GDP and its measurement
Gross Domestic Product
Two definitions:
1. Total expenditure on
final goods and services
2. Total income earned by
factors of production
slide 0
slide 1
The Circular Flow
Why expenditure = income
Income ($ )
In
In every
every transaction,
transaction,
the
’s expenditure
buyer
the buyer’
buyer’s
expenditure
becomes
the
seller’
’s income.
seller
becomes the seller’s
income.
Labor
Thus,
Thus, the
the sum
sum of
of all
all
expenditure
equals
expenditure equals
the
the sum
sum of
of all
all income.
income.
Households
Firms
Goods (bread )
Expenditure ($ )
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slide 3
Circular flow
Value added
definition:
A firm’s value added is
the value of its output
Inner: households sell labor to firms, firms sell bread to households;
outer: households pay firms for bread, firms pay wages and profit to
households
minus
GDP = total income from production of bread
= total expenditure on bread
the value of the intermediate goods
the firm used to produce that output.
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slide 5
1
Final goods, value added, and GDP
Example
ƒ A farmer grows a bushel of wheat
ƒ GDP = value of final goods produced
and sells it to a miller for $1.00.
= sum of value added at all stages
of production
ƒ The miller turns the wheat into flour
ƒ The value of the final goods already includes
the value of the intermediate goods,
so including intermediate goods in GDP
would be double-counting.
and sells it to a baker for $3.00.
ƒ The baker uses the flour to make a loaf of
bread and sells it to an engineer for $6.00.
ƒ The engineer eats the bread.
Compute
– value added at each stage of production
– GDP for this simple economy
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Answer
The expenditure components of GDP
Each person’s value-added (VA) equals the value
of what he/she produced minus the value of the
intermediate inputs he/she started with.
ƒ
Farmer’s VA = $1
ƒ
Miller’s VA = $2
ƒ
Baker’s VA = $3
ƒ
GDP = $6
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• consumption
• investment
• government spending
• net exports
ƒ Note that GDP = value of final good = sum of
value-added at all stages of production.
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Consumption (C
(C)
slide 9
U.S. Consumption, 2001
def: the value of all goods • durable goods
last a long time
and services bought by
ex: cars, home
households. Includes:
$$ billions
billions
appliances
• non-durable goods
last a short time
ex: food, clothing
• services
work done for
consumers
ex: dry cleaning,
air travel.
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Consumption
Consumption
Durables
Durables
$7,064.5
$7,064.5
%
% of
of
GDP
GDP
69.2%
69.2%
858.3
858.3
8.4
8.4
Nondurables
Nondurables
2,055.1
2,055.1
20.1
20.1
Services
Services
4,151.1
4,151.1
40.7
40.7
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2
Investment (I
(I)
Services
ƒ Share of manufacturing has fallen (<
20%) in all major economies.
ƒ Services and manufacturing have become
intertwined: GM financial; Sony
def1: spending on newly produced capital goods.
def2: spending on goods bought for future use.
Includes:
ƒ business fixed investment
spending on plant and equipment that firms will
use to produce other goods & services
ƒ residential fixed investment
spending on housing units by consumers and
landlords
ƒ inventory investment
the change in the value of all firms’ inventories
slide 12
U.S. Investment, 2001
$$ billions
billions
Investment
Investment
$1,633.9
$1,633.9
Business
Business fixed
fixed
slide 13
Investment
%
% of
of
GDP
GDP
16.0%
16.0%
1,246.0
1,246.0
12.2
12.2
Residential
Residential fixed
fixed
446.3
446.3
4.4
4.4
Inventory
Inventory
-58.4
-58.4
-0.6
-0.6
ƒ In definition #1, note that aggregate
investment equals total spending on
newly produced capital goods.
ƒ If I pay $1000 for a used computer for
my business, then I’m doing $1000 of
investment, but the person who sold it to
me is doing $1000 of disinvestment, so
there is no net impact on aggregate
investment.
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slide 15
Investment vs. Capital
Housing
ƒ think of a house as a piece of capital
which is used to produce a consumer
service, called “housing services”. Thus,
spending on the house counts in
“investment”, and the value of the
housing services that the house provides
counts under “consumption” (regardless
of whether the housing services are being
consumed by the owner of the house or a
tenant).
slide 16
ƒ Capital is one of the factors of production.
At any given moment, the economy has a
certain overall stock of capital.
ƒ Investment is spending on new capital.
ƒ It is new additions (flow) to the existing
capital stock.
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3
Investment vs. Capital
Inventories
ƒ If total inventories are $10 billion at the
Example
– 1/1/2002: economy has $500b worth of
capital
ƒ during 2002:
investment = $37b
beginning of the year, and $12 billion at
the end, then inventory investment
equals $2 billion for the year.
