Gross Domestic Product

A Starting Point

Gross Domestic Product

• The market value of all final goods and services produced within a nation in a given time period

• Measuring GDP– The value of what is produced– The value of what is demanded and purchased

MEASURING A NATION’S INCOME 3

The Circular-Flow Diagram• a simple depiction of the macroeconomy

• illustrates GDP as spending, revenue, factor payments, and income

• Preliminaries:– Factors of production are inputs like labor, land,

capital, and natural resources. – Factor payments are payments to the factors of

production (e.g., wages, rent).

The circular-flow diagramHouseholds buy goods and services from firms, and firms use their revenue from sales to pay wages to workers, rent to landowners, and profit to firm owners. GDP equals the total amount spent by households in the market for goods and services. It also equals the total wages, rent, and profit paid by firms in the markets for the factors of production.

Measurement of Gross Domestic Product

• Gross domestic product (GDP)– Market value of all final goods and services– Produced within a country – In a given period of time

• “GDP is the market value…”– Market prices - reflect the value of the goods

• “… of all…”– All items produced in the economy

• And sold legally in markets– Excludes most items

• Produced and sold illicitly• Produced and consumed at home

• “… final…”– Value of intermediate goods is already included in the prices of the

final goods

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Measurement of Gross Domestic Product

• “… goods and services…”– Tangible goods & intangible services

• “… produced…”– Goods and services currently produced

• “… within a country…”– Goods and services produced domestically,

regardless of the nationality of the producer• “… in a given period of time”

– A year or a quarter

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The Components of GDP

• Y = C + I + G + NX– Identity– Y = GDP– C = consumption– I = investment– G = government purchases– NX = net exports

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The Components of GDP

• Consumption – Spending by households– On goods and services– Exception: purchases of new housing

• Investment– Spending on capital equipment, inventories, and

structures– Including household purchases of new housing– Inventory accumulation

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The Components of GDP

• Government purchases– Government consumption expenditure and gross

investment– Spending on goods and services – By local, state, and federal governments– Does not include transfer payments

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The Components of GDP

• Net exports = Exports - Imports– Exports

• Spending on domestically produced goods by foreigners

– Imports• Spending on foreign goods by domestic residents

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MEASURING A NATION’S INCOME 11

U.S. GDP and Its Components, 2007

–2,344

8,905

7,037

32,228

$45,825

per capita

–5.1

19.4

15.4

70.3

100.0

% of GDP

–708

2,690

2,125

9,734

$13,841

billions

NX

G

I

C

Y

In each of the following cases, determine how much GDP and each of its components is affected (if at all).

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them.

A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11

GDP and its componentsGDP and its components

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

Consumption and GDP rise by $200.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

Investment rises by $1800, net exports fall by $1800, GDP is unchanged.

A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11

AnswersAnswers

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Real Versus Nominal GDP• Total spending rises from one year to the next

– Economy - producing a larger output of goods and services

– And/or goods and services are being sold at higher prices

• Nominal GDP– Production of goods and services– Valued at current prices

• Real GDP– Production of goods and services– Valued at constant prices

Gross Domestic Product…“… does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.”

- Senator Robert Kennedy, 1968 15

MEASURING A NATION’S INCOME 16

GDP Does Not Value:• the quality of the environment

• leisure time

• non-market activity, such as the child care a parent provides his or her child at home

• an equitable distribution of income

MEASURING A NATION’S INCOME 17

Then Why Do We Care About GDP?• Having a large GDP enables a country to afford

better schools, a cleaner environment, health care, etc.

• Many indicators of the quality of life are positively correlated with GDP. For example…

GDP and Life Expectancy in 12 countries

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Lif

e e

xp

ec

tan

cy

(y

ears

)

Real GDP per capita

U.S.Germany

Japan

Mexico

Russia

Brazil

China

India

Indonesia

Pakistan

Bangladesh

Nigeria

GDP and Literacy in 12 countries

19

Ad

ult

Lit

era

cy

(%

of

po

pu

lati

on

)

Real GDP per capita

U.S.Germany Japan

Mexico

Russia

Brazil

China

India

Indonesia

Nigeria

Pakistan

Bangladesh

GDP and Internet Usage in 12 countries

20

Inte

rne

t U

sa

ge

(%

of

po

pu

lati

on

)

Real GDP per capita

U.S.

Germany

Japan

Mexico

Russia

Brazil

ChinaIndia

Indonesia

Nigeria

Bangladesh

Pakistan