1 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income CHAPTER 7 7 GDP: Measuring Total Production and Income Fernando Quijano Prepared by:

2 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income GDP: Measuring Total Production and Income Microeconomics The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Business cycle Alternating periods of economic expansion and economic recession.

3 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income GDP: Measuring Total Production and Income Recession The period of a business cycle during which total production and total employment are decreasing. Economic growth The ability of an economy to produce increasing quantities of goods and services. Inflation rate The percentage increase in the price level from one year to the next. Expansion The period of a business cycle during which total production and total employment are increasing.

4 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Gross domestic product (GDP): The market value of all final goods and services newly produced within a country during a specified period of time, typically one year. Measuring Total Production: Gross Domestic Product 7.1 LEARNING OBJECTIVE Explain how total production is measured.

5 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Final good or service A good or service purchased by a final user. Measuring Total Production: Gross Domestic Product Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. GDP Includes Only Newly Produced Items GDP Includes the Market Value of all Final Goods GDP includes only production that takes place during the indicated time period. 7.1 LEARNING OBJECTIVE Explain how total production is measured.

6 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Calculating GDP Solved Problem 7-1 PRODUCTION AND PRICE STATISTICS FOR 2013 (1) PRODUCT (2) QUANTITY (3) PRICE PER UNIT Eye examinations 100$50.00 Pizzas Textbooks Paper 2, PRODUCT (1) QUANTITY (2) PRICE PER UNIT (3) VALUE Eye examinations100$50$5,000 Pizzas Textbooks201002, LEARNING OBJECTIVE Explain how total production is measured.

7 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Production, Income, and the Circular-Flow Diagram FIGURE 7-1 The Circular Flow and the Measurement of GDP 7.1 LEARNING OBJECTIVE Explain how total production is measured.

8 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Transfer payments (TR) Payments by the government to individuals for which the government does not receive a new good or service in return. Production, Income, and the Circular-Flow Diagram 7.1 LEARNING OBJECTIVE Explain how total production is measured.

9 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Components of GDP Consumption Spending by households on goods and services, not including spending on new houses. Consumption Expenditure or Consumption (C) Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households and firms on new houses. Private Domestic Investment or Investment (I) 7.1 LEARNING OBJECTIVE Explain how total production is measured.

10 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Components of GDP Government purchases Spending by federal, state, and local governments on goods and services. Gov’t [Consumption plus Investment] or Government Purchases (G) 7.1 LEARNING OBJECTIVE Explain how total production is measured.

11 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production Components of GDP Net exports Exports minus imports. Net Exports of Goods and Services or Net Exports (NX) An Equation for GDP and Some Actual Values 7.1 LEARNING OBJECTIVE Explain how total production is measured.

12 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income 12 of 41 © 2015 Pearson Education, Inc. Components of GDP in 2012 Consumption is the largest component of GDP; within that, services are the largest component—almost half of GDP. An Equation for GDP and Some Actual Values

13 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production An Equation for GDP and Some Actual Values Consumer spending on services is greater than the sum of spending on durable and nondurable goods. Business fixed investment is the largest component of investment. Purchases made by state and local governments are greater than purchases made by the federal government. Imports are greater than exports, so net exports are negative. 7.1 LEARNING OBJECTIVE Explain how total production is measured.

14 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Will U.S. Consumers Be Spending Less? Making the Connection 7.1 LEARNING OBJECTIVE Explain how total production is measured.

15 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Gross Domestic Product Measures Total Production FIRM VALUE OF PRODUCTVALUE ADDED Cotton farmerValue of raw cotton = $1Value added by cotton farmer= 1 Textile mill Value of raw cotton woven into cotton fabric = $3 Value added by cotton textile mill = ($3 – $1)= 2 Shirt company Value of cotton fabric made into a shirt = $15 Value added by shirt manufacturer = ($15 –$3)= 12 L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35 Value added by L.L. Bean = ($35 – $15)= 20 Total Value Added= $35 Measuring GDP by the Value-Added Method Value-Added The market value a firm adds to a product. Table 7-1 Calculating Value Added 7.1 LEARNING OBJECTIVE Explain how total production is measured.

16 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Does GDP Measure What We Want It to Measure? Household production refers to goods and services people produce for themselves. Why is GDP not a perfect measure of production? Excludes Household Production Excludes the Underground Economy Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being.

17 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Does GDP Measure What We Want It to Measure? Other problems with using GDP as a measure of well-being The value of leisure is not included in GDP GDP is not adjusted for pollution or other negative effects GDP is not adjusted for changes in crime and other social problems GDP measures the “size of the pie” but not how the pie is “divided up” 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being.

18 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Real GDP versus Nominal GDP Real GDP (Y) The value of final goods and services evaluated at base-year prices. Calculating Real GDP Nominal GDP The value of final goods and services evaluated at current-year prices. 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP.

19 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Solved Problem 7-3 Calculating Real GDP PRODUCT 2015 QUANTITY 2009 PRICEVALUE Eye examinations100$40$4,000 Pizzas Textbooks20901, PRODUCTQUANTITYPRICEQUANTITYPRICE Eye examinations80$40100$50 Pizzas Textbooks LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP.

20 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income 20 of 41 © 2015 Pearson Education, Inc. Comparing Real GDP and Nominal GDP The current base year for calculating prices is 2009, so real and nominal GDP are equal in Growth figures reported in the media are the growth in real GDP. Since prices have generally increased since 2009, real GDP is less than nominal GDP, and the opposite is true before Nominal GDP and real GDP:

21 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Real GDP versus Nominal GDP Price level (P) A measure of the average prices of goods and services in the economy. The GDP deflator GDP deflator (P) A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP.

22 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Real GDP versus Nominal GDP FORMULAAPPLIED TO 2011APPLIED TO 2012 GDP Deflator NOMINAL GDP$15,534 billion$16,245 billion REAL GDP$15,052 billion$15,471 billion The GDP Deflator From these values for the deflator, we can calculate that the price level increased by 1.9 percent between 2011 and 2012: 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP.

23 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Other Measures of Total Production and Total Income Gross National Product (GNP) Disposable Personal Income (Y D ) National Income Personal Income Become familiar with other measures of total production and total income. 7.4 LEARNING OBJECTIVE Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. National income is calculated as GDP minus the consumption of fixed capital, or depreciation. Disposable personal income is equal to personal income minus personal tax payments (Y – T). Personal income is income received by households.

24 of 33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 7: GDP: Measuring Total Production and Income Business cycle Consumption (C) Economic growth Expansion Final good or service GDP deflator (P) Government purchases (G) Gross domestic product (GDP) Inflation rate Intermediate good or service Investment (I) Macroeconomics Microeconomics Net exports (NX) Nominal GDP Price level (P) Real GDP (Y) Recession Transfer payments (TR) Underground economy Value added KEY TERMS