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A CASE STUDY
Gross Domestic Product
First Quarter, 2005
Date of Announcement
May 26, 2005
Date of Next Announcement
June 29, 2005
Announcement
Real gross domestic product (GDP) during the first quarter (January through March)
of 2005 increased at an annual rate of 3.5 percent. This is the preliminary estimate of the
change in real GDP for the first quarter. It is a revision of the advance estimate of a 3.1
percent increase in real GDP in the first quarter.
The increase in real GDP was primarily due to increases in consumption and
inventory, software, equipment, residential housing investment, and exports. Imports did
increase during the quarter.
The rate of increase has
been increasing.
Interactive question.
What has been the trend over the last
several years in changes in real GDP?
The rate of increase has
been decreasing.
The rate of increase has
been steady.
Answer.
(This should pop up.)
The rate of increase has
been increasing.
The increase in real GDP has been increasing since the recession of 2001. The
increase for this quarter is slightly less than the increase for all of 2004. The growth
rates in 2001, 2002, 2003, and 2004 were .8 percent, 1.9 percent, 3.0 percent, and 4.4.
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Attention Teachers
Material that appears in italics is included in the teacher version only. All other
material appears in the student version. Throughout the semester, the GDP cases
become progressively more comprehensive and advanced.
Goals of Case Study
The goals of the GDP Case Studies are to provide teachers and students:
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access to easily understood, timely interpretations of monthly announcements of
rates of change in real GDP and the accompanying related data in the U.S.
economy;
descriptions of major issues surrounding the data announcements;
brief analyses of historical perspectives;
questions and activities to use to reinforce and develop understanding of relevant
concepts; and
a list of publications and resources that may benefit classroom teachers and
students interested in exploring inflation.
Meaning of the Announcement
Real gross domestic product increased during the first quarter (January through
March) of 2005 increased at an annual rate of 3.5 percent. This is the second release of
the estimate and is described as the preliminary estimate. This increase compares to rates
of 4.0 and 3.8 percent in the previous two quarters. The growth rates in 2001, 2002,
2003, and 2004 were .8 percent, 1.9 percent, 3.0 percent, and 4.4.
The U.S. economy experienced a recession in 2001 and had only modest growth in
real GDP in 2002. Employment fell and unemployment increased for much of that time.
Growth increased significantly in the middle of 2003, as real GDP increased at an annual
rate of 5.8 percent over the last six months of the year, and has continued to grow at a
relatively rapid pace.
The current announcement along with improving employment reports continues the
good news. The major causes of the 3.5 percent increase in real GDP were the increases
in investment, consumption, and exports. The effects of those increases in spending were
somewhat offset by increases in imports.
Figure 1
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Interactive question
If we know that real GDP increased at a rate of 3.5 percent and that the GDP price
index increased at an annual rate of 3.1 percent, what was the approximate annual rate of
increase in the GDP in the economy during the quarter?
Prices:
Increased by
.3 percent
Decreased by
.3 percent
Pop-up answer-
Increased by
6.6 percent
Increased by
3.5 percent
Increased by
6.6 percent
Correct answer. The reasoning is that if real GDP increased by 3.5 percent and prices
increased by 3.1 percent, GDP in current prices increased approximately by the sum
of the two figures. That is 6.6 percent at an annual rate. GDP actually increased by
6.7 percent. The difference is due to rounding.
For math classes and more advanced students, the more exact method of calculation
is to multiply 1.035 by 1.031, which equals the actual 6.7 percent increase.
Definition of Gross Domestic Product
Gross domestic product (GDP) is one measure of economic activity, the total amount
of goods and services produced in the United States in a year. It is calculated by adding
together the market values of all of the final goods and services produced in a year.
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It is a gross measurement because it includes the total amount of goods and
services produced, some of which are simply replacing goods that have
depreciated or have worn out.
It is domestic production because it includes only goods and services produced
within the U.S.
It measures current production because it includes only what was produced during
the year.
It is a measurement of the final goods produced because it does not include the
value of a good when sold by a producer, again when sold by the distributor, and
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once more when sold by the retailer to the final customer. We count only the
final sale.
Changes in GDP from one year to the next reflect changes in the output of goods and
services and changes in their prices. To provide a better understanding of what actually
is occurring in the economy, real GDP is also calculated. In fact, these changes are more
meaningful, as the changes in real GDP show what has actually happened to the
quantities of goods and services, independent of changes in prices.
Why are Changes in Real Gross Domestic Product Important?
The measurement of the production of goods and services produced each year permits
us to evaluate our monetary and fiscal polices our investment and saving patterns, the
quality of our technological advances, and our material well-being. Changes in real GDP
per capita provide our best measures of changes in our material standards of living.
