Why GDP Is Important

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What is gross domestic product (GDP)? Currency value (such as U.S. dollar) of all final goods and services produced within a country in a given period Total income of a nation Measure of nation’s economic well-being Measure of a nation’s economic growth from one period to the next

What’s included in GDP? Consumption by households Goods: groceries, clothes, iPods Services: haircuts, oil changes Consumption (C) is the expenditure by households on consumption goods and services. It includes durables (goods lasting three or more years), nondurables, and services.

What’s included in GDP? Investment by businesses and households Fixed assets for production New homes Inventories Investment (I) is the purchase of new capital goods (tools, instruments, machines, buildings, and other constructions) and additions to inventories. In other words, it is spending by firms, including final purchases on machinery, equipment and tools, all construction of new houses, buildings, and apartments, and additions to inventory.

What’s included in GDP? Government expenditures by local, state, and federal government Roads and schools Government purchases of goods and services (G) are purchases of goods and services by all levels of government. It excludes transfer payments (welfare spending and unemployment compensation) because those payments do not represent new products or services; rather, they are transfers of income.

What’s included in GDP? Net exports Value of a country’s exports to other nations, less its imports from other nations Net exports of goods and services (X-IM or NX) is the value of exports of goods and services minus the value of imports of goods and services. In the United States, it is the value by which American spending on foreign goods and services exceeds foreign spending on American goods and services.

What’s included in GDP? GDP = Consumption + Investment + Government spending + Net exports GDP is equal to all of the spending by households, businesses, government, and the international sector on final goods. It is also the dollar value of the nation’s goods and services produced in a given period within the nation’s borders.

What’s not included in GDP? Intermediate goods Used goods Underground production (black market) Financial transactions Household production Transfer payments Intermediate goods. Only the final goods and services purchased for final use and not for resale or further processing and manufacturing are included in GDP. Intermediate goods are not counted in GDP. Intermediate goods are goods and services that are used for further processing and manufacturing or resale, for example, the lead that will eventually go in a pencil. This process avoids double-counting and therefore exaggerating GDP. Goods produced but not sold do go into GDP in the form of inventory investment. After that, they are not included in the GDP of the year in which they are sold. Second-hand sales/used goods. Expenditure on used goods is not part of GDP because these goods were part of GDP in the period in which they were produced and during which time they were new goods. Buying a house that is not new is not part of GDP. Also, bartered goods are not included in GDP. The black market/underground production. Illegal drugs, illegal goods, and illegal services in the underground economy are not part of GDP. The hidden part of the economy in which people trade in illegal goods and services and try to avoid taxes and regulations cannot be correctly ascertained. Financial transactions. When households buy financial assets such as bonds and stocks, they are making loans, not buying goods and services. Nothing new has been produced. Transfer payments. Transfer payments are payments from the government, including education grants, Social Security payments, welfare checks, and unemployment checks. They do alter household income, but they do not reflect the economy’s production.

What are the components of GDP? Personal Consumption Expenditures (C) Investment (I) Government (G) Net Exports (NX) Fixed Investment Inventories Exports Imports Nonresidential Residential Expenditures on final goods and services are divided into four types: consumption, investment, government purchases, and net exports (exports – imports) of goods and services. GDP = C + I + G + NX

How much of GDP is each component? Average Percent of GDP since 2003 Component % of GDP Government 19% Investment 16% Consumption (PCE) 70 % The chart shows the average percent since 2003 of GDP for each component of GDP. Consumption is the highest proportion of GDP, at 70%. Government spending accounts for 19% of GDP on average, and investment, 16%. Net exports have averaged -5%. Since imports have exceeded exports, net exports has been a drag on GDP. Changes to components of real GDP will change the overall level of real GDP. Calculated using data from the Bureau of Economic Analysis (BEA): www.bea.gov Net Exports -5% GDP 100% Source: Bureau of Economic Analysis

What is a good rate of growth? For a developed economy like the United States, a desirable rate of growth is approximately 3 % to 3.5%. The U.S. economy has grown at about a 3% average rate since 1980.

Real and nominal GDP When GDP is computed in the current year’s prices, rising prices (inflation) can make it difficult to determine if a change in GDP from one year to the next is due to the country’s production of more goods and services or to increases in the price level. Nominal GDP: GDP that is not adjusted for inflation. The value of goods and services in current prices. Real GDP: The dollar price of GDP in a base year’s price, used to compare changes in GDP from one year to the next. An increase in real GDP is an increase in economic growth. Nominal GDP measures the total spending on goods and services in all markets in the economy. If total spending rises from one year to the next, one of two things must be true: The economy is producing a larger output of goods and services, and/or goods and services are being sold at higher prices. To obtain a measure of the amount produced that is not affected by changes in prices, we use real GDP, the production of goods and services valued at constant prices. We calculate real GDP by choosing one year as a base year to express the prices in. Real GDP uses constant base-year prices to place a value on the economy’s production of goods and services.

What GDP does not tell us Does not measure income distribution Does not measure non-monetary output or transactions (e.g., barter, household activities) Does not take into account desirable externalities, such as leisure or environment Does not measure social well-being Correlates to standard of living but is not a measure of standard of living