ECONOMIC MEASURES• In order to ensure that our economic goals

of full employment, stable prices and economic growth are met, our government constantly takes measurements of the economy.

• Three important measurements are– Gross Domestic Product (GDP)– Unemployment rate– Inflation rate

GDPThis is the most important measure of

economic activity.

Gross Domestic Product

What’s a Gross What’s a Gross Domestic Product?Domestic Product? Broccoli?Broccoli? I was gonna say I was gonna say

“Preparation H.”“Preparation H.”

GDP is used to compare economies’ standard of living world wide

Top GDPs of the World

GDP is a measure of the income and expenditures of an economy.

Firms Households

Market for Factors

of Production

Market for Goods

and Services

ExpendituresExpenditures

Income

Goods & Services

Goods & Services

Labor, land, and capital

Inputs for production

ExpenditurExpenditureses

Income

+Government Spending+Government Spending 20% 20%+Government Spending+Government Spending 20% 20%

++Foreign Spending -4 % (Net Exports) ++Foreign Spending -4 % (Net Exports)

Consumer Spending Consumer Spending 71%71% (Consumption)(Consumption) Consumer Spending Consumer Spending 71%71% (Consumption)(Consumption)

+Business Spending +Business Spending 13 % 13 % ((Investment)Investment)+Business Spending +Business Spending 13 % 13 % ((Investment)Investment)

EXPENDITURES APPROACHEXPENDITURES APPROACH

Net Exports = Exports – Imports[Imports represent production outside a country]

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=6&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Qtr&FirstYear=2011&LastYear=2011&3Place=N&Update=Update&JavaBox=no

This approach adds together all the income earned in the production of goods & services

Wages (income from labor)

+ Rents (income from natural resources)

+ Interest (income from capital investments)

+ Owner’s Income (profit earned by sole proprietorship and partnerships)

+ Corporate Profits= TOTAL INCOME EARNED

THE INCOME APPROACHTHE INCOME APPROACH

The Definition of Gross Domestic Product

GDP is the dollar value of all final goods and services

produced within a country in a given year.

PersonalPersonal Spending ( Consumption ) Spending ( Consumption )Spending by HouseholdsSpending by Households

PersonalPersonal Spending ( Consumption ) Spending ( Consumption )Spending by HouseholdsSpending by Households

EXPENDITURES APPROACHEXPENDITURES APPROACH

•Durable Goods[12%]•Nondurable Goods[29%][soup & soap]•Services[59%]

InvestmentInvestment - - Spending by BusinessesSpending by BusinessesInvestmentInvestment - - Spending by BusinessesSpending by Businesses

EXPENDITURES APPROACHEXPENDITURES APPROACH

4 Subcategories4 Subcategories A. Tools, equipment , machineryB. Buildings (offices, factories)C. Residential buildings (your house) D. Inventory adjustments

GGovernmentovernment P Purchasesurchases [state/local & federal][state/local & federal]GGovernmentovernment P Purchasesurchases [state/local & federal][state/local & federal]

EXPENDITURES APPROACHEXPENDITURES APPROACH

Government purchases of goods/services produced (not transfer payments)

3 Subcategories A. Federal government 37% B. 50 State governments C. 84,000 local governments 63% for state and

local

Net ExportsNet Exports Net ExportsNet Exports

EXPENDITURES APPROACHEXPENDITURES APPROACH

Net Exports = Exports – Imports [Imports represent production outside a country]

Intermediate GoodsIntermediate Goods – components of the final good. A. Ford buys batteriesbatteries or tirestires for its cars.

B. KFC buys chickenschickens to eventually sell to customers.

GDP measures FINAL GOODS AND SERVICES (products in the form sold to

consumers) not intermediate goods

ChevyChevy

Second Hand SalesSecond Hand Sales = no current productionno current production. A. If a 1957 Chevy1957 Chevy is bought in 2009

[It has not been produced againnot been produced again so would not count.]

B. Boots producedBoots produced in in 20002000 are bought in a Resale Store in 09. They also have not been produced againnot been produced again.

A salesman’s commission on a used good commission on a used good would countwould count. You are buying his services.

It includes goods and services CURRENTLY PRODUCED, not transactions involving goods produced in the past.

– what is not countedwhat is not counted

Purely Financial TransactionsPurely Financial Transactions – stocks, bonds, CDs. There is no current productionno current production. A. If 100 shares of Dell stock100 shares of Dell stock is bought

I’m going to buy 100 I’m going to buy 100 shares of Dell Stock.shares of Dell Stock.

Exchanging one financial asset for anotherExchanging one financial asset for another

–– what is not countedwhat is not countedTransfer PaymentTransfer Paymentss ––welfare, unemployment, social securitywelfare, unemployment, social security. [There is no contribution to final production]

“Now that I’ve gotten my welfare check, I can get a mini iPod.”

