Increases in GDP Help Revive American Airlines

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 31

Increases in GDP Help Revive American Airlines

7.1 Explain how total production is measured.

7.2 Discuss whether GDP is a good measure of well-being.

7.3 Discuss the difference between real GDP and nominal GDP.

7.4 Become familiar with other

measures of total production

and total income.

Learning Objectives

The business cycle does not affect all industries in the same way. For example, some trucking firms experienced slow sales during 2006 while airlines were prospering.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


GDP: Measuring Total Production and Income

Microeconomics The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.

Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

Business cycle Alternating periods of economic expansion and economic recession.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


GDP: Measuring Total Production and Income

Recession The period of a business cycle during which total production and total employment are decreasing.

Economic growth The ability of an economy to produce increasing quantities of goods and services.

Inflation rate The percentage increase in the price level from one year to the next.

Expansion The period of a business cycle during which total production and total employment are increasing.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Gross Domestic Product Measures Total Production

Learning Objective 7.1

Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year.

Measuring Total Production: Gross Domestic Product

GDP Is Measured Using Market Values, Not Quantities

The word value is important in the definition of GDP: We want dollar value!

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Gross Domestic Product Measures Total Production


Final good or service A good or service purchased by a final user.

Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck.

GDP Includes Only Current Production:GDP includes only production that takes place during the indicated time period.

Only goods and services produced within the year (not sold in that year)

Only production within the geographic boundaries of the United States.

GDP Includes Only the Market Value of Final Goods

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Measuring Total Production: Gross Domestic Product

GDP = sum of the money values of all final goods and services produced in the domestic economy within a specified period of time. (such as a year).

Suppose in country A there are a total of n goods and services produced; then in year t:

Nominal GDPt = P1,t *Q 1,t + P 2,t *Q 2,t + … + Pn,t *Q n,t

Nominal GDP may change if prices change and the

quantities are constant.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Solved Problem 7-1Calculating GDP


PRODUCTION AND PRICE STATISTICS FOR 2007

(1)PRODUCT

(2)QUANTITY

(3)PRICE PER UNIT

Eye examinations 100 $50.00

Pizzas 80 10.00

Textbooks 20 100.00

Paper 2,000 0.10

PRODUCT(1)

QUANTITY(2)

PRICE PER UNIT(3)

VALUE

Eye examinations 100 $50 $5,000

Pizzas 80 10 800

Textbooks 20 100 2,000

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


How to calculate GDP?

• Expenditure Approach

• Income Approach

• Value Added Approach

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Expenditure Approach: GDP as the Sum of Final Goods and Services


Consumption Spending by households on goods and services, not including spending on new houses.

C:Personal Consumption Expenditures, or “Consumption”

Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses.

I: Gross Private Domestic Investment, or “Investment”

Don’t Let This Happen to YOU!Remember What Economists Mean by Investment

( )GDP C I G X IM

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e




Government purchases Spending by federal, state, and local governments on goods and services.

G: Government Consumption and Gross Investment, or “Government Purchases”

(X-IM): Net exports Exports minus imports.

(X-IM) or NX: Net Exports of Goods and Services, or “Net Exports”

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e




Some Actual Values

FIGURE 7-2

Components of GDP in 2006

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e




Some Actual Values

• Consumer spending on services is greater than the sum of spending on durable and nondurable goods.

• Business fixed investment is the largest component of investment.

• Purchases made by state and local governments are greater than purchases made by the federal government.

• Imports are greater than exports, so net exports are negative.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


VA Approach: GDP as the Sum of Values Added

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $1 Value added by cotton farmer = 1

Textile Mill Value of raw cotton woven into cotton fabric = $3

Value added by cotton textile mill = ($3 – $1) = 2

Shirt Company Value of cotton fabric made into a shirt = $15

Value added by shirt manufacturer = ($15 –$3) = 12

L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35

Value added by L.L. Bean = ($35 – $15) = 20

Total Value Added = $35


GDP = sum of values added to goods in all firms

Value added = firm’s revenue from selling a product minus the amount paid for goods and services purchased from other firms

Table 7-1

Calculating Value Added

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Income Approach: GDP as the Sum of All Income

The income approach to measuring GDP is to add up all the income earned by households and firms in a single year.