ƒ Note that inventory investment can be
negative.
ƒ 1/1/2003:
economy will have $537b worth of capital
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Government spending (G
(G)
slide 19
Government spending, 2001
ƒ G includes all government spending on goods and
services.
ƒ G excludes transfer payments
(e.g. unemployment insurance payments), because
they do not represent spending on goods and
services.
ƒ People who receive transfer payments use these
funds to pay for their consumption.
ƒ avoid double-counting by excluding transfer
payments from G.
$$ billions
billions
Gov
Gov spending
spending
Federal
Federal
$1,839.5
$1,839.5
%
% of
of
GDP
GDP
18.0%
18.0%
615.7
615.7
6.0
6.0
Non-defense
Non-defense
216.6
216.6
2.1
2.1
Defense
Defense
399.0
399.0
3.9
3.9
1,223.8
1,223.8
12.0
12.0
State
State&&local
local
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GDP review
An important identity
Y = C+I+G
We have now seen that GDP measures
ƒ total income
ƒ total output
ƒ total expenditure
ƒ the sum of value-added at all stages
in the production of final goods
where
Y = GDP = the value of total output
C + I + G = aggregate expenditure
ƒY = C+I+G
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slide 23
4
Inflation: The connection between money and prices
ƒ price = amount of money required to
Consumer Price Index (CPI)
ƒ A summary measure of the overall level of
buy 1 unit of a good.
prices
ƒ Value of $1 = how many units of the good
ƒ Published by the Bureau of Labor
ƒ Inflation rate = the percentage increase
ƒ Used to
Statistics (BLS)
does $1 buy?
– track changes in the typical household’s cost of
in the average level of prices.
living
– adjust many contracts for inflation (i.e. “COLAs”)
– allow comparisons of dollar figures from
different years
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slide 25
Exercise: Compute the CPI
How the BLS constructs the CPI
1. Survey consumers to determine composition
of the typical consumer’s “basket” of goods.
2. Every month, collect data on market prices
of all items in the basket; compute cost of
basket
prices:
2000
2001
2002
2003
3. CPI in any month equals
100 ×
The basket contains 20 pizzas and
10 compact discs.
Cost of basket in that month
Cost of basket in base period
pizza
$10
$11
$12
$13
For each year, compute
ƒ the cost of the basket
CDs
$15
$15
$16
$15
ƒ the
the
ƒ the
the
CPI (use 2000 as
base year)
inflation rate from
preceding year
slide 26
U.S. inflation & its trend, 19601960-2001
answers:
CPI
inflation
rate
2000
$350
100.0
n.a.
2001
370
105.7
5.7%
2002
400
114.3
8.1%
2003
410
117.1
2.5%
16
14
12
% per year
cost of
basket
slide 27
10
8
6
4
2
0
1960
Suppose prices in 2003 were $12 and $15 respectively.
Then inflation rate between 2002 and 2003 would be :
-2.5%; called deflation
1965
1970
1975
1980
inflation rate
slide 28
1985
1990
1995
2000
inflation rate trend
slide 29
5
Deflation
CPI basket
ƒ FOOD AND BEVERAGES (breakfast cereal, milk,
coffee, chicken, wine, full service meals and
snacks);
ƒ HOUSING (rent of primary residence, owners'
equivalent rent, fuel oil, bedroom furniture);
ƒ APPAREL (men's shirts and sweaters, women's
dresses, jewelry);
ƒ TRANSPORTATION (new vehicles, airline fares,
gasoline, motor vehicle insurance);
ƒ MEDICAL CARE (prescription drugs and medical
supplies, physicians' services, eyeglasses and
eye care, hospital services);
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CPI basket
slide 31
Main problems with CPI
ƒ RECREATION (televisions, cable
television, pets and pet products, sports
equipment, admissions);
ƒ The CPI may not be applicable to all
population groups. Urban bias. Elderly.
ƒ EDUCATION AND COMMUNICATION
ƒ New goods
(college tuition, postage, telephone
services, computer software and
accessories);
ƒ Better goods
ƒ OTHER GOODS AND SERVICES (tobacco
and smoking products, haircuts and other
personal services, funeral expenses).
ƒ Excluded: stocks, bonds, investment
items
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Real vs. Nominal GDP
slide 33
Real GDP controls for inflation
ƒ GDP is the $ value of all final goods and
Changes in nominal GDP can be due to:
ƒ changes in prices
ƒ changes in quantities of output
produced
services produced.
