A CASE STUDY
Gross Domestic Product
The Second Quarter, 2003
Date of Announcement
September 26, 2003
Dates of Future Announcements
October 30, 2003
(The advance announcement of the third quarter, 2003 data.)
Announcement
Real Gross Domestic Product (GDP) during the second quarter (April through June)
of 2003 increased at an annual rate of 3.3 percent. This is the third release of the data for
the second quarter and is an increase that is higher than the previously announced 2.4
percent and 3.1 percent. The rate of growth in the second quarter compares to annual
rates of 4.0, 1.4, and 1.4 percent in each of the previous three quarters. For the entire
2002 year, real GDP increased at a rate of 2.4 percent. During 2001, real GDP increased
by .3 percent - a year in which real GDP fell during the first three quarters. Annual
growth rates in 1999 and 2000 were 4.1 percent and 3.8 percent.
This announcement received a great deal of attention in the press because it
represented more evidence that the economy is recovering from its 2001 recession. The
increase in real GDP was largely due to increased consumption spending and national
defense spending, with a small increase in investment spending.
Productivity of workers is still increasing faster than output and that means that it is
unlikely for unemployment to fall soon.
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.
[Insert the following interactive exercises here]
--Gross domestic product is approximately equal to:
$1 trillion,
$5 trillion,
$10 trillion, or
$15 trillion?
The correct answer is approximately $10 trillion (actually $10.8 trillion in second
quarter of 2003).
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How can GDP be $10.8 in the second quarter when GDP is defined as the value
of production in a country in a year?
It is actually $10.8 trillion at an annual rate. That is, if the economy continued
for one entire year, at the same level of production that occurred during the
second quarter, the annual GDP would have been $10.8 trillion.
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.
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.
[Insert the following interactive exercise here]
--Match the following percentages of GDP with the corresponding correct
components of GDP. The same percentage may be matched with more than one
components.
Consumption _________
70 %
Exports _________
35%
Government _________
20%
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Investment_________
15%
Imports_________
10%
Purchases of stocks and bonds_________
0%
The correct answers are:
Consumption 70 %
Exports 10%
Government 20%
Investment 15%
Imports 15%
Purchases of stocks and bonds 0%
included in GDP.)
(Purchases of stocks and bonds are not
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 policies, 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 is discussed in news reports as a sign that the economy continues in its recovery
from the recession in 2001 and the growth is significantly above that of the previous two
quarters.
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 often use decreases 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 2001 recession.)
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;
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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.
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. The
changes in real GDP were negative for the first time since 1993. The recession ended in
November 2001, but growth in real GDP has been modest since.
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 again by another .5 percent in November 2002 and most recently another
.25 percent in June of 2003). (See the Federal Reserve and Monetary Policy Cases.) The
effects of stimulative monetary policy and the resulting low interest rates have helped
increase consumer spending during and since the recession. However, the growth
throughout 2002 (2.4%) and into the first and second quarters of this year are still below
that of the late 1990s.
Figure 1
Long-run Trends
The rate of increase in real GDP has been not only higher in the last part of the 1990s
than in the first half of the 1990s, but also when compared to most 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.
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.
Figure 2
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Real GDP increases over time occurs when labor or capital increases, when labor is
more productive, and when technology changes. Increases in capital, skills and abilities
of the labor force, and technology can lead to increases in real GDP per person and
ultimately standards of living.
Prices
The price index for GDP increased at an annual rate of one percent during the second
quarter of 2003, compared to an increase of 2.4 percent during the first quarter of 2003.
It increased at an annual rate of 1.1 percent for all of 2002, compared to 2.4 percent for
2001. Inflation is still not a current concern; some observers have even been concerned
with the possibility of deflation.
[Insert the following interactive exercises here]
1. If GDP has increased by 3 percent and inflation is 1 percent, what has happened
to real GDP?
2. If GDP increases by 5 percent and real GDP increased by 5 percent, what has
happened to the average price level?
Answers
1. If nominal GDP has increased by 3 percent and inflation was 1 percent, the
amount of output has increased by 2 percent. The remaining (after inflation)
increase in nominal GDP must be due to real output increases.
2. If nominal GDP increases by 5 percent and the amount of output increases by 5
percent, then prices must not have changed.
Details of the Second-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 3.3 percent in the second quarter of 2003,
greater than the 1.4 percent in the first quarter of 2003. The major contributors to the
increase in real GDP in the second quarter were increases in personal consumption and
federal defense spending. National defense spending increased at an annual rate of 46
percent during the quarter. Investment spending increased slightly after falling in the first
quarter. Imports, which are a subtraction in the calculation of GDP, increased, lowering
the calculated increase in real GDP. Exports fell slightly.
