Download Chapter 5

Chapter 5
Measuring GDP and Economic
Growth
You will learn
• How GDP is measured
• The difference between real and nominal
GDP
• Aggregate income and aggregate
expenditures
• How real GDP is used to compute
economic growth
• Problems with interpreting real GDP
•
GDP or gross domestic product, is the
market value of all final goods and
services produced in a country in a given
time period
1.
2.
3.
4.
Market value
Final goods
Produced domestically
In a given time period (usually a year or quarter)
Market value
GDP  Apples  Oranges  Cars  Haircuts 
GDP  Q1  Q2  Q3 
But you can't add these things together.
You can add the dollar value of the items
GDP=P1Q1 +P2Q 2 +P3Q3 +
Final goods
• The materials($8,000) used in producing a
new car are included in the price to dealer
• The price to the dealer is $12,000
• The price to the customer is $20,000
• Should the value of the car be
– $20,000+$12,000+$8,000=$40,000
• The value of the car is $20,000 (avoid
double counting).
• Produced domestically – within a country
• In a given time period –usually a year or
quarter
AE—aggregate expenditure
Who can buy output?
– Consumers (C)
– Businesses (I—investment spending)
– Government (G)
– Foreigners (X-M net exports)
C  CUS  CM
I  IUS  I M
G  GUS  GM
C  I  G  CUS  CM  IUS  I M  GUS  GM
C  I  G  CUS  IUS  GUS   CM  I M  GM 
C  I  G  CUS  IUS  GUS   M
C  I  G  ( X  M )  CUS  IUS  GUS   M  ( X  M )
C  I  G  ( X  M )  CUS  IUS  GUS   X
AE—one way to compute GDP
• AE=GDP
• AE=C+I+G+(X-M)
• C+I+G+(X-M)=GDP
Aggregate Income (Y)—another
way to compute GDP
•
GDP=what firms take in when they sell output.
What do firms do with these funds.
1.
2.
3.
4.
5.
Pay employees (wages)
Pay lenders (interest)
Pay owners of land and buildings (rent)
Pay stockholders (corporate profits--interest)
Profits—to entrepreneurs (sole proprietors and
partnerships)
Recall these are payments to the factors of production
Y=factor income
• Y=Wages+Interest+Rent+Profits
Y=factor income
• What can you do with income
– Pay taxes (T)
– Consume some (C)
– Save what is left (S)
Y=C+S+T
Two ways of computing GDP
• Aggregate expenditures approach
– AE=GDP=C+I+G+(X-M)
• Factor income appoach
– GDP=Y=wages+interest+rent+profits
– Y=C+S+T
G
100
120
120
130
T
100
100
110
130
20
10
0
20
30
30
Deficit 0
G-T
Nation 0
al debt
Government deficit
• If the government runs a deficit it must
borrow the money to finance the deficit.
• The Treasury borrows money by selling
bonds in the bond market.
• Who buys the bonds? Anybody that wants
to.
• Businesses also borrow by selling bonds.
International trade deficits
•
•
•
•
(X-M)=current account=balance of trade
X=what we sell to foreigners (exports)
M=what we buy from them (imports)
If M>X we buy more than we sell (a trade
deficit)
• What do foreigners do with these dollars?
– They buy government bonds and corporate
stocks and bonds.
Total U.S. borrowing
• U.S. government debt (G-T)
• Plus
• U.S. private debt—domestic + (X-M)
Two ways to estimate prices
• Directly by constructing price indexes
– Consumer Price Index (CPI)
• Not in book
• Indirectly by computing the implicit price
deflator
Price index for groceries
• Market basket (in base year of 1960)
– 1 dozen eggs
– 2 chickens
– 3 pounds hamburger
– Other things a typical family might buy
Price of basket =$100 in 1960
Price of basket = $200 in 1970
Price index
• The market basket does not change so
any difference must be due to prices.
• Price indexes however miss
– Substitution effect
– New goods
– Quality changes
– Discount stores
Computing real GDP using price
index
•
Nominal GDP
Real GDP 
P
Implicit price deflator
• Can get good estimate of Nominal GDP
– Nominal GDP = Sum of Value Added
• Estimate real GDP by determining what
people buy now using base year prices
– If year 2000 is the base year compute real
GDP by determining what year 2003 GDP
would have cost in 2000
Implicit price deflator
•
Nominal GDP
P
Real GDP
See spreadsheet
• GDP calculations.xls
Economic growth
• Economic growth is the percent change in
real GDP from one time period to the next
time period
• If real GDP is 100 one year and 105 next
year, the percent change is 5%. We would
say that real GDP grew by 5%
Economic growth
• Using the numbers on the previous slide
GDPt 1  GDPt
Growth 
100%
GDPt
105  100
Growth 
100%  5%
100
Economic growth
We measure economic growth so we can make:
– Economic welfare comparisons
– International welfare comparisons
– Business cycle forecasts
Economic growth
• Rule of 72
72
 Approximate time to double GDP
Growth rate in percent
Economic growth
Growth rate
Time to double
10%
7.2 years
5%
14.4 years
3%
24 years
Economic welfare comparisons
• Compare GDP now with GDP in some
other year to determine how much output
has changed.
• Does GDP measure economic welfare?
GDP and economic welfare
• GDP computed using CPI overstates real
GDP
• Computed GDP ignores non market
activities
– Household work
– Underground economy 9—30% of real output
GDP and economic welfare
• GDP ignores changes in heath and life
expectancy
• GDP ignores leisure time (early
retirement)
• GDP ignores environmental quality
• GDP ignores political freedom and social
justice
International comparisons
• You can compare GDP values between
two countries.
– Need to be careful
– In 2003 US GDP per person = $39,000
– In 2003 China’s GDP per person = Y9,500
– Exchange rate $1=Y8.276
– China GDP =Y9,500*($1/Y8.276)=$1147.90
– US GDP per person 34 times greater than
China
International comparisons
• The US—China comparison is misleading
• The Chinese government keeps the
exchange rate deliberately low to
encourage exports
• Use purchasing power parity to make
comparisons.
Purchasing power parity (PPP)
• The McDonald’s hamburger index
– What does a McDonald’s hamburger cost in
the US.
– What does it cost in China.
– The real purchasing price parity index using a
number of goods
– Adjusting for PPP indicates US GDP per
person is approximately 6 times that of China
GDP and business cycle
forecasting
• Declining GDP for 2 quarters is a
commonly used measure for recession.
• Compare GDP growth rates for time
periods.