Chapter 4: Measuring GDP and Economic Growth

1. Chapter 4: Measuring GDP and Economic Growth Objectives: Define GDP Income and expenditure approach Measurement of GDP and its major components. GDP as a measure of economic growth. Shortcomings of GDP as a measure of economic growth or the standard of living.

2. Definition of GDP • GDP (Gross Domestic Product) is the market value of all final goods and services produced in a country in a given time period. • Market value • goods & services are valued at their market prices. • GDP rises if prices rise (more on this later) • Final goods and services • Bought by final user • Intermediate goods are produced by one firm, bought by another, and used as a component of a final good or service. • Exlude intermediate goods to avoid double counting.

3. Definition of GDP • Produced within a country • Any domestic production, regardless of who owns the resources • In a given time period • Production during a specific year (sales of used items excluded, except value of service in sale) • Inventory adjustments account for goods produced in one year but sold in another • if inventories rise by $10 million during 2010, $10 million is added to sales of final goods & services • If inventories fall by $10 million during 2010, $10 million is subtracted from sales of final goods & services

4. Expenditure Components of GDP • Consumption (C) • total payment for consumer goods and services • Investment (I) • purchase of new plant, equipment, and buildings • additions to inventories • Purchases of new housing • Government spending (G): • government purchases of goods and services from firms • excludes “transfer payments” such as Social Security, Unemployment Insurance • Net exports (X-M) • (exports-imports) • Imports subtracted because counted as part of C,I,G and are not part of domestic production.

6. GDP: Income & Expenditure Approach • GDP can be measured by income or expenditure side • Circular flow demonstrates that Y = C + I + G + (X-M)

7. GDP and Circular Flow • Households sell factors of production to firms in factor markets • Factors of production: land, labor, capital • Wages for labor • Interest for loans used to purchase capital • Rent for the use of land • Profit to owners of capital • Total income paid to households=Y

8. Y=total income; C=consumption; I=investment; G=government purchases; X-M=exports-imports=net exports

9. Gross vs Net Domestic Product • GDP is before subtracting depreciation (capital consumption allowance) • NDP =GDP- CCA • NDP is “net of” depreciation. • Capital in t = Capital in (t-1) + Gross Investment –CCA = Capital in (t-1) + Net Investment where Net investment = Gross investment – CCA

10. GDP: The Income Side • Income includes 1. Compensation of employees 2. Rental income 3. Net interest 4. Corporate profits 5. Proprietors’ income • Two adjustments to income required: 1.Indirect taxes minus subsidies are added to get from factor cost to market prices. 2. Depreciation (or capital consumption) is added to get from net domestic product to gross domestic product

12. GDP: Adjusting for changes in prices Nominal GDP • the value of goods and services produced during a given year valued at the prices that prevailed in that same year. • Nominal GDP is a more precise name for GDP. Real GDP • the value of final goods and services produced in a given year when valued at the prices of a reference base year.

14. GDP Deflator • GDP deflator • Provides a comparison of current and base year prices

17. 2002 NGDP ________ 2003 NGDP ________ Base year of 2002 2002 RDGP ________ 2003 RGDP ________ Real GDP and the Price Level

18. For your answers to the next several slides, give your estimates of GDP to the nearest dollar, do not include decimals, and do not include $ signs.

20. Lucas Wedge • dollar value of the accumulated gap between what real GDP per person would have been if the 1960s growth rate had persisted and what real GDP per person turned out to be.

21. Temporary fluctuations in GDP:The Business Cycle • 4 stages to a business cycle • Peak • Recession • Trough • Expansion

22. Comparing Standard of Living Across Countries • Use per capita real GDP • Must make two adjustments • Convert into common currency • Goods and services must be valued at same prices • Using the exchange rate to convert can be problematic because prices of some products may differ after conversion • Purchasing Power Parity exchange rate is the exchange rate that would make the prices of goods and services equal across countries. • Using actual exchange rate instead of PPP exchange rate causes underestimate of standard of living in less developed countries.

23. With actual exchange rates, China RGDP per capita in 2010 is 7% of that in U.S. • With PPP exchange rates, China RDDP per capita is 15% of that in U.S.

24. Real GDP per capita across the world Source: http://www.imf.org/external/datamapper/index.php

25. Limitations of GDP as measure of standard of living • Household production • Underground economic activity • Health and life expectancy • Leisure time • Environmental quality • Political freedom and social justice