Chapter 9 Gross Domestic Product 9-1 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives What is GDP? How is GDP measured? What are the national income accounts? What is the difference between GDP and real GDP? How does our GDP compare to those of other nations? How is per capita GDP calculated? What are the shortcomings of GDP as a measure of national economic well-being? 9-2 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

GDP is the nation’s expenditures on all FINAL goods and services produced during the year at market prices. What Is GDP? 9-3 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-4 Consumption –Durable goods …………$ 820 –Nondurable goods …….. 2,010 –Services ……………….. 3,929 –Total C …………………………….$6,759 Investment –Plant & Equipment …….$ 1,361 –Residential Housing …… 416 –Inventory change ………. 57 –Total I ……………………………….1,834 Government Purchases –Federal ………………….$ 595 –State and Local …………..1,148 –Total G ……………………………..$1,743 Net Exports (Xn) –Exports ………………….$ 1,099 –Imports …………………..- 1,466 –Xn …………………………………$ GDP …… …………………………$9,966 The Components of GDP, 2000 (in $ billions) Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-5 Consumption –Durable goods …………$ 820 –Nondurable goods …….. 2,010 –Services ……………….. 3,929 –Total C …………………………….$6,759 Investment –Plant & Equipment …….$ 1,361 –Residential Housing …… 416 –Inventory change ………. 57 –Total I ……………………………….1,834 Government Purchases –Federal ………………….$ 595 –State and Local …………..1,148 –Total G ……………………………..$1,743 Net Exports (Xn) –Exports ………………….$ 1,099 –Imports …………………..- 1,466 –Xn …………………………………$ GDP …… …………………………$9,966 The Components of GDP, 2000 (in $billions) GDP = C + I + G + X n GDP = 6,759+1,834+1,743+(-370) GDP = 9,966 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-6 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-7 Same As Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-8 Same As Value of what is produced Value of what is spent Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-9 Same As Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports 9-10 Same As Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach (GDP = C + I + G + Xn ) Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-11 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. C, I, and G as Percentages of GDP, Consumption has consistently been between 60 and 70% of our GDP, with a slow upward trend over this period. [C + I + G add up to more than 100% because X n is negative.]

9-12 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Global Breakdown of GDP Expenditures for Select Countries, 2000

The Flow of Income Approach (Most Complex) 9-13 Consumption +Investment + Government Spending +Net Exports GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Flow of Income Approach 9-14 GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) Why is NDP better than GDP? Country North Atlantis South Atlantis GDP Depreciation NDP North Atlantis is better because it had a higher NDP! South Atlantis had a lower NDP because it had to devote more of its resources to replacing worn out and obsolete equipment. These resources could not go toward additional plant & equipment nor could they even be used for more consumer goods. Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Flow of Income Approach 9-15 GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) Indirect business taxes and subsidies are mainly general sales taxes on specific items such as gasoline, liquor and cigarettes and subsidies (such as government payments to farmers). Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) 9-16 The Flow of Income Approach Distribution of Domestic Income (2000) Wages, salaries & fringes ……….70.4% Net Interest ……………………… 7.0% Proprietor’s Income …………….. 8.8% Corporate Profits ……………… % Rent …………………………….. 1.8% Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) 9-17 The Flow of Income Approach Earnings not received are almost all Social Security taxes and corporate profits that were not paid out as dividends Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) 9-18 The Flow of Income Approach Receipts not earned are mainly Social Security benefits and other government transfer payments, and interest income Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-19 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. National Product and Income, 2000

9-20 The Flow of Income Approach GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) Personal taxes are chiefly personal income taxes Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-21 The Flow of Income Approach GDP (Gross Domestic Product) -Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) Disposable Personal Income is ours to dispose of, to spend and save as we see fit Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-22 The Flow of Income Approach GDP (Gross Domestic Product) - Depreciation NDP (Net Domestic Product) - Indirect business taxes and subsidies DI (Domestic Income) - Earnings not received + Receipts not earned PI (Personal Income) - Personal taxes DPI (Disposable Personal Income) The “red” indicates the three main parts of the “Flow of Income” approach to GDP Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-23 The Flow of Income Approach GDP (Gross Domestic Product) (+) - Depreciation NDP (Net Domestic Product) (+) - Indirect business taxes and subsidies DI (Domestic Income) (+) - Earnings not received (-) + Receipts not earned PI (Personal Income) (+) - Personal taxes DPI (Disposable Personal Income) If we start with “DPI” and work up - the signs have to be changed! Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Two Things to Avoid when Compiling GDP Multiple counting –Only expenditures on final products – what consumers, businesses, and government units buy for their own use belong in GDP Intermediate goods are not counted Used goods are not counted Transfer payments –Transfer payments are not payments for currently produced goods and services When they are spent for final goods and services they will go into GDP as consumer spending Financial transactions don’t go into GDP 9-24 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-25 The Value-added Approach to Measuring GDP Production Generated Added Farmer harvest wheat $100 $100 Miller makes into flour Baker makes into bread $600 $300 GDP counts only the $ value of the final good This is the same as the “value-added.” Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