While inflation and unemployment rates and changes in our income distribution
provide us additional measures of the successes and weaknesses in our economy, none is
a more important indicator of our economy's health than the rate of change in real GDP.
Changes in real GDP are discussed in the press and on the nightly news after every
monthly announcement of the latest quarter's data or revision. The current increase in
real GDP is discussed in news reports as a sign that the economy is growing and may
well continue to do so.
Real GDP trends are prominently included in discussions of potential slowdowns and
economic booms. They are featured in many discussions of trends in stock prices.
Economic commentators use decreases in real GDP as indicators of recessions. The most
popular (although inaccurate) definition of a recession is at least two consecutive quarters
of declining real GDP. The most widely used definition by policy makers and
economists includes measures of changes in industrial production, retail trade,
employment, and real income.
Data Trends
The growth in real GDP at the end of the 1990s has been relatively high when
compared with the early part of the 1990s. However, during the third quarter of 2000 and
the first and third quarters of 2001, the rate of growth of real gross domestic product was
actually negative as the U.S. economy entered a recession in March of 2001. The
changes in real GDP were actually negative for the first time since the 1991 recession.
The Federal Reserve responded to slowing growth and the recession by reducing the
target federal funds rate twelve times from January 2001 to January 2003. (See the
Federal Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy
and the resulting low interest rates helped increase investment and consumer spending
during and since the recession.
As the economy recovered, the growth of real GDP increased and beginning in June
2004, the Federal Reserve began to be concerned with potential inflationary pressures.
The target federal funds rate was raised eight times to a current level of 3.0 percent.
Figure 2
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The rate of increase in real GDP has been not only higher in the last several years
than in the first part of the 1990s, but also when compared to much of the 1970s and
1980s. Economic growth, as measured by average annual changes in real GDP, was 4.4
percent in the 1960s. Average rates of growth decreased during the 1970s (3.3%), the
1980s (3.1%), and the first half of the 1990s (2.3%).
In the last five years of the 1990s, the rate of growth in real GDP increased to 3.9
percent, with the last three years of the 1990s equaling an average of 4.4 percent per year.
The upward trend in economic growth over the past decade has been accompanied by
increases in the rates of growth of consumption spending, investment spending, and
exports, somewhat offset by increases in imports. That pattern is identical to the results
for this quarter. Productivity increases, expansions in the labor force, decreases in
unemployment, and increases in the amount of capital have allowed real GDP to grow at
the faster rates. The changes in productivity have had the most lasting effects on our
average incomes.
HOW CAN WE INCREASE ECONOMIC GROWTH IN THE FUTURE?
Write out your answer
Economic growth is a function of technological innovation and the amount
and quality of labor and capital in the economy:
As more people are employed, the amount of capital increases, education
levels increase, the quality of capital improves, or technology increases,
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the productive capacity of the economy increases. Therefore, the economy
can increase its output. As a result, consumers have more disposable
income and can increase consumption spending. Businesses have more
resources to use for investment and government can provide more public
goods and services.
Increased labor force participation increases output. Expanded, improved
education creates more productive workers. Business and government
spending on research and development enhance our abilities to produce
and allow each worker to become more productive, increasing incomes
for all. Finally, to achieve a higher level of real GDP in the future,
consumers need to limit consumption spending and increase savings
today, permitting businesses to invest more in capital goods. If resources
are invested in building an economy now, future generations will enjoy a
higher level of economic growth; our businesses will produce more goods
and consumers can purchase more goods. Expansion of output at rates
faster than our population growth is what gives us the opportunity to enjoy
increased real GDP per capita and thus, higher standards of living.
Details of the First-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 3.5 percent in the first quarter of 2005
compared to a rise of 3.8 percent in the fourth quarter of 2004. The major contributors to
the increase in real GDP were the increase in overall investment of 10 percent, the
increase in consumption spending of 3.6 percent, and the rise in exports of 7.2 percent.
Government spending decreased by .2 percent.
Increases in imports were 9.1 percent. This means that a portion of the increases in
investment and consumption were not spent on goods and services produced in the U.S.
and thus did not add to real GDP here.
The price index for GDP increased at an annual rate of 3.1 percent during the first
quarter of 2005, compared to increases at annual rates of 1.4 and 2.3 percent during the
third and fourth quarters of 2004. The price index for GDP for all of 2004 increased by
2.1 percent.
This gradually increasing rate of change in prices is becoming of some concern as the
Federal Reserve continues to increase the target federal funds rate. (See the most recent
Federal Reserve case study.)
GDP, Productivity, and Unemployment
A major factor in the continued growth in the American economy, as seen in the
increase of 3.5 percent in real GDP growth in the first quarter, is the continued
improvement in productivity. (See the most recent Productivity case study).
