Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year. Gross Domestic Product Measures Total Production GDP Is Measured Using Market Values, Not Quantities The worth of a thing is the price it will bring. • Final good or service A good or service purchased by a final user: • Household consumption • Business investment, including all residential construction • Government purchases • Exports to foreigners Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. vs GDP Includes Only Current Production
Production, Income, and the Circular Flow Diagram Im Sprivate G + Tr C T NX = X - Im Deficit G T X I = Sprivate - NX - Deficit
Y: Components of GDP = $15.5 trillion (2012:Q1) C: Personal Consumption Expenditures = “Consumption” = 71.6% of Y Consumption Spending by households on goods and services, not including spending on new houses. I: Gross Private Domestic Investment, or “Investment” = 12.9% of Y Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses. G: Government Consumption and Gross Investment,or“Government Purchases” = 19.4 % of Y Government purchasesSpending by federal, state, and local governments on goods and services. NX: Net Exports of Goods and Services, or “Net Exports” = -0.6% of Y X = 13.9 % of Y Im = 17.7% of Y
Transfer payments are not included in GDP: Payments by the government to individuals for which the government does not receive a new good or service in return. • Unemployment benefits paid to someone not working. • Social security benefits paid to someone who is retired. • Interest income paid to a government bondholder Since the government doesn’t produce anything for the market, the interest payment can’t be for any productive service. “Underground economy” activities are not included in GDP • Production “off-the-books” • Illegal activities Household production is not included in GDP
Does GDP Measure What We Want It to Measure? Shortcomings of GDP as a Measure of Well-Being The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up
• Consumer spending on services is greater than the sum of spending on durable and nondurable goods. • • Business fixed investment is the largest component of investment. Gross private domestic investment includes • New plant and equipment • New residential construction • Net additions to business inventories • Purchases made by state and local governments are greater than purchases made by the federal government. • Imports are greater than exports • net exports are negative.
An Equation for GDP and Some Actual Values Components of GDP in 2006
Measuring GDP by the Value-Added Method Value added The market value a firm adds to a product.
Real GDP The value of this year’s final goods and services evaluated at base-year prices. Nominal GDP The value of this year’s final goods and services evaluated at this year’s prices. Real GDP versus Nominal GDP vs
Comparing Real GDP and Nominal GDP Nominal GDP and Real GDP, 1990–2006
The GDP Deflator GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. $ GDP = Price Level x Real Output $Y = P x Y P = $Y/Y
Other Measures of Total Production and Total Income • Gross National Product (GNP) • =GDP + Net Foreign Earnings of US Residents • Compensation of employees earned abroad • Interest and profits earned abroad Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation) National Income (NI) = NNP - Indirect Business Taxes = Income earned from production of national product Personal Income (PI) = NI + Net Transfer Payments Disposable Income (DI) = PI - Income Taxes • Disposable Income is split between consumption and saving
Other Measures of Total Production and Total Income FIGURE 7-4 Measures of Total Production and Total Income, 2006
Other Measures of Total Production and Total Income The Division of Income FIGURE 7-5 The Division of Income
K e y T e r m s Macroeconomics Microeconomics Net exports Nominal GDP Price levelReal GDP Recession Transfer payments Underground economy Value added Business cycle Consumption Economic growth Expansion Final good or service GDP deflator Government purchases Gross domestic product (GDP) Inflation rate Intermediate good or serviceInvestment