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.