- 1. Measuring GDP and Economic Growth CHAPTER 21
2. After studying this chapter you will be able to
-
- Define GDP and use the circular flow model to explain why GDP
equals aggregate expenditure and aggregate income
-
- Explain the two methods used by the Bureau of Economic Analysis
to measure U.S. GDP
-
- Explain how the Bureau of Economic Analysis measuresrealGDP and
the GDP deflator to separate economic growth from inflation
-
- Explain the uses and limitations of real GDP
3. An Economic Barometer
- How do we use GDP to tell us whether our economy is in a
recession or how rapidly our economy is expanding?
- How do we take the effects of inflation out of GDP to reveal
the rate of growth of our economic well-being?
- And how to we compare economic well-being across
countries?
4. Gross Domestic Product
-
- GDPorgross domestic productis the market value of all final
goods and services produced in a country in a given time
period.
-
- This definition has four parts:
-
- Produced within a country
5. Gross Domestic Product
-
- GDP is a market valuegoods and services are valued at their
market prices.
-
- To add apples and oranges, computers and popcorn, we add the
market values so we have a total value of output in dollars.
6. Gross Domestic Product
-
- GDP is the value of thefinal goods and servicesproduced.
-
- Afinal good(or service) is an item bought by its final user
during a specified time period.
-
- A final good contrasts with anintermediate good , which is an
item that is produced by one firm, bought by another firm, and used
as a component of a final good or service.
-
- Excluding intermediate goods and services avoids double
counting.
7. Gross Domestic Product
-
- Produced Within a Country
-
- GDP measures production within a countrydomestic
production.
-
- GDP measures production during a specific time period, normally
a year or a quarter of a year.
8. Gross Domestic Product
- GDP and the Circular Flow of Expenditure and Income
-
- GDP measures the value of production, which also equals total
expenditure on final goods and total income.
-
- The equality of income and output shows the link between
productivity and living standards.
-
- The circular flow diagram in Fig. 5.1 illustrates the equality
of income, expenditure, and the value of production.
9. Gross Domestic Product
-
- The circular flow diagram shows the transactions among
households, firms, governments, and the rest of the world.
10. Gross Domestic Product
-
- These transactions take place in factor markets, goods markets,
and financial markets.
11. Gross Domestic Product
-
- Firms hire factors of production from households. The blue
flow,Y , shows total income paid by firms to households.
12. Gross Domestic Product
-
- Households buy consumer goods and services. The red flow,C ,
shows consumption expenditure.
13. Gross Domestic Product
-
- Households save,S , and pay net taxes,T . Firms borrow some of
what households save to finance their investment.
14. Gross Domestic Product
-
- Firms buy capital goods from other firms. The red
flowIrepresents this investment by firms.
15. Gross Domestic Product
-
- Governments buy goods and services,G , and borrow or repay debt
if spending exceeds or is less than net taxes.
16. Gross Domestic Product
-
- The rest of the world buys goods and services from us,X , and
sells us goods and services,M . Net exports areX M.
17. Gross Domestic Product
-
- And the rest of the world borrows from us or lends to us
depending on whether net exports are positive or negative.
18. Gross Domestic Product
-
- The blue and red flows are the circular flow of expenditureand
income. The green flows are financial flows.
19. Gross Domestic Product
-
- The sum of the red flows equals the blue flow.
20. Gross Domestic Product
21. Gross Domestic Product
-
- The circular flow demonstrates how GDP can be measured in two
ways.
-
- Total expenditure on final goods and services, equals the value
of output of final goods and services, which is GDP.
-
- Total expenditure= C+I+G+ ( XM ).
22. Gross Domestic Product
-
- Aggregate income equals the total amount paid for the use of
factors of production: wages, interest, rent, and profit.
-
- Firms pay out all their receipts from the sale of final goods,
so income equals expenditure,
23. Gross Domestic Product
-
- Flows through financial markets finance deficits and
investment.
-
- Household savingSis income minus net taxes and consumption
expenditure.
-
- Saving flows into the financial markets.
24. Gross Domestic Product
-
- IfGexceedsT , the government has a budget deficit ( G T ) and
the government borrows from the financial markets.
-
- IfTexceedsG , the government has a budget surplus( TG ) and
this surplus flows to the financial markets.
-
- If U.S. imports exceed U.S. exports, the United States borrows
an amount equal to ( MX ) from the rest of the world. Rest of world
saving finances some investment in the United States.
-
- If U.S. exports exceed U.S. imports, the United States lends an
amount equal to ( XM ) to the rest of the world. U.S. saving
finances some investment in other countries.
25. Gross Domestic Product
- How Investment Is Financed
-
- Investment is financed from three sources:
-
- 2. Government budget surplus, ( TG )
-
- 3. Borrowing from the rest of the world ( MX ).
26. Gross Domestic Product
-
- We can see these three sources of investment finance by using
the equality of aggregate expenditure and aggregate income.
-
- Private savingSplus government saving ( TG ) is callednational
saving .