GDP, Productivity, and Unemployment
A major factor in the long-term growth in the American economy is continued
improvement in productivity. (See the most recent Productivity case study). Productivity
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increased at an annual rate of 5.7 percent in the second quarter of 2003, 2.1 percent in the
first quarter, and 5.4 percent for all of 2002. Businesses are able to gain more output
from the same number of workers or in this instance, even fewer workers. This explains
how real GDP can increase at the same time employment is falling. If real GDP grows
more slowly (3.1%) than the increase in productivity (5.7%), fewer workers are needed to
produce the real GDP. If unemployment is to fall, spending and output in the economy
will have to grow faster than the increase in productivity.
The Federal Reserve has stated in 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 allows the Fed to cut rates greater than it would otherwise, as
inflationary pressures are reduced. Chairman 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.
[Insert the following interactive exercises here]
1. If productivity rise by less than real GDP, what is likely to have happened to
employment?
Increase? Decrease? Cannot tell.
2. If real GDP increased by 4 percent and employment increased by 3 percent, what
is likely to have happened to productivity?
Increase? Decrease? Cannot tell
Answers
1. INCREASE. Because output increased by more than the output per worker, it
must take more workers to produce the increased output.
2. INCREASE. If real GDP increases by more than the rate of increase in the
number of workers, than output per worker must have increased, by
approximately one percent.
The 2001 Recession
On November 26, 2001, the National Bureau of Economic Research announced
though its Business Cycle Dating Committee that it had determined that a peak in
business activity occurred in March of 2001. That signaled the official beginning of a
recession.
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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 current data show a decline in employment,
but not as large as in the previous recession. Real income growth slowed but did not
decline. Manufacturing and trade sales and industrial production both declined and had
been doing so for some time.
The recession ended in November of 2001, but employment has yet to recover and
continues to decrease. As long as growth in real GDP is less than the growth in the labor
force and productivity, employment will decrease and unemployment will increase.
For the full press release from the National Bureau of Economic Research see:
http://cycles-www.nber.org/cycles/
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
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 2002.
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Durable goods are items such as cars, furniture, and appliances, which are used for
several years (8%).
Non-durable goods are items such as food, clothing, and disposable products, which
are used for only a short time period (20%).
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. It is currently down as falls in
investment spending have been a major cause of the recession and decrease in growth.
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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
(11%).
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 (less than -1%).
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 4 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 goods and services
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. (For more information on the balance of
trade, see the Trade Report case study.)
HOW CAN WE INCREASE ECONOMIC GROWTH IN THE FUTURE?
Economic growth is a function of the technological innovation and the amount and
quality of labor and capital in the economy:
As more people are employed, the amount of capital increases, education levels increase,
the quality of capital changes, or the technology increases, the productive capacity of the
economy increases. Therefore, the economy can increase its output giving consumers
more disposable income, promoting an increase in consumption spending, and providing
resources for business to use for further investment and government to use to provide
public goods and services.
Increased labor force participation increases output. Expanded, improved education
creates more productive workers. Business and government spending on research and
development enhance our abilities to produce and allow each worker to become more
productive, increasing incomes for all. Finally, to achieve a higher level of GDP in the
future, consumers need to limit consumption spending and increase savings today,
permitting businesses to invest more in capital goods. If resources are invested into
building an economy now, future generations will enjoy a higher level of economic
growth; our businesses will produce more goods and consumers can purchase more
goods. Expansion of output at rates faster than our population growth is what gives us
the opportunity to enjoy higher standards of living.
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GDP as a Measure of Well-Being
Changes in real GDP are a more accurate representation of meaningful economic
growth than changes in nominal GDP, because changes in real GDP represent changes in
quantities produced, while prices are held constant. Real GDP per capita is even more
relevant because it measures goods and services produced per person and thus
approximates the amount of goods and services each person can enjoy. If real GDP
grows, but the population grows faster, then each person, on average, is actually worse
off than the change in real GDP would indicate.
Consider the table below. While the mainland part of China has a GDP of $991
billion, its GDP per capita is only $791.30. Hong Kong has a much smaller GDP of $159
billion. However, its GDP per capita is much higher at $23,639.58. Other nations, such
as France and Germany, may have quite different GDPs, but GDPs per capita that are
very close.
See first table.
