; Gross Domestic Product
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Gross Domestic Product


  • pg 1
• In order to ensure that our economic goals
  of full employment, stable prices and
  economic growth are met our government
  constantly takes measurements of the
• Three important measurements are
  – Gross Domestic Product (GDP)
  – Unemployment rate
  – Inflation rate
      Gross Domestic Product
What’s a Gross
Domestic Product?             Broccoli?   I was gonna say
                                          “Preparation H.”

   This is the most important measure of
               economic activity.
GDP is used to compare economies’
   standard of living world wide
   The Definition of GDP

 GDP is the dollar value of all
   final goods and services
produced within a country in a
          given year.
GDP is a measure of the spending and
       income of an economy.
 Expenditures          Market for         Expenditures
    Goods & Services
                                       Goods & Services
                       and Services

 Firms                                            Households

     Inputs for                         Labor, land,
     production         Market for      and capital
    Income             of Production
Consumer Spending              70% (Consumption)

+Business Spending              17 %   (Investment)

+Government Spending 18%
+Foreign Spending -5% (Net Exports)

   Net Exports = Exports – Imports
 [Imports represent production outside a country]
This approach adds together all the income
earned in the production of goods & services
 Wages (income from labor)
+ Rents (income from natural resources)
+ Interest (income from capital investments)
+ Owner’s Income (profit earned by sole
proprietorship and partnerships)
+ Corporate Profits
   The Expenditure Approach
• In calculating GDP we need to be careful
  to not double-count items, so we leave out
  the value of the following:
  – Intermediate goods
  – Second-hand sales
  – Transfer payments
 SERVICES (products in the form sold to
 consumers) not        intermediate goods
Intermediate Goods – components of the final good.
 A. Ford buys batteries or tires for its cars.

 B. KFC buys chickens to eventually sell to customers.
It includes goods and services CURRENTLY PRODUCED,
not transactions involving goods produced in the past.
      Second Hand Sales = no current production.
        A. If a 1957 Chevy is bought in 2009

[It has not been produced again so would not count.]

B. Boots produced in 2000 are bought in a Resale Store in 09.
 They also have not been produced again.

A salesman’s commission on a used good
would count. You are buying his services.
                – what is not counted
Transfer Payments –welfare, unemployment, social security.
  [This money will be counted when the unemployed or
      Grandma go spend it]
                              “Now that I’ve gotten
                              my welfare check, I
                              can get a mini iPod.”
    The Expenditure Approach
• Since GDP measures the dollar value of
  goods and services produced, purchased
  and reported within a year, there are
  several other things that are left out of the
  – Purely financial transactions
  – Unreported legal and illegal market activities
  – Non-market activities
                 – what is not counted
Purely Financial Transactions – stocks, bonds, CDs.
 There is no current production.
  A. If 100 shares of Dell stock is bought

  I’m going to buy 100
  shares of Dell Stock.
                 Exchanging one financial asset for another
       Unreported Legal Business Activity

Unreported “legal” business activity does not count.
This is two-thirds of the “underground economy.”

                                                 And what if the
What if an eye surgeon        And what if this   dentist doesn’t
doesn’t report $500 of his    waitress doesn’t   report $400 for
his $3,400 IntraLASIK bill?   report all tips?   teeth whitening?
Illegal business activity, because it goes unreported,
also does not count. Making up 1/3 of the “underground
economy,” it includes murder for hire, gambling,
 and drugs

 Illegal business activity is also not counted.

                  “I’m getting $1,000 to kill
                  you, Ziggy, but at least it
                  will not count in GDP.”
      Non-market Transactions Are Not
Work in your own household or volunteer work
in the community does not count because there was
no payment.

  So, don’t marry your maid, gardener, or
  fitness instructor, or you will hurt GDP.
           The Measurement of GDP
•   It measures the value of production
    regardless of who owns the company.
•   It does NOT measure production by U.S.
    companies outside the U.S.

            in Chicago
      BMW in Waco

                                  Nike in
  The Measurement of GDP
It measures the value of production
that takes place WITHIN A SPECIFIC
TIME PERIOD, usually a year or a
quarter (three months).
Nominal GDP versus Real GDP
• We use GDP to evaluate whether or not
  our economy is growing.
• If we produce more goods and services
  this year than last year we can conclude
  that we are growing.
• Because GDP is measured by adding up
  our spending on output (PRICE X quantity)
  this is not always clear since prices tend to
  rise from year to year.
Nominal GDP versus Real GDP
• Nominal GDP is the dollar amount we
  spent this year on goods and services.
  – It is found by multiplying output bought at
    current price level. If we have inflation
    nominal GDP goes up.
• Real GDP is corrected for the effects of
  – It is found by multiplying output bought at a
    constant price level. If Real GDP has
    increased then output has increased.
      Year 1 Nominal GDP
   Suppose an economy‘s entire output is cars and
   This year the economy produces:

    10 cars at $15,000 each = $150,000
+ 10 trucks at $20,000 each = $200,000
                             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.
     Year 2 Nominal GDP
In the second year, the economy’s output
does not increase, but the prices of the cars
and trucks do:
    10 cars at $16,000 each = $160,000
+ 10 trucks at $21,000 each = $210,000
                           Total = $370,000
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
                         CHANGES IN GDP
The level of output (income and expenditures) is changed
if there is a change in AGGREGATE DEMAND.

           Price Level

                         P2                          b
                         P1                      a

                              o                Q1 Q2
                                  Real Gross Domestic Product
                         CHANGES IN GDP
The level of output (income and expenditures) is changed
if there is a change in AGGREGATE SUPPLY.

           Price Level                                        AS2

                         P1                   a
                         P2                        b

                              o             Q1    Q2
                              Real Gross Domestic Product
Personal   Spending ( Consumption )
               Spending by Households
•Durable Goods[12%]
•Nondurable Goods[29%][soup & soap]

Investment - Spending by Businesses

4 Subcategories
A. Tools, equipment , machinery
B. Buildings (offices, factories)
C. Residential buildings (your house)
C. Inventory adjustments
Government Purchases          [state/local & federal]

Government purchases of goods/services
 produced   (not transfer payments)

3 Subcategories
 A. Federal government                37%
 B. 50 State governments
 C. 84,000 local governments          63% for state and
Net Exports

Net Exports = Exports – Imports
 [Imports represent production outside a country]

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