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Gross Domestic Product, GDP:
A Definition
– A nation’s gross domestic product (GDP)
• Total value of all final goods and services produced
for the marketplace during a given period within the
nation’s borders
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Gross Domestic Product, GDP:
A Definition
• The total value
– Approach of GDP is to add up dollar value of every good or
service—the number of dollars each product is sold for
• However, using the dollar prices at which goods and services actually
sell also creates a problem
– If prices rise, then GDP will rise, even if we are not actually producing
more
– GDP must be adjusted to take away the effects of inflation
– Nominal GDP vs. Real GDP
• …of all final…
– When measuring production, we do not count every good or
service produced in the economy
• Only those that are sold to their final users
• Avoids over-counting intermediate products when measuring GDP
– Value of all intermediate products is automatically included in value of final
products they are used to create
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Gross Domestic Product, GDP:
A Definition
• …goods and services…
– Goods: cars, furniture, computers, beer, etc.
– Services: medical, financial, educational, etc.
• …produced…
– In order to contribute to GDP, something must
be produced.
Q: should stocks or bonds be included in the calculation
of GDP?
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Gross Domestic Product, GDP:
A Definition
• …for the marketplace…
– GDP does not include all final goods and services
produced in the economy
• Includes only the ones produced for the marketplace—that is,
with the intention of being sold
• …during a given period…
– GDP measures production during some specific period
of time
• Only goods produced during that period are counted
how about used goods?
• GDP is actually measured for each quarter, and then reported
as an annual rate for the quarter
• Once fourth quarter figures are in, government also reports
official GDP figure for entire year
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Gross Domestic Product, GDP:
A Definition
• …within the nation’s borders
– U.S. GDP measures output produced
within U.S. borders
• Regardless of whether it was produced by
Americans
– Americans abroad are not counted
– However, foreigners producing goods or services
within the country are included:
Chinese Acrobat Team, Honda, Rolling Stones
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The Expenditure Approach to GDP
• Expenditure approach divides output into four
categories according to which group in the
economy purchases it as final users
– Consumption goods and services (C)—purchased by
households
– Private investment goods and services (I)—purchased
by businesses
– Government goods and services (G)—purchased by
government agencies
– Net exports (NX)—purchased by foreigners
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The Expenditure Approach to GDP
• When we add up the purchases of all four
groups we get GDP
GDP = C + I + G + NX
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Consumption Spending
• Consumption is the part of GDP purchased
by households as final users
– Almost everything households buy during the
year is included as part of consumption
spending when we calculate GDP
– One exception is construction of new homes
• Counted as private investment
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Private Investment
• Private investment has three components
– Business Purchases of Plant, Equipment, and Software
• A firm’s plant, equipment, and software are intended to last for many years—
only a small part of them is used up to make the current year’s output
• Are regarded as final goods, and firms that buy them as final users of those
goods
– New Home Construction
• Residential housing is an important part of nation’s capital stock
• House will continue to provide services into the future
– Changes in Inventories
• We count the change in firms’ inventories as part of investment in measuring
GDP
• Why?
– When goods are produced but not sold during the year, they end up in some firm’s
inventory stocks
– Part of the nation’s capital stock
– Will provide services in the future, when they are finally sold and used
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Government Purchases
• Purchases by state, local governments and
federal government are included
• Government purchases include
– Goods
• Fighter jets, police cars, school buildings, spy satellites, etc.