Productivity, defined as the amount of output per hour of work, increased at an annual
rate of 2.6% in the first quarter and 2.5 percent over the previous twelve months. The
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Federal Reserve has stated in its recent releases that continued productivity growth is a
key component in the continued growth in the American economy. Businesses are able
to keep costs low by reducing the need to hire new employees to create growth. Real
output and therefore real income per person is able to increase. The most important cause
of this productivity growth has been investment in information technology and software.
This growth allowed the Federal Reserve to cut the target federal funds rate more than
it otherwise would have during and following the 2001 recession and has reduced
inflationary pressures in the recovery since.
The number of hours worked increased by 1.4 percent over the last 12 months. If
productivity did not change, real GDP would have increased by 1.4 percent. However,
with the 2.5 percent increase in output per hour, total output was able to increase by 3.9
percent (slightly different from the actual increase in real GDP due to rounding and
inclusion of a slightly different collection of goods and services in the productivity
figures).
A Hint about News Reports
Many news reports simply use "gross domestic product" as a term to describe this
announcement. The actual announcement focuses on the real gross domestic product,
and that is the meaningful part of the report. In addition, newspapers will often refer to
the rate of growth during the most recent quarter and will not always refer to the fact
that it is reported at annual rates of change. This is contrasted to the reports of the
consumer price index, which are reported at actual percentage changes in the index for a
single month, and not at annual rates.
Explanations of GDP and its Components
It is common to see the following equation in economics textbooks:
GDP = C + I + G + NX
Consumption spending (C) consists of consumer spending on goods and services. It
is often divided into spending on durable goods, non-durable goods, and services. These
purchases accounted for 70 percent of GDP in 2004.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years (8%).
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period (20%).
Services include rent paid on apartments (or estimated values for owner-occupied
housing), airplane tickets, legal and medical advice or treatment, electricity and other
utilities. Services are the fastest growing part of consumption spending (41%).
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Investment spending (I) consists of non-residential fixed investment, residential
investment, and inventory changes. Investment spending accounts for 16 percent of GDP,
but varies significantly from year to year.
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Non-residential fixed investment is the creation of tools and equipment to use in the
production of other goods and services. Examples are the building of factories, the
production of new machines, and the manufacturing of computers for business use
(10%).
Residential investment is the building of a new homes or apartments (6%).
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold (less than 1%).
Government spending (G) consists of federal, state, and local government spending
on goods and services such as research, roads, defense, schools, and police and fire
departments. This spending (19%) does not include transfer payments such as Social
Security, unemployment compensation, and welfare payments, which do not represent
production of goods and services.
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Federal spending now accounts for approximately 7 percent of GDP. Five percent of
GDP is federal spending on defense.
State and local spending on goods and services accounts for 12 percent of GDP.
Net Exports (NX) is equal to exports minus imports.
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Exports are items produced in the U.S. and purchased by foreigners (10%).
Imports are items produced by foreigners and purchased by U.S. consumers (15%).
Thus, net exports (exports minus imports) are negative, about 5% of the GDP.
Revisions in GDP Announcements
Real GDP for each quarter is announced in each of three months and often the
revisions are significant. The month following the end of the quarter is described as the
advance GDP; the next is a revision described at the preliminary announcement; and the
third announcement is a revision labeled the final announcement. Even this final
announcement will likely be revised in year end announcements and periodic
reexaminations of the accuracy of the data.
The causes of the changes are often changes in inventory and international trade data
– two particularly difficult estimates to make accurately in a quick fashion. This month is
the preliminary estimate and is .4 percent higher than the advance estimate of one month
ago. The average revision of the advance estimate to the preliminary estimate is .5
percent. This revision occurred primarily due to a downward adjustment in the increase
in imports and an increase in the estimate of inventory investment. Changes in these two
areas are the most common causes of revisions.
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Interactive questions –
1. What happens to real GDP as
Increases
Decreases
Stays the same
export spending increases?
2. What happens to export
Increases
Decreases
Stays the same
spending as real GDP increases?
3. What is the difference or the
similarity?
4. What happens to real GDP as
Increases
Decreases
Stays the same
import spending increases?
5. What happens to import
Increases
Decreases
Stays the same
spending as real GDP increases?
6. What is the difference or the
similarity?
Answers –
1. Increases
2. Stays the same
3. The difference is in causation. In the first case, as export spending increases, and
because it is part of GDP, real GDP increases. The increase in spending by
individuals and businesses abroad causes spending here and then production to
increase.
In the second, an increase in real GDP causes income and therefore spending in
the U.S. to increase. However, how much foreigners want to purchase is not
influenced (unless prices here rise more slowly or faster than prices abroad).
4. Decreases
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5. Increases
6. If consumers in the U.S. decide to spend more on imports and reduce spending in
the U.S. than U.S. real GDP will fall. However, if real GDP increases, income
increases, and consumers increase consumption spending. Some of that spending
is very likely to be on imported goods.
