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Chapter 12 Gross Domestic Product (GDP) http://en.wikipedia.org/wiki/Gross_domestic_product Table of Contents What is GDP? Other Vocabulary / Approaches to GDP Measurements of Macroeconomics The Business Cycle “Stuff” How much money you have does not measure your economic well-being. Money, by itself, has no intrinsic value. It will not make you live longer. It does not entertain you. It does not make it easier to get around town, and so on. The only reason to have money is so you can exchange it for something that does have intrinsic value, like a car or a stereo or a sandwich or an doctor’s services or a macroeconomics tutor or what not. “Stuff” How much stuff you have does measure your economic well-being. Your car makes getting around town easier. Sandwiches keep you from starving and if they taste good, you enjoy eating them. Stereos entertain you. Doctors' services help you live longer. Gross Domestic Product (GDP) The dollar value of all final goods and services produced within a country’s borders in a given year Signals the health of the economy Basically, you want GDP to increase Example If a person from China comes to the U.S. and produces items in the U.S., those items are part of the U.S.’s GDP If a person from the U.S. goes to Italy and produces items in Italy, those items are part of Italy’s GDP U.S. GDP includes "foreign" goods produced in American soil, such as a Toyota built in Kentucky. U.S. GDP excludes "American" goods produced on foreign soil, such as a Ford built in England. GDP does NOT include: (Limitations) Intermediate goods Used Products Non-market activities Black market Externality Quality of life Intermediate Goods Goods that are used in the production of a final good and services Examples: Raw materials Intermediate Example: Apples If the purpose of the However, if the apples to sell the apples purpose of the apple is as is, then the apples to make applesauce, ARE included in GDP then the apple is an intermediate good and is NOT counted in GDP. The applesauce would be counted in GDP Examples The steel used to make cars. The bread used in sandwiches that are sold in delis. The gas used in the cars of taxicabs. We do this to prevent double counting Example: counting the steel in its raw form and second in its final form, as the automobile Example: Paper is the intermediate good; the book is the final good. The book is counted in GDP Used Products Products can ONLY be counted ONE time— the year they were FINISHED being made A product does NOT have to be SOLD. It only has to finish being made. Example GDP is for 2005 If you finish building a house in 2005. It is counted in GDP for 2005 If you resell the house in 2006, it does NOT count in 2006’s GDP. Example GDP is for 2005 A 2006 Volkswagon Jetta is made in 2005. Therefore, the car is considered part of 2005’s GDP Example Additions to houses sometimes are considered part of the year the addition was made It all depends on several factors, such as the size, and who constructed it. Non-market activities Goods that people do themselves Example: Childcare, mowing lawn Example If a farmer grows tomatoes and sells them to me at the farmer's market, the tomatoes are included in GDP. But if I grow tomatoes and eat them myself, the tomatoes are NOT included in GDP. Loophole If the business (childcare, mowing lawn) is by the books—legitimate—then, it may be considered part of GDP Black Market The market for illegal goods Examples: Drugs, weapons, babies Externality Unintended economic side effects have a monetary value that is often NOT reflected in GDP Examples: Building a pool causes changes in ecology However, If you pay someone to fix up the ecology that was destroyed, that person’s income is part of GDP Quality of life Additional goods do NOT necessarily make people happier Examples: Pleasant surroundings, personal safety, leisure time Other Vocabulary Durable goods Goods that last for more than ONE year Examples: Refrigerator, Washer, Dryer Nondurable goods Goods that last for less than ONE year Examples: Light bulbs, food, sneakers Price level Average of all prices in an economy Expenditure Amounts spent National Income Accounting Collects statistics to define and measure GDP The Great Crash (1929) The stock market fell rapidly, causing people to lose much of their money Caused a severe economic decline The government found a way to predict and prevent economic downturns Approaches to GDP Output Approach Expenditure Approach Income Approach (sometimes people combine the Output and Expenditure approach) Output Approach Adding up the market value (the market price) of all final goods and services produced domestically (within the borders of the country) Expenditure Approach Estimate the annual expenditures on four final goods and services. Expenditure Approach Y = GDP Y = C + I + G + Nx Nx = (X - M) Expenditure Approach C = Consumption (household items; ex: food, cars) I = Investments (business; ex: factories, equipment, houses) G = Government (ex: navy purchases, tanks, guns) Nx = Net Exports X = Exports (going OUT of country) M = Imports (coming INTO