Economic Performance: Key Q’s
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What is gross domestic product (GDP)?
How is GDP calculated? (2 methods)
What is the difference between nominal and real GDP?
What are the limitations of GDP measurements?
What are other measures of income and output?
What factors influence GDP?
• Key Concept: National income accounting provides a
conceptual framework. Categories and vocab from
nat’l income is used by economists in assessing the
macroeconomy.
Factoids
• The United States has the highest Gross
Domestic Product in the World. In 2009, it
reached $14.1 TRILLION, up from $5.7
Trillion in 1990.
• Economists monitor the macroeconomy using
national income accounting, a system
that collects statistics on production, income,
investment, and savings. The United States
looks very good on paper, as you will find
out.
Gross Domestic Product—
The Measure of Domestic Output
• Gross domestic product (GDP) is the dollar value of all
FINAL goods and services produced within a country’s
borders in a given year. Invented in 1930s to measure
depression.
• GDP does not include the value of intermediate goods.
Intermediate goods are goods used in the production
of final goods and services. EX: Wood that’s cut into
a baseball bat, but before it’s sanded, stamped, or the
lacquer is put on is an intermediate good.
• Secondhand sales are excluded. Garage sales don’t
count as GDP!
• Increase in GDP= Economic Growth
• National Income and Product Accounts (NIPA) are
maintained by the Department of Commerce’s Bureau
of Economic Analysis (BEA)
Top-10 World GDP Nations
2 Methods of Calculating GDP
The Expenditure Approach
• The expenditure approach totals annual
expenditures on four categories of final
goods or services. C+I+G+F
1. consumer goods and services
2. business goods and services
3. government goods and services
4. net exports or imports of goods or
services.
Consumer goods include durable goods,
goods that last for a relatively long time
like refrigerators, and nondurable goods,
or goods that last a short period of time,
like food and light bulbs
The Income Approach
The income
approach calculates
GDP by adding up
all the incomes in
the economy.
The Income Approach:
Add the following to get GDP
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Wages and Salaries
Proprietors’ income
Rental income
Interest income
Corporate Profits
Indirect Business Taxes
Depreciation
DO NOT ADD TRANSFER PAYMENTS
Real and Nominal GDP
• Nominal GDP is GDP
measured in current prices.
It does not account for price
level increases from year to
year.
• Real GDP is GDP
expressed in
constant, or
unchanging, dollars.
Nominal and Real GDP
Year 1
Nominal GDP
Suppose an economy‘s entire
output is cars and trucks.
Year 2
Nominal GDP
In the second year, the economy’s
output does not increase, but the
prices of the cars and trucks do:
This year the economy produces:
10 cars at $16,000 each = $160,000
10 cars at $15,000 each = $150,000
+ 10 trucks at $20,000 each = $200,000
+ 10 trucks at $21,000 each = $210,000
Total = $370,000
Total = $350,000
Since we have used the current
year’s prices to express the
current year’s output, the result
is a nominal GDP of $350,000.
This new GDP figure of $370,000
is misleading. GDP rises because
of an increase in prices.
Economists prefer to have a
measure of GDP that is not
affected by changes in prices. So
they calculate real GDP.
Year 3
Real GDP
To correct for an increase in
prices, economists establish a set
of constant prices by choosing
one year as a base year. When
they calculate real GDP for other
years, they use the prices
from the base year. So we
calculate the real GDP for Year 2
using the prices from Year 1:
10 cars at $15,000 each = $150,000
+ 10 trucks at $20,000 each = $200,000
Total = $350,000
Real GDP for Year 2, therefore,
is $350,000
Calculating Nominal GDP
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Suppose the following:
GDP 1990= $5.7 Trillion
GDP 2001= $8.1 Trillion
If inflation averaged 4%/year, had REAL GDP grown?
Real GDP grows if GDP increase > inflation rate
($8.1 trillion/ $5.7 trillion)= 42.1% growth in GDP
Inflation rate 3%/year * 11 years= 33% increase
Real GDP increased during the 1990s. Got reasons?