27. Gross Domestic Product
- Gross and Net Domestic Product
-
- Gross means before deducting the depreciation of capital. The
opposite ofgrossisnet .
-
- To understand this distinction, we need to distinguish between
flows and stocks.
-
- Flows and Stocks in Macroeconomics
-
- Aflowis a quantity per unit of time.
-
- Astockis the quantity that exists at a point in time.
28. Gross Domestic Product
-
- Wealth , the value of all the things that people own, is a
stock.
-
- Savingis theflowthat changes thestock of wealth .
-
- Wealth at the start of this year equals wealth at the start of
last year plus saving during last year.
29. Gross Domestic Product
-
- Capitalis the plant, equipment, and inventories of raw and
semi-finished materials that are used to produce other goods.
-
- Investmentis theflowthat changes thestock of capital .
30. Gross Domestic Product
-
- Depreciationis the decrease in the capital stock that results
from wear and tear and obsolescence.
-
- Gross investmentis the total amount spent on purchases of new
capital and on replacing depreciated capital.
-
- Net investmentis the change in the capital stock.
-
- Net investment = Gross investmentDepreciation.
31. Gross Domestic Product
-
- Figure 21.2 illustrates the relationships among the capital
stock, gross investment, depreciation, and net investment.
32. Gross Domestic Product
-
- Gross profits, and GDP, include depreciation.
-
- Similarly, gross investment includes that amount of purchases
of new capital goods that replace depreciation.
-
- Net profits, net domestic product, and net investment subtract
depreciation from the gross concepts.
33. Gross Domestic Product
-
- The Short Run Meets the Long Run
-
- Capital and investment play a central role in the understanding
the growth and fluctuations in real GDP.
-
- Investment adds to the capital stock, so investment is one
source of real GDP growth.
-
- Investment fluctuates, so investment is one source of
fluctuations in real GDP.
34. Measuring U.S. GDP
-
- The Bureau of Economic Analysis uses two approaches to measure
GDP:
35. Measuring U.S. GDP
-
- Theexpenditure approachmeasures GDP as the sum of consumption
expenditure, investment, government expenditure on goods and
services, and net exports.
-
- Table 21.1 in the textbook shows the expenditure approach with
data for 2006.
-
- GDP = $9,079 + $2,215 + $2,479$765
36. Measuring U.S. GDP
-
- Theincome approachmeasures GDP by summing the incomes that
firms pay households for the factors of production they hire.
37. Measuring U.S. GDP
-
- TheNational Income and Expenditure Accountsdivide incomes into
five categories:
-
-
- 1. Compensation of employees
-
- These five income components sum tonet domestic income at
factor cost .
38. Measuring U.S. GDP
-
- Two adjustments must be made to get GDP:
-
- Indirect taxes minus subsidies are added to get fromfactor
costtomarket prices .
-
- Depreciation (or capital consumption) is added to
getfromnetdomestic product togrossdomestic product.
-
- Table 21.2 in the textbook shows the income approach with data
for 2006.
39. Real GDP and the Price Level
-
- Real GDPis the value of final goods and services produced in a
given year when valued at constant prices.
-
- The first step in calculating real GDP is to calculate nominal
GDP.
-
- Nominal GDPis the value of goods and services produced during a
given year valued at the prices that prevailed in that same
year.
40. Real GDP and the Price Level
-
- The table provides data for 2005 and 2006.
-
- Expenditure on balls = $100
-
- Expenditure on bats = $100
$0.50 160
$1.00 100
$22.50 22
$5.00 20
41. Real GDP and the Price Level
-
- Expenditure on balls = $80
-
- Expenditure on bats = $495
$0.50 160
$1.00 100
$22.50 22
$5.00 20
42. Real GDP and the Price Level
-
- Base-Year Prices Value of Real GDP
-
- This method of calculating real GDP is to value each years
output at the prices of a base year.
-
- In the base year, real GDP equals nominal GDP.
-
- Suppose 2005 is the base year, then real GDP in 2005 is
$200.
-
- This methodis the traditional method.
$0.50 160
$1.00 100
$22.50 22
$5.00 20
43. Real GDP and the Price Level
-
- Using the traditional base-year prices method to calculate real
GDP in 2006:
-
- Expenditure on balls in 2006 valued at 2005 prices is
$160.
-
- Expenditure on bats in 2006 valued at 2005 prices is $110.
-
- So real GDP in 2006 would be recorded as $270.
$0.50 160
$1.00 100
$22.50 22
$5.00 20
44. Real GDP and the Price Level
-
- The new method of calculating real GDP, which is called the
chain-weighted output index.
-
- Thechain-weighted output indexmethod, uses the prices of two
adjacent years to calculate the real GDP growth rate.
-
- This calculation has four steps described on the next
slide.
45. Real GDP and the Price Level
-
- Step 1: Value last years production and this years production
atlast years pricesand then calculate the growth rate of this
number from last year to this year.
-
- Step 2: Value last years production and this years production
atthis years pricesand then calculate the growth rate of this
number from last year to this year.
-
- Step 3: Calculate the average of the two growth rates. This
average growth rate is the growth rate of real GDP from last year
to this year.
