Chapter 12 Gross Domestic Product Chapter 12 Gross Domestic Product and Growthand Growth

1.1. Gross Domestic ProductGross Domestic Product2.2. Business CyclesBusiness Cycles3.3. Economic GrowthEconomic Growth

How do we know if the economy is healthy . . . Economists measureGross Domestic and Gross National Product!

Yes: Money paid by shoppers in New York for corn grown in Iowa.

Yes: Money paid by buyers in Indiana for cars made by a Japanese company at a factory in Kentucky.

Yes: Fees charged to patients by a dentist in Texas

No: Money paid by a computer factory in New Mexico for computer chips produced in California.

No: Cost of processing wood pulp into paper at a factory in Maine.

No: Money paid by shoppers in Florida for jeans manufactured in Mexico by a company headquartered in North Carolina.

National Income AccountingNational Income Accounting System to System to collect and organize macroeconomic statisticscollect and organize macroeconomic statistics on on

production, income, investment, and savingsproduction, income, investment, and savings Under the Under the Department of CommerceDepartment of Commerce

Cabinet position in the Executive Branch of government whose main focus to promote economic growth.

Hello, I am Gary Locke, the Secretary of Commerce in

President Obama’s Cabinet. I am the first Chinese-American

Secretary. I was two term governor of Washington, the

nation’s most trade-dependent state.

1. Gross Domestic Product1. Gross Domestic Product Dollar ValueDollar Value -- cash value of all goods and servicescash value of all goods and services Final Goods and ServicesFinal Goods and Services -- All goods/services offered to All goods/services offered to

consumersconsumers Within a CountryWithin a Country’’s borders border -- American and foreign within U.S.American and foreign within U.S. tracks the exchange of moneytracks the exchange of money

DOLLAR VALUE

YES: Cash value of all goods and services sold

NO: Cost of producing goods and services

FINAL GOODS AND SERVICES

YES: Goods and services offered to consumers

NO: Intermediate goods used to produce other goods and services

WITHIN A COUNTRYS BORDER

YES: American or foreign companies producing in the United States

NO: American companies producing overseas

Calculated Two WaysCalculated Two Ways

Expenditure ApproachExpenditure Approach --what we what we spendspend Consumer, business, and government goods and services as Consumer, business, and government goods and services as

well as net exportswell as net exports Durable goodsDurable goods -- goods that last awhilegoods that last awhile Non durable goodsNon durable goods -- short period of timeshort period of time

Income ApproachIncome Approach --what we what we makemake firm sells a product or service, the selling price minus the firm sells a product or service, the selling price minus the

dollar value of goods/servicesdollar value of goods/services In theory, they should give us In theory, they should give us same totalsame total

Expenditure ApproachExpenditure Approach Suppose an economy’s entire output is cars and trucks. This year the

economy produces: 10 cars at $15,000 each = $150,000 10 trucks at $20,000 each = $200,000 total = $350,000

The economy’s GDP for this year is $350,000!

Income ApproachIncome Approach Suppose an economy’s entire output is cars and trucks.

All employed citizens, therefore, would work in the car and truck industry, or for its suppliers.

The combined selling price of all the cars and trucks reflects the money paid to all the people who helped build the vehicles.

The economy’s GDP for this year, then, is the sum of the income of all its working citizens, or $350,000 (This includes the combined income of all engineers, designers, planners, assembly-line workers, managers, suppliers, etc.)~

The economy’s GDP for this year is $350,000!

Nominal Versus Real GDPNominal Versus Real GDP Nominal Nominal -- GDP measured GDP measured in current pricesin current prices Real Real -- GDP measured GDP measured in constant, unchanging pricesin constant, unchanging prices

To correct for an increase in prices, economists establish a set of constant prices by choosing one year as a base year. When the y calculate real GDP for other years, they use the prices from the base year. So we calculate the real GDP for Year 2 using the prices from Year 1:

10 cars at $15,000 each = $150,000

10 trucks at $20,000 each = $200,000 350,000

Real GDP is $350,000

In the second year, the economy’s output does not increase, but he prices of the cars and trucks do:

10 cars at $16,000 each = $160,000

10 trucks at $21,000 each = $210,000 370,000

This new GDP figure of $370,000, is misleading. GDP rises because of an increase in prices. Economists prefer to have measure of GDP that is not affected by changes in prices. So they calculate real GDP.