country) Expenditure Approach Y = GDP Y = C + I + G + Nx Nx = (X - M) Income Approach The total income of everyone in the economy compromises all payments to the factors of production—land, labor, and capital—in the form of rent, wages, interest, and profits MOST accurate Income Approach Is problematic in the sense that it takes into consideration the suppliers of the resources, which is difficult to define. Moreover it is problematic to calculate Interest and Profit. Measures of GDP Nominal GDP (“Current GDP”) GDP measured in current year’s prices Real GDP Expressed in constant, unchanging prices Problem: A general increase in prices appears to make GDP rise—when it really didn’t MORE accurate Measures of GDP Year Nominal GDP Real GDP 2001 $1 x 1000 = $1,000 $1 x 1000 = $1,000 2002 $2 x 2000 = $4,000 $1 x 2000 = $2,000 2003 $3 x 3000 = $9,000 $1 x 3000 = $3,000 2004 $4 x 4000 = $16,000 $1 x 4000 = $4,000 2005 $5 x 5000 = $25,000 $1 x 5000 = $5,000 Measurements of Macroeconomics Gross Domestic Product (GDP) Gross National Product (GNP) Net National Product (NNP) National Income (NI) Personal Income (PI) Disposable Personal Income (DPI) Gross National Product (GNP) GDP + Income earned outside U.S. by U.S. firms & citizens - Income earned by foreign firms & citizens in the U.S. Means: Products produced by Americans Does NOT account for depreciation Net National Product (NNP) GNP - Cost of depreciation Means: Reflects depreciation Does NOT reflect taxes What is depreciation? Decreases in value Example: Car What is Appreciation? Increases in value Example: House National Income (NI) NNP - (Sales tax + Excise tax) Means: Reflects taxes What is an excise tax? A tax on items the government believes is “harmful” to people Purpose: is to deter people from buying or using the product Example: Cigarettes, alcohol, gas Personal Income (PI) NI - (firms reinvested profits + firm’s income taxes + social security taxes ) + Other household income Means: What everyone in the household makes—before taxes AKA: Gross Income Disposable Personal Income (DPI) PI - Individual taxes Means: Income to spend or put in the bank AKA: Net Income Business Cycle A period of Macroeconomic expansion followed by a period of contraction Business Cycle Peak Contraction Expansion Trough Business Cycle Expansion: Recovery, growth. A period of economic growth as measured by a rise in Real GDP Peak: The height of the economic expansion, when real GDP stops rising Contraction: A period of economic decline marked by a falling real GDP Trough: The lowest point in an economic contraction, when real GDP stops falling Business Cycle (Levels of Severity) Recession: A prolonged economic contraction, 2 consecutive quarter of decreased GDP Depression: A recession that is especially long and severe Stagflation: A decline in real GDP combined with a rise in the price level Business Cycle (with Levels of Severity) Business Cycle (with Levels of Severity) Peak Expansion Contraction Trough Recession Depression Business Cycle Business Cycle Peak Expansion Trough Contraction Leading Indicators (Economic Variables) Key economic variables that economists use to predict a new phase of the business cycle Business Investment Explanation Positive Examples & Characteristics Expansion leads Hire more to sales and workers profits keep rising until a Increase Output point when firms expand enough or demand for a product drops Negative Examples & Characteristics Lay off workers Reduce output Interest Rates & Credit Explanation Positive Examples & Characteristics Negative Examples & Characteristics Consumers use credit to purchase “big ticket” items Low interest rates High interest rates Businesses BORROW money Businesses PAY back loans Interest Rate Calculator Low Interest Rates… More money saved Spend more money on other “things” Businesses stay operating People keep jobs People spend… Consumer Expectations Explanation Positive Examples & Characteristics Negative Examples & Characteristics Partially determined by consumer spending Expectation of rapid growth Fears of a weakening economy External Shocks Explanation Positive Examples & Characteristics Negative Examples & Characteristics Huge events occur— usually suddenly Discovery of Oil Wars or Mineral Droughts deposits Shortages Disruption of oil supply September 11, 2001 Positives Negatives Bush says positives to boost WAR—September 11th consumer confidence Lower Interest Rates Bush give money to families “New Discoveries” advertized September 11, 2001 “It’s often said that if you ask ten economists the same question you will get ten different answers.” “Economists were virtually unanimous in their forecast that the horrific tragedy of September 11, 2001, would lead to a contraction of economic activity.” --Naked Economics, page xii Review Are these positive factors, or negative factors? Expansionary Business Hire more workers. Expansionary Businesses borrow money from banks Expansionary People feel good about the economy Contraction The government increases interest rates Expansionary Businesses increase output Contraction The United States enters a war Standards 6.1.12 CD 6.2.12 I 6.4.12 ABCDEFG 6.5.12 E