-
- Step 4: Apply the growth rate this year to last years real GDP
to calculate this years real GDP.
46. Real GDP and the Price Level
-
- Value of 2005 quantities at 2005 prices (GDP in 2005) is
$200.
-
- Value of 2006 quantities at 2005 prices is $270.
-
- At 2005 prices, the value of production increased from $200 to
$270 an increase of35 percent.
$0.50 160
$1.00 100
$22.50 22
$5.00 20
47. Real GDP and the Price Level
-
- Value of 2005 quantities at 2006 prices is $500.
-
- Value of 2006 quantities at 2006 prices (GDP in 2006) is
$575.
-
- At 2006 prices, the value of production increased from $500 to
$575 an increase of15 percent.
$0.50 160
$1.00 100
$22.50 22
$5.00 20
48. Real GDP and the Price Level
-
- At 2005 prices, the 2006 growth rate is 35 percent.
-
- At 2006 prices, the 2006 growth rate is 15 percent.
-
- The average of these two growth rates is 25 percent.
$0.50 160
$1.00 100
$22.50 22
$5.00 20
49. Real GDP and the Price Level
-
- So with 2005 as the base year, real GDP in 2006 is $250 25
percent more that $200 in 2005 .
$0.50 160
$1.00 100
$22.50 22
$5.00 20
50. Real GDP and the Price Level
- Calculating the Price Level
-
- The average level of prices is called theprice level .
-
- One measure of the price level is theGDP deflator , which is an
average of the prices of the goods and services in GDP in the
current year expressed as a percentage of the base-year
prices.
-
- The GDP deflator is calculated in the table on the next
slide.
51. Real GDP and the Price Level
-
- Nominal GDP and real GDP are calculated in the way that youve
just seen.
-
- GDP Deflator = (Nominal GDPReal GDP)100.
-
- In 2005, the GDP deflator is ($200$200)100 = 100.
-
- In 2006, the GDP deflator is ($575$250)100 = 230.
52. Real GDP and the Price Level
- Deflating the GDP Balloon
-
- Nominal GDP increases because productionreal GDP
increases.
53. Real GDP and the Price Level
-
- Nominal GDP also increases because prices rise.
54. Real GDP and the Price Level
-
- We use the GDP deflator to let the inflation air out of the
nominal GDP balloon and reveal real GDP.
55. The Uses and Limitations of Real GDP
-
- We use real GDP to calculate the economic growth rate.
-
- Theeconomic growth rateis the percentage change in the quantity
of goods and services produced from one year to the next.
-
- We measure economic growth so we can make
-
- Economic welfare comparisons across time
-
- International comparisons across countries
56. The Uses and Limitations of Real GDP
- Economic Welfare Comparisons Over Time
-
- Economic welfare measures the nations overall state of economic
well-being.
-
- Real GDP is not a perfect measure of economic welfare for seven
reasons:
-
- 1. Inflation rate tends to be overestimated because
qualityimprovements are neglected, so real GDP
isunderestimated.
-
- 2. Real GDP does not include household production productive
activities done in and around the house bymembers of the
household.
57. The Uses and Limitations of Real GDP
-
- 3. Real GDP, as measured, omits theunderground economy , which
is illegal economic activity or legal economic activity that goes
unreported for tax avoidance reasons.
-
- 4. Health and life expectancy are not directly included in real
GDP.
-
- 5. Leisure time, a valuable component of an individuals
welfare, is not included in real GDP.
-
- 6. Environmental damage is not deducted from real GDP.
-
- 7. Political freedom and social justice are not included in
real GDP.
58. The Uses and Limitations of Real GDP
- Economic Welfare Comparisons Across Countries
-
- Real GDP is used to compare economic welfare in one country
with that in another.
-
- Two special problems arise in making these comparisons.
-
- Real GDP of one country must be converted into the same
currency units as the real GDP of the other country, so an exchange
rate must be used.
-
- The same prices should be used to value the goods and services
in the countries being compared, but often are not.
59. The Uses and Limitations of Real GDP
-
- Using the exchange rate to compare GDP in one country with GDP
in another country is problematic because prices of particular
products in one country may be much less or much more than in the
other country.
-
- For example, using the market exchange rate to value Chinese
GDP in dollars leads to an estimate that in 2006, U.S. real GDP per
person was 28 times Chinese real GDP per person.
60. The Uses and Limitations of Real GDP
-
- Figure 21.4 illustrates the problem.
-
- Using the market exchange rate and domestic prices leads to an
estimate that China is very poor.
-
- U.S. GDP per person is 28 times that in China.
61. The Uses and Limitations of Real GDP
-
- Using purchasing power parity prices leads to an estimate that
U.S. GDP per person is (only) 12 times that in China.
62. The Uses and Limitations of Real GDP
-
- Real GDP is used to measure business cycle fluctuations.
-
- These fluctuations are probably accurately timed, but the
changes in real GDP probably overstate the changes in total
production and peoples welfare caused by business cycles.
63. THE END