Unreported Legal Business ActivityUnreported Legal Business Activity

Unreported “legal”“legal” business activity does not count.This is two-thirdstwo-thirds of the “underground economy.”“underground economy.”

What if an eye surgeon doesn’t reportdoesn’t report $500 $500 of his his $3,400 IntraLASIK bill?

And what if thiswaitress doesn’tdoesn’treport all tipsreport all tips?

And what if the dentist doesn’t doesn’t report $400 forreport $400 forteeth whiteningteeth whitening?

Illegal business activity is also not counted.Illegal business activity is also not counted.

Illegal business activity, because it goes unreported,also does not count. Making up 1/31/3 of the “underground“undergroundeconomy,”economy,” it includes murder for hire, gambling, and drugs

“I’m getting $1,000 to killyou, Ziggy, but at least itwill not count in GDP.”

Non-market Transactions Non-market Transactions Are Not Are Not CountedCounted

Work in your own householdown household or volunteer workvolunteer workin the community does not count because there wasno payment.

So, don’t marry your housekeeper, gardener, don’t marry your housekeeper, gardener, or or

fitness instructorfitness instructor, or you will hurt GDP.

It measures the value of production that takes place WITHIN A SPECIFIC TIME PERIOD, usually a year or a quarter (three months).

The Measurement of GDP

GDP - LocationGDP - LocationAll goods/services produced All goods/services produced legally for pay legally for pay inin a country’s borders. a country’s borders.[[GeographyGeography matters, matters, not citizenshipnot citizenship]]

GNP – OwnershipGNP – OwnershipAll goods/services produced All goods/services produced legally for pay legally for pay byby citizens of a country. citizens of a country.[[CitizenshipCitizenship mattered, mattered, not geography]not geography]

The difference between GDP & GNP is about 2/10 of 1%.

Nike inNike inIndonesiaIndonesia

Plano, TXPlano, TX

ChinaChina EuropeEurope

BMW in WacoBMW in Waco

PProvo,rovo,UTUT

Honda in OhioHonda in Ohio

in Chicagoin Chicago

Nominal GDP versus Real GDP

• We use GDP to evaluate whether or not our economy is growing.

• If we produce more goods and services this year than last year we can conclude that we are growing.

• Because GDP is measured by adding up our spending on output (PRICE X quantity) this is not always clear since prices tend to rise from year to year.

Nominal GDP versus Real GDP• Nominal GDP is the dollar amount we

spent this year on goods and services. – It is found by multiplying output bought at

current price level. If we have inflation nominal GDP goes up.

Calculating Nominal GDP:

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200

2002 ($2 per hot dog x 150 hot dogs) + ($3 per hamburger x 100 hamburgers) = $600

2003 ($3 per hot dog x 200 hot dogs) + ($4 per hamburger x 150 hamburgers) = $1200

Nominal GDP versus Real GDP

• Real GDP is corrected for the effects of inflation. – It is found by multiplying output bought at a

constant price level. If Real GDP has increased then output has increased.

Calculating Real GDP (base year 2001):

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200

2002 ($1 per hot dog x 150 hot dogs) + ($2 per hamburger x 100 hamburgers) = $350

2003 ($1 per hot dog x 200 hot dogs) + ($2 per hamburger x 150 hamburgers) = $500

GDP Deflator

• An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.

• The GDP deflator measures the current level of prices relative to the level of prices in the base year.

• It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

GDP Deflator

100GDP Real

GDP Nominal=deflator GDP

The GDP deflator is calculated as follows:

100X )deflator (GDP) GDP (Nominal

=GDP Real20xx

20xx20xx

Converting Nominal GDP to Real GDP

Nominal GDP is converted to real GDP as follows:

GDP Growth• How fast GDP grows determines to a large

extent the level of economic prosperity a country enjoys.

• For a nation to enjoy continued prosperity GDP must grow at a faster rate than the population.

• GDP growth can be determined using the rate of change formula.

Current GDP – Previous GDP x 100

Previous GDP

GDP and Economic Well-Being

• GDP is the best single measure of the economic well-being of a society.

• GDP per person (per capita) tells us the income and expenditure of the average person in the economy.

• Higher GDP per person indicates a higher standard of living.

GDP IS NOT A PERFECT MEASURE

• Does not include the value of leisure time.

• Does not include value of labor done at home or on a volunteer basis.

• Excludes any measure of the quality of the environment.

• Does not account for the unequal distribution of income.

• May overstate incomes & production because of inflation

Q2

CHANGES IN GDP

o

P1

AS1

AD1

a

Q1

Pri

ce L

evel

Real Gross Domestic Product

bP2

AD2

The level of output (income and expenditures) is changed if there is a change in AGGREGATE DEMAND.

Q2

CHANGES IN GDP

o

P1

AS1

AD1

a

Q1

Pri

ce L

evel

Real Gross Domestic Product

bP2

AS2

The level of output (income and expenditures) is changed if there is a change in AGGREGATE SUPPLY.