A Case Study
Gross Domestic Product
Third Quarter, 2003
Date of Announcement
November 25, 2003
Dates of Future Announcements
December 23, 2003
Announcement
Real Gross Domestic Product (GDP) during the third quarter (July through
September) of 2003 increased at an annual rate of 8.2 percent.
Interactive question.
High
Is this rate of increase high relative to recent
increases? Low? About the same?
Low
About the
same
Answer. (This should pop up.) This increase is quite high and compares to rates of
increase of 1.4 percent in the first quarter and 3.3 percent in the second quarter of this
year. During 2002, real GDP increased by 2.4 percent. Annual growth rates in 2000
and 2001 were 3.8 percent and .3 percent.
Attention Teachers
Material that appears in italics is included in the teacher version only. All other
material appears in the student version. Throughout the semester, the GDP cases will
become progressively more comprehensive and advanced.
Goals of Case Study
The goals of the GDP case studies are to provide teachers and students:
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access to easily understood, timely interpretations of monthly announcements of
rates of change in real GDP and the accompanying related data in the U.S.
economy;
descriptions of major issues surrounding the data announcements;
brief analyses of historical perspectives;
questions and activities to use to reinforce and develop understanding of relevant
concepts; and
a list of publications and resources that may benefit classroom teachers and
students interested in exploring inflation.
Announcement
Real Gross Domestic Product (GDP) during the third quarter (July through
September) of 2003 increased at an annual rate of 8.2 percent. This is the second release
of the number and was revised upward from the initial announcement of 7.2% released
one month ago. This compares to rates of 1.4 and 3.3 percent in the first and second
quarters of 2003. During 2002, real GDP changed at annual rates of 5.0 percent, 1.3
percent, 4.0 percent and 1.4 percent for each quarter respectively.
The growth rate in real GDP for all of 2001 was .3 percent. That compares to 4.1
percent annual growth rates in 1999 and 3.8 percent in 2000.
Meaning of the Announcement
The U.S. economy was in a recession during most of 2001 and has experienced only
modest growth in real GDP since. In fact, employment has fallen and unemployment has
increased for much of the time since the recession ended in November of 2001. This
announcement, which is an even more rapid rate of increase than previously announced,
along with improving employment reports is good news. However, we should be
cautious with the results of any single quarter. (Real GDP did increase as much as 5.0
percent in the first quarter of 2002, only to fall to significantly lower rates of increase
since.)
Definition of Gross Domestic Product
Gross Domestic Product (GDP) is one measure of economic activity, the total amount
of goods and services produced in the United States in a year. It is calculated by adding
together the market values of all of the final goods and services produced in a year.
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It is a gross measurement because it includes the total amount of goods and
services produced, some of which are simply replacing goods that have
depreciated or have worn out.
It is domestic production because it includes only goods and services produced
within the U.S.
It measures current production because it includes only what was produced during
the year.
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It is a measurement of the final goods produced because it does not include the
value of a good when sold by a producer, again when sold by the distributor, and
once more when sold by the retailer to the final customer. We count only the
final sale.
Changes in GDP from one year to the next reflect changes in the output of goods and
services and changes in their prices. To provide a better understanding of what actually
is occurring in the economy, real GDP is also calculated. In fact, these changes are more
meaningful, as the changes in real GDP show what has actually happened to the
quantities of goods and services, independent of changes in prices.
Why are Changes in Real Gross Domestic Product Important?
The measurement of the production of goods and services produced each year permits
us to evaluate our monetary and fiscal polices, our investment and saving patterns, the
quality of our technological advances, and our material well-being. Changes in real GDP
per capita provide our best measures of changes in our material standards of living.
While rates of inflation and unemployment and changes in our income distribution
provide us additional measures of the successes and weaknesses of our economy, none is
a more important indicator of our economy's health than rates of change in real GDP.
Changes in real GDP are discussed in the press and on the nightly news after every
monthly announcement of the latest quarter's data or revision. This current increase in
real GDP will be discussed in news reports as a sign that the economy may have already
come out of the recession that began in March of last year.