Other Income and Output Measures
Gross National Product (GNP)--GNP is a measure of the
market value of all goods and services produced by
Americans in one year.
Net National Product (NNP)--NNP is a measure of the
output made by Americans in one year minus
adjustments for depreciation. Depreciation is the loss
of value of capital equipment that results from normal
wear and tear. NNP is always lower than GNP.
National Income (NI)--NI is equal to NNP minus sales and
excise taxes. NI is lower than NNP.
Personal Income (PI)--PI is the total pre-tax income paid
to U.S. households.
Disposable Personal Income (DPI)--DPI is equal to
personal income minus individual income taxes. It’s
what you have left after taxes that you can spend.
Key Macroeconomic Measurements
Measurements of the Macroeconomy
Gross Domestic
Product
+
income earned outside
U.S. by U.S. firms and
citizens
Gross National
Product
–
depreciation of
capital equipment
Net National
Product
–
sales and excise taxes
National Income
–
• firms‘ reinvested profits
• firms‘ income taxes
• social security
Personal Income
–
individual income taxes
–
income earned by foreign
firms and foreign citizens
located in the U.S.
=
Net National
Product
=
National Income
+
other household income
=
Disposable
Personal Income
=
Gross National
Product
=
Personal Income
The Output-Expenditure Model:
A 2nd Way of Figuring GDP! Oh boy!
• GDP= C + I + G +F where:
• C= Consumer Expenditures (rent, groceries, cars,
clothes, etc.) -- accounts for two-thirds of all economic
activity in the United States
• I= Business Investment in plants, offices, equipment,
inventories, and other capital goods
• G= Government Spending on national defense, income
security, national debt interest, health care, roads,
education, etc. Transfer payments DO NOT count.
Why?????????
• F= NET Foreign Trade (Foreign purchases minus foreign
imports—usually a negative number)
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Limitations of GDP
(What GDP fails to take into
account)
Nonmarket Activities--GDP does not measure goods and
services that people make or do themselves, such as caring
for children, mowing lawns, or cooking dinner. Doesn’t
measure “psychic income.”
• Negative Externalities--Unintended economic side effects,
such as pollution, have a monetary value that is often not
reflected in GDP. Externalities inflate GDP. WHY?
• The Underground Economy--There is much economic activity
which, although income is generated, never reported to the
government. Examples include black market transactions
and "under the table" wages. GDP is undercounted here.
• Quality of Life--Although GDP is often used as a quality of
life measurement, there are factors not covered by it. These
include leisure time, pleasant surroundings, and personal
safety. GDP tells us nothing about product quality.
Section Review—Nat’l Income
Accounting
1. Real GDP takes which of the following into
account?
(a) changes in supply
(b) changes in prices
(c) changes in demand
(d) changes in aggregate demand
2. Which of the following is an example of a
durable good?
(a) a refrigerator
(b) a hair cut
(c) a pair of jeans
(d) a pizza
Inflation
• Inflation—A rise in the GENERAL PRICE LEVEL. Not a
rise in the price of 1 good or a group of goods.
• Purchasing power, the ability to purchase goods and
services, is decreased by rising prices.
• Price level is the relative cost of goods and services
in the entire economy at a given point in time.
• Example: Cars, clothing, and most other consumer
goods have increased in price since you were born.
• Some prices increase faster than others (milk prices
per gallon have blown away gasoline prices when it
comes to inflation—both were 79 cents in 1979)
Price Indexes
A price index is a measurement that shows how the
average price of a standard group of goods changes
over time.
• The consumer price index (CPI) is computed each
month by the Bureau of Labor Statistics. May 2002 was
0.5%--6% annual inflation. Yikes!
• The CPI is determined by measuring the price of a
standard group of goods meant to represent the typical
“market basket” of an urban consumer. 1982-84 base.
• Changes in the CPI from month to month help
economists measure the economy’s inflation rate--the
percentage change in price level over time.
• The Producer Price Index (PPI) has a base year of 1982
and samples 100,000 commodities used as inputs.
