gross Domestic Product Measures Total Production
Components of GDP
Personal Consumption Expenditures, or “Consumption”
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 on new houses.
Don’t Let This Happen to YOU!
Remember What Economists Mean by Investment
Gross Domestic Product Measures Total Production
Components of GDP
Government Consumption and Gross Investment, or
“Government Purchases”
Government purchases
Spending by federal, state,
and local governments on
goods and services.
Transfer payments Payments
by the government to individuals
for which the government does
not receive a new good or
service in return.
!!! NOT A PART OF GDP !!!
Gross Domestic Product Measures Total Production
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.
!!! NOT A PART OF GDP !!!
GDP Excludes Non-production Transactions
These are:
1- Purely financial transactions are excluded:
a.
Public transfer payments, like social security payments,
welfare payments, and veteran’s payments. These
contribute nothing to current production in return.
b.
Private transfer payments, like student allowances or
money given by parents to children. They produce no
output
c.
The sale of stocks and bonds represent a transfer of
existing assets (just swap of papers). Note: the brokers’
fees are included in GDP for services rendered.
2 - Secondhand sales are excluded; they do not represent
current output. (However, any value added between
purchase and resale is included, e.g., used car dealers).
To avoid multiple counting
1.
Only consider the value of final products. Or
2.
Measure and cumulate the value added at each stage of
production
Value added = market value of the product – the value of
inputs. This is paid as wages, rent, interest and profits.
Example
Suit production
stages of production
firm A: sheep ranch
firm B: wool processor
firm C: suit manufacturer
firm D: Clothing wholesaler
firm E: Retail Clothier
Total Sales value
Value Added
sales value of
materials or product
0
120
180
220
270
350
1140
Value added
120 (=120-0)
60 (=180-120)
40 (=220-180)
50 (=270-220)
80 (=350-270)
350
Two ways to calculate GDP
Gross Domestic Product Measures Total Production
Components of GDP
Net Exports of Goods and Services, or “Net Exports”
Net exports Exports
minus imports.
An Equation for GDP and Some Actual Values
Y  C  I  G  NX
Gross Domestic Product Measures Total Production
An Equation for GDP and Some Actual Values
Kuwait GDP
Sector
Oil & Gas
2003
2004
2005
2006
5797.8 7822.0 12832.8 16214.9
Mining and Quarrying
17.0
22.5
32.4
41.3
Agriculture and Fishing
64.9
70.9
71.1
74.4
Manufacturing of which :
1127.0 1455.9 1712.9 1973.4
Refined Products Industry :
572.4
795.5
970.2
1159.2
Electricity, Gas and Water
299.4
306.9
319.1
336.6
Construction
349.3
401.9
437.1
479.3
Wholesale and Retail Trade
890.2
950.2
1017.8 1088.8
Restaurants and Hotels
174.2
170.5
168.0
Transport, Storage and Communications
799.9
1048.0 1230.7 1397.4
Financial Instituitions
1171.7 1496.5 2776.6 3813.4
Insurance
64.9
62.1
78.8
171.2
97.7
Real Estate
1062.0 1094.8 1208.4 1295.8
Business Services
186.6
Community, Social and Personal Services
2726.4 2950.0 3228.3 3478.7
GDP at Producer's Price
14731.3 18079.4 25356.3 30716.3
227.2
242.3
253.4
Imputed Bank & insurance Service Charges -612.9
-724.2 -1052.1 -1318.1
Imports Duties
161.5
GDP at Purchaser's Price Value
135.1
173.6
174.6
14253.5 17516.7 24477.8 29572.8
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.
Solved Problem
7-3
Calculating Real GDP
2000
PRODUCT
QUANTITY
PRICE
2009
Value
QUANTITY
PRICE
Value
Eye examinations
80
$40
3200
100
$50
5000
Pizzas
90
11
990
80
10
800
Textbooks
15
90
1350
20
100
2000
GDP
5540
PRODUCT
Eye examinations
2009
QUANTITY
7800
2000
PRICE
VALUE
100
$40
$4,000
Pizzas
80
11
880
Textbooks
20
90
1,800
Real GDP
6680
Real GDP versus Nominal GDP
Comparing Real GDP and Nominal GDP
FIGURE 7-3
Nominal GDP and
Real GDP, 1990–2006
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
Nominal GDP
Real GDP 
 100
GDP deflator
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
 2.7%
113
GDP vs GDP per capita
WHICH economy has enjoyed the best economic performance over
the past five years: America's or Japan's? Most people will pick
America. The popular perception is that America's vibrant economy
was sprinting ahead. And it is true that America's average annual real
GDP growth of 2.9% was much faster than Japan's 2.1%. However,
the single best gauge of economic performance is not growth in GDP,
but GDP per person, which is a rough guide to average living
standards. It tells a completely different story.
