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McGraw-Hill/Irwin

Chapter 7Chapter 7Chapter 7Chapter 7

The First Step Into Macroeconomics

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Chapter ObjectivesChapter ObjectivesChapter ObjectivesChapter Objectives

• Macroeconomics

• Measuring the economy

• Gross Domestic Product (GDP)

• Components of GDP

• Understanding GDP

• What GDP does not include

• International comparisons

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MacroeconomicsMacroeconomicsMacroeconomicsMacroeconomics

• Macroeconomics studies the economy as a whole.

• Core concepts include the issues of output, growth, inflation, and unemployment.

• Questions raised include:– Is the economy heating up or slowing down?– Are prices rising too quickly?– Are there jobs available for students graduating from

college?– What will happen to interest rates for car loans and

mortgages?

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Measuring the EconomyMeasuring the EconomyMeasuring the EconomyMeasuring the Economy

• Measure the size of the economy in order to identify economic problems, diagnose the causes, and figure out what the right policy might be to fix them.

• But measuring the size and growth of the economy is not an easy task.

• In the 1930’s, Simon Kuznets developed a framework for measuring the economy.

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Measuring the EconomyMeasuring the EconomyMeasuring the EconomyMeasuring the Economy

• Today, the Bureau of Economic Analysis (BEA), the Bureau of Labor Statistics (BLS), the Census Bureau, and the Federal Reserve are the main statistical agencies in Washington.

• They conduct surveys, collect data, and regularly publish reports on the key economic statistics. These include production, unemployment, inflation, productivity, and foreign trade.

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The Basics of Gross Domestic The Basics of Gross Domestic ProductProduct

The Basics of Gross Domestic The Basics of Gross Domestic ProductProduct

• Gross Domestic Product (GDP) is the dollar value of the output of the national economy.

• All the statistics that feed into the process of measuring GDP are known as the system of national accounts.

• The process requires measuring the output and price of over a million goods and services.

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The Basics of Gross Domestic The Basics of Gross Domestic ProductProduct

The Basics of Gross Domestic The Basics of Gross Domestic ProductProduct

• The problem in measuring GDP is that different types of goods and services are each measured in different units. – For example, how do we compare automobiles with

haircuts or aquariums?

• There is no easy way to add them all up. • The key is to express the output of each good

and service as a dollar amount and then add these dollar amounts up.

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Components of GDPComponents of GDPComponents of GDPComponents of GDP

• GDP is made up of the following components:– personal consumption, which includes goods and

services bought by households.– nonresidential investment, which are the buildings,

equipment, and software businesses purchase to use in production.

– residential investment, which include the construction of new homes and the renovation of existing homes.

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Components of GDPComponents of GDPComponents of GDPComponents of GDP

– government consumption and investment, which are goods and services purchased by the government.

– inventory investment, or goods produced by businesses that are not immediately purchased.

– net exports, which includes the difference between exports and imports.

• GDP is the sum of these components.

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Components of GDP, 2007Components of GDP, 2007Components of GDP, 2007Components of GDP, 2007

Category Billions of dollars

Personal consumption 9,734

Nonresidential investment 1,482

Residential investment 641

Change in inventories 3

Government purchases 2,690

Net exports -708

Gross Domestic Product 13,841

The following table shows the value of the different components of GDP for 2007.

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No Double-CountingNo Double-CountingNo Double-CountingNo Double-Counting

• Only final goods and services count in GDP; that is, goods and services purchased by the final user.

• Purchases of intermediate inputs are left out of GDP to avoid double-counting.– Intermediate inputs are any goods and services used

or bought by a business as an input in the production process.

• For example, a printing company uses paper and ink to produce a book.

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Consumption ExpendituresConsumption ExpendituresConsumption ExpendituresConsumption Expenditures

• The largest category of GDP is personal consumption expenditures, or consumer spending.

• This category includes all sorts of goods and services that households spend money on, including food, telephone services, personal computers, automobiles, and gasoline.

• Medical spending is part of consumer spending.

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Nonresidential InvestmentNonresidential InvestmentNonresidential InvestmentNonresidential Investment

• Nonresidential investment is the total spending by businesses on the structures, equipment, and software they need to run their operations.

• The biggest category of business investment spending today is software.

• A new factory in the United States, even if built by a foreign-owned company, is counted as part of US GDP.– It is location, not ownership, that counts for GDP.

