Chapter 24 – Measuring Domestic Output and National Income

Gross Domestic Product (GDP) GDP is the primary measure of the economy’s performance GDP is the market value of all final goods and services produced within a nation in a year (Dodge, 2005). GDP measures Aggregate Spending, Income and Output.

Counted or Not Counted? GDP counts all final, domestic production for which there is a market transaction in that year. Used and intermediate goods are not counted in order to avoid double-counting. Non-market production is not counted. Underground or ‘black market’ activity is not counted.

Nonproduction transactions If there is no production – the transaction is excluded Financial transactions – transfer payments (social security, welfare…) Private transfer payments – money for your birthday… Stock market transactions – they are a swap and create no production

Counted or Not Counted? Which of the following are counted or not counted in U.S. GDP and why? New U.S. manufactured Goodyear tire sold to the General Motors Corporation New U.S. manufactured Goodyear tire sold to a consumer Child care services provided by you for the neighbor’s kid The ingredients to a cherry pie for sale at a bakery A new Boeing 787 New Tundra pick-up truck manufactured in San Antonio by Japanese firm Toyota You pay your stock broker to purchase 20 shares of GOOGLE stock

Aggregate Spending The expenditure approach GDP = C + IG + G + XN C = Consumption IG = Gross Private Investment G = Government Spending XN= Net Exports = Exports (X) – Imports (M)

Consumption Consumer spending on Durable goods (cars, appliances…) Non-durable goods (food, clothing…) Services (plumbing, college…) Consumer spending is the largest component of U.S. GDP.

Gross and Net Private Investment Gross Investment is spending in order to increase future output or productivity Business spending on capital New construction Change in unsold inventories Net Investment Gross investment minus depreciation (capital used up over the course of the year) If depreciation is more than gross investment, it is called disinvesting

Government Spending All levels of government spending on final goods and services and infrastructure count toward GDP. Remember!! - Government transfer payments do not count toward GDP.

Net Exports Exports – Imports X – M Exports create a flow of money to the United States in exchange for domestic production. Imports create a flow of money away from the United States in exchange for foreign production.

Aggregate Income Income approach GDP measures spending and income. Income = r + w + i + p = factor payments r = rent (payment for natural resources) w = wages (payment for labor – largest share of national income) i = interest (payment for capital, also includes interest on savings) p = corporate profits (payment for entrepreneurship – dividends, corp income tax, undistributed corp profit – also call retained earnings)

Figure 24.3 page 496 Review this figure US domestic output and the flows of expenditures and income

Nominal vs. Real GDP Nominal GDP is current GDP measured at current market prices Nominal GDP may overstate the value of production because of the effects of inflation or understate due to deflation Real GDP is current GDP measured with a fixed dollar You must deflate GDP when prices rise and inflate GDP when prices fall **KEY POINT** Use a reference year to do this Real GDP holds the value of the dollar constant and is useful for making year to year comparisons Real GDP is the IMPORTANT ONE!!!

CPI compared to the GDP deflator Link to Video

The adjustment process Consumer Price Index – market basket of goods (collection of goods and services in a given year compared to an identical collection in the reference year) PI = (price of the market basket in a specific year/price of the same basket in the base year) x 100 cpi video Real GDP = nominal GDP/Price index (in 100s) Work through table 24.5 and worked problem

Changes in GDP GDP is a measure of a nation’s prosperity and economic growth As GDP grows the burden of scarcity is lessened for a society GDP per capita provides a better measure of individual well-being than GDP

Shortcomings of GDP Nonmarket activities – except the portion of a farmers output that he consumes is estimated and included Leisure time, although increased in the last century, is ignored Improved product quality – this improves economic well being but this is not reflected Underground economy – this includes tips, off the books or cash transactions, barters Environment – air pollution, water, etc. not counted so GDP may over state our national well being Composition/distribution of GDP is not revealed (nuclear waste) GDP doesn’t measure total well being – crime, war, reduction of addictive goods