Gross Domestic Product (GDP) The total market value of all final goods and services produced annually within a country’s borders. Ways to Compute GDP - Expenditure Approach Add the amount of money spent by buyers of final goods and services* Avoid double counting. Do not count intermediate goods** * Goods in the hands of their final users. ** Goods that are inputs for the production of final goods. Ways to Compute GDP Income and Value –added Approaches Income Approach – add the sum of all incomes earned (wages, interest, rents, and profits) in producing goods and services Value-added Approach – add the value added at each stage of production of all goods and services What’s Not Included in GDP Certain non- market goods and services such as chores performed at home by family members. What’s Not Included in GDP Underground activities, both legal and illegal What’s Not Included in GDP Sales of used Government transfer payments such as social security goods Financial transactions such as trading of stocks and bonds Leisure time GDP and Bads GDP counts the goods and services, but it does not net out the air and water pollution. Thus, some economists argue that GDP overstates our overall economic welfare. GDP Per Capita GDP - Expenditure Approach 4 Sectors Household Sector - Consumption Business Sector - Investment Government Sector – Government Purchases Foreign Sector – Net Exports GDP = C + I + G + (X – M) Consumption The sum of household spending on: Durable goods Nondurable goods Services Durable Goods Durable goods are goods that are expected to last for more than three years, such as refrigerators, ovens, or cars. Nondurable Goods Nondurable goods are goods that are not expected to last for more than three years, such as food. Services Services are intangible items such as lawn care, car repair, and entertainment. Investment The sum of all purchases of: Newly produced capital goods - Business purchases of capital goods, such as machinery and factories Changes in business inventories - Changes in the stock of unsold goods. Purchases of new residential housing Government Purchases Includes: Federal, state, and local government purchases of goods and services and gross investment in highways, bridges, and so on. Excludes: Government transfer payments to persons that are not made in return for goods and services currently supplied. Net Exports Exports (X) - Total foreign spending on domestic (U.S.) goods Less Imports (M) - Total domestic (U.S.) spending on foreign goods Expenditure Approach GDP 2006 GDP – Income Approach 1. Purchases (expenditures) made in product markets flow to business firms. 2. Business firms then use these monies to buy resources in resource markets. 3. These monies flow to the owners (suppliers) of land, labor, capital, and entrepreneurship. 4. The sum of these resource payments is total income, which flows to households. In this simple economy total purchases (expenditures) equal total income. 5. Because total purchases (expenditures) equal GDP and total purchases equal total income, it follows that GDP equals total income. National Income Total income earned by U.S. citizens and businesses, no matter where they reside or are located. National income is the sum of the payments to resources (land, labor, capital, and entrepreneurship). Computing National Income National income = Compensation of employees + Proprietors’ income + Corporate profits + Rental income +Net interest COMPENSATION OF EMPLOYEES Compensation of employees consists of wages and salaries paid to employees plus employers’ contributions to Social Security and employee benefit plans plus the monetary value of fringe benefits, tips, and paid vacations. PROPRIETORS’ INCOME Proprietors’ income includes all forms of income earned by self-employed individuals and the owners of unincorporated businesses, including unincorporated farmers. CORPORATE PROFITS Corporate profits include all the income earned by the stockholders of corporations. RENTAL INCOME (OF PERSONS) Rental income is the income received by individuals for the use of their non- monetary assets (land, houses, offices). It also includes returns to individuals who hold copyrights and patents. Finally, it includes an imputed value to owner-occupied houses. NET INTEREST Net interest is the interest income received by U.S. households and government minus the interest they paid out. From NI to GDP GDP = National income - Income earned from the rest of the world + Income earned by the rest of the world + Indirect business taxes + Capital consumption allowance + Statistical discrepancy GDP = Income Approach Net Domestic Product NDP measures the total value of new goods available in the economy in a given year after worn-out capital goods have been replaced. Net domestic product (NDP) = GDP – Capital consumption allowance* *The estimated amount of capital goods used up in production through natural wear, obsolescence, and accidental destruction. Personal and Disposable Income Personal income = National income – Undistributed corporate profits – Social insurance taxes – Corporate profits taxes + Transfer payments Disposable income = Personal income – Personal taxes Real GDP The value of the entire output produced annually within a country’s borders, adjusted for price changes (inflation). Economic Growth Economic Growth is measured by increases in Real GDP. Business Cycle Recurrent swings (up and down) in Real GDP.