• You may also hear of the “GDP Deflator.” It measures
the same thing—inflation—so you can calculate real
Calculating Inflation
To determine the inflation rate from one year to the next,
use the following steps:
(CPI for Year A – CPI for Year B) /( CPI for Year B) *100
• For example:
• If the CPI for 1998 (Year A) = 163 and the CPI for
1997 (Year B) = 160.5….then
(163 – 160.5) = 2.5 ÷160.5 = 0.156 * 100 = 1.6
The inflation rate for 1998 was 1.6%.
Economic Growth: Focus
Questions
• How do economists measure economic growth?
• What is capital deepening?
• How are saving and investing related to
economic growth?
• How does technological progress affect
economic growth?
• What other factors can affect economic
growth?
Measuring Economic Growth
The basic measure of a nation’s economic growth rate is
the percentage change of real GDP over a given period
of time.
GDP and Population Growth
• In order to account for population increases in an
economy, economists use a measurement of real GDP
per capita. It is a measure of real GDP divided by the
total population.
• Real GDP per capita is considered the best measure of a
nation’s standard of living.
GDP and Quality of Life
• Like measurements of GDP itself, the measurement of
real GDP per capita excludes many factors that affect
the quality of life.
Capital Deepening
• The process of increasing the amount of
capital per worker is called capital deepening.
Capital deepening is one of the most important
sources of growth in modern economies.
• Firms increase physical capital by purchasing
more equipment. Firms and employees
increase human capital through additional
training and education.
The Effects of Savings & Investing
• The proportion of disposable
income spent to income
saved is the savings rate.
• When consumers save or
invest money in banks, their
money becomes available for
firms to borrow or use. This
allows firms to deepen
capital. In the long run, more
savings will lead to higher
output and income for the
population, raising GDP and
living standards.
How Saving Leads to Capital Deepening
Shawna’s income: $30,000
$25,000 spent
$5,000 saved
$3,000 in a mutual
fund (stocks and
corporate bonds)
$2,000 in “rainy day”
bank account
Mutual-fund firm makes
Shawna’s $3,000
available to firms
Bank lends Shawna’s
money to firms in forms
such as loans and
mortgages
Firms spend money
on business capital
investment
The Effects of Technology
• Besides capital deepening, the other key source of economic
growth is technological progress.
• Technological progress is an increase in efficiency gained by
producing more output without using more inputs.
• A variety of factors contribute to technological progress:
Innovation When new products and ideas are successfully
brought to market, output goes up, boosting GDP and
business profits.
Scale of the Market Larger markets provide more incentives
for innovation since the potential profits are greater.
Education and Experience Increased human capital makes
workers more productive. Educated workers may also
have the necessary skills needed to use new technology.
Other Factors Affecting
Economic Growth
Population Growth--If population grows while the supply
of capital remains constant, the amount of capital per
worker will actually shrink.
Government--Government can affect the process of
economic growth by raising or lowering taxes.
Government use of tax revenues also affects growth:
funds spent on public goods increase investment, while
funds spent on consumption decrease net investment.
Foreign Trade--Trade deficits, the result of importing
more goods than exporting goods, can sometimes
increase investment and capital deepening if the
imports consist of investment goods rather than
consumer goods.
Section 3 Review
1. Capital deepening is the process of
(a) increasing consumer spending.
(b) selling off obsolete equipment.
(c) decreasing the amount of capital per worker.
(d) increasing the amount of capital per worker.
2. Taxes and trade deficits can contribute to economic
growth if the money involved is spent on
(a) consumer goods.
(b) investment goods.
(c) additional services.
(d) farming.
Population in the United
States
• Remember our buddy Malthus?
• Census Bureau performs constitutionally-mandated
Census every 10 years since 1790. It also conducts
monthly surveys.
• The Bureau tabulates data in 2 classifications: urban
and rural.
• Population continues to grow in the U.S., but the rate of
growth has fallen since 1860. 2000 rate= 0.9%.
Smaller households, especially among white Americans.
• Population center has also shifted—to the south & west.
• Debate in 2000—sampling or count? Politically charged!
