ChapterGross Domestic Product and Growth 16 Introduction  What does the Gross Domestic Product (GDP) show about the nation’s economy?  GDP measures the amount of money brought into a nation in a single year through the selling of that nation’s goods and services.  GDP is a measurement of how well a nation’s economy is doing for a particular year. A high GDP means the nation is doing well. A low GDP means the nation is doing poorly.

ChapterGross Domestic Product and Growth 16 GDP  The most important data economists analyze is gross domestic product (GDP), which is the dollar value of all final goods and services produced within a country’s borders in a given year.

ChapterGross Domestic Product and Growth 16 What is GDP?  Basically, gross domestic product tracks exchanges of money.  To understand GDP, you need to understand which exchanges are included in the final calculations—and which ones are not.

ChapterGross Domestic Product and Growth 16 Expenditure Approach  One method used to calculate GDP is to estimate the annual expenditures on four categories of final goods and services:  Consumer goods  Business goods and services  Government goods and services  Net exports

ChapterGross Domestic Product and Growth 16 Income Approach  Another method calculates GDP by adding up all the incomes in the economy.  The rationale for this approach is that when a firm sells a product or service, the selling price minus the dollar value of goods service purchased from other firms represents income from the firm’s owners and employees.

ChapterGross Domestic Product and Growth 16 Nominal versus Real GDP  Nominal GDP is measured in current prices.  To calculate nominal GDP, we use the current year’s prices to calculate the value of the current year’s output.  The problem with nominal GDP is that it does not account for the rise in prices. Even though your output might be the same from year to year, the prices won’t be and nominal GDP would be different.  To solve this problem, economists determine real GDP, which is GDP expressed in constant, or unchanging, prices.

ChapterGross Domestic Product and Growth 16 Limitation of GDP  Nonmarket Activities—GDP does not measure goods and services that people make or do themselves.  The Underground Economy—GDP does not account for black market activities or people paid “under the table” without being taxed

ChapterGross Domestic Product and Growth 16 Influences on GDP  Aggregate Supply  Aggregate supply is the total amount of goods and services in the economy available at all possible price levels.  As the price level rises, real GDP, or aggregate supply rises. As the price level falls, real GDP falls.

ChapterGross Domestic Product and Growth 16 Influences on GDP, cont.  Aggregate Demand  Aggregate demand is the amount of goods and services that will be purchased at all possible price levels.  As price levels in the economy move up and down, individuals and firms change how much they buy—in the opposite direction that aggregate supply changes.

ChapterGross Domestic Product and Growth 16 Phases of a Business Cycle  Checkpoint: What are the four phases of a business cycle?  Business cycles are made up of major changes in real GDP above or below normal levels.  The business cycle consists of four phases: Expansion Peak Contraction Trough

ChapterGross Domestic Product and Growth 16 Contractions  There are three types of contractions, each with different characteristics.  A recession is a prolonged economic contraction that generally lasts form 6 to 18 months and is marked by a high unemployment rate.  A depression is a recession that is especially long and severe characterized by high unemployment and low economic output.  Stagflation is a decline in real GDP combined with a rise in price level, or inflation.

ChapterGross Domestic Product and Growth 16 Business Investment  Business cycles are affected by four main economic variables.  Business Investment  When the economy is expanding, business investment increases, which in turn increases GDP and helps maintain the expansion.  When firms decide to decrease spending, the result is a decrease in GDP and the price level.

ChapterGross Domestic Product and Growth 16 Interest Rates and Credit  Consumers often use credit to buy new cars, home, electronics, and vacations. If the interest rates on these goods rise, consumers are less likely to buy them.  The same principle holds true for businesses who are deciding whether or not to buy new equipment or make large investments.

ChapterGross Domestic Product and Growth 16 Consumer Expectations  If people expect that the economy is going to start to contract, they may reduce spending.  High consumer confidence, though, will lead to people buying more goods, pushing up GDP.

ChapterGross Domestic Product and Growth 16 External Shocks  Negative external shocks, like war breaking out in a country where U.S. banks and businesses have invested heavily, can have a great effect on business, causing GDP to decline.  Positive external shocks, like the discovery of large oil deposits, can lead to an increase in a nation’s wealth.

ChapterGross Domestic Product and Growth 16 Business Cycle Forecasting  Checkpoint: Why is it difficult to predict business cycles?  To predict the next phase of a business cycle, forecasters must anticipate movements in real GDP before they occur.  Economists use leading indicators to help them make these predictions. The stock market is a leading indicator. Today, the stock market turns sharply downward before a recession.

ChapterGross Domestic Product and Growth 16 The Great Depression  Before the 1930s, many economists believed that when an economy declined, it would recover quickly on its own.  The Great Depression changed this belief and led economists to consider the idea that modern market economies could fall into long-lasting contractions.  Not until World War II, more than a decade later, did the economy achieve full recovery.

ChapterGross Domestic Product and Growth 16 The Great Depression, cont.  Declining GDP and high unemployment were two major signs of the Great Depression, the longest recession in U.S. history.  In what year did the Great Depression hit its trough?  How long did it take GDP to return to its pre- Depression peak?

ChapterGross Domestic Product and Growth 16 Later Recessions  OPEC Embargo  In the 1970s, the United States experienced an external shock when the price of gasoline and heating fuels skyrocketed as a result of the OPEC embargo on oil shipped to the United States.  The U.S. economy also experienced a recession in the early 1980s and another brief one in 1991, followed by a period of steady economic growth.  The attacks of 9/11 led to another sharp drop in consumer spending in many service industries.

ChapterGross Domestic Product and Growth 16 The Business Cycle Today  The economy began to grow slowly in 2001 and was surging by late 2003 with GDP growing at a rate of 7.5 percent over three months.  However, growth slowed again as a result of high gas prices in  The subprime mortgage crisis caused further decline in  The stock market decline in 2008 appeared to be bringing the country into yet another recession.

ChapterGross Domestic Product and Growth 16 GDP and Quality of Life  GDP measures the standard of living but it cannot be used to measure people’s quality of life.  In addition, GDP tells us nothing about how output is distributed across the population.  While real GDP per capita tells us little about individuals it does give us a starting point for measuring a nation’s quality of life.  In general, though, nations with a high GDP per capita experience a greater quality of life.

ChapterGross Domestic Product and Growth 16 Capital Deepening  A nation with a large amount of physical capital will experience economic growth.  The process of increasing the amount of capital per worker, known as capital deepening, is one of the most important sources of growth in modern economies.  What is capital deepening?

ChapterGross Domestic Product and Growth 16 Saving and Investment  Checkpoint: How is saving linked to capital deepening?  If the amount of money people save increases, then more investment funds are available to businesses.  These funds can then be used for capital investment and expand the stock of capital in the business sector.

ChapterGross Domestic Product and Growth 16 Government  Checkpoint: Do higher tax rates increase or reduce investment?  If government raises taxes, households will have less money. People will reduce saving, thus reducing the money available to businesses for investment.  However, if government invests the extra tax revenues in public goods, like infrastructure, this will increase investment, resulting in capital deepening.

ChapterGross Domestic Product and Growth 16 Technological Progress  Technological progress is a key source of economic growth.  It can result from new scientific knowledge, new inventions, and new production methods

ChapterGross Domestic Product and Growth 16 Technological Progress, cont.  Causes of technological progress include:  Scientific research  Innovation New products increase output and boost GDP and profits  Scale of the market Larger markets provide more incentives for innovation  Education and experience Increases human capital  Natural resources Increased natural resources use can create a need for new technology