1. Gross Domestic Product Measures Total Production Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year. GDP Is Measured Using Market Values, Not Quantities The worth of a thing is the price it will bring. Final good or service A good or service purchased by a final user: Household consumption Business investment, including all residential construction Government purchases Exports to foreigners vs Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. GDP Includes Only Current Production

2. PRODUCTION AND PRICE STATISTICS FOR 2011 (1) PRODUCT (2) QUANTITY (3) PRICE PER UNIT Eye examinations 100$50.00 Pizzas 8010.00 Textbooks 20100.00 Paper (for textbooks) 2,0000.10 PRODUCT (1) QUANTITY (2) PRICE PER UNIT (3) VALUE Eye examinations100$50$5,000 Pizzas8010800 Textbooks201002,000 Total GDP = $7,800

3. Production, Income, and the Circular Flow Diagram S private Im X C T T G + Tr G Deficit NX = X - Im I = S private - NX - Deficit

4. Y: Components of GDP = $16.0 trillion (2013:Q1) Consumption Spending by households on goods and services, not including spending on new houses. C : Personal Consumption Expenditures = “Consumption” = 71.0% of Y Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses. I : Gross Private Domestic Investment, or “Investment” = 13.4% of Y G : Government Consumption and Gross Investment,or “Government Purchases” = 19.0 % of Y Government purchases Spending by federal, state, and local governments on goods and services. NX : Net Exports of Goods and Services, or “Net Exports” = -3.4% of Y X = 13.7 % of YIm = 17.1% of Y

5. Transfer payments are not included in GDP : Payments by the government to individuals for which the government does not receive a new good or service in return. Unemployment benefits paid to someone not working. Social security benefits paid to someone who is retired. Interest income paid to a government bondholder Since the government doesn’t produce anything for the market, the interest payment can’t be for any productive service. “Underground economy” activities are not included in GDP Production “off-the-books” Illegal activities Household production is not included in GDP

6. Does GDP Measure What We Want It to Measure? Shortcomings of GDP as a Measure of Well-Being The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

7. Per Capita Real GDP and Life Satisfaction

9. Consumer spending on services is greater than the sum of spending on durable and nondurable goods. Business fixed investment is the largest component of investment. Gross private domestic investment includes New plant and equipment New residential construction Net additions to business inventories Purchases made by state and local governments are greater than purchases made by the federal government. Imports are greater than exports  net exports are negative.

10. Consider the data above (in billions of dollars) for an economy: Gross domestic product (in billions of dollars) for this economy equals A) $2,200. B) $1,600. C) $1,400. D) $1,200. C onsumption expenditures $800 I nvestment expenditures 200 G overnment purchases 300 Ex ports 100 Im ports 200 W ages 800

11. Measuring GDP by the Value-Added Method Value added The market value a firm adds to a product. FIRMVALUE OF PRODUCTVALUE ADDED Cotton FarmerValue of raw cotton = $1 Value added by cotton farmer= 1 Textile Mill Value of raw cotton woven into cotton fabric = $3 Value added by cotton textile mill = ($3 – $1)= 2 Shirt Company Value of cotton fabric made into a shirt = $15 Value added by shirt manufacturer = ($15 –$3)= 12 L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35 Value added by L.L. Bean = ($35 – $15)= 20 Total Value Added= $35

12. PRODUCT 2009 QUANTITY 2000 PRICEVALUE Eye examinations100$40$4,000 Pizzas8011880 Textbooks20901,800 20002009 PRODUCTQUANTITYPRICEQUANTITYPRICE Eye examinations80$40100$50 Pizzas90 118010 Textbooks15 9020100 Real GDP versus Nominal GDP Real GDP The value of this year’s final goods and services evaluated at base-year prices. Nominal GDP The value of this year’s final goods and services evaluated at this year’s prices. vs

13. Comparing Real GDP and Nominal GDP Nominal GDP and Real GDP, 1990–2006

14. The GDP Deflator GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. $ GDP = Price Level x Real Output $Y = P x Y P = $Y/Y

15. If the GDP deflator is greater than 100, real GDP is greater than nominal GDP. a) True b) False c) The GDP deflator measures the general price level and has nothing to do with GDP, nominal or real, which measure output.

16. Increase in real GDP would overstate the increase of well-being in a country over time if a)average hours worked per week increased b)the amount of pollution increased c)the crime rate increased d)All of the above e)None of the above

17. Other Measures of Total Production and Total Income Gross National Product (GNP) =GDP + Net Foreign Earnings of US Residents Compensation of employees earned abroad Interest and profits earned abroad Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation) National Income (NI) = NNP - Indirect Business Taxes Personal Income (PI) = NI + Net Transfer Payments = Income earned from production of national product Disposable Income (DI) = PI - Income Taxes Disposable Income is split between consumption and saving

18. Other Measures of Total Production and Total Income FIGURE 7-4 Measures of Total Production and Total Income, 2006

19. Other Measures of Total Production and Total Income The Division of Income FIGURE 7-5 The Division of Income

20. Business cycle Consumption Economic growth Expansion Final good or service GDP deflator Government purchases Gross domestic product (GDP) Inflation rate Intermediate good or service Investment K e y T e r m s Macroeconomics Microeconomics Net exports Nominal GDP Price level Real GDP Recession Transfer payments Underground economy Value added