GDP and the Standard of Living CHAPTER 5

GDP What are economist concerned about? What is an economy? Defn: The SOL is the level of consumption of goods and services in an economy. (housing, food, clothes, health care, transportation, ect..) Environmental quality and life expectancy also determine a countries standard of living. What would you guess is the easiest way to measure standard of living? “ The U.S economy has seen a fall in GDP of 3.5%” What does this mean?

5.1 GDP, INCOME, AND EXPENDITURE GDP defined. Not Included in GDP Intermediate goods U.S firms’ production in other countries Financial assets Home production Leisure time Underground production Ques- which contributes more to GDP, the production of a pound of ham, or the production of a pound of rice? Why?

5.1 EXPENDITURE APPROACH Expenditure Approach GDP= C+I+G+NX -Consumption (including rent for housing, not including the purchase of a new house) -Investment ( including the purchase of a new house) -Government expenditure on goods and services (government transfers) -Net exports of goods and services What do you guess is the share of each in U.S GDP? Some persons argue we in the U.S consume too much. Is it necessarily a bad thing?

5.2 Income Approach Measures GDP by summing the incomes that firms pay households for the factors of production they hire. (recall the factors of production) 1)Net domestic product= wages +rent +interest + profit Terminology: operating surplus =rent + interest +profit GDP = net dom. Prod. + (indirect taxes-subsidies)+depreciation n.b Adding indirect taxes moves from factor cost to market price Adding depreciation moves from net product to gross product, the profit of a firm is measured after accounting for depreciation. 2) Statistical Discrepancy: is the number difference in GDP between the income approach and the expenditure approach.

Example Ex 1) In the United states of LCG workers earn $6 million, spend $3 million on food, purchase $1 million in stocks and bonds,$2 million is spent on building new houses, and $1million on imported goods. Firms earn $2 million in profit,$ 1 million in interest income, $500k in rent. Depreciation on capital is $250k, and taxes paid total $250K.The government spent $3 million dollars on new roads, and there were $2 million in exports. Calculate GDP using the i) income approach ii) expenditure approach iii) Calculate the statistical discrepancy. 2) Explain how the purchases of used goods and of financial assets affect GDP. Why are they not included in GDP?

Gross National Product Recall: GDP does not include U.S production in foreign countries. It only captures what is produced within the borders. If we want to value the level of production produced by “American”, regardless of where in the world it is produced we calculate GNP. Defn. Gross national product or GNP U.S. GNP = U.S. GDP + Net factor income from abroad Another measure of the performance of the economy is disposable personal income.

Real vs. Nominal Values FOX news flash: Kmart’s retails sales in 2007 was $10mil, in 2008 it was $14 mil. “The retail giant is selling more goods and services” Isn’t that obvious? Real GDP is the value of the final goods and services produced in a given year expressed in the prices of the base year. Nominal GDP is the value of the final goods and services produced in a given year expressed in the prices of that same year.

5.2 MEASURING U.S. GDP Real GDP in 2008 is what the total expenditure would have been in 2008 if prices had remained the same as they were in the base year. Increases in real GDP will tell by how much the quantity of good and services has increased. Point- We look at GDP to 1)Estimate National income, to get an idea of the standard of living. 2)Estimate the performance of an economy, how much is being produced.

5.3 THE USE AND LIMITATIONS OF REAL GDP We use estimates of real GDP for two main purposes: To compare the standard of living over time To compare the standard of living among countries  The Standard of Living Over Time To compare living standards we calculate real GDP per person— real GDP divided by the population.

Example YearProductPrice ($)QuantityPopulation 2006Cereal4103 DVD Cereal5102 DVD1242 Calculate nominal GDP in 2006 and i)Based on nominal GDP, can you say there is more output in 2006 than 2007? ii)What does real GDP tell us about the performance of this economy between 06 and 07? iii)What about the standard of living between 06 and 07?