Economic Growth (GDP)

With Mrs. Eskra

OBJECTIVES: • WHAT WILL YOU LEARN? – What GDP is and what it measures.– The two approaches to calculating GDP• Income• Expenditure

– Shortcomings of GDP as a measure of growth.– We need to be careful only to count FINAL

goods and services.

Measuring Economic Activity

• After the Great Depression, economists realized they needed a better way to keep track of the U.S. economy.

• It is normal to go through fluctuations of growth and contraction.– How can we better predict when a major

depression is coming?– How can we measure economic growth over

time?

Measuring Economic Activity

The answer was to calculate GDP – Gross Domestic Product.

Big Idea: GDP attempts to measure all economic activity in a country in a year.

Measuring Economic Activity

If the figure rises from one year to the next, we can feel confident that the

economy is more productive than the year before (or growing)!

If GDP falls, it is an indication that the economy is slowing.

GDP

Gross Domestic Product; the sum of all final goods and services

sold within a nation’s domestic borders;

a measurement of economic activity.

FINAL goods only, please!

GDP measures FINAL goods and services, not intermediate goods.

Intermediate = something purchased in the production process to make a final

good/service.

Measuring Only Final Goods:Example

• Before I buy a new car, the manufacturer has purchased tires (and a lot of other components) to put on the car. – Do we count those tires in GDP?

• No! That would be double-counting.• They are already counted in the final selling price of

the vehicle.

• But if I need new tires for my car this winter, then the tires I purchase to replace my old ones WILL count this year.

GDP

• There are two approaches to calculating GDP:

1) Income Approach2) Expenditure Approach

They are really two sides of the same coin!

EXPENDITURE APPROACH

Sum of all final goods and services purchased in an economy; typically referenced as Y = C + I + G + (X-M);

Y (GDP), C (consumer purchases), I (investment outlays), G (net

government spending), X (exports), M (imports).

Expenditure Approach

• This approach calculates economic activity by adding up what people spend money to purchase.

Activity in the Output Market from Circular Flow

Expenditure Approach

• C + I + G + (X-M)– C = Consumer purchases – I = Investment in capital (generally by

businesses)– G = Government purchases– (X-M) = Exports minus Imports

Expenditure Approach: Circular Flow Model

HouseholdsFirms

Wages, rent, interest, profits paid for land, labor and capital

Payments for goods & services

Government

Taxes

TaxesPayments for g/s

Wages, interest, transfer payments

OUTPUT MARKET

Rest of

world

Imports: Our purchases from foreign countries (SUBTRACT)

Exports: Foreign purchases from us.(ADD)

INCOME APPROACH

Sum of the amount of resources used to produce goods and services, or sum of the income received from

purchases of these resources.

W + R + I + P

Resource Cost / Income Approach

• This approach calculates economic activity by adding up the costs that go into producing goods and services (all the ways that people make money in an economy).

Activity in the Input Market from Circular Flow

Resource Cost / Income Approach

• Cost of land, labor, and capital OR the income received from these resources being purchased.

• WRIP:– Income earned by workers: wages, salaries,

benefits – Rental income earned by landlords– Interest income earned by lending money to

businesses– Profits earned by businesses

Resource Cost / Income Approach

Process:• We have data on the income that people

make from tax returns.– Not all of this equates to income for business,

though.• Ex: adjust for depreciation of equipment

– Include income that foreigners make HERE.– Exclude income that Americans make ABROAD.

Resource Cost / Income Approach: Circular Flow Model

HouseholdsFirms

Wages, rent, interest, profits paid for land, labor and capital

Payments for goods & services

Government

Taxes

TaxesPayments for g/s

Wages, interest, transfer payments

INPUT MARKET

Expenditure & Income Approach

• Will arrive at the same GDP because:

One person’s spending becomes another person’s income.

You can see this on the Circular Flow Model!

GDP GROWTH

The measure of change in GDP over time.

GDP Growth

• This is the most common way of measuring growth today.

GDP growth is a measure or indication of a “healthy” macroeconomy.

Other measures?

• GNP = Gross National Product

– Calculates the value of goods and services produced BY Americans (instead of IN America).

– Was used in the past.

GDP: Shortcomings

• Is it a perfect measure of all economic activity or how people live in a country?– Does not measure any nonmarket activities:• Cleaning our own homes• Caring for children• Changing the oil on our own car

– Does not measure the value we place on leisure, either.

GDP: Shortcomings

• It is an average:

If GDP per capita (person) rises, we can say our standard of living has improved.

But does that mean everyone is better off?

RECAP

• What did you learn?– What GDP is and what it measures.– The two approaches to calculating GDP• Income• Expenditure

– Shortcomings of GDP as a measure of growth.– We need to be careful only to count FINAL

goods and services.