Source: “Grossly distorted picture” The Economist, March 13th, 2008.
URL: http://www.economist.com/finance/displaystory.cfm?story_id=10852462
GDP vs GDP per capita
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.
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
Gross Domestic Product Measures Total Production
Measuring GDP by the Value-Added Method
Value added The market value
a firm adds to a product.
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
Other Measures of Total Production and Total Income
The Division of Income
FIGURE 7-5
The Division of 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.)
Two Ways to Look at GDP:
Spending and Income
•
Expenditures Approach:
GDP is divided into the categories of buyers in the
market; household consumers, businesses,
government, and foreign buyers.
•
Add up all the spending on final goods and services
took place throughout the year. These are:
1.
Personal Consumption Expenditures (C):
On durable goods (goods lasting 3 years or more),
non-durable goods and services.
2. Gross Private Domestic Investment (Ig):
Includes:
a.
All final purchases of machinery, equipment, and tools by
businesses.
b.
All construction (including residential).
c.
Changes in business inventory.
•
Positive and negative changes in inventories
A. If total output exceeds current sales, inventories build up.
When inventory increases, output produced by the
economy will be greater than what purchased. We need to
calculate unsold output (inventory accumulation) as part
of this year’s GDP (add it).
B. If businesses are able to sell more than they currently
produce, changes in inventory will be a negative number.
when inventory decreases, output produced will be less
than what is purchased. Since this inventory depletion had
been counted in GDP of previous years, we need to
subtract it from this year’s GDP.
•
Net Private Domestic Investment (In)
includes only investment in the form of added capital.
Each year as current output is being produced, existing
capital equipments are wearing out and buildings are
deteriorating; this is called depreciation or consumption
of fixed capital.
Net investment = gross investment - (consumption of fixed
capital) depreciation
Note:
• If Gross investment > depreciation Positive net
investment. the productive capacity of the economy will
expand
• If Gross investment < depreciation  Negative net
investment (disinvestment). The economy’s production
capacity will decline.
• If Gross investment = depreciation  Net investment equals
zero. The nation’s productive capacity will be static.
• Non-investment transactions.
1. Transfer of paper assets (stocks and bonds)
2. Transfer of tangible assets (e.g., houses)
• These transactions do not create new capital
Definition:
Investment is the creation of new capital assets, that create jobs and income.
3. Government Purchases (of consumption goods and capital
goods) – (G)
They include two components:
a)
Expenditures for goods and services that the government
consumes in providing public services
b) Expenditures on social capital such as schools or
highways.
Remember, This entry excludes government transfer
payments because they generate no production of any
sort.
4 - Net Exports (Xn):
All spending on final goods produced in Kuwait must be
included in GDP, whether the purchase is made here or
abroad.
These include spending on domestic output by foreigners
(Exports X). They also include expenditures by residents on
foreign made goods (Imports M).
Instead of adding exports and subtracting imports we only
add “net exports”
Xn = X - M
Now adding all things together
GDP = C + Ig + G + Xn(X-M)
GLOBAL PERSPECTIVE
Comparative GDPs in Trillions, 2001
0
United States
Japan
Germany
United
Kingdom
France
China
Italy
Canada
Mexico
Spain
Brazil
India
Korea, Rep.