Interactive questions
Given the following data (in billions of current dollars) 1. What is the level of investment in the calculation of GDP?
2. What is the level of net exports?
3. What is the level of government spending?
4.
Calculate the level of Gross Domestic Product.
Consumption spending
Federal and state and local spending on
goods
Federal and state and local spending on
services
Federal and state and local spending on
social security
State and local spending on
goods, services, and all other expenses
Sales of existing homes
Goods produced during the year
but not sold
Goods produced in the U.S. and
sold abroad
Business purchases of new factories
and equipment
Goods produced abroad and
sold in the U.S.
$ 9,000
1,500
1,000
1,000
1,200
700
500
2,500
2,500
1,500
Answers to interactive questions.
1. Investment equals $3,000 ($2,500 + 500).
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New factories and equipment and construction of new homes are included in
investment. Sales of existing homes are not. Goods that are produced but not
sold are additions to inventories and are counted as increases in investment.
2. Net exports equal $1,000 ($2,500 - 1,500).
Net exports are exports minus imports. In this case, the economy has a balance
of trade surplus. Exports are goods produced in the U.S. and sold abroad and
imports are goods produced abroad and sold here.
3. Government spending equals $2,500 ($1,000 plus $1,500).
Government spending is equal to the sum of federal spending on goods and
services and state and local spending on goods and services. All federal and
state and local spending on goods and services are included. Social security
payments are transfers of income from tax payers to social security recipients
and do not represent the production of goods and services.
4. GDP equals $15,500 billion ($9,000 + 3,000 + 2,500 + 1,000).
GDP equals consumption spending plus investment spending plus government
spending on goods and services plus net exports.
Key Concepts
Consumption
Investment
Government expenditures
Net exports
Real GDP and nominal GDP
Real GDP per capita
Productivity
Economic growth
Relevant National Economic Standards
The relevant national economic standards are numbers 15, 18, 19, and 20.
15. Investment in factories, machinery, new technology and in the health,
education, and training of people can raise future standards of living.
Students will be able to use this knowledge to predict the consequences of
investment decisions made by individuals, businesses, and governments.
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18. A nation's overall levels of income, employment, and prices are
determined by the interaction of spending and production decisions made
by all households, firms, government agencies, and others in the economy.
Students will be able to use this knowledge to interpret media reports
about current economic conditions and explain how these conditions can
influence decisions made by consumers, producers, and government policy
makers.
19. Unemployment imposes costs on individuals and nations. Unexpected
inflation imposes costs on many people and benefits some others because
it arbitrarily redistributes purchasing power. Inflation can reduce the rate
of growth of national living standards because individuals and
organizations use resources to protect themselves against the uncertainty
of future prices. Students will be able to use this knowledge to make
informed decisions by anticipating the consequences of inflation and
unemployment.
20. Federal government budgetary policy and the Federal Reserve
System's monetary policy influence the overall levels of employment,
output, and prices. Students will be able to use this knowledge to
anticipate the impact of federal government and Federal Reserve System
macroeconomic policy decisions on themselves and others.
Original U.S. Bureau of Economic Analysis Announcement and Data
http://www.bea.gov/newsrel/gdpnewsrelease.htm
Sources of Additional Activities
Advanced Placement Economics: Macroeconomics. (National Council on
Economic Education)
Unit 2: Measuring Economic Performance
Focus on Economics: High School Economics (National Council on Economic
Education)
Lesson 18. Economics Ups and Downs
Economics USA: A Resource Guide for Teachers
Lesson 6: U.S. Economic Growth: What Is the Gross National Product?
Capstone: The Nation’s High School Economics Course
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Unit 5: 2.
Unit 5: 3.
Unit 6: 2.
Unit 6: 3.
Unit 6: 4.
Unit 6: 5.
What Do We Want from Our Economy?
An Economy Never Sleeps
Making a Macro Model: Consumers
Making a Macro Model: Investment
Making a Macro Model: Government
Making a Macro Model: Imports and Exports
Handbook of Economic Lessons (California Council on Economic Education)
Lesson 6: Measuring How Our Economy is Doing
Lesson 7: Measuring How Our Economy Is Doing: GNP
Lesson 20: Plotting the Ups and Downs of the U.S. Economy
Lesson 21: The Fluctuating Economy: A Look at Business Cycles
Learning from the Market: Integrating the Stock Market Across the Curriculum
Lesson 23. Business Cycles and Investment Choices
Geography: Focus on Economics
Lesson 4. International Interdependence
Lesson 7. Places and Production
Lesson 8. GDP and Life Expectancy
All are available in Virtual Economics, An Interactive Center for Economic Education
(National Council on Economic Education) or directly through the National Council on
Economic Education.
Author: Stephen Buckles
Vanderbilt University
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