1. Introduction to Gross Domestic Product

2. Learning Objectives
Define gross domestic product and explain how it is measured using the expenditure approach.
Explain the difference between nominal and real GDP.

5. GDP Dating Exercise
Describe the empirical facts before you (ie. GDP generally increases).
Identify peaks, valleys what happened.
Is there regularity in the frequency of changes?

6. Expansion and Contraction: The Business Cycle
An expansion, or boom, is the period in the business cycle from a trough up to a peak, during which output and employment rise.
A contraction, recession, or slump is the period in the business cycle from a peak down to a trough, during which output and employment fall.

7. Real GDP,

8. Real GDP, 1970 I-2003 II

9. Macroeconomic Concerns
Three of the major concerns of macroeconomics are:
Inflation
Unemployment
Output growth

10. Output Growth: Short Run and Long Run
The business cycle is the cycle of short-term ups and downs in the economy.
The main measure of how an economy is doing is aggregate output:
Aggregate output is the total quantity of goods and services produced in an economy in a given period.

11. Output Growth: Short Run and Long Run
A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession.
A prolonged and deep recession becomes a depression.
Policy makers attempt not only to smooth fluctuations in output during a business cycle but also to increase the growth rate of output in the long-run.

12. The Components of the Macroeconomy
Everyone’s expenditure is someone else’s receipt. Every transaction must have two sides.

13. An Overview of National Income and Product Accounting (NIPA)
Detailed calculations were first worked out by Simon Kuznets during the Great Depression
Large quantities of data collected and organized from a variety of sources around the country
These data are summarized, assembled into a coherent framework, and reported by the government

14. Gross Domestic Product and Gross National Product
GDP is the market value of all newly produced final goods and services produced by resources located in the United States, regardless of who owns those resources

15. Final and Intermediate Goods and Services
Final goods and services sold to ultimate, users
Cotton shirts are a final good
Intermediate goods and services are purchased for further reprocessing and resale
Cotton is intermediate good
Keeping final goods and intermediate goods separate in our thinking allows us to avoid double counting
Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.
In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales.

16. Calculating GDP GDP can be computed in two ways:
The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period.
The income approach:

17. The Expenditure Approach
The expenditure approach calculates GDP by adding together the four components of spending. In equation form:

18. The Circular Flow of Income and Expenditure
aggregate income = GDP
transfer payments
taxes
Disposable income
Financial
markets
consumption (C) S
Investment (I)
Gov’t (G)
X-M
C+I+G+X-M

19. Categories of Expenditures
Consumption (C)
All household purchases (blue jeans, twinkies, etc.)
Investment (I)
Purchases not used for current consumption (newly built homes,plant, new inventories)
Government Purchases (G)
Examples include missile systems and paper clips
Net Exports (X - M)
Net exports = exports (X) - imports (M)

20. Personal Consumption Expenditures
Personal consumption expenditures (C) are expenditures by consumers on the following:
Durable goods: Goods that last a relatively long time, such as cars and appliances.
Nondurable goods: Goods that are used up fairly quickly, such as food and clothing.
Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

21. Gross Private Domestic Investment
Investment refers to the purchase of new capital.
Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector.

22. Gross Private Domestic Investment
Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on.
Residential investment includes expenditures by households and firms on new houses and apartment buildings.
Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.
The relationship between total production and total sales is:
GDP = final sales + change in business inventories

23. Government Consumption and Gross Investment
Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

24. Net Exports
Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative.
Exports (EX) are sales to foreigners of U.S.-produced goods and services.
Imports (IM) are U.S. purchases of goods and services from abroad).

25. Classify each of these scenarios
You buy an old house
You buy some marijuana from a friend
You buy stock in GM
A Japanese firm buys City Brewery
The government makes a welfare payment
You buy a used car
A business fails to sell some of its inventory
A business buys a new truck
You buy an old house
You buy some marijuana from a friend
You buy stock in GM
A Japanese firm buys City Brewery
The government makes a welfare payment
You buy a used car
A business fails to sell some of its inventory
A business buys a new truck

26. Components of GDP, 2002: The Expenditure Approach
BILLIONS OF DOLLARS
PERCENTAGE OF GDP
Personal consumption expenditures (C)
7303.7
69.9
Durable goods
871.9
8.3
Nondurable goods
2115.0
20.2
Services
4316.8
41.3
Gross private domestic investment (l)
1543.2
14.8
Nonresidential
1117.4
10.7
Residential
471.9
4.5
Change in business inventories
3.9
Government consumption and gross investment (G)
1972.9
18.9
Federal
693.7
6.6
State and local
1279.2
12.2
Net exports (EX – IM)
- 4.1
Exports (EX)
1014.9
9.8
Imports (IM)
1438.5
13.8
Total gross domestic product (GDP)
100.0
Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis.

27. Current and Historical Data
US data (BEA)
Historical US Data
International

28. GDP and Social Welfare
Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP.
An increase in leisure is an increase in social welfare, but not counted in GDP.
Nonmarket and household activities are not counted in GDP even though they amount to real production.

29. GDP and Social Welfare
GDP accounting rules do not adjust for production that pollutes the environment.
GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP.
GDP is neutral to the kinds of goods an economy produces.