Netherlands
Australia
1
2
3
4
5
6
7
8
9
10
Source: World Bank
Kuwait’s GDP
Sector
Oil & Gas
2003
2004
2005
2006
5797.8 7822.0 12832.8 16214.9
Mining and Quarrying
17.0
22.5
32.4
41.3
Agriculture and Fishing
64.9
70.9
71.1
74.4
Manufacturing of which :
1127.0 1455.9 1712.9 1973.4
Refined Products Industry :
572.4
795.5
970.2
1159.2
Electricity, Gas and Water
299.4
306.9
319.1
336.6
Construction
349.3
401.9
437.1
479.3
Wholesale and Retail Trade
890.2
950.2
1017.8 1088.8
Restaurants and Hotels
174.2
170.5
168.0
Transport, Storage and Communications
799.9
1048.0 1230.7 1397.4
Financial Instituitions
1171.7 1496.5 2776.6 3813.4
Insurance
64.9
62.1
78.8
171.2
97.7
Real Estate
1062.0 1094.8 1208.4 1295.8
Business Services
186.6
Community, Social and Personal Services
2726.4 2950.0 3228.3 3478.7
GDP at Producer's Price
14731.3 18079.4 25356.3 30716.3
227.2
242.3
253.4
Imputed Bank & insurance Service Charges -612.9
-724.2 -1052.1 -1318.1
Imports Duties
161.5
GDP at Purchaser's Price Value
135.1
173.6
174.6
14253.5 17516.7 24477.8 29572.8
The Income Approach to GDP
•
Demonstrates how the expenditures on final products are
allocated to resource suppliers. Items that make up
national income are:
1.
•
•
•
Compensation of employees includes:
wages,
salaries,
payments made on behalf of workers like social security
and other health and pension plans.
2.
Rents: payments for supplying property resources (if
adjusted for depreciation it will be the net rent).
3.
Interest: payments from private business to suppliers of
money capital. It also includes interest the households
receive on their savings deposits, CDs (certificates of
deposits), and corporate bonds
4.
Profits:
A. Proprietors’ income: income of incorporated businesses: sole
proprietorships, partnerships, and cooperatives.
A. Corporate profits: After corporate income taxes(1) are paid to
government, dividends(2) are distributed to the shareholders,
and the remainder is left as undistributed corporate profits(3).
•
The sum of the above entries equals national income: all
income earned by Kuwaiti-supplied resources, whether
here or abroad
From National Income to GDP
National income is all income that flows to nationals,
whether resident in the country or abroad.
Adjustments required to balance expenditures and
income. To get GDP we have to add three items:
1- indirect business taxes:
These include general sales taxes, excise taxes,
business property taxes and customs duties. (the
seller treats these taxes as a cost of production,
hence, they are part of the market value of output, but
not of income).
2.
Depreciation/Consumption of Fixed Capital: The firm also
regards the decline of its capital stock as a cost of
production. In addition to the depreciation of private
capital, depreciation public capital (government buildings,
port facilities, etc.), must be included in this entry.
•
This is a cost of production and should be included in the
gross value of output. Since this does add to income it
must be added to national income to balance with the
economy’s expenditures
3.
Net foreign factor income:
National income measures the income of Kuwaitis both
here and abroad. To make this final adjustment, the
income of foreign nationals must be added and Kuwaiti
income earned abroad must be subtracted. Sometimes
this entry is a negative number.
GROSS DOMESTIC PRODUCT
Expenditures Approach
Consumption
by Households
Income Approach
Wages
+
Expenditures
+
Rents
+
Interest
+
Profits
+
Statistical
by Foreigners
Adjustments
+
Investment
G
by Businesses
=
=
D
+
Government
P
Purchases
OTHER NATIONAL ACCOUNTS (USA EXAMPLE)
U.S. GDP, NDP, NI, PI, & DI, 2002
•Gross Domestic Product (GDP)
Consumption of fixed capital
•Net Domestic Product (NDP)
Net foreign factor income earned
in the U.S.
Indirect business taxes
•National Income (NI)
Social security contributions
Corporate income taxes
Undistributed corporate profits
Transfer payments
•Personal Income (PI)
Personal Taxes
•Disposable Income (DI)
$10,446
-1,393
$9,053
- 10
- 695
$8,348
-748
-213
-141
+1,683
$8,929
-1,113
$7,816
Definitions:
A. Net domestic product (NDP) is equal to GDP minus
depreciation allowance (consumption of fixed capital).
B. National income (NI) is income earned by Kuwaiti-owned
resources here or abroad. Adjust NDP by subtracting
indirect business taxes and adding net Kuwaiti income
earned abroad. (Note: This may be a negative number if
foreigners earned more in Kuwait than Kuwaiti resources
earned abroad.)
C.
Personal income (PI) is income received by households.
