1

Measuring a Nation’s Income

Chapter 10

2

Definition

GDP: market value of final goods and services produced in a country in a given year

3

Definition

GDP: market value of final goods and services produced in a country in a given year

Only goods purchased or put into inventory Only transactions officially recorded (illegal

and under-the-table transactions not included.)

4

Definition

GDP: market value of final goods and services produced in a country in a given year

Intermediate goods (inputs) not included

5

Definition

GDP: market value of final goods and services produced in a country in a given year

Services make up almost half the GDP

6

Definition

GDP: market value of final goods and services produced in a country in a given year

GDP is a flow. The level corresponds to the amount produced in a year.

7

$15.8 trillion 2012Q4U.S. Department of Commerce: Bureau of Economic Analysis

8

The Circular-Flow Diagram

Households: own the factors of production,

sell/rent them to firms for income buy and consume goods & services

Households: own the factors of production,

sell/rent them to firms for income buy and consume goods & services

Households

Firms: buy/hire factors of production,

use them to produce goods and services

sell goods & services

Firms: buy/hire factors of production,

use them to produce goods and services

sell goods & services 9

The Circular-Flow Diagram

Income (=GDP)Wages, rent, profit (=GDP)

Factors of production

Labor, land, capital

Spending (=GDP)

G & S bought

G & S sold

Revenue (=GDP)

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11

GDPDollar flow ofexpenditureson final goods

=Dollar flow of

income (and indirect cost) of final goods

=

Two Ways of Measuring GDP

12

GDP: output produced within the US border

GNP: income earned by US citizens

Bureau of Economic Analysis switched to GDP as key measure in 1991.

13

Components of GDP

C: consumption

I : investment in plant & equipment

G: government spending

X-M: net exports

14

Components of GDP

C: consumption

I : investment in plant & equipment

G: government spending

X-M: net exports

15

Components of GDP

C: consumption

I : investment in plant & equipment

G: government spending

X-M: net exports

16

Investment includes residential housing …

… and imputed rental payments are included in consumption.

17

Investment includes inventories

18

Components of GDP

C: consumption

I : investment in plant & equipment

G: government spending

X-M: net exports

Government spending does not include transfer payments

Transfer payments include Social Security, Welfare, Unemployment Insurance

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20

Components of GDP

C: consumption

I : investment in plant & equipment

G: government spending

X-M: net exports

X-M is negative for U.S.

Imports are subtracted because they are included in C, I and G

21

U.S. GDP and Its Components, 2012

–1,915

9,767

6,657

35,459

$49,968

per capita

–3.8

19.5

13.3

71.0

100.0

% of GDP

–598

3,048

2,078

11,068

$15,596

billions

NX

G

I

C

Y

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ACTIVE LEARNING ACTIVE LEARNING 1

GDP and its componentsGDP and its componentsIn each of the following cases, determine how much GDP and each of its components is affected (if at all).

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them.

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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24

Real vs Nominal

Nominal GDP: GDP measured in current dollars.

Real GDP: GDP adjusted for inflation, measured in base year dollars.

Nominal and Real GDP in the U.S., 1965–2012

Real GDP (base year

2005)

Nominal GDP

billi

ons

25

EXAMPLE:

Compute nominal GDP in each year:

2011: $10 x 400 + $2 x 1000 = $6,000

2012: $11 x 500 + $2.50 x 1100 = $8,250

2013: $12 x 600 + $3 x 1200 = $10,800

Pizza Latte

year P Q P Q

2011 $10 400 $2.00 1000

2012 $11 500 $2.50 1100

2013 $12 600 $3.00 1200

37.5%

Increase:

30.9%

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EXAMPLE:

Compute real GDP in each year, using 2011 as the base year:

Pizza Latte

year P Q P Q

2011 $10 400 $2.00 1000

2012 $11 500 $2.50 1100

2013 $12 600 $3.00 1200

20.0%

Increase:

16.7%

$10 $2.00

2011: $10 x 400 + $2 x 1000 = $6,000

2012: $10 x 500 + $2 x 1100 = $7,200

2013: $10 x 600 + $2 x 1200 = $8,40027

EXAMPLE:

In each year,

• nominal GDP is measured using the (then) current prices.

• real GDP is measured using constant prices from the base year (2011 in this example).

yearNominal

GDPReal GDP

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

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EXAMPLE:

• The change in nominal GDP reflects both prices and quantities.

yearNominal

GDPReal GDP

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

20.0%

16.7%

37.5%

30.9%

The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation).

Hence, real GDP is corrected for inflation. 29

The GDP Deflator

One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next.

GDP deflator = 100 x GDP deflator = 100 x nominal GDP

real GDP

EXAMPLE:

Compute the GDP deflator in each year:

yearNominal

GDPReal GDP

GDP Deflator

2011 $6000 $6000

2012 $8250 $7200

2013 $10,800 $8400

2011: 100 x (6000/6000) = 100.0

100.0

2012: 100 x (8250/7200) = 114.6

114.6

2013: 100 x (10,800/8400) = 128.6

128.6

14.6%

12.2%

GDP & Well-being

32

GDP and Life Expectancy in 12 countries

33

Lif

e e

xp

ec

tan

cy

(y

ears

)

Real GDP per capita

U.S.Germany

Japan

Mexico

Russia

Brazil

China

India

Indonesia

Pakistan

Bangladesh

Nigeria

33

GDP and Literacy in 12 countries

34

Ad

ult

Lit

era

cy

(%

of

po

pu

lati

on

)

Real GDP per capita

U.S.Germany Japan

Mexico

Russia

Brazil

China

India

Indonesia

Nigeria

Pakistan

Bangladesh

34

GDP and Internet Usage in 12 countries

35

Inte

rne

t U

sa

ge

(%

of

po

pu

lati

on

)

Real GDP per capita

U.S.

Germany

Japan

Mexico

Russia

Brazil

ChinaIndia

Indonesia

Nigeria

Bangladesh

Pakistan

35

Gross Domestic Product…“… does not allow for the health of our children, the quality of their education,

or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity

of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country.

It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.”

- Senator Robert Kennedy, 1968

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37

What is the effect on the GDP of an increase in labor force participation of women?

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Shortcomings of GDP has a measure of well being.

– does not count non-market production.

– does not count the underground economy.

– makes no adjustment for leisure.

– probably understates output increases because of the problem

of estimating improvements in the quality of products.

– does not adjust for harmful side effects.

– does not account for the uneven distribution of income.

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Bhutan:Gross National Happiness

Spans over 38,394 square km of mountainous terrain

Population - 600,000

Bhutan – basic facts

Communities and villages are often isolated from each other by harsh, mountainous terrain

An urban center in Bhutan