30. The Underground Economy
The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.
About $1 trillion in US
Highest in Greece at 29% of GDP.

31. Gross National Income per Capita
To make comparisons of GNP between countries, currency exchange rates must be taken into account.
Gross National Income (GNI) is a measure used to make international comparisons of output. GNI is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation.
GNI divided by population equals gross national income per capita.

32. Per Capita Gross National Income for Selected Countries, 2002
COUNTRY
U.S. DOLLARS
Switzerland
36,970
Portugal
10,670
Japan
35,990
South Korea
9,400
Norway
35,530
Argentina
6,860
United States
34,870
Mexico
5,540
Denmark
31,090
Czech Republic
5,270
Ireland
28,880
Brazil
3,060
Sweden
25,400
South Africa
2,900
United Kingdom
24,230
Turkey
2,540
Netherlands
24,040
Colombia
1,910
Austria
23,940
Jordan
1,750
Finland
23,840
Romania
1,710
Germany
23,700
Philippines
1,050
Belgium
23,340
China
890
France
22,640
Indonesia
680
Canada
21,340
India
460
Australia
18,770
Pakistan
420
Italy
18,470
Nepal
250
Spain
14,860
Rwanda
220
Greece
11,780
Ethiopia
100
Source: The World Bank Atlas, 2002.

33. Accounting for Price Changes

34. Nominal Versus Real GDP
Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices.
When a variable is measured in current dollars, it is described in nominal terms.

35. Real GDP
Real GDP is the value of GDP measure in terms of dollars of fixed purchasing power
Real GDP is measured in the dollars of the base year
The base year is a reference year against which other years are measured

36. The Simplest Example of a Price Index (One Product)

37. The GDP Price Index, Nominal GDP, and Real GDP
The GDP price index is a comprehensive price index of all goods and services included in the gross domestic product

38. Calculating Real GDP
A weight is the importance attached to an item within a group of items.
A base year is the year chosen for the weights in a fixed-weight procedure.
A fixed-weight procedure uses weights from a given base year.

39. Calculating Real GDP A Three-Good Economy (1) (2) (3) (4) (5) (6) (7)
(8)
GDP IN
YEAR 1
YEAR 2 IN
PRODUCTION
PRICE PER UNIT
PRICES Q1 Q2 P1 P2
P1 x Q1
P1 x Q2
P2 x Q1
P2 X Q2
Good A 6 11
$.50
$ .40
$3.00
$5.50
$2.40
$4.40
Good B 7 4
.30
1.00
2.10
1.20
7.00
4.00
Good C 10 12
.70
.90
8.40
9.00
10.80
Total
$12.10
$15.10
$18.40
$19.20
Nominal GDP in year 1
Nominal GDP in year 2

40. The Problems of Fixed Weights
The use of fixed price weights to estimate real GDP leads to problems because it ignores:
Structural changes in the economy.
Supply shifts, which cause large decreases in price and large increases in quantity supplied.
The substitution effect of price increases.

41. Hypothetical Data Used to Develop Chain-Weighted Indexes

42. Calculating the GDP Deflator
The GDP deflator is one measure of the overall price level. The GDP deflator is computed by the Bureau of Economic Analysis (BEA).
Overall price increases can be sensitive to the choice of the base year. For this reason, using fixed-price weights to compute real GDP has some problems.

43. Appendix
Slides after this point will most likely not be covered in class. However they may contain useful definitions, or further elaborate on important concepts, particularly materials covered in the text book.
They may contain examples I’ve used in the past, or slides I just don’t want to delete as I may use them in the future.

44. Introduction to Macroeconomics
Macroeconomists often reflect on the microeconomic principles underlying macroeconomic analysis, or the microeconomic foundations of macroeconomics.

45. Government in the Macroeconomy
Fiscal policy refers to government policies concerning taxes and spending.
Monetary policy consists of tools used by the Federal Reserve to control the quantity of money in the economy.
Growth policies are government policies that focus on stimulating aggregate supply instead of aggregate demand.

46. The Components of the Macroeconomy
The circular flow diagram shows the income received and payments made by each sector of the economy.

47. The Methodology of Macroeconomics
Connections to microeconomics:
Macroeconomic behavior is the sum of all the microeconomic decisions made by individual households and firms. We cannot understand the former without some knowledge of the factors that influence the latter.

48. Measuring Economic Aggregates

49. Gross Domestic Product and Gross National Product
GDP is the market value of all final goods and services produced by resources located in the United States, regardless of who owns those resources
GNP is the market value of all final goods and services produced by resources supplied by U.S. residents and firms, regardless of location

50. Calculating GDP GDP can be computed in two ways:
The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period.
The income approach: A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.