Real GDP trends are prominently included in discussions of potential slowdowns and
economic booms. They are featured in many discussions of trends in stock prices.
Economic commentators use falls in real GDP as indicators of recessions. The most
popular (although inaccurate) definition of a recession is at least two consecutive quarters
of declining real GDP. See below for a discussion of the current recession.
Data Trends
The growth in real GDP at the end of the 1990s has been relatively high when
compared with the early part of the 1990s. However, during the last two quarters of
2000, the rate of growth of real gross domestic product slowed significantly and during
the first three quarters of 2001, the rate of growth of real gross domestic product was
actually negative as the U.S. economy entered a recession in March of 2001 lasting
through November of 2001. The changes in real GDP were actually negative for the first
time since 1993.
The Federal Reserve responded to slowing growth and the recession by reducing the
target federal funds rate by 475 basis points (4.75%) from January 2001 to December
2001 and then two more times since. The most recent was in June of 2003. (See Federal
Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy and the
resulting low interest rates helped increase consumer spending during and since the
recession.
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The price index for GDP increased at an annual rate of 1.7 percent during the third
quarter of 2003, compared to an increase of 1.0 percent during the second quarter of
2003. It increased at an annual rate of 1.1 percent for 2002, compared to 2.4 percent for
2001.
Figure 2
The rate of increase in real GDP has been not only higher in the last several years
than in the first part of the 1990s, but also when compared with much of the 1970s and
1980s. Economic growth, as measured by average annual changes in real GDP, was 4.4
percent in the 1960s. Average rates of growth decreased during the 1970s (3.3%), the
1980s (3.0%), and the first half of the 1990s (2.2%). In the last five years of the 1990s,
the rate of growth in real GDP increased to 3.8 percent, with the last three years of the
1990s being at or over 4.1 percent per year.
Figure 3
The upward trend in economic growth over the past decade has been accompanied by
increases in the rates of growth of consumption spending, investment spending, and
exports. Productivity increases, expansions in the labor force, decreases in
unemployment, and increases in the amount of capital have allowed real GDP to grow at
the faster rates. Increases in productivity, that is, output per hour worked, are the key to
increases in real GDP per capita and therefore to increases in material standards of living.
Details of the Third-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 8.2 percent in the third quarter of 2003
compared to a rise of 3.3 percent in the second quarter of 2003. The major contributors
to the increase in real GDP were the increase in consumption spending, business
investment, and investment in housing. There was also a small increase in exports and a
slower rate of growth in imports, both of which contributed to a more rapid rise in real
GDP. Federal government spending on defense actually fell after the second quarter
extremely rapid rise of 45 percent.
Gross private domestic investment increased at an annual rate of 18.2 percent during
the third quarter of 2003, compared to an increase of 2.0 percent in the second quarter of
2003. For all of 2002, investment spending increased by only 1 percent.
Third quarter exports increased by 11 percent (compared to a decrease of 1 percent in
the second quarter) and imports increased by 1.5 percent (compared to an increase of 8.8
percent in the second quarter). Net exports rose significantly during the quarter.
GDP, Productivity, and Unemployment
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A major factor in the continued growth in the American economy, as seen in the
strong increase of 8.2% real GDP growth in the third quarter, is the continued
improvement in productivity.
Productivity, defined as the amount of output per hour of work, increased at an annual
rate of 8.1% in the third quarter and 7.0% growth in the second quarter. Businesses are
able to gain more output from the same number of workers, boosting economic results.
This explains how the economy continues to grow strongly even as the unemployment
rate stays high and employment grows only slowly.
The Federal Reserve has stated in its recent releases that continued productivity
growth is a key component in the continued growth in the American economy.
Businesses are able to keep costs low by reducing the need to hire new employees to
create growth. The biggest cause of this productivity growth has been investment in
information technology and software. This growth has allowed the Fed to cut rates more
than it would otherwise, as inflationary pressures are reduced. Alan Greenspan has
repeatedly cited productivity growth and was one of the first to view the 1990’s boom in
technology spending as a period of sustainable growth above historical levels.
