LectureSlides Chp5

8/8/2019 LectureSlides Chp5

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Chp. 5 1

Chapter 5

GDP: A Measure of Total

Production and Income


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Gross Domestic Product (GDP)

Gross domestic product (GDP) is the

market value of all the final goods and

serv

ices

produced w

ith

ina

cou

ntry

inagiven time period.


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Market value?

Using dollar values or market value avoids theapples and oranges problem. You cannot add

apples and oranges,BUT you can add up

dollars worth of apples and oranges.


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Final goods and services?

The term final goods and services refers to a good

orservice that is produced forits final user and notas a component of another good orservice.

Intermediate good or service is a good orservicethat is used up as a component in production of a

final good orservice. We do not separately include the value of

intermediate goods since the value of theintermediate goods are included in the price (value)of the final product.

Ifintermediate goods were separately included, thenyou would double count them and overestimateGDP.


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Produced?

A good orservice has to be produced to becounted in GDP.

Sales ofstocks and bonds are not counted inGDP because thisinvolves only transfer ofownership of financial assets without any goods

orservices being produced.

Note: If you buy a stock or bond from a broker andpaid a fee for that service that service fee will beincluded in GDP since a new service (the brokersservice) was produced.


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Within a country?

Any final good orservice produced within theborders of a country iscounted in that country's

GDP where the good has been produced.

Thisis regardless of ownership of the factors of

production.


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In a given time period?

GDP calculated for a given year will only includevalue ofnew goods and services produced in

that year.

Pur chases of used goodsisnot part of GDP

because these goods were part of GDP in theperiod in which they were produced and during

which time they were new goods.


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Two ways of calculating GDP

Expenditure Approach:

Adds up amount spent on

all final goods and services

during a given period

Income Approach:

Adds up all income received by all

factors of productionin producing the

goods

GDP Calculation

Total payment/ expenditure Total receipt/ incomeEQUALS


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Expenditure categories under Expenditure Approach

1. Consumption (C)

2. Investment (I)

3. Government spending (G)

4. Net Exports (NX)


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Consumption (C)

Expenditure by households onconsumptiongoods and services.

Durable goodsi.e. goods that are used over a

long period of time e.g. furniture, vehicles,

appliances. Non-Durable goodsi.e. goods that are consumed

immediately or over a short time e.g. food,

clothing.

Services e.g. medical service, banking service.


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Investment (I)

Non-residential investment i.e. purchase ofnewcapital goods (tools,instruments, machines) by

firms.

Residential investment i.e. purchase ofnew

houses and buildings by firms and households.

Change in businessinventories.


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Government Spending (G)

Spending by all levels of government onnewgoods and services Federal Spending such asnational defense.

State Spending such asnew highways.

Local Spending such as a new park or elementaryschool.

Note: Government transfer paymentssuch associal security benefits, welfare payments etc. arenot counted in G since they dont involveproduction ofnew goods and services


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GDP as expenditure

GDP = Total expenditure = C+I+G +NX


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What GDP measures?

GDP = Value of production = Expenditure = Income


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Value of Production = Expenditure

Anything not purchased in a yeariscounted asbusinessinventory investment by the firm that

produced the product.

So productionin a year (GDP) = Final salesin

that year+change in businessinventories


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Expenditure = Income

An expenditure by the buyer of anitem isincome for the producer orseller of that item


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Problem in comparing GDP of two years The problem arises because while productioncan

change between two yearsso can prices.

Prices are needed to calculate GDP which years

price to use to calculate GDP i.e. value of goods

and services?

If pr ices of respective years are used to calculate

GDP of those years thensuch GDP measure is

called nominal GDP.

e.g. nominal GDP of 2005 = units of goods andservices produced in 2005 valued in 2005 prices

Similarly nominal GDP of 2010 = units of goods and

services produced in 2010 valued in 2010 prices


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Problem in comparing GDP of two years Changesinnominal GDP can be caused by

changesin production,changesin prices, or both.

How can we then find out whether production ofgoods and services has really changed between twoyears? we use real GDP.

Real GDP measures value of goods and services

using price of a chosen yearcalled the base yeare.g. if we fix year 2005 as the base year, then

real GDP of 2005 = units of goods and servicesproduced in 2005 valued in 2005 (base year) prices

real GDP of 2010 = units of goods and servicesproduced in 2010 valued in 2005 (base year) prices


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Real GDP and Nominal GDP

N

ominal GDPis the value of the final goods andservices produced in a certain year expressed inthe prices of that same year.

Real GDPis the value of the final goods andservices produced in a given year expressed inthe prices of a chosen or base year.

Any change in real GDP is due to change inproduction only.


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Standard of Living

To compare living standards over time wecalculate real GDP per person i.e. real GDPdivided by the population.

To compare living standards acrosscountries,we must convert real GDP into a commoncurrency and commonset of prices,calledpurchasing power parity.


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Chp. 5 24Source:measuringworth.com


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Limitations of Real GDP

Household Production Real GDP omits household production,it

underestimates the value of the production of manypeople, most of them women.

Underground Production Hidden from government to avoid taxes and

regulations orillegal.

Because underground economic activity isunreported,it is omitted from GDP.


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Leisure Time Our working time is valued as part of GDP, but our

leisure time isnot.

Environment Quality

Pollutionisnot subtracted from GDP. We do not count the deteriorating atmosphere as a

negative part of GDP.

If ourstandard of living is adversely affected bypollution, our GDP measure doesnot show this fact.


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Health and Life Expectancy Good health and a long life do not show up directly in

real GDP.

Political Freedom and Social Justice

A country might have a very large real GDP perperson but have limited political freedom and socialjustice.

A lowerstandard of living than one that had the sameamount of real GDP but in which everyone enjoyed

political freedom.

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LectureSlides Chp5