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© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 7 GDP: Measuring Total Production and Income

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Page 1: Chap7pp

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Fernando & Yvonn Quijano

Prepared by:

Chapter

7

GDP: Measuring Total Production and Income

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© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 31

Increases in GDP Help Revive American Airlines

7.1 Explain how total production is measured.

7.2 Discuss whether GDP is a good measure of well-being.

7.3 Discuss the difference between real GDP and nominal GDP.

7.4 Become familiar with other

measures of total production

and total income.

Learning Objectives

The business cycle does not affect all industries in the same way. For example, some trucking firms experienced slow sales during 2006 while airlines were prospering.

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GDP: Measuring Total Production and Income

Microeconomics The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.

Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

Business cycle Alternating periods of economic expansion and economic recession.

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GDP: Measuring Total Production and Income

Recession The period of a business cycle during which total production and total employment are decreasing.

Economic growth The ability of an economy to produce increasing quantities of goods and services.

Inflation rate The percentage increase in the price level from one year to the next.

Expansion The period of a business cycle during which total production and total employment are increasing.

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year.

Measuring Total Production: Gross Domestic Product

GDP Is Measured Using Market Values, Not Quantities

The word value is important in the definition of GDP.

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Final good or service A good or service purchased by a final user.

Measuring Total Production: Gross Domestic Product

Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck.

GDP Includes Only Current Production

GDP Includes Only the Market Value of Final Goods

GDP includes only production that takes place during the indicated time period.

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Solved Problem 7-1Calculating GDP

Learning Objective 7.1

PRODUCTION AND PRICE STATISTICS FOR 2007

(1)PRODUCT

(2)QUANTITY

(3)PRICE PER UNIT

Eye examinations 100 $50.00

Pizzas 80 10.00

Textbooks 20 100.00

Paper 2,000 0.10

PRODUCT(1)

QUANTITY(2)

PRICE PER UNIT(3)

VALUE

Eye examinations 100 $50 $5,000

Pizzas 80 10 800

Textbooks 20 100 2,000

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Production, Income, and the Circular Flow Diagram

FIGURE 7-1

The Circular Flow and the Measurement of GDP

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Transfer payments Payments by the government to individuals for which the government does not receive a new good or service in return.

Production, Income, and the Circular Flow Diagram

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Components of GDP

Consumption Spending by households on goods and services, not including spending on new houses.

Personal Consumption Expenditures, or “Consumption”

Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses.

Gross Private Domestic Investment, or “Investment”

Don’t Let This Happen to YOU!Remember What Economists Mean by Investment

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Components of GDP

Government purchases Spending by federal, state, and local governments on goods and services.

Government Consumption and Gross Investment, or “Government Purchases”

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Learning Objective 7.1

Spending on Homeland SecurityMaking

the

Connection

Government spending on homeland security more than doubled between 2001 and 2006.

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Components of GDP

Net exports Exports minus imports.

Net Exports of Goods and Services, or “Net Exports”

An Equation for GDP and Some Actual Values

NXGICY

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

An Equation for GDP and Some Actual Values

FIGURE 7-2

Components of GDP in 2006

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

An Equation for GDP and Some Actual Values

• Consumer spending on services is greater than the sum of spending on durable and nondurable goods.

• Business fixed investment is the largest component of investment.

• Purchases made by state and local governments are greater than purchases made by the federal government.

• Imports are greater than exports, so net exports are negative.

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Gross Domestic Product Measures Total Production

Learning Objective 7.1

Measuring GDP by the Value-Added Method

Value added The market value a firm adds to a product.

Table 7-1

Calculating Value Added

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $ Value added by cotton farmer = 1

Textile Mill Value of raw cotton woven into cotton fabric = $3

Value added by cotton textile mill = ($3 – $1) = 2

Shirt Company Value of cotton fabric made into a shirt = $15

Value added by shirt manufacturer = ($15 –$3) = 12

L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35

Value added by L.L. Bean = ($35 – $15) = 20

Total Value Added = $35

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Does GDP Measure What We Want It to Measure?

Learning Objective 7.2

Household production refers to goods and services people produce for themselves.

Shortcomings in GDP as a Measure of Total Production

Household Production

The Underground Economy

Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

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Learning Objective 7.2

How the Underground Economy Hurts Developing Countries

Makingthe

Connection

In some developing countries, more than half the workers may be in the underground economy.

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Does GDP Measure What We Want It to Measure?

Learning Objective 7.2

Shortcomings of GDP as a Measure of Well-Being

The Value of Leisure Is Not Included in GDP

GDP Is Not Adjusted for Pollution or Other Negative Effects of Production

GDP Is Not Adjusted for Changes in Crime and Other Social Problems

GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

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Learning Objective 7.2

Did World War II Bring Prosperity?Making

the

Connection

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Real GDP versus Nominal GDP

Learning Objective 7.3

Real GDP The value of final goods and services evaluated at base-year prices.

Calculating Real GDP

Nominal GDP The value of final goods and services evaluated at current-year prices.

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Solved Problem 7-3Calculating Real GDP

Learning Objective 7.3

PRODUCT2009

QUANTITY2000

PRICE VALUE

Eye examinations 100 $40 $4,000

Pizzas 80 11 880

Textbooks 20 90 1,800

2000 2009

PRODUCT QUANTITY PRICE QUANTITY PRICE

Eye examinations 80 $40 100 $50

Pizzas 90 11 80 10

Textbooks 15 90 20 100

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Real GDP versus Nominal GDP

Learning Objective 7.3

Comparing Real GDP and Nominal GDP

FIGURE 7-3

Nominal GDP and Real GDP, 1990–2006

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Real GDP versus Nominal GDP

Learning Objective 7.3

Price level A measure of the average prices of goods and services in the economy.

The GDP Deflator

GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.

100Nominal GDP

GDP deflatorReal GDP

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Real GDP versus Nominal GDP

FORMULA APPLIED TO 2005 APPLIED TO 2006

GDPDeflator

2005 2006

NOMINAL GDP $12,456 billion $13,247 billion

REAL GDP $11,049 billion $11,415 billion

100GDP Real

GDP Nominal

Learning Objective 7.3

The GDP Deflator

116100billion $11,415

billion 247,13$

116 1132.7%

113

113100billion $11,049

billion 456,12$

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Other Measures of Total Production and Total Income

Learning Objective 7.4

Gross National Product (GNP)

Net National Product (NNP)

National Income

Personal Income

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Other Measures of Total Production and Total Income

Learning Objective 7.4

Disposable Personal Income

FIGURE 7-4

Measures of Total Production and Total Income, 2006

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Other Measures of Total Production and Total Income

Learning Objective 7.4

The Division of Income

FIGURE 7-5

The Division of Income

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An Inside LOOK Trucking Industry Depends on the Goods—Not Services—Component of GDP

Economic Slowdown Slams Breaks on Trucking Sector

As goods decline as a percentage of GDP, so does the demand for ground-freight transportation services. (The goods and services shares of GDP do not sum to 100 percent because GDP is composed of goods, services, and structures.)

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Business cycle

Consumption

Economic growth

Expansion

Final good or service

GDP deflator

Government purchases

Gross domestic product (GDP)

Inflation rate

Intermediate good or service

Investment

K e y T e r m s

Macroeconomics

Microeconomics

Net exports

Nominal GDP

Price level

Real GDP

Recession

Transfer payments

Underground economy

Value added