Eventually, continued productivity and economic growth will spur new investment and
hiring.
Recessions
On November 26, 2001, the National Bureau of Economic Research (NBER)
announced though its Business Cycle Dating Committee that it had determined that a
peak in business activity occurred in March of 2001. That signals the official beginning
of a recession. More recently the NBER announced that the recession actually ended in
November of 2001.
The NBER defines a recession as a "significant decline in activity spread across the
economy, lasting more than a few months, visible in industrial production, employment,
real income, and wholesale-retail trade."
The previous recession began in July of 1990 and ended in March of 1991, a period
of eight months. However, the beginning of the recession was not announced until April
of 1991 (after the recession had actually ended). The end of the recession was announced
in December of 1992, almost 21 months later. One of the reasons the ends of that
recession and the most recent one were so difficult to determine was that the economy
did not grow very rapidly even after it came out a period of falling output and income.
For the full press release from the National Bureau of Economic Research see:
http://cycles-www.nber.org/cycles.html
A Hint About News Reports
Many news reports simply use "gross domestic product" as a term to describe this
announcement. The actual announcement focuses on the REAL gross domestic product,
and that is the meaningful part of the report. In addition, newspapers will often refer to
the rate of growth during the most recent quarter and will not always refer to the fact
that it is reported at annual rates of change. This is contrasted to the reports of the
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consumer price index, which are reported at actual percentage changes in the index for a
single month, and not at annual rates.
Explanations of GDP and its Components
It is common to see the following equation in economics textbooks:
GDP = C + I + G + NX
Consumption spending (C) consists of consumer spending on goods and services. It
is often divided into spending on durable goods, non-durable goods, and services. These
purchases accounted for 70 percent of GDP in the third quarter.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years (9%).
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period (21%).
Services include rent paid on apartments (or estimated values for owner-occupied
housing), airplane tickets, legal and medical advice or treatment, electricity and other
utilities. Services are the fastest growing part of consumption spending (41%).
Investment spending (I) consists of non-residential fixed investment, residential
investment, and inventory changes. Investment spending accounts for 15 percent of
GDP, but varies significantly from year to year.
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Non-residential fixed investment is the creation of tools and equipment to use in the
production of other goods and services. Examples are the building of factories, the
production of new machines, and the manufacturing of computers for business use
(10%).
Residential investment is the building of a new homes or apartments (5%).
Inventory changes consist of changes in the level of stocks of goods necessary for
production and finished goods ready to be sold (0%).
Government spending (G) consists of federal, state, and local government spending
on goods and services such as research, roads, defense, schools, and police and fire
departments. This spending (19%) does not include transfer payments such as Social
Security, unemployment compensation, and welfare payments, which do not represent
production of goods and services. Federal defense spending now accounts for
approximately 5 percent of GDP. State and local spending on goods and services
accounts for 12 percent of GDP.
Net Exports (NX) is equal to exports minus imports. Exports are items produced in
the U.S. and purchased by foreigners (10%). Imports are items produced by foreigners
and purchased by U.S. consumers (14%). Thus, net exports (exports minus imports) are
negative, about - 4% of the GDP.
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Interactive questions –
1. What happens to real GDP as
Increases
Decreases
Stays the same
consumption spending increases?
2. What happens to consumption
Increases
Decreases
Stays the same
spending as real GDP increases?
3. What is the difference or the
similarity?
Answers –
1. Increases
2. Increases
3. The results are the same, but the difference is in causation. In the first case,
consumption spending increases causing real GDP to increase. In the second, an
increase in real GDP causes income to increase and consumption to increase as a
result.
A trade deficit
In the latest announcement of U.S. international trade conditions, the Department of
Commerce said that total September exports of $86.2 billion and imports of $127.4
billion resulted in a goods and services deficit of $41.3 billion, $1.8 billion more than the
$39.5 billion than the revised August amount.