ƒ Nominal GDP measures these values
using current prices.
ƒ Real GDP measure these values using
Changes in real GDP can only be due to
changes in quantities,
because real GDP is constructed using
constant base-year prices.
the prices of a chosen base year.
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6
Practice problem, part 1
2001
2002
Answers to practice problem, part 1
2003
ƒ Nominal GDP
P
Q
P
Q
P
Q
good A
$30
900
$31
1,000
$36
1,050
good B
$100
192
$102
200
$100
205
ƒ Real GDP
ƒ Compute nominal GDP in each year
multiply Ps & Qs from same year
2001: $46,200 = $30 × 900 + $100 × 192
2002: $51,400
2003: $58,300
multiply each year’s Qs by 2001 Ps
2001: $46,300
2002: $50,000
2003: $52,000 = $30 × 1050 + $100 × 205
ƒ Compute real GDP in each year using
2001 as the base year.
slide 36
11,000
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
1965
(billions of U.S. dollars)
(billions of U.S. dollars)
U.S. Real & Nominal GDP, 19671967-2001
slide 37
11,000
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
1965
1970
1975
1980
NGDP (billions of $)
1970
1975
1980
NGDP (billions of $)
1985
1990
1995
2000
RGDP (billions of 1996 $)
1985
1990
1995
2000
RGDP (billions of 1996 $)
Take 1970. When the economy’s output of 1970 is measured in the
(then) current prices, GDP is about $1 trillion. Between 1970 and
1996, most prices have risen. Hence, if you value the country’s 1970
using 1996 prices (to get real GDP), you get a bigger value than if
you just measure 1970’s output in 1970 prices (nominal GDP).
slide 38
Real interest rate
1980: $ 1; 1990: $ 2; 2000: $ 3
1980: 100 apples; 1990: 200 apples; 2000: 300 apples
In current prices:
GDP (1980) = $ 100; GDP (1990) = $ 400; GDP (2000) = $ 900
ƒ The real interest rate is
the real cost of borrowing
the real opportunity cost of using one’s
own funds to finance investment
spending.
z
z
In 1990 prices:
GDP (1980) = $200; GDP (1990) = $400; GDP (2000) = $ 600
Since prices rose over time, output to the left of base year has
higher value and output to right of base year has smaller value
Explains why nominal GDP is lower than real GDP to the
left of the base year and higher than real GDP to the right
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7
Real v nominal (example)
Real vs nominal interest rates
Percent
16
In 2000: $100; can buy 50 apples [1 apple = $2]
Interest on $100 for a year at 10% = $10; nominal income in 2001 =
$110
14
12
Suppose in 2001, price of an apple went up to $2.20; can now buy
110/2.20 = 50 apples
10
Even though nominal income went up from $100 to $110, real income
did not go up
8
Nominal
interest rate
6
Real interest rate is 0%
4
Suppose instead: price of an apple had gone up to $2.10; 52.38 apples
Inflation
rate
2
Real interest rate = (52.38 – 50)/50 * 100 = 4.76 % = approximately 5%
0
-2
1950
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Year
slide 42
Employment categories
slide 43
Two important labor force concepts
ƒ unemployment rate
ƒ employed
working at a paid job
percentage of the labor force that is
unemployed
ƒ unemployed
not employed but looking for a job
ƒ labor force participation rate
ƒ labor force
the fraction of the adult population
that ‘participates’ in the labor force
the amount of labor available for producing
goods and services; all employed plus
unemployed persons
ƒ not in the labor force
not employed, not looking for work.
slide 44
Exercise: Compute labor force statistics
U.S. adult population by group, April 2002
Number employed
= 134.0 million
Number unemployed =
8.6 million
Adult population
= 213.5 million
Use the above data to calculate
• the labor force
• the number of people not in the labor force
• the labor force participation rate
• the unemployment rate
slide 45
Answers:
ƒ data: E = 134.0, U = 8.6, POP = 213.5
ƒ labor force
L = E +U = 134.0 + 8.6 = 142.6
ƒ not in labor force
NILF = POP – L = 213.5 – 142.6 = 70.9
ƒ unemployment rate
U/L = 8.6/142.6 = 0.06 or 6.0%
ƒ labor force participation rate
L/POP = 142.6/213.5 = 0.668 or 68.8%
slide 46
slide 47
8
Exercise: Compute percentage
changes in labor force statistics
Change in employment status in a typical month
Suppose
‰
‰
‰
the population increases by 1%
the labor force increases by 3%
the number of unemployed persons
increases by 2%
Compute the percentage changes in
the labor force participation rate: 2%
the unemployment rate: −1%
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slide 49
9