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Growth in Technology SpendingGrowth in Technology SpendingGrowth in Technology SpendingGrowth in Technology Spending

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Residential InvestmentResidential InvestmentResidential InvestmentResidential Investment

• Residential investment is the spending on the building of new homes and the renovation of existing ones.

• In contrast, if you buy an existing home, the spending does not count as part of residential investment, since no actual production or construction occurred. – Remember, GDP is about production of new goods

and services. • Residential investment is highly volatile over

time.

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Ups and Downs of Residential Ups and Downs of Residential InvestmentInvestment

Ups and Downs of Residential Ups and Downs of Residential InvestmentInvestment

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Government SpendingGovernment SpendingGovernment SpendingGovernment Spending

• The federal, state, and local governments in the United States are an important part of the economy, spending a total of $4.6 trillion in 2007.

• There are two types of government spending:– The first type is called government consumption

and investment, which includes all of the government’s purchases of goods and services, such as salaries paid to government employees.

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Government SpendingGovernment SpendingGovernment SpendingGovernment Spending

– The other type of government spending is money which is sent out by the government, but the actual spending is done by the private sector.

• For example, government programs such as Medicare and Medicaid spend enormous sums of money, but most of the actual healthcare is done by private hospitals and doctors.

• Social Security checks are sent out by the federal government, but spent by individuals.

• These expenditures are not counted as part of government spending.

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Change in InventoriesChange in InventoriesChange in InventoriesChange in Inventories

• The change in inventories is a rather small but important category.

• When companies add to their inventories, it contributes positively to GDP.

• This is because it counts as production, even if no one has bought the goods.

• In contrast, when companies reduce their inventories by selling goods, the change gets subtracted from GDP.

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Net ExportsNet ExportsNet ExportsNet Exports

• Net exports equals exports minus imports.

• Exports are goods and services produced in the United States and sold outside the country, so they add positively to GDP.

• Imports are goods and services produced outside the United States and consumed within this country. They enter the GDP calculation with a negative sign.

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The Flow of Exports and Imports in The Flow of Exports and Imports in 20072007

The Flow of Exports and Imports in The Flow of Exports and Imports in 20072007

Exports Imports

$1.64trillion

$2.35trillion

$12.20trillion

Foreign purchases of goods and services produced in the US

US purchases of goods and services produced overseas

US purchases of goods and services produced in the US

Gross Domestic Product

$13.84 trillion

US production of goods and services

Gross Domestic Purchases

$14.55 trillion

US purchases of goods and services

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Exports and Imports, 1950-2007Exports and Imports, 1950-2007Exports and Imports, 1950-2007Exports and Imports, 1950-2007

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What GDP Does Not IncludeWhat GDP Does Not IncludeWhat GDP Does Not IncludeWhat GDP Does Not Include

• GDP focuses on the market economy.

• Thus, non-market transactions are not included.– All the work put in by volunteers at hospitals, schools,

and religious organizations is not counted as part of GDP.

– All the time and effort that goes into raising children, cleaning house, and cooking food by a stay-at-home parent is not counted as part of GDP.

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What GDP Does Not IncludeWhat GDP Does Not IncludeWhat GDP Does Not IncludeWhat GDP Does Not Include

• GDP also does not include the underground economy.

• The underground economy includes illegal activities such as drug dealing and ‘off-the-book’ activities such as the babysitter or landscaper who gets paid in cash and does not report it to the Internal Revenue Service. – The underground economy could be as large as 10%

of GDP.

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International Comparisons of GDPInternational Comparisons of GDPInternational Comparisons of GDPInternational Comparisons of GDP

• Other countries calculate their own GDP using roughly the same methods as the US.

• This allows us to make an international comparison of GDP.

• GDP per capita is the economic output of a country, divided by the size of its population. – If we want to determine which countries have the

highest living standards, we use GDP per capita.

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GDP per Capita Across CountriesGDP per Capita Across CountriesGDP per Capita Across CountriesGDP per Capita Across Countries

806

1,300

2,659

3,725

5,292

9,695

12,775

14,692

24,783

33,188

33,577

34,181

35,134

36,494

38,435

41,128

45,845

53,037

0 10,000 20,000 30,000 40,000 50,000 60,000

Ethiopia

Bangladesh

India

Indonesia

China

Brazil

Mexico

Russia

Korea

France

Japan

Germany

United Kingdom

Sweden

Canada

Switzerland

United States

Norway

Average GDP per person, 2007 (dollars)