If the trade deficit continues at the same pace of a year, the deficit in trade would be
almost $500 billion dollars or 4.5 percent of GDP. Such a deficit, particularly at a time of
relatively high unemployment, raises concerns and often results in political pressure to
use tariffs and quotas to reduce imports. The goal of such a policy is to make imports
more expensive and cause consumers and businesses to switch to domestically produced
goods. The intended final result is to increase employment and decrease unemployment
in the U.S.
Such a policy is however counterproductive.
Interactive questions 1. What will happen to imports with the placing of tariffs on imported goods?
Increase
Decrease
Stay the same
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2. What will likely happen to exports?
Increase
Decrease
Stay the same
3. What will likely happen to U.S. employment?
Increase
Decrease
Stay the same
Answers –
1. Decrease. Decrease as imports become more expensive.
2. Decrease. May decrease as other countries respond with tariffs on U.S. goods.
3. Stay approximately the same. U.S. employment rises in firms competing with
foreign imports and falls in U.S. export industries.
Note to teachers. More advanced students may discuss the fundamental cause of
trade deficits and recognize that decreases in imports will eventually raise the
international value of the dollar and result exports becoming more expensive and
thus falling.
Revisions in GDP Announcements
Real GDP for each quarter is announced three times. The month following the end of
the quarter is described as the advance GDP; the second announcement or revision is
described as the preliminary announcement; and the third month is the final. While
labeled as the final version, even it will eventually be revised after the final data for the
year are published. Since 1978, the advance estimates have been revised an average
increase of 0.5 percent in the rate of growth of GDP and the preliminary estimates have
been revised by an average increase of 0.3 in the rate of growth of GDP.
Revisions in inventory investment and the international trade data are often the
causes of changes in the GDP figures. Because changes in inventories and international
trade data make up significant portions of the current report, one should be particularly
cautious in using the “advance” and “preliminary” figures.
Questions (All of these should be placed in an interactive mode.)
Components of GDP
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Determine if each of the items listed below should be included in GDP and under
which component or components: Consumption, Investment, Government, Exports or
Imports.
1. A stereo produced and sold in the U.S. by a Japanese company
2. College tuition
3. Social Security payments
4. Microsoft stock purchased from Microsoft
5. A space shuttle launch
6. The purchase of a plane ticket to London on British Airways
7. The purchase of a U.S. Treasury Bond by an individual
8. A new factory
9. The sale of a previously occupied house
10. A bottle of French wine, sold in the U.S.
11. A television produced, but not sold.
12. A home cooked meal
13. A dinner at a restaurant
14. A computer produced in the U.S. and sold in Canada
15. A new interstate
Answers 1. Consumption – A stereo produced and purchased in the U.S. is counted as a
consumption good and not an import, regardless of the ownership of the
company.
2. Consumption
3. Not included – This is a type of transfer payment and is not included in GDP,
because it does not represent the production of goods and services.
4. Not included – The purchase of a stock is a transfer of money and does not
represent the production of goods and services.
5. Government
6. Imports and consumption – This is an import and part of consumption, because it
is the consumption of a good produced outside the U.S by a consumer in the U.S.
7. Not included – The purchase of a U.S. Treasury Bond is a transfer of money from
the consumer to the Treasury and does represent the production of goods and
services.
8. Investment
9. Not included – Only current construction is counted in GDP. The house was
accounted for in GDP when it was originally built. When resold later, it does not
represent the production of goods and services.
10. Imports and consumption – This is both an import and a consumption good,
because it was produced outside the U.S. and purchased by a consumer in the
U.S. for personal consumption.
11. Investment – A good that is produced but not sold is counted as an increase in
business inventories, a category of investment. They are counted in GDP because
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they represent the current production of goods; they are a business investment to
be sold in the future.
12. Not included
13. Consumption
14. Export
15. Government
Other Questions for Class Discussions
1. If gross domestic product increases by three percent over a year, are we better off?
Why or why not?
