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Definition of GDP:
GDP is the market value of all the final
goods and services newly produced in a
country during some time period.
Three important points about how GDP is
defined:
I. This definition can be broken up in terms of what,
when, and where:
What: Newly produced goods and services.
Where: Only goods and services produced within
the borders of a country are included in
GDP.
When: Only goods and services produced during
some specified period of time.
II. Prices Determine The Weight Or Importance Of
Goods And Services In GDP.
GDP is a single number, but there are many goods and
services included in GDP. This is why GDP measures the
value of the final goods and services produced as opposed to
the amount produced. To determine value, the output of each
good or service is weighted by their market price.
Example: Suppose an economy produces 10 footballs and 10
baseballs. The price of a football is $50 and the price of a baseball is
$5. The total values of footballs produced is $500 ($50/football X 10
footballs) and the total value of baseballs is $50 ($5/baseball X 10
baseballs). The production of footballs and baseballs adds $550 to
GDP.
III. Final Goods Vs Intermediate Goods.
A final good or service is a good or service produced for final use.
An intermediate good is a good used as an input in the production of
final goods and services.
Measuring GDP
There are three different methods that can be used to
measure GDP.
1. The Spending or Expenditure Approach
2. The Income Approach
3. The Production or Value Added Approach
I. The Spending Approach
2nd Quarter of 2004
Gross Private
Domestic Government
GDP Consumption Investment Purchases Net Exports
$11,657.50 $8,153.80 $1,920.70 $2,174.30 ($591.30)
Share of GDP 69.94% 16.48% 18.65% -5.07%
Note: The values for 2nd quarter of 2004 are from Table 1.1.5. Gross Domestic Product. Published by the
Bureau of Economic Analysis and last revised on September 29, 2004.
Key Ideas of the Spending Approach
• Keep your eye on the ball: we want to measure
production.
• four spending groups:
– households, firms, governments, foreigners
– consumption by households
– investment by firms
• why add inventory investment?
• why add net exports?
• government purchases only--not transfers
An Important Equation: Y = C + I +G + X
X is net exports.
II. Income Approach
Adding up the income of what everybody earns will also
give us a measure of GDP.
Percent
nd of GDP
2 Quarter of 2003
GDP $11,657.5
Employee Compensation (Wages,
Salaries, and Fringe Benefits) 6,568.0 56.3%
Income of private enterprises + surplus
of government enterprises +subsidies 2,887.3 24.8%
(profits, interest and rent)
Depreciation 1,375.2 11.8%
Taxes on production and imports less
subsidies 796.3 6.8%
Net Income of Foreigners
(Income earned by foreigners in the
-36.1 -0.3%
United States less the income earned
by Americans who are abroad)
Statistical Discrepancy 67 0.6%
nd
Note: The values for 2 quarter of 2004 are from Table 1.7.5. Relation of Gross Domestic Product, Gross
National Product, Net National Product, National Income, and Personal Income Table 1.12. National
Income by Type of Income Published by the Bureau of Economic Analysis and revised on
September 29, 2004.
Note: Taxes on production and imports less subsidies used to
be known as indirect business taxes.
Why the G in GDP?
– GDP includes production of
goods used to replace
depreciated goods
– that is, GDP is gross because it
includes depreciation
Net Investment = Gross Investment – Depreciation
net domestic product is GDP minus depreciation
national income = net domestic product
- taxes on production and
imports less subsidies
Net Investment and Capital Accumulation
The capital stock is the total accumulation of all the plant
(factories), and equipment used to produce goods and services in
an economy.
The more capital there is, the more output a given unit of labor can
produce. As the labor force grows, it is important for the capital
stock to grow.
Because the capital stock is simply the accumulation of past
investment, growth in the capital stock requires continuous
investment. However, the type of investment that matters is net
investment, the amount of new plant and equipment that's left over
after replacing worn-out plant and equipment. The greater the
amount of net investment taking place, the higher the rate of
capital accumulation, and therefore, the more productive the labor
force will be.
Hence:
Capital at the end of this year = net investment during the year
+ capital at the end of last year.
This concept is illustrated in the diagram below.
III. The Production Approach: Value Added
• Perhaps the most straightforward way of measuring
GDP
• But must avoid double counting
• value-added = value of production less value of
intermediate goods
• Value-added is the source of income.
At each stage of production only add value-added to avoid
double counting.
The Figure below is a simple example showing how value-
added avoids double counting.
A breakdown of real GDP in terms of value added for
1988 and 2001 by industrial sector is shown in the below
table.
Real Gross Domestic Product by Industry
1988 Value Added 1988's Share 2001 Value Added 2001’s Share
in Billions of of Value in Billions of of Value
Chained (1996) Added Chained (1996) Added
Dollars Dollars
Gross domestic product 5,108.30 9,214.5
Private industries 4,401.80 86.17% 8,189.4 88.40%
Agriculture, forestry, and fishing 89.1 1.74% 163.9 1.78%
Mining 99.2 1.94% 106.8 1.16%
Construction 237.2 4.64% 371.9 4.04%
Manufacturing 979.9 19.18% 1,490.3 16.17%
Transportation and public utilities 449 8.79% 780.5 8.47%
Wholesale trade 346.6 6.79% 748.7 8.13%
Retail trade 461.5 9.03% 951.2 10.32%
Finance, insurance,
893.7 17.50% 1,843.5 20.01%
and real estate
Services 887.9 17.38% 1843.3 20.00%
Government 706.5 13.83% 1,107.5 12.02%
Statistical discrepancy -42.2 -0.83% -108.3 -1.18%
Notice that manufacturing was the largest producer of value added in 1988. In 2001,
manufacturing's share was less than the services sector, the finance, insurance, and
real estate sector, and the combination of wholesale and retail trade sectors.
