Production, Income,
and Employment
© 2003 South-Western/Thomson Learning
Production and Gross
Domestic Product
•GDP: A Definition
•The Expenditure Approach to GDP
•Other Approaches to GDP
•Measuring GDP: A Summary
•Real Versus Nominal GDP
•How GDP Is Used
•Problems with GDP
Gross Domestic Product
Gross Domestic Product (GDP)
The total value of all final goods and
services produced for the marketplace
during a given year, within the nation’s
borders
Stages of Production
$1.00
(Wood Chips)
Lumber
Mill
$1.50
(Raw Paper)
$2.25
(Notebook
Paper)
Paper
Mill
Office Supplies
Manufacturer
$3.50
(Notebook
Paper)
Wholesaler
$5.00
(Notebook
Paper)
Retailer
Gross Domestic Product
Intermediate Goods
Goods used up in producing final goods
Final Good
A good sold to its final user
Gross Domestic Product
Flow Variable
A measure of a process that takes place
over a period of time
Stock Variable
A measure of an amount that exists at a
moment in time
Expenditure Approach to
GDP
Four categories of output:
•Consumption: purchased by households
•Private Investment: purchased by business
•Government: purchased by government
agencies
•Net Exports (NX): purchased by
foreigners
Expenditure Approach to
GDP
Measuring GDP by adding the value of
goods and services purchased by each
type of final user
GDP = C + I + G + NX
Consumption Spending
Consumption (C)
The part of GDP purchased by
households as final users
Private Investment
Capital Stock: The total value of all goods
that will provide useful services in future years
Private Investment (I): The sum of business
plant and equipment purchases, new home
construction, and inventory changes
Net Investment: Total investment minus
depreciation
Government Purchases
Government Purchases (G)
Spending by federal, state, and local
governments on goods and services
Transfer Payment
Any payment that is not compensation
for supplying goods or services
Net Exports
Net Exports (NX)
Total exports minus total imports
To properly account for output sold to and
bought from foreigners, net exports must be
included as part of the expenditure in GDP.
Other Approaches to GDP
Value-Added Approach
Measuring GDP by summing the value
added by all firms in the economy
Value Added: The revenue a firm
receives minus the cost of the
intermediate goods it buys.
Other Approaches to GDP
Value-Added Approach
In any year, the value added by a firm
is equal to the total factor payments
made by that firm.
Other Approaches to GDP
Factor Payments Approach
Measuring GDP by summing the factor
payments made by all firms in the
economy
Factor Payments: Payments to the owners of
resources that are used in production
Other Approaches to GDP
Factor Payments Approach
GDP - the total output of the
economy - is equal to the total
income earned in the economy.
Measuring GDP
Expenditure Approach: C + I + G + NX
Value-Added Approach: Sum of value
added by all firms
Factor Payments Approach: Sum of
factor payments by all firms = Wages
and salaries + interest + rent + profit =
Total household income
Real vs. Nominal GDP
Nominal Variable
A variable measured without adjustment
for the dollar’s changing value
Real Variable
A variable adjusted for changes in the
dollar’s changing value
How GDP is Used
1. In the short run, GDP alerts us to
recessions and gives us a chance to
stabilize the economy
2. In the long run, GDP tells us
whether our economy is growing fast
enough to raise output per capita and our
standard of living, and fast enough to
generate sufficient jobs for a growing
population
How GDP is Used
Real GDP
Growth
Rate
(Percent
Change
from
Previous
Period)
8
7
6
5
4
3
2
1
0
–1
–2
–3
Actual GDP growth rate
GDP growth
needed for constant
unemployment rate
GDP growth
needed for constant
output per capita
1960
1965
1970
1975
1980
1985
1990
1995 1999 2001
Year
Problems with GDP
Nonmarket Production
Goods and services that are
produced, but not sold, in a market
Short-Term Changes
Short-term changes in real GDP are fairly
accurate reflections of the state of the
economy.
A significant short-term drop in real
GDP virtually always indicates a decrease
in production, rather than a
measurement problem.
Employment and
Unemployment
•Types of Unemployment
•The Costs of Unemployment
•How Unemployment Is Measured
•Problems in Measuring Unemployment
Types of Unemployment
Frictional Unemployment
Joblessness experienced by people who are
between jobs or who are just entering or reentering the labor market.
Seasonal Unemployment
Joblessness related to changes in weather,
tourist patterns, or other seasonal factors.
Types of Unemployment
Structural Unemployment
Joblessness arising from mismatches between
workers’ skills and employers’ requirements,
or workers’ locations and employers’ locations
Cyclical Unemployment
Joblessness arising from changes in
production over the business cycle
Full Employment
In macroeconomics, full employment is
achieved when cyclical unemployment has
been reduced to zero.
But the overall unemployment rate at full
employment is > zero because there are still
positive levels of frictional, seasonal, and
structural unemployment.
Cyclical Unemployment
Unemployment
Rate
11
(Percent)
10
9
8
7
6
5
4
3
2
1
1960
1965
1970
1975
1980
1985
1990
1995
2001
Year
Economic Costs of
Unemployment
When there is cyclical unemployment,
the nation produces less output, and so
some group or groups within society
must consume less output.
Economic Costs of
Unemployment
Potential Output
The level of output the economy
could produce if operating full
employment
How Unemployment Is
Measured
Labor Force
Those people who have a job or are
looking for one
Unemployment Rate
The fraction of the labor force that is
without a job
How Unemployment Is
Measured
Worked one or
more hours
for pay?
Yes
Employed
No
Temporary
layoff?
Yes
Unemployed
No
Searched for
work?
No
Not in
Labor Force
Yes
Unemployed
How Unemployment Is
Measured
Unemployment Rate
Unemployed

Labor Force
Unemployed

(Unemployed  Employed)
Problems in Measuring
Unemployment
Involuntary Part-Time Workers
Individuals who would like a full-time job, but
who are working only part time
Discouraged Workers
Individuals who would like a job, but have
given up searching for one
GDP after September 11
The destruction caused by the
terrorist attacks of 9/11 had almost
no direct impact on the U.S.
economy or the U.S. GDP.
Indirect Impacts on GDP
Short-run impact: substantial
GDP declined more that it otherwise
would, deepening a recession already
in progress
Indirect Impacts on GDP
Long-run impact: will be negative
The nation will shift away from
production of other goods/services
and toward security.
Potential output will grow more
slowly than it otherwise would have.