The rationale behind the income approach is that total expenditures on final goods and services are eventually received by households and firms in the form of wage, profit, rent, and interest income.

Therefore, by adding together wage, profit, rent, and interest income, one should obtain the same value of GDP as is obtained using the expenditure approach.

GDP = wages + interest + rents + profits + statistical adjustment

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Income Approach: GDP as the Sum of All Income


The Division of Income: Total: $13,247 bil.

FIGURE 7-5

The Division of Income

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Other Measures of Total Production and Total Income

Gross National Product (GNP)is the total income acquired by Americans both within the

U.S. and elsewhere.

includes foreign production by U.S. firms but excludes U.S. production by foreign firms.

GNP= GDP + net foreign factor income

National Income = GNP – depreciation – indirect business taxes

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Income-expenditure identity: Expenditure = Income Y=C+I+G+NX

=

GDP

Net foreign factor income

GNP

DepreciationIndirect business taxes

Rents

Interest

Profits

Employee compensation

National Income

(3)

Income

(2)

Output

Net exportsGovernment expenditures

Investment

Consumption

(1)

Expenditures=

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Does GDP Measure What We Want It to Measure?


Household production refers to goods and services people produce for themselves.

Shortcomings in GDP as a Measure of Total Production

Household Production

The Underground Economy

Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Does GDP Measure What We Want It to Measure?


Shortcomings of GDP as a Measure of Well-Being

The Value of Leisure Is Not Included in GDP

GDP Is Not Adjusted for Pollution or Other Negative Effects of Production

GDP Is Not Adjusted for Changes in Crime and Other Social Problems

GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



Did World War II Bring Prosperity?Making

the

Connection

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


An Inside LOOK Trucking Industry Depends on the Goods—Not Services—Component of GDP

Economic Slowdown Slams Breaks on Trucking Sector

As goods decline as a percentage of GDP, so does the demand for ground-freight transportation services. (The goods and services shares of GDP do not sum to 100 percent because GDP is composed of goods, services, and structures.)

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Real GDP versus Nominal GDP


Real GDP The value of final goods and services evaluated at base-year prices.

Calculating Real GDP

Nominal GDP The value of final goods and services evaluated at current-year prices.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Solved Problem 7-3Calculating Real GDP


PRODUCT2009

QUANTITY2000

PRICE VALUE

Eye examinations 100 $40 $4,000

Pizzas 80 11 880

Textbooks 20 90 1,800

2000 2009

PRODUCT QUANTITY PRICE QUANTITY PRICE

Eye examinations 80 $40 100 $50

Pizzas 90 11 80 10

Textbooks 15 90 20 100

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e




Comparing Real GDP and Nominal GDP

FIGURE 7-3

Nominal GDP and Real GDP, 1990–2006

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e


Real GDP in the U.S.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



100Nominal GDP

GDP deflatorReal GDP


Price level A measure of the average prices of goods and services in the economy.

The GDP Deflator

GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



FORMULA APPLIED TO 2005 APPLIED TO 2006

GDPDeflator

2005 2006

NOMINAL GDP $12,456 billion $13,247 billion

REAL GDP $11,049 billion $11,415 billion

100GDP Real

GDP Nominal 113100

billion $11,049

billion 456,12$


The GDP Deflator

116100billion $11,415

billion 247,13$

116 1132.7%

113The increase of price level

Ch

apte

r 7:

G

DP

: M

eas

uri

ng

To

tal

Pro

du

ctio

n a

nd

In

com

e



2005 2006

NOMINAL GDP $12,456 billion $13,247 billion

REAL GDP $11,049 billion $11,415 billion


Growth Rate of Nominal GDP and Real GDP

Nominal GDP in year t+1 - Nominal GDP in year t

Nominal GDP in year t

Growth rate of GDP from year t to t+1:

Nominal GDP:

Real GDPReal GDP in year t+1 - Real GDP in year t

Real GDP in year t

Documents

Increases in GDP Help Revive American Airlines