ECO 1003Handouts for

Chapters 6-11-12

Measuring GDP

• gross domestic product (GDP) The total market value of all final goods and services produced within a given period by factors of production located within a country• GDP is the total market value of a country’s output

Measuring GDP

• final goods and services Goods and services produced for final use

• intermediate goods Goods that are produced by one firm for use in further processing by another firm

• value added The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage

Measuring GDP

• In calculating GDP• We can either sum up the value added at each stage of production

OR • We can take the value of final sales

• We do not use the value of total sales in an economy to measure how much output has been produced

Measuring GDPEXCLUSION OF USED GOODS AND TRANSACTIONS•GDP is concerned only with new, or current, production•GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced

EXCLUSION OF OUTPUT PRODUCED ABROAD BY DOMESTICALLY OWNED FACTORS OF PRODUCTION•GDP is the value of output produced by factors of production located within a country

Measuring GDP

•gross national product (GNP) The total market value of all final goods and services produced within a given period by factors of production owned by a country’s citizens, regardless of where the output is produced

Measuring GDP

• expenditure approach A method of computing GDP that measures the amount spent on all final goods during a given period

• income approach A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods

Measuring GDPTHE EXPENDITURE APPROACH• Expenditure Categories:

• Personal consumption expenditures (C): household spending on consumer goods

• Gross private domestic investment (I): spending by firms and households on new capital, i.e., plant, equipment, inventory, and new residential structures

• Government consumption and gross investment (G)

• Net exports (EX - IM): net spending by the rest of the world, or exports (EX) minus imports (IM)

GDP = C + I + G + (EX - IM)

Measuring GDPPersonal Consumption Expenditures (C)• personal consumption expenditures (C) A major

component of GDP: expenditures by consumers on goods and services

• There are three main categories of consumer expenditures: durable goods, nondurable goods, and services• durable goods Goods that last a relatively long time,

such as cars and household appliances• nondurable goods Goods that are used up fairly

quickly, such as food and clothing• services The things we buy that do not involve the

production of physical things, such as legal and medical services and education

Measuring GDP

Gross Private Domestic Investment (I)• gross private domestic investment (I) Total investment in capital—that is, the purchase of new housing, plants, equipment, and inventory by the private (or non-government) sector

• nonresidential investment Expenditures by firms for machines, tools, plants, and so on

• residential investment Expenditures by households and firms on new houses and apartment buildings

Measuring GDP• change in business inventories The amount by which firms’ inventories change during a period• Inventories are the goods that firms produce now but intend to sell later

• GDP is not the market value of total final sales during a period—it is the market value of total production

GDP = final sales + change in business inventories

Measuring GDPGross Investment versus Net Investment•depreciation The amount by which an asset’s value falls in a given period

•gross investment The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period

•net investment Gross investment minus depreciation

capitalend of period = capitalbeginning of period + net investment

Measuring GDP

Government Consumption and Gross Investment (G)

• government consumption and gross investment (G) Expenditures by governments for final goods and services (school buildings, military salaries)

Net Exports (EX - IM)• net exports (EX - IM) The difference between exports (sales to foreigners of domestically- produced goods and services) and imports (domestic purchases of goods and services from abroad)• The figure can be positive or negative

Measuring GDP

THE INCOME APPROACH•Calculate GDP in terms of who receives it as income rather than as who purchases it•national income The total income earned by the factors of production owned by a country’s citizens

Measuring GDP• compensation of employees Includes wages, salaries, and various supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government

• proprietors’ income The income of unincorporated businesses

• rental income The income received by property owners in the form of rent

• corporate profits The income of corporate businesses

Measuring GDP• net interest The interest paid by business• indirect taxes minus subsidies Taxes such as sales taxes, customs duties, and license fees, less subsidies that the government pays for which it receives no goods or services in return

• net business transfer payments Net transfer payments by businesses to others

• surplus of government enterprises Income of government enterprises

Relation between GDP and National IncomeGDPPlus: Receipts of factor income from the rest of the worldLess: Payments of factor income to the rest of the world(National income is income of the country’s citizens not the income of the residents of the country and we need to first move from GDP to GNP)Equals: GNPLess: Depreciation (When we calculate GDP using expenditure approach, depreciation is not subtracted, whereas in national income we have corporate profits with deduction of depreciation)Equals: Net national product (NNP) Less: Statistical discrepancy(Data collection procedure not accrued, measurement error)Equals: National incomeNet national product (NNP) Gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock

Measuring GDP

• personal income The total income of households before paying personal income taxes

• disposable personal income or after-tax income Personal income minus personal income taxes (The amount that households have to spend or save)

• personal saving The amount of disposable income that is left after total personal spending in a given period

Relation between National Income and Personal IncomeNational incomeLess: Amount of national income not going to householdsEquals: Personal income (The difference between national income and personal income is the profits of corporations not paid to households in the forms of dividends, called the retained earnings of corporations, this income that goes to corporations rather than to households is part of national income but not personal income)Less: Personal income taxesEquals: Disposable personal income (Disposable income=personal income minus taxes)Personal consumption expendituresPersonal interest paymentsTransfer payments made by households(All add up to total personal spending, disposable income less total spending=saving)Equals: Personal saving

NOMINAL VERSUS REAL GDP

• nominal GDP Gross domestic product measured in current prices

• If we use nominal GDP to measure growth, we can be misled into thinking production has grown when all that has really happened is a rise in the price level

NOMINAL VERSUS REAL GDP

The (Implicit) GDP Deflator

• Comparing what has happened to nominal and to real GDP over the same period implies the existence of a price index measuring the change in prices over that period

GDP Deflator =[GDPcurrent/GDPbase]*100

Economic growth

• output growth The growth rate of the output of the entire economy

• per-capita output growth The growth rate of output per person in the economy

• productivity growth The growth rate of output per worker

Economic growth

• recession Roughly, a period in which real GDP declines for at least two consecutive quarters• Marked by falling output and rising unemployment

• depression A prolonged and deep recession• The precise definitions of prolonged and deep are debatable

DEFINING INFLATION

• inflation An increase in the overall price level

• deflation A decrease in the overall price level

• sustained inflation An increase in the overall price level that continues over a significant period

PRICE INDEXES

• consumer price index (CPI) A price index computed each month by TUIK using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer

CPI=[(basket price)current / (basket price)base]*100

Inflation =(CPIcurrent- CPIbase)/ CPIbase