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Understanding GDP: Measuring Economic Output

Learn how economists define and measure an economy's output using various methods, compute nominal and real GDP, and analyze the relationship between GDP and economic well-being.

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Understanding GDP: Measuring Economic Output

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  1. Chapter 4 Spending, Income, and GDP

  2. Macroeconomics: Data and Issues

  3. Learning Objectives • Explain how economist define and measure an economy's output • Use the expenditure method for measuring GDP to analyze economic activity • Define and compute nominal GDP and real GDP • Discuss the relationships between GDP and economic well-being

  4. Measuring Output

  5. Market Value • Aggregate measure of quantities produced • Weighs more expensive items more • Willingness to pay is an indication of benefit from the good • Orchardia's GDP is $64

  6. Market Value • A convenient way to aggregate the many different goods and services produced in a modern economy. • However, non-market activities are not counted in GDP • Unpaid work of a homemaker • paid house keeping and child care services

  7. Women's labor force participation and GDP measurement • Women's labor force participation increased since 1960 • Measured GDP increased • Working women's output measured and counted • a real addition to GDP • Paid workers provide previously unpaid childcare • Not a real addition to goods and services produced • Measured change in GDP overstates actual change

  8. Final Goods and Services • Final goods are consumed by the ultimate user • End products of production • Included in GDP • Intermediate goods are used up in the production of final goods • Not included in GDP • Avoids double counting • A barber's assistant earns $2 per haircut for providing services such as shampooing and sweeping up • Barber charges $10 per haircut • Haircut's contribution to GDP is $10, not $12.

  9. Value-added Method • Value added is the market value of the product minus the cost of inputs purchased from other firms • Count value added in the year it is produced • Hot'n'Fresh buys flour and other inputs to make bread that sells for $2.00

  10. Produced in a Country in a Period of Time • "Domestic" in GDP means the activity is measured within a country's borders • Nationality of owners or company is not relevant • Value must be produced in the year considered • Sell a 20-year old house for $200,000 • Pay $12,000 commission • Value added is $12,000 • House was not produced in the period of time studied

  11. Expenditure Method for GDP • Four users of final goods • Households ■ Firms • Government ■ Foreigners • Assumes all goods produced are purchased by one of these groups in a given year • Amount spent = market value • GDP can be measured by: • Total spending for final goods less value of imports

  12. US GDP, 2007 (billions of dollars)

  13. Consumption Expenditure • Spending by households for goods and services • Consumer durables are long-lived consumer goods • Consumer non-durable goods are shorter-lived goods • Services are the largest component of consumer spending

  14. Investment • Business fixed investment is purchases of new capital goods • Residential investment is construction of new homes and apartment buildings • Inventory investment is the change in unsold goods to the company's inventory • These goods are produced but not yet sold • This entry can be positive or negative • Negative inventory investment means less in inventory at year-end than at the beginning

  15. Economic Investment and Financial Investment • Financial investments include purchases of stocks, bonds, and other financial assets • Purchase generally transfers ownership of a portion of the firm's existing capital stock • Does not correspond to any increase in physical capital or production capacity • Economic investment refers to the increase in the capital goods used to produce other goods • This value is based on purchase price of the capital goods, not on stock value

  16. Government Purchases • Federal, state, and local government purchase final goods and services • Excludes transfer payments • Transfer payments are made by government but the government receives no current goods or services • Spending by recipients is included in GDP • Excludes interest paid on government debt

  17. Net Exports • Net exports are exports minus imports • Exports are goods and services produced domestically and sold abroad • Exports reduce the amount available to the domestic economy • Imports are purchases in the US of goods and services produced abroad • Imports increase the amount available to the domestic economy

  18. GDP Expenditures Equation • Terminology • Expenditure approach to measuring GDP Y = C + I + G + NX

  19. GDP Example • Total production is 1 million cars, $15,000 each • Production value is 1 million times $15,000 = $15 billion • 25,000 cars are unsold • Investment in inventories increases by $0.375 billion, In what category is this number included?

  20. Income Approach to GDP • When a good is sold, its proceeds are distributed to workers or business owners • GDP = labor income + capital income • Labor income is wages, salaries, benefits, and incomes of the self-employed • About ⅔ of GDP • Capital income pays for physical capital and intangibles • Measured before taxes

  21. Three GDP Approaches Production Expenditure Income Market Value of Final Goods and Services Consumption Labor Income Investment Government purchases Capital Income Net exports

  22. Adjusting for Price Changes • Compare GDP for different years to see how much output has changed • GDP changes over time because • Prices change AND • Quantity of output changes • To see how much output has grown, use only the changes in quantities • Hold prices constant

  23. The Pizza and Calzone Economy • GDP in 2009 is $175; GDP in 2013 is $420 • GDP in 2013 is 2.4 times the GDP in 2009 • Only twice as many pizzas and calzones were produced in 2013 • Market value of output grew faster than the physical volume of output

  24. Real GDP and Nominal GDP • Nominal GDP values output in the current year using prices from the current year • Nominal GDP is the current dollar value of production • Real GDP values output in the current year using the prices from the base year • Real GDP measures the physical volume of production • Nominal GDP adjusted for inflation Comparisons of economic activity at different times should always be done using real GDP.

  25. Calculating Real GDP for 2013 • Use 2009 as the base year • Nominal GDP for 2009 is $175 and for 2013, $420 • Calculate real GDP using current year quantities and base year prices • Real GDP in 2013 is (20 pizzas) ($10) + (30 calzones) (5) = $350 • Real GDP doubled between 2009 and 2013

  26. Real GDP and Economic Well-Being • Real GDP is a flawed measure of well-being • It values only market transactions • Omits illegal transactions, volunteer work, and household production • Maximizing GDP will not necessarily maximize national well-being • Whether increases in output increase welfare is a case-by-case issue

  27. GDP Does Not Value Leisure • Amount of leisure time has increased in the past 100 years • Work weeks are shorter • People enter the labor force at an older age • People retire earlier • Leisure produces no goods for market • GDP places a value of zero on all leisure time • Opportunity cost of an hour of leisure is your hourly wage • Omission of the value of leisure time makes GDP seem smaller

  28. Environmental Quality and resource depletion • Suppose a factory is built in your town • People are employed and output is produced • Productive activity is included in GDP • the factory creates pollution • No adjustment is made for the decline in resource availability when mining is done • One more barrel of oil on the market means one less barrel for future use • Environmental quality and resource depletion are difficult to value • They have value and that value is omitted from GDP

  29. Other Quality of Life Considerations • GDP does not account for intangibles people value • Crime rates • Traffic congestion • Civic organizations • Open space • Sense of community

  30. Poverty and Economic Inequality • GDP does not capture the effects of income inequality • Most would prefer living in a relatively equal society to one with a few wealthy and many poor • Inequality matters and it is increasing in the US

  31. GDP as a Welfare Measure • GDP per capita is positively associated with several measures of well-being • Material standard of living: more goods and services • Health and life expectancy • Residents of industrialized countries fare better than residents of developing countries in a range of health measures • Education • Literacy and school enrollment rates are higher in high-income countries

  32. Spending, Income, and GDP Gross Domestic Product Production Method Expenditure Method Income Method Real and Nominal Values GDP and Well-Being

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