– Services
• Such as those performed by police, legislators, and military
personnel
• Government is considered to be a purchaser even
if it actually produces the goods or services itself
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Government Purchases
• Transfer payments represent money
redistributed from one group of citizens
(taxpayers) to another (poor, unemployed,
elderly)
– While transfers are included in government
budgets as outlays they are not purchases of
currently produced goods and services
• Not included in government purchases or in GDP
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Net Exports
• Once we recognize dealings with the rest of
the world, we must correct an inaccuracy in
our measure of GDP
– Deduct all U.S. imports during the year, leaving
us with just output produced in United States
• To properly account for output sold to, and
bought from, foreigners
– We must include net exports—difference
between exports and imports—as part of
expenditure in GDP
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Other Approaches to GDP: The
Value-Added Approach
• Value added
– Firm’s contribution to a product or
– Revenue it receives for its output
• Minus cost of all the intermediate goods that
it buys
• GDP is sum of values added by all
firms in economy
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Other Approaches to GDP: The
Factor Payments Approach
• In any year, value added by a firm is equal to total
factor payments made by that firm
• Thus, GDP must equal total factor payments made by all firms
in the economy
• All of these factor payments are received by households in the
form of wages and salaries, rent, interest or profit
– GDP is measured by adding up all of the income—wages and
salaries, rent, interest, and profit—earned by all households in the
economy
• Gives us an important insight into the
macroeconomy
– Total output of economy (GDP) is equal to total income
earned in the economy
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Measuring GDP: A Summary
• Different ways to calculate GDP
– Expenditure Approach
• GDP = C + I + G + NX
– Value-Added Approach
• GDP = Sum of value added by all firms
– Factor Payments Approach
• GDP = Wages and Salaries + interest + rent + profit
Therefore, Total output = Total household income
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Problems With GDP
•
•
•
•
Quality Changes
Underground Economy
Non-market Production
Not a perfect measure of economic wellbeing
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Quality Change
– While BEA includes impact of quality changes for many
goods and services (such as automobiles and
computers)
• Does not have the resources to estimate quality changes for
millions of different goods and services
By ignoring these quality improvements, GDP probably
understates true growth from year to year.
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The Underground Economy
• Some production is hidden from
government authorities
– Either because it is illegal or
• Drugs, prostitution, most gambling
– Because those engaged in it are avoiding taxes
• Production in these hidden markets cannot be
measured accurately
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Non-Market Production
• GDP does not include non-market production
– Goods and services that are produced, but not sold in the
marketplace
• Whenever a non-market transaction becomes a
market transaction GDP will rise
– Even though total production has remained the same
• Can exaggerate the growth in GDP over long periods of time
• What do these problems tell us about value of
GDP?
– For certain purposes—especially interpreting long-run changes in
GDP—we must exercise caution
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Not a perfect measure of economic well-being
• No value measured on leisure
• “Bad” things can raise GDP.
Disasters, wars, etc.
• Externality – ecological cost
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Types of Unemployment
• In United States, people are considered
unemployed if they are not working AND actively
seeking a job
– Unemployment can arise for a variety of reasons, each
with its own policy implications
– This is why economists have found it useful to classify
unemployment into four different categories
–
–
–
–
Frictional unemployment
Seasonal unemployment
Structural unemployment
Cyclical unemployment
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Frictional Unemployment
• Short-term joblessness experienced by people who are
between jobs or who are entering the labor market for first
time or after an absence
• Because frictional unemployment is, by definition, shortterm, it causes little hardship to those affected by it
• By spending time searching rather than jumping at the first
opening that comes their way
– People find jobs for which they are better suited and in
which they will ultimately be more productive
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Seasonal Unemployment
• Joblessness related to changes in weather, tourist
patterns, or other seasonal factors
• Is rather benign
– Short-term
– predictable
– Workers are often compensated in advance for unemployment
they experience in off-season
• To prevent any misunderstandings, government usually
reports the seasonally-adjusted rate of unemployment
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Structural Unemployment
• Joblessness arising from mismatches
between workers’ skills and employers’
requirements
– Or between workers’ locations and employers’
locations
• Generally a stubborn, long-term problem
– Often lasting several years or more
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Cyclical Unemployment
• When the economy goes into a recession
and total output falls, the unemployment
rate rises
• Since it arises from conditions in the overall
economy, cyclical unemployment is a
problem for macroeconomic policy
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Figure 3: U.S. Quarterly
Unemployment Rate, 1960–2003
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Figure 4: Actual And Potential Real
GDP, 1960–2003
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How Unemployment is Measured
• The unemployed are those willing and able to
work, but who do not have jobs
• Others were able to work, but preferred not to
– Including millions of college students, homemakers,
and retired people
– Still others were in the military and are counted in the
population
• But not counted when calculating civilian employment statistics
• To be counted as unemployed, you must have
recently searched for work
– But how can we tell who has, and who has not, recently
searched for work?
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Figure 5: How BLS Measures
Employment Status
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Problems In Measuring
Unemployment
– Treatment of involuntary part-time workers
• Some economists have suggested that involuntary
part-time workers should be regarded as partially
employed and partially unemployed
– Treatment of discouraged workers
• Individuals who would like to work but, because they
feel little hope of finding a job, have given up
searching
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Figure 6: Employment Status of the
U.S. Population—June 2003
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