2. If consumers begin to purchase more automobiles manufactured in the U.S. instead of
those manufactured abroad, what will happen to real GDP?
3. Why is income not included in gross domestic product?
Sample Answers for Additional Questions
1. It is not clear whether or not we are better off. The answer depends upon what is
happening to prices and what is happening to population growth. If prices and
population together are rising by more than three percent per year, than we, on
average, are worse off. We have fewer goods and services per person. An example
would be if we were experiencing three percent inflation and a one percent growth in
population, real GDP per capita would have fallen over the year by one percent.
2. Consumption spending will remain the same if the total spending on automobiles has
not changed; however, imports will decrease. Real GDP in the U.S. will increase.
3. Gross domestic product includes all of the production of final goods and services in a
year. Production of consumption, investment, government, and export goods and
services are included.
Income is not added to the total amounts of production when calculating GDP.
However, wages, salaries, dividends, profits, and rents are part of the costs on
producing those goods and services and are thus indirectly included. An alternative
way of calculating GDP is to add all of the income payments together.
Key Concepts
Consumption
Investment
Government expenditures
Net exports
Real GDP and nominal GDP
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Real GDP per capita
Economic growth
Relevant National Economic Standards
The relevant national economic standards are numbers 15, 18, 19, and 20.
15. Investment in factories, machinery, new technology and in the health,
education, and training of people can raise future standards of living.
Students will be able to use this knowledge to predict the consequences of
investment decisions made by individuals, businesses, and governments.
18. A nation's overall levels of income, employment, and prices are
determined by the interaction of spending and production decisions made
by all households, firms, government agencies, and others in the economy.
Students will be able to use this knowledge to interpret media reports
about current economic conditions and explain how these conditions can
influence decisions made by consumers, producers, and government policy
makers.
19. Unemployment imposes costs on individuals and nations. Unexpected
inflation imposes costs on many people and benefits some others because
it arbitrarily redistributes purchasing power. Inflation can reduce the rate
of growth of national living standards because individuals and
organizations use resources to protect themselves against the uncertainty
of future prices. Students will be able to use this knowledge to make
informed decisions by anticipating the consequences of inflation and
unemployment.
20. Federal government budgetary policy and the Federal Reserve
System's monetary policy influence the overall levels of employment,
output, and prices. Students will be able to use this knowledge to
anticipate the impact of federal government and Federal Reserve System
macroeconomic policy decisions on themselves and others.
Sources of Additional Activities
Advanced Placement Economics: Macroeconomics. (National Council on
Economic Education)
Unit 2: Measuring Economic Performance
Focus on Economics: High School Economics (National Council on Economic
Education)
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Lesson 18. Economics Ups and Downs
Economics USA: A Resource Guide for Teachers
Lesson 6: U.S. Economic Growth: What Is the Gross National Product?
Capstone: The Nation’s High School Economics Course
Unit 5: 2.
Unit 5: 3.
Unit 6: 2.
Unit 6: 3.
Unit 6: 4.
Unit 6: 5.
What Do We Want from Our Economy?
An Economy Never Sleeps
Making a Macro Model: Consumers
Making a Macro Model: Investment
Making a Macro Model: Government
Making a Macro Model: Imports and Exports
Handbook of Economic Lessons (California Council on Economic Education)
Lesson 6: Measuring How Our Economy is Doing
Lesson 7: Measuring How Our Economy Is Doing: GNP
Lesson 20: Plotting the Ups and Downs of the U.S. Economy
Lesson 21: The Fluctuating Economy: A Look at Business Cycles
Learning from the Market: Integrating the Stock Market Across the Curriculum
Lesson 23. Business Cycles and Investment Choices
Geography: Focus on Economics
Lesson 4. International Interdependence
Lesson 7. Places and Production
Lesson 8. GDP and Life Expectancy
All are available in Virtual Economics, An Interactive Center for Economic Education
(National Council on Economic Education) or directly through the National Council on
Economic Education.
Authors: Stephen Buckles
Erin Kiehna
Vanderbilt University
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