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General plan: check to see where Slavin introduces GDP segment Slides about nominal vs. real GDP Expand discussion of GDP vs. GPI Reading on same? Separate set of slides for C, I, G, X Separate section on syllabus for Inflation etc. Gross Domestic Product Chapter 9 Gross Domestic Product • What is it? – It is the monetary measure of the total annual output of all goods and services. Gross Domestic Product • Defined as: – THE MARKET VALUE OF ALL FINAL GOODS AND SERVICES PRODUCED IN A YEAR WITHIN A COUNTRY. Gross Domestic Product • MARKET VALUE: – The market value is the market price. • FINAL GOODS AND SERVICES: – What is purchased by a consumer. Gross Domestic Product • PRODUCED IN A YEAR: – The year of production, not the year of sale. • WITHIN A COUNTRY: – Within the boundaries of the US, regardless of who owns the business. The Components of GDP Gross Domestic Product • GDP equation: • GDP = C + I + G + X GDP Components C = HOUSEHOLD CONSUMPTION I = BUSINESS INVESTMENT G = GOVERNMENT SPENDING X = NET EXPORTS Net Domestic Product • NDP equation: • NDP = GDP - Depreciation Net Domestic Product • Depreciation: the wearing out of equipment, machinery, buildings, roads and infrastructure. • NDP measures economic growth after replacement of worn out capital. Nominal GDP vs. Real GDP Nominal vs. Real GDP Problem: GDP statistics are based on the purchase price of everything bought by consumers. If prices go up, so does the GDP. Nominal GDP vs. Real GDP How much of the growth of the GDP is due to inflation (price increases), and how much is due to the growth of the economy? Nominal vs. Real GDP Nominal GDP = output in terms of the current dollar value Real GDP = output in terms of constant price Calculating Percentage Change % Change = Change Original Number Calculating Percentage Change Real GDP = Current GDP – Original GDP Original Real GDP This allows us to compute the percentage change in Real GDP Calculating Percentage Change Real GDP = Nominal GDP * 100 GDP deflator This allows us to compute the percentage change in the GDP, adjusting for inflation. What is Excluded from the GDP What is Excluded from the GDP? • The GDP is our best estimate of the size of the economy of a country. • However, many products are not counted in the GDP. What is Excluded from the GDP? • Financial Transactions • Nonmarket Production • The Underground Economy Financial Transactions 1. Stock market transactions – The purchase and sale of all stocks and bonds is excluded because it is merely a transfer of ownership. – Brokers’ services are counted because each time a stock is sold, a new service has been performed. Financial Transactions 2. Public transfer payments – Such as Social Security, veteran’s payments, welfare – They are not counted because they are not payments for current production Financial Transactions 3. Private transfer payments – Such as private pension plans or family gifts – They are not counted because they are not payments for current production Financial Transactions • All of these activities are perfectly legal, thoroughly recorded, and frequently taxed. • We have very good numbers for them. Nonmarket Production 1. Any work that you do yourself - Such as painting your own house 2. All of the necessary household tasks performed by homemakers. – Such as food preparation, cooking, cleaning Nonmarket Production 1. These activities are legal, but not done in the marketplace. 2. Therefore we can only estimate that amount of nonmarket production. 3. Studies suggest that this activity is extremely large, somewhere between 10% and 20% of the size of the recorded GDP The Underground Economy 1. Second hand sales - Already counted 2. Legal but not reported - working under the table 3. Illegal and not reported Other Problems with Current GDP 1. Quality changes aren’t well tracked. 2. Pollution not correctly counted. 3. Leisure time is not accounted for. 4. Certain costs to humans not correctly counted. 5. Volunteer work not counted. Quality Changes 1. Price increases reflect product improvement as well as inflation, and it is difficult to separate the two out. 2. Example: cars today are much more expensive than they were 10, 20 years ago. 3. Part of this price increase is due to increase in quality (standard features that were optional or didn’t even exist previously). Pollution Not Correctly Counted 1. The damage to the environment is not counted. 2. The money spent cleaning up pollution is counted as part of the GDP. So the more we spend cleaning up pollution, the more the GDP grows. Leisure is not counted 1. We don’t track leisure time in our GDP statistic. Stress is Miscounted 1. The increase in stress due to more work and less leisure doesn’t show up in the GDP. 2. What shows up is the increase in aspirin, alcohol and legal drug consumption. So the increase in work hours is “good” because more stuff is produced and we buy more pain relievers. Volunteer work is not counted 1. We don’t track volunteer work in our GDP statistic. 2. How would Little League, Girl Scouts, churches, function without volunteers? 3. Chad Pegrake’s work isn’t counted. Results of Flawed GDP Techniques 1. Housework is not counted. 2. The underground economy is not counted. 3. True environmental costs not counted. 4. Decreased leisure and increased stress not counted.
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