51. Gross Private Domestic Investment
Remember that GDP is not the market value of total sales during a period—it is the market value of total production.
The relationship between total production and total sales is:
The relationship between total production and total sales is:
GDP = final sales + change in business inventories
GDP = final sales + change in business inventories

52. Consumer Price Index
The consumer price index is a measure over time of the cost of a fixed “market basket” of consumer goods and services

53. Review Terms and Concepts
base year
change in business inventories
compensation of employees
corporate profits
current dollars
depreciation
disposable personal income, or after-tax income
durable goods
expenditure approach
final goods and services
fixed-weight procedure
government consumption and gross investment (G)
gross domestic product (GDP)
gross investment
gross national income (GNI)
gross national product (GNP)
gross private domestic investment (I)
income approach
indirect taxes
intermediate goods
national income
national income and product accounts

54. Review Terms and Concepts
net exports (EX – IM)
net factor payments to the rest of the world
net interest
net investment
net national product (NNP)
nominal GDP
nondurable goods
nonresidential investment
personal consumption expenditures (C)
personal income
personal saving
personal saving rate
proprietors’ income
rental income
residential investment
services
subsidies
underground economy
value added
weight

55. Skip The slides that follow
We skipped some of the slides for time consideration and some because it is material I do not care to cover.

56. The Components of the Macroeconomy
Transfer payments are payments made by the government to people who do not supply goods, services, or labor in exchange for these payments.

57. The Three Market Arenas
Households, firms, the government, and the rest of the world all interact in three different market arenas:
Goods-and-services market
Labor market
Money (financial) market

58. The Three Market Arenas
Households and the government purchase goods and services (demand) from firms in the goods-and services market, and firms supply to the goods and services market.
In the labor market, firms and government purchase (demand) labor from households (supply).
The total supply of labor in the economy depends on the sum of decisions made by households.

59. The Three Market Arenas
In the money market—sometimes called the financial market—households purchase stocks and bonds from firms.
Households supply funds to this market in the expectation of earning income, and also demand (borrow) funds from this market.
Firms, government, and the rest of the world also engage in borrowing and lending, coordinated by financial institutions.

60. Financial Instruments
Treasury bonds, notes, and bills are promissory notes issued by the federal government when it borrows money.
Corporate bonds are promissory notes issued by corporations when they borrow money.

61. Financial Instruments
Shares of stock are financial instruments that give to the holder a share in the firm’s ownership and therefore the right to share in the firm’s profits.
Dividends are the portion of a corporation’s profits that the firm pays out each period to its shareholders.

62. Review Terms and Concepts
aggregate behavior
aggregate demand
aggregate output
aggregate supply
business cycle
circular flow
contraction, recession, or slump
corporate bonds
deflation
depression
dividends
expansion or boom
fine tuning
fiscal policy
Great Depression
hyperinflation
inflation
macroeconomics
microeconomic foundations of macroeconomics
microeconomics
monetary policy
recession
shares of stock
stagflation
sticky prices
supply-side policies
transfer payments
Treasury bonds, notes, bills
unemployment rate

63. Inflation and Deflation
Inflation is an increase in the overall price level.
Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations are rare, but have been used to study the costs and consequences of even moderate inflation.
Deflation is a decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation.

64. Unemployment
The unemployment rate is the percentage of the labor force that is unemployed.
The unemployment rate is a key indicator of the economy’s health.
The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium. Why do labor markets not clear when other markets do?

65. Unemployment Rate, 1970 I-2003 II

66. Percentage Change in the GDP Deflator (Four-Quarter Average), 1970 I-2003 II

67. Introduction to Macroeconomics
Microeconomics examines the behavior of individual decision-making units—business firms and households.
Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices.
Aggregate behavior refers to the behavior of all households and firms together.

68. Introduction to Macroeconomics
Microeconomists generally conclude that markets work well. Macroeconomists, however, observe that some important prices often seem “sticky.”
Sticky prices are prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded.

69. The Roots of Macroeconomics
The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s.

70. The Roots of Macroeconomics
Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems.
However, simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. This provided the impetus for the development of macroeconomics.
And they often fail to explain any involuntary unemployment.

71. The Roots of Macroeconomics
In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money.
Keynes believed governments could intervene in the economy and affect the level of output and employment.
During periods of low private demand, the government can stimulate aggregate demand to lift the economy out of recession.
This is a theory of insufficient aggregate demand. Keynes argued that govt should pay people to dig holes and others to fill them.

72. Recent Macroeconomic History
Fine-tuning was the phrase used by Walter Heller to refer to the government’s role in regulating inflation and unemployment.
The use of Keynesian policy to fine-tune the economy in the 1960s, led to disillusionment in the 1970s and early 1980s.

73. Recent Macroeconomic History
Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).
70’s staglflation was not easily explainable by Keynesian models

74. Aggregate Supply and Aggregate Demand
Aggregate demand is the total demand for goods and services in an economy.
Aggregate supply is the total supply of goods and services in an economy.
Very different then micro.
AD does not increase as price falls due to the substitution effect (among goods anyway). There may be some substitution among financial assets, and there may be an income effect.
While there is also some controversy on the supply side it can’t be upward slopping because the price of inputs is fixed, P represents the price of all goods and services including those that are inputs.
Aggregate supply and demand curves are more complex than simple market supply and demand curves.

75. Government in the Macroeconomy
There are three kinds of policy that the government has used to influence the macroeconomy:
Fiscal policy
Monetary policy
Growth or supply-side policies