What is GDP? & How is GDP Calculated?

Important Definition! GDP: The dollar value of all final goods and services produced within a country within a given amount of time. What are we measuring?

Gross Domestic Product Output! The amount of money that is flowing through our economies factories, shops, and businesses each month, quarter, or year.

What is GDP? Final Goods and Services: When measuring GDP the key is Final goods… a tire is used in the production of a car, but is not a final good, the car is the final good. Intermediate goods are not counted in the GDP, they are goods used to produce a final good, like a tire. If we counted intermediate goods in the GDP we would be counting those goods twice (Double Counting).

What is GDP? What about goods that are not sold within the specific amount of time (year)? All goods produced within a specified amount of time are counted. Ex. Cars produced in 2010, but not sold in 2010 (still sitting at the car dealership). Those goods are still counted in the GDP because they were produced.

What is GDP? What about multi-national corporations? Ex. My Nike’s are designed by a U.S. owned company, but made in the Philippines they still get counted in the GDP right? NO! Only goods produced in that country are counted. The shoe’s would count toward the GDP of the Philippines.

GDP Excludes Public Transfer Payments: Social Security Payments, Welfare Payments, Veteran’s Payments Private Transfer Payments: Family gifts, money exchanged from person to person. Stock Market Transactions: Buying and selling stock is like swapping paper no good is being produced Secondhand Sales: These transactions contribute nothing to current production. No new production (good/service) is gained from these payments so they are not counted in GDP.

Calculating GDP There are two ways GDP can be calculated: 1)The GDP of an economy can be reached by totaling the expenditures on goods and services produced during the specified amount of time. 2)GDP can be calculated by summing the income payments to the resource suppliers of the things used to produce those goods and services. The Dollar Flow of Expenditures on Final Goods=The Dollar Flow of income from Final Goods

Calculating GDP Expenditure Approach: The GDP of an economy can be reached by totaling the expenditures on goods and services produced during the specified amount of time.

Expenditure Approach Consumption Purchases (C): largest GDP Component, when individuals or businesses purchase nondurable goods or services. Ex. Food, Clothing, recreation, medical services, legal services, gas.

Expenditure Approach Investment Spending (I): Production or Consumption of CAPITAL goods that will benefit production in the future. Ex. Machinery, New Home, Business Inventories, Construction

Expenditure Approach Government Purchases (G): All government purchases except Transfer Payments. Transfer Payments= Money paid to individuals that don’t increase production. Ex. Social Security, Welfare, etc…

Expenditure Approach Net Exports(X): The Total Exports-Total Imports. Generally this number has been negative because our country tends to import more than we export. So… C+I+G+X=GDP

Resource Cost-Income Approach If adding up all the expenditures gives us the GDP, then… Adding up all the money needed to produce those goods and services must give us the same result. Resource Cost/Income Approach: Sum of the costs incurred and income (including profits) generated producing goods and services during the period.

Resource Cost-Income Approach Resource Cost/Income Approach Components: Employee Compensation Self-Employment income Rents Interest Corporate Profit = National Income

Two measurements of GDP

GDP Components

Real vs. Nominal GDP Real vs. Nominal= Nominal is the actual (current) monetary value of our GDP on a year to year basis. Real is the monetary value minus inflation, measured in base year prices.

Why Real? This allows economists to compare the true (real) market values of GDP from year to year. %Growth rate= GDP year2-GDP year1 x100 GDP year1 Or… new – old x 100 = Percent Change old

Accuracy of GDP Is GDP an accurate way to measure the productivity (total output) and the well being of a countries citizens? GDP is reasonably accurate and highly useful to measure how well or poorly an economy is performing, but there are several shortcomings.

Shortfalls of GDP Nonmarket Activities Leisure Improved Product Quality The Underground Economy GDP and the Environment

Resource Cost-Income Approach We must also take into consideration: Indirect Business Taxes: These are taxes collected on the production or sale of a good that don’t go to the business as income, but must still be calculated. Ex. You buy a candy bar for $1 with 6% sales tax. The candy bar costs you $1.06 but the business only collects $1 in revenue. So we need to add the taxes to account for the extra money being spent.

Resource Cost-Income Approach Depreciation: The estimated amount of capital that is being used each year. This amount is not paid to anyone, but allows us to not overstate or understate profit each year.

Resource Cost-Income Approach Net Foreign Income Factor: National Income vs. Domestic Income National income is all the money made by Americans no matter where they live. Domestic income is all the money made inside the U.S. no matter nationality. So we must take: Income foreigners earn in the U.S. minus the income Americans earn abroad.

Resource Cost-Income Approach Components: Wages, Rents, Self Employment Income, Interest, Corporate Profit, Indirect Business Taxes, Depreciation, and Net income of foreigners Together these components equal the expenditure approach