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1 of 33Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.

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CHAPTER19CHAPTER 19

GDP: Measuring Total Production and Income

Fernando QuijanoPrepared by:

In the more than 100 years that Ford

Motor Company has been in business, its

experiences have often mirrored those of the U.S economy.


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19.1 Gross Domestic Product Measures Total ProductionExplain how total production is measured.

19.2 Does GDP Measure What We Want It to Measure?Discuss whether GDP is a good measure of well-being.

19.3 Real GDP versus Nominal GDPDiscuss the difference between real GDP and nominal GDP.

19.4 Other Measures of Total Production and Total IncomeBecome familiar with other measures of total production and total income.


Chapter Outline andLearning Objectives

CHAPTER19CHAPTER 19


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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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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

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.

19.1 LEARNING OBJECTIVEExplain how total production is measured.


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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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Calculating GDPSolved Problem 19-1

PRODUCTION AND PRICE STATISTICS FOR 2011

(1)PRODUCT

(2)QUANTITY

(3)PRICE PER UNIT

Eye examinations 100 $50.00Pizzas 80 10.00Textbooks 20 100.00Paper 2,000 0.10

PRODUCT(1)

QUANTITY(2)

PRICE PER UNIT(3)

VALUE

Eye examinations 100 $50 $5,000Pizzas 80 10 800Textbooks 20 100 2,000

YOUR TURN: For more practice, do related problem 1.12 at the end of this chapter.



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Gross Domestic Product Measures Total ProductionProduction, Income, and the Circular-Flow DiagramFIGURE 19-1The Circular Flow and the Measurement of GDP

The circular-flow diagram illustrates the flow of spending and money in the economy. Firms sell goods and services to three groups: domestic households, foreign firms and households, and the government. To produce goods and services, firms use factors of production: labor, capital, natural resources, and entrepreneurship. Households supply the factors of production to firms in exchange for income in the form of wages, interest, profit, and rent. Firms make payments of wages and interest to households in exchange for hiring workers and other factors of production.The sum of wages, interest, rent, and profit is total income in the economy. We can measure GDP as the total income received by households.



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Gross Domestic Product Measures Total ProductionProduction, Income, and the Circular-Flow DiagramFIGURE 19-1 (continued)

The diagram also shows that households use their income to purchase goods and services, pay taxes, and save. Firms and the government borrow the funds that flow from households into the financial system. We can measure GDP either by calculating the total value of expenditures on final goods and services or by calculating the value of total income.

The Circular Flow and the Measurement of GDP



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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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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 and firms on new houses.

Gross Private Domestic Investment, or “Investment”

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


YOUR TURN: Test your understanding by doing related problem 1.8 at the end of this chapter.


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Components of GDP

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

Government Consumption and Gross Investment, or “Government Purchases”



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NXGICY +++=

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



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Gross Domestic Product Measures Total ProductionAn Equation for GDP and Some Actual Values

FIGURE 19-2Components of GDP in 2008Consumption accounts for 70 percent of GDP, far more than any of the other components. In recent years, net exports typically have been negative, which reduces GDP.



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Gross Domestic Product Measures Total ProductionAn 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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Will U.S. Consumers Be Spending Less?

Makingthe

Connection




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FIRMVALUE OF PRODUCT VALUE ADDED

Cotton farmer Value of raw cotton = $1 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

Measuring GDP by the Value-Added Method

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

Table 19-1Calculating Value Added



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Does GDP Measure What We Want It to Measure?

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.

19.2 LEARNING OBJECTIVEDiscuss whether GDP is a good measure of well-being.


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Why Do Many Developing CountriesHave Such Large Underground Economies?

Makingthe

Connection

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



A large informal sector can be a sign of government policies that are retarding economic growth.


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Does GDP Measure What We Want It to Measure?

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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Did World War II Bring Prosperity?Making

theConnection

World War II was a period of extraordinary sacrifice and achievement by the “greatest generation.” But statistics on GDP may give a misleading indication of whether it was also a period of prosperity.




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Real GDP versus Nominal GDP

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.

19.3 LEARNING OBJECTIVEDiscuss the difference between real GDP and nominal GDP.


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Solved Problem 19-3Calculating Real GDP

PRODUCT2011

QUANTITY2005

PRICE VALUEEye examinations 100 $40 $4,000

Pizzas 80 11 880

Textbooks 20 90 1,800

2005 2011

PRODUCT QUANTITY PRICE QUANTITY