To calculate, take NI minus payroll taxes (social security
contributions), minus corporate profits taxes, minus
undistributed corporate profits, and add transfer
payments.
D.
Disposable income (DI) is personal income less personal
taxes.
Nominal versus Real GDP
•
Nominal GDP is the market value of all final goods and
services produced in a year. This creates problems when
we compare GDP over time.
•
If GDP increases, this may be due to rises in quantities or
in prices or both. But it is only the quantity of goods we
produce that affects our standards of living not the price.
• To measure changes in the quantity of output, we need a
yardstick that stays the same size.
• To make comparisons of real output, a K.D. must keep the
same purchasing power over time.
• Unadjusted (nominal) GDP: is based on current prices
•
To overcome this problem we deflate GDP when prices
rise, or inflate GDP when prices fall. Adjusted (real) GDP
is deflated or inflated to reflect changes in prices.
Adjustment process in one product economy.
Valid comparisons cannot be made with nominal GDP
alone, since both prices and quantities are subject to
change. Some methods to separate the two effects must
be devised.
Adjustment Process:
• First Method: GDP Price Index: first determine a
price index, then adjust the nominal GDP figures by
dividing by this price index
• Price index = (price of market basket in a specific
year/ price of the same basket in base year) x 100.
• Real GDP = (Nominal GDP/Price index) x 100
Price Index: is a measure of the price of a specified collection of
goods and services called a “market basket” in a given year (e.g.
current year) compared to the price of an identical collection of
goods and services in a reference (base) year.
NOMINAL GDP vs. REAL GDP: GDP Output of Pizza
(4)
(5)
(3)
(2)
(1)
Adjusted,
Price Price Index Unadjusted,
Units of
or Nominal, Or Real,
Year 1 =
Pizza
Output
GDP,
GDP
100
Year Of Pizza Per Unit
(1)x(2)
1
2
3
4
5
5
7
8
10
11
$ 10
20
25
30
28
100
200
250
-
$ 50
140
200
-
$ 50
70
80
-
Note:
The market basket is composed of pizzas only
Year 1 is the base year
Real GDP can be calculated by multiplying units of output by base year prices
Adjustment Process:
An alternative method
• Multiply current quantities of goods and services by
prices of the base year to calculate real GDP
• Multiply current quantities of goods and services by
current year prices to calculate nominal GDP
• Calculate the price index (Multiply by 100 to put it in
standard index form) by:
• Price index = (nominal GDP/real GDP) x 100
• Consumer Price Index
Reports the price of a market basket of some consumer
goods and services purchased by a typical urban consumer
•
CPI = (price of a market basket in any given year / price of
the same market basket in base year) x 100
SHORTCOMINGS OF GDP
• Non-market Transactions
GDP doesn’t measure some very useful output because it is
unpaid (homemakers’ services, parental child care,
volunteer efforts, home improvement projects), e.g., the
services of a carpenter who repairs his own home are not
included in GDP.
One exception: output that farmers consume themselves is
estimated and added.
• Improved Product Quality:
Over time product quality improves though prices may be
the same. Quality affects our welfare. GDP doesn’t measure
improvements in product quality
• Leisure (GDP ignores leisure value):
We spend more leisure time. GDP doesn’t measure
improved living conditions as a result of more leisure. This
affects our welfare, but this is not reflected in GDP.
•
Composition and Distribution of Output: GDP makes no
value adjustments for changes in the composition of
output or the distribution of income.
Nominal GDP simply adds the dollar value of what is
produced; it makes no difference if the products are guns
or food.
GDP figures do not provide information about how the
income is distributed.
•
The Underground Economy:
Illegal activities are not counted in GDP (estimated to be around 8% of
U.S. GDP).
Legal economic activity may also be part of the “underground,” usually
in an effort to avoid taxation
•
GDP and the environment:
The harmful effects of pollution are not deducted from GDP (e.g., oil
spills, increased incidence of cancer, destruction of habitat for wildlife,
the loss of a clear unobstructed view).
Note that GDP does include payments made for cleaning up oil spills
and the cost of health care for cancer victims.
GLOBAL PERSPECTIVE
The Underground Economy as a Percent of GDP
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United
Kingdom
Japan
United States
Switzerland
0
5
10
15
20
25
30
Source: The Journal of Economic Literature, 2000