Suppose an economy’s entire output is cars and trucks.This year the economy produces:

10 cars at $15,000 each = $150,000

10 trucks at $20,000 each = $200,000 350,000

Since we have used the current year’s prices to express the current year’s output, the result is a nominal GDP of $350,000

Year 3: Real GDPYear 3: Real GDPYear 2: Nominal GDPYear 2: Nominal GDPYear 1: Nominal GDPYear 1: Nominal GDP

Limitations of GDPLimitations of GDP NonNon--market activitiesmarket activities --wash car, mow lawnwash car, mow lawn The Underground economyThe Underground economy -- black marketblack market Negative ExternalitiesNegative Externalities -- power plants pollutingpower plants polluting Quality of LifeQuality of Life -- leisure timeleisure time

Look at the Pollution!

What do you mean I’m not

counted toward the

GDP

Other Output and Income Other Output and Income MeasuresMeasures

Gross National ProductGross National Product -- the the annual incomeannual income earned by a nationearned by a nation’’s s firm and citizensfirm and citizens

Does not account for depreciation Does not account for depreciation -- loss of the value or a goodloss of the value or a good

Measurements of the Macro Measurements of the Macro economyeconomy

Gross Domestic ProductGross Domestic Product + + income earned outside the U.S. by income earned outside the U.S. by U.S. firms and citizensU.S. firms and citizens –– income earned by foreign firms and income earned by foreign firms and foreign citizens located in the U.S.foreign citizens located in the U.S. = Gross National Product= Gross National Product

Gross National ProductGross National Product –– depreciation of capital equipment depreciation of capital equipment = Net = Net National ProductNational Product

Net National ProductNet National Product + + minor statistical adjustmentsminor statistical adjustments -- = = National IncomeNational Income

National IncomeNational Income -- FirmsFirms’’ reinvested profits, Firmsreinvested profits, Firms’’ income income taxes, Social Security Taxes taxes, Social Security Taxes + + other household incomeother household income = = Personal IncomePersonal Income

Personal IncomePersonal Income -- individual income taxes individual income taxes = = Disposable Personal Income Disposable Personal Income

Influences on GDPInfluences on GDP Price LevelPrice Level -- the average of all pricesthe average of all prices Aggregate SupplyAggregate Supply -- total amount of all goods and services in the total amount of all goods and services in the

economy available at all price levelseconomy available at all price levels Aggregate DemandAggregate Demand -- the total amount of all goods and services in the total amount of all goods and services in

the economy that will be purchased at all possible price levelsthe economy that will be purchased at all possible price levels Equilibrium Aggregate Supply /DemandEquilibrium Aggregate Supply /Demand

Price

leve

l

Real GDP

Aggregate Supply Aggregate Demand

2. Business Cycles2. Business Cycles A periods of macroeconomic A periods of macroeconomic expansion followed byexpansion followed by one of one of

contractioncontraction

Where do you suppose we are? Why?

Phases of Business CyclesPhases of Business Cycles

Expansion Expansion -- economic growtheconomic growth measured by by measured by by rise in GDPrise in GDP economic growth economic growth -- long term increaselong term increase peakpeak -- the height of economic growththe height of economic growth

ContractionContraction -- economic declineeconomic decline marked by a marked by a fall in GDPfall in GDP trough trough -- the lowest point the lowest point recession recession -- prolonged economic contractionprolonged economic contraction depression depression -- recession that is long and severerecession that is long and severe Stagflation Stagflation -- decline in real GDP decline in real GDP -- combined with rise in the combined with rise in the

price levelprice level

What Keeps a Business GoingWhat Keeps a Business Going Business Investments Business Investments –– when economy is expanding, business when economy is expanding, business

expect sales and profits to keep rising, therefore businesses expect sales and profits to keep rising, therefore businesses invest heavily; however sometimes too much expansioninvest heavily; however sometimes too much expansion

Interest Rates and Credit Interest Rates and Credit –– creditcredit for big purchases, cars and for big purchases, cars and homes, the cost is the interest rate financial institutions charhomes, the cost is the interest rate financial institutions chargege

