1 Measuring a Nation’s Income Chapter 10

2 Definition GDP: market value of final goods and services produced in a country in a given year

3 Definition GDP: market value of final goods and services produced in a country in a given year  Only goods purchased or put into inventory  Only transactions officially recorded (illegal and under-the-table transactions not included.)

4 Definition GDP: market value of final goods and services produced in a country in a given year  Intermediate goods (inputs) not included

5 Definition GDP: market value of final goods and services produced in a country in a given year  Services make up almost half the GDP

6 Definition GDP: market value of final goods and services produced in a country in a given year  GDP is a flow. The level corresponds to the amount produced in a year.

7 $15.8 trillion 2012Q4 U.S. Department of Commerce: Bureau of Economic Analysis

8

The Circular-Flow Diagram Households:  own the factors of production, sell/rent them to firms for income  buy and consume goods & services Households:  own the factors of production, sell/rent them to firms for income  buy and consume goods & services Households Firms:  buy/hire factors of production, use them to produce goods and services  sell goods & services Firms:  buy/hire factors of production, use them to produce goods and services  sell goods & services 9

The Circular-Flow Diagram Income (=GDP) Wages, rent, profit (=GDP) Factors of production Labor, land, capital Spending (=GDP) G & S bought G & S sold Revenue (=GDP) 10

11 GDP Dollar flow of expenditures on final goods = Dollar flow of income (and indirect cost) of final goods = Two Ways of Measuring GDP

12 GDP: output produced within the US border GNP: income earned by US citizens Bureau of Economic Analysis switched to GDP as key measure in 1991.

13 Components of GDP C: consumption I : investment in plant & equipment G: government spending X-M: net exports

14 Components of GDP C: consumption I : investment in plant & equipment G: government spending X-M: net exports

15 Components of GDP C: consumption I : investment in plant & equipment G: government spending X-M: net exports

16 Investment includes residential housing … … and imputed rental payments are included in consumption.

17 Investment includes inventories

18 Components of GDP C: consumption I : investment in plant & equipment G: government spending X-M: net exports

Government spending does not include transfer payments Transfer payments include Social Security, Welfare, Unemployment Insurance 19

20 Components of GDP C: consumption I : investment in plant & equipment G: government spending X-M: net exports

X-M is negative for U.S. Imports are subtracted because they are included in C, I and G 21

U.S. GDP and Its Components, 2012 –1,915 9,767 6,657 35,459 $49,968 per capita – % of GDP –598 3,048 2,078 11,068 $15,596 billions NX G I C Y 22

ACTIVE LEARNING GDP and its components ACTIVE LEARNING 1 GDP and its components In each of the following cases, determine how much GDP and each of its components is affected (if at all). A.Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston. B.Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. C.Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. D.General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23

24 Real vs Nominal Nominal GDP: GDP measured in current dollars. Real GDP: GDP adjusted for inflation, measured in base year dollars.

Nominal and Real GDP in the U.S., 1965–2012 Real GDP (base year 2005) Nominal GDP billions 25

EXAMPLE: Compute nominal GDP in each year: 2011:$10 x $2 x 1000 = $6, :$11 x $2.50 x 1100 = $8, :$12 x $3 x 1200 = $10,800 PizzaLatte yearPQPQ 2011$10400$ $11500$ $12600$ % Increase: 30.9% 26

EXAMPLE: Compute real GDP in each year, using 2011 as the base year: PizzaLatte yearPQPQ 2011$10400$ $11500$ $12600$ % Increase: 16.7% $10 $ :$10 x $2 x 1000 = $6, :$10 x $2 x 1100 = $7, :$10 x $2 x 1200 = $8,400 27

EXAMPLE: In each year, nominal GDP is measured using the (then) current prices. real GDP is measured using constant prices from the base year (2011 in this example). year Nominal GDP Real GDP 2011$ $8250$ $10,800$

EXAMPLE: The change in nominal GDP reflects both prices and quantities. year Nominal GDP Real GDP 2011$ $8250$ $10,800$ % 16.7% 37.5% 30.9%  The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation. 29

The GDP Deflator  One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next. GDP deflator = 100 x nominal GDP real GDP

EXAMPLE: Compute the GDP deflator in each year: year Nominal GDP Real GDP GDP Deflator 2011$ $8250$ $10,800$ :100 x (6000/6000) = :100 x (8250/7200) = :100 x (10,800/8400) = % 12.2%

GDP & Well-being 32

GDP and Life Expectancy in 12 countries 33 Life expectancy (years) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Pakistan Bangladesh Nigeria 33

GDP and Literacy in 12 countries 34 Adult Literacy (% of population) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Nigeria Pakistan Bangladesh 34

GDP and Internet Usage in 12 countries 35 Internet Usage (% of population) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Nigeria Bangladesh Pakistan 35

Gross Domestic Product… “… does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.” - Senator Robert Kennedy,

37 What is the effect on the GDP of an increase in labor force participation of women?

38 Shortcomings of GDP has a measure of well being. –does not count non-market production. –does not count the underground economy. –makes no adjustment for leisure. –probably understates output increases because of the problem of estimating improvements in the quality of products. –does not adjust for harmful side effects. –does not account for the uneven distribution of income.

39 Bhutan:Gross National Happiness

 Spans over 38,394 square km of mountainous terrain  Population - 600,000 Bhutan – basic facts

Communities and villages are often isolated from each other by harsh, mountainous terrain

An urban center in Bhutan