GDP Versus Real GDP (RGDP) $8 $9 $10 $ GDP is the Price RGDP is the pie GDP is measured in current dollars. Therefore it appears as if GDP was larger in 2001 than in previous years. To make year-to-year GDP comparisons, we have to get rid of inflation 9-26 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Deflating GDP to Get RGDP RGDP cy = GDP cy X GDP DEFLATORcy GDP DEFLATORby 9-27 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Deflating GDP to Get RGDP RGDPcy = GDPcy X GDP DEFLATOR cy GDP DEFLATOR by 9-28 RGDP 86 = X Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Deflating GDP to Get RGDP RGDPcy = GDPcy X GDP DEFLATOR cy GDP DEFLATOR by 9-29 RGDP 86 = X RGDP 86 = X Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Deflating GDP to Get RGDP RGDPcy = GDPcy X GDP DEFLATOR cy GDP DEFLATOR by 9-30 RGDP 86 = X RGDP 86 = X RGDP 86 = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-31 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X GDP DEFLATOR by GDP DEFLATOR 97 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-32 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = X ` Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-33 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = X ` RGDP 97 = X Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-34 Deflating GDP to Get RGDP RGDP 97 = GDP 97 X GDP DEFLATOR by GDP DEFLATOR 97 RGDP 97 = X ` RGDP 97 = X RGDP 97 = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-35 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. GDP and Real GDP(in 1992Dollars),

Calculating Percentage Changes 9-36 % change = Change Original Number Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-37 % change = Change Original Number 1980 GDP = GDP = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-38 % change = Change Original Number 1980 GDP = GDP = Change -----> Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-39 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-40 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = % change = = 8.8% Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-41 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = % change = = 8.8% 1980 RGDP = RGDP = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-42 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = % change = = 8.8% 1980 RGDP = RGDP = Change > 12.9 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-43 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = % change = = 8.8% 1980 RGDP = RGDP = Change > 12.9 % change = Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Calculating Percentage Changes 9-44 % change = Change Original Number 1980 GDP = GDP = Change -----> % change = % change = = 8.8% 1980 RGDP = RGDP = Change > 12.9 % change = % change = =.26 % Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Trillion Dollar Economies, Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Per Capita GDP 9-46 Per capita GDP = GDP Population Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Per Capita GDP 9-47 Per capita GDP = GDP Population Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Per Capita GDP 9-48 Per capita GDP = GDP Population Per capita GDP = $9,966,000,000, ,000,000 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Per Capita GDP 9-49 Per capita GDP = GDP Population Per capita GDP = $9,966,000,000, ,000,000 Per capita GDP = $35, Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Per Capita Real GDP 9-50 Per capita real GDP = Real GDP Population To compare per capita GDP in one year with that of another year we have to correct for inflation. In other words, we really need to revise our formula Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9-51 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Per Capita Real GDP, Selected Years, Year Per Capita Real GDP 1929 $ 9, , , , , , , ,466

9-52 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Per Capita GDP of the 10 Leading nations, 2000 International comparisons for per capita GDP are at least somewhat suspect because of varying national income accounting systems as well as fluctuations of foreign exchange rates

The Cost of Living in the United States and Russia: An Alternate Comparison 9-53 Good U. S. Russia Sugar, per pound 3 minutes29 minutes Bread, per pound 5 minutes14 minutes Milk, half-gallon 9 minutes1 hour, 10 minutes Sausage, per pound12 minutes2 hours, 27 minutes Gasoline, per gallon 8 minutes1 hour, 16 minutes Television, average 6 days71 days Minutes of work required in 1994 to pay for selected goods in the United States and Russia Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Shortcomings of GDP as a Measure of National Economic Well-being Production that is excluded –Household production –Illegal production –The underground economy Treatment of leisure time Human cost and benefits GDP gives us a ballpark idea of how much we produce, not necessarily how well off we are 9-54 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

James Tobin and William Nordhaus: A Measure of Economic Welfare What Goes into GDP 9-55 GDP The economic bads The regrettable necessities Household, unreported, and illegal production A Measure of Economic Welfare Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

When a large part of our production goes toward national defense, police protection, pollution control devices, repair and replacement of poorly made cars and appliances, and cleanups of oil spills, a large GDP is not a good indicator of how we’re doing In general, the problem with using GDP as a measure of national economic well-being is that GDP is just one number, and no single number can possibly provide us with all of the information we need What Goes Into GDP 9-56 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Last Word on GDP GDP includes some things that really shouldn’t be counted GDP has excluded some things that should be included If we can accept GDP, while acknowledging all of its limitations, it serves us well 9-57 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.