GDP per capita is not a perfect estimate of well-being. When individuals grow their
own food, build their own houses and sew their own clothes, they are not producing
goods and services to be sold in a marketplace and therefore GDP does not change. As a
result, many countries South America and Africa have a low GDP per capita that
underestimates their well-being.
(The comparisons in the above table are of nominal GDP per capita, not real GDP
per capita. As we are comparing per capita figures for the same year there is no need to
deflate the nominal figures into real figures.)
ARE ESTIMATES OF GDP ACCURATE MEASURES OF OUR WELL BEING?
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GDP fails to account for many forms of production that improve a person’s well being.
For example, if you make a meal at home, the labor is not included. However, if you
were to go out to a restaurant and consume that same meal, the labor is included in
GDP. Unpaid work at home or for a friend and volunteer work is not included and thus
GDP does not reflect production of all we produce.
External effects of production, such as pollution, are not subtracted from the value of
GDP. Although two countries may have similar GDP growth rates, one country may
have significantly cleaner water and air, and therefore is truly better off than the other
country. If as economic growth accelerates, producers begin to employ production
techniques that create more pollution, the effects of the growth are overstated.
GDP includes police protection, new prisons, and national defense as goods and
services. It is not always clear that if we have to devote increased resources for such
purposes that we are better off as a result.
GDP includes the effects of price changes. An increase in GDP due solely to inflation
does not signal an improvement in living standards. Real GDP is a better measure. Nor
does GDP reflect population growth. Changes in the income distribution are not
measured. It is also difficult to compare rates of growth for different countries, as
countries use different means of estimating income and price levels in their economy.
There are a variety of other weaknesses and inaccuracies, but GDP accounting is the
best that we have. Real GDP does provide sound signals as to the direction of change of
a selected large part of what we produce each year. Government statisticians and
academics are constantly working to improve its accuracy and its ability to reflect our
well-being.
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 real 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 of the rate of growth in real GDP
have been revised an average of 0.5 percent in the next month's preliminary estimate.
The preliminary estimates have been revised by an average of an additional 0.3 percent.
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.
An Interactive questions for students.
1. Given the following data (in billions of current dollars),
a.
what is the level of government spending in the calculation of GDP?
b.
what is the level of investment?
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c.
what is the level of net exports?
d.
calculate the level of gross domestic product.
Consumption spending
Social security payments
Income tax receipts
Exports
Business purchases of new factories
and equipment and changes in inventories
Federal government spending on
goods and services
Construction of new homes
State and local spending on
goods and services
Changes in inventories
Imports
Wages
$7,000
500
1,000
1,100
1,800
550
200
1,300
- 300
1,500
6,000
Answers to interactive question.
1. a. Government spending equals $1,850 ($550 plus $1,300).
Government spending is equal to the sum of federal spending on goods and services
and state and local spending on goods and services. Social security payments are
transfers of income from tax payers to social security recipients and do not represent
the production of goods and services.
b. Investment equals $1,700 ($1,800 + 200 - 300).
New factories and equipment and construction of new homes are included in
investment. However, since business inventories fell, we subtract $300 billion from
investment in structures, equipment, and residential housing to get the investment
portion of GDP.
c. Net exports equal a minus $400 ($1,100 - 1,500).
Net exports are exports minus imports. In this case, the economy has a balance of
trade deficit.
d. GDP equals $10,150 billion ($7,000 + 1,850 + 1,700 - 400).
GDP equals consumption spending plus government spending on goods and
services plus investment spending plus net exports.
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Other Questions for Students
1. If gross domestic product increases by 10 percent over a year, are we better off?
Why or why not?
2. If consumers begin to purchase automobiles manufactured abroad instead of those
manufactured in the U.S., what will happen to real GDP? Will the answer be
different if consumers are simply increasing their spending and those purchases are
of automobiles manufactured abroad?
Sample Answers for Additional Questions
1. Perhaps we are better off. Part of the answer depends upon what is happening to
prices and what is happening to population. If prices and population together are
rising by more than 10 percent per year, than we, on average, are worse off. We
have fewer goods and services per person.
2. Consumption spending will remain the same; however, imports will increase. Real
GDP in the U.S. will decrease. In the second instance, consumption spending
increased, but imports increased by an equal amount. Real GDP does not change.
The components do change.
Key Concepts
Consumption
Investment
Government expenditures
Net exports
Real GDP and nominal GDP
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.
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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.
Original U.S. Bureau of Economic Analysis Announcement and Data
http://www.bea.doc.gov/bea/newsrel/gdp301p.htm
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)
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?
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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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