Consumer Expectations Consumer Expectations –– consumer spending is determined by consumer spending is determined by consumer expectations. If consumers expect economy to consumer expectations. If consumers expect economy to contract, they reduce spending and vice a versacontract, they reduce spending and vice a versa

External Shocks External Shocks –– disruptions in oil, wars, droughts and disruptions in oil, wars, droughts and hurricaneshurricanes

Business Cycle ForecastingBusiness Cycle Forecasting Prediction is quite difficultPrediction is quite difficult Leading indicatorsLeading indicators -- set of key economic variables that set of key economic variables that

economists use to predict future market trendseconomists use to predict future market trends stock marketstock market The Conference BoardThe Conference Board

“In my opinion the wealth of the country is bound to increase at a very rapid rate . . . Anyone who believes that opportunities are now closed and that from now on the country will get worse instead of better is welcome to the opinion-and whatever increment it will bring. I think that we have scarcely started . . . I am firm in my belief that anyone not only can be rich but ought to be rich.

-John Jakob Raskob, interview in the Ladies Home Journal, August 1929

Business Cycles throughout Business Cycles throughout historyhistory

The Great DepressionThe Great Depression -- the U.S. stock market the U.S. stock market crash in 1929 crash in 1929 John Maynard KeynesJohn Maynard Keynes -- Theory of Theory of

Employment, Interest, and Money Employment, Interest, and Money --the government should intervene to pull an economy out of the market

Some later recessionsSome later recessions 19701970’’s OPEC s OPEC -- oil market shortage oil market shortage 19801980’’s recession s recession -- high interest rateshigh interest rates 1991 1991 -- brief recession brief recession -- unemploymentunemployment

3. Economic Growth3. Economic Growth Economic rise in the nationEconomic rise in the nation

05

10152025303540

1970 1975 1980 1985 1990 1995 2000 2005

Real GDP percapita,1970-2005

Americans have seen a fairly steady rise in their standard of living

Measuring Economic GrowthMeasuring Economic Growth Real GDP per capitaReal GDP per capita -- real GDP divided by the total population of real GDP divided by the total population of

a countrya country Capital DeepeningCapital Deepening -- increasing the amount of capital per workerincreasing the amount of capital per worker Savings and InvestmentsSavings and Investments -- income not used for consumptionincome not used for consumption

Capital Deepening

Physical Capital

Increased Labor Productivity

Increased Wages

Increased Output

Human Capital

Increased Labor Demands

+

Population, Government and Population, Government and Foreign TradeForeign Trade

Population GrowthPopulation Growth -- leads to leads to lower standardslower standards Government Government -- raising taxesraising taxes to to pay for government servicespay for government services, ,

households will have less money but will have more serviceshouseholds will have less money but will have more services Foreign TradeForeign Trade -- trade deficittrade deficit -- importing more than exportingimporting more than exporting

When the economy is on the upswing, financial institutions are more likely to lend money. A strong economy means you have a greater access to loans that help pay for education.

Many economists see teen spending as a huge source of future economic growth. When you spend money responsibly, you help expand the economy.

Technological Progress Technological Progress An An increase in efficiencyincrease in efficiency gained by producing more output gained by producing more output

without using more inputswithout using more inputs CausesCauses

scientific research scientific research innovationinnovation

The The Government aids innovationGovernment aids innovation

Important Measures of Economic GrowthImportant Measures of Economic Growth

MNP minus taxesHow much pretax income businesses actually pay to U.S. household

National IncomeNational Income

GNP minus cost of depreciation

TaxesGNP with the cost of replacing the physical capital

Net National Net National ProductProduct

GDP plus income earned outside U.S. by U.S. firms and citizens minus income earned by foreign firms and foreign citizens located in the U.S.

DepreciationAnnual income earned by U.S. owned firms and U.S. citizens

Gross National Gross National Product Product

Expenditure and Income Approach Variations:Nominal and Real

Products made in another country by American manufacturer

Dollar value of all final goods and services produced within a country’s borders in a year

Gross Domestic Gross Domestic ProductProduct

How CompiledHow CompiledDoes Not IncludeDoes Not IncludeDefinitionDefinition