• Democrats say sampling is more scientific, would count
more minorities and homeless in inner cities
• Republicans want “count,” win in court
Factors Affecting Population
Growth
• Fertility rate: Number of births per 1000 women
during their lifetime. Currently about 2,119
(2.12/woman). Vastly different for whites, blacks, and
hispanics. Why so low nowadays?
• Life expectancy: average remaining life span of people
who reach a certain age. Currently 75.9, will rise to
82.1 by 2050.
• Net immigration (About + 880,000 people/year)
• Who cares? Well, businesses and government need to
plan.
• What might be some demographic trends that need to
be noticed? Need for more medical supplies and
Population
Projections/Demographics
• The aging “baby boomer” population will drive most
characteristics (baby boom was 1946-64).
• Trouble is coming as baby boomers retire starting in
2011. In 2012, Social Security will be paying out more
money than it takes in.
• The Dependency ratio will increase—from 63.9 in 1998
to 80.0 by 2040. DR= # of children and elderly per
100 persons 18-64.
• More widows as people life longer, but women live
way longer. If anyone mentions “Tadpole,” I will hit
you.
• By 2050, whites will be a bare majority (52.7%). Asian
Immigration in the U.S.
• Old immigrants—from N. and W. Europe. Blended easily.
Came before 1880. Most were Protestant.
• New Immigrants—from S. and E. Europe, came 18801924. Spoke different languages, darker, had different
religions, took longer to blend but were successful
• It is true immigrants helped build this country. EX:
Chinese laborers and Transcontinental RR
• Significant immigrants include: Albert Einstein, Bob
Hope, Joseph Pulitzer, Felix Frankfurter, Enrico Fermi,
Samuel Gompers, Madeleine Albright, John Audubon,
Cary Grant, Sonja Henie, Werner von Braun, and
Alexander Hamilton. Immigration has been good.
• BUT, We must look at this academically and realize
there is a downside. Diversity in other countries has
posed severe problems—Yugoslavia, even Quebecois in
Canada. As the US changes, ethnic conflict will result
Section Review--Population
• 1. What will likely happen to the
percentage of the population of the
United States that lives in Michigan over
the next 20-50 years?
• 2. Why is knowing population
demographics important to the average
businessman or politician?
More on Economic Growth
• Now, we know that not every country has the
U.S.’s standard of living, or quality of life
• Compare U.S. and India Nominal GDP
• U.S.= $8.1 Trillion. India= $500 Billion. (It’s
that big? $500 Billion is nothing to shake a
stick at)
• Real GDP stats are still not perfect. To get the
true picture, you need to determine
• Real GDP per capita
• In other words, divide Real GDP by the # of
people
Why Economic Growth is Not Only
Important, But Actually A Cure-All
• Economic growth in the U.S. helps everyone in the world—
not just Americans.
• Tax revenues increase with more earnings. Healthier tax
bases mean government can provide more services or tax
cuts. During the 1980s, revenue doubled in 8 years with tax
cuts. You need investment for growth—why do you think we
love British and Japanese capital? The British know they get
a good return on their investments! And then we tax the
growth and play the game all over again IF WE DON’T TAX
TOO MUCH.
• Economic growth solves domestic problems (poverty is the
source of so many social problems—drugs, unsupervised
kids, wages rise because demand for labor increases)
• We can help other nations more if we are well-off.
• A healthy U.S. capitalistic system is an excellent role model
for the world, especially for China, a definite threat
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Factors Influencing Growth:
What do we do to get that
growth??
Land—Conserve our own natural resources, make use
of renewable resources, and use everyone else’s
resources
• Capital—Keep capital-to-labor ratio high. Capital
investments are a better choice than immediate
consumption
• Labor—Educate labor force and keep population
growing. Much 1900s economic growth is due to
women working outside the home, although society
has paid for that
• Entrepreneurs—create incentives for entrepreneurs
(low government regulation, low taxes) Best example
of why this works: The Internet
Section Review—Peculiarities
of Economic Growth
• Which U.S. President was hurt by going along
with a tax increase, and a recession that
actually cleared up by election day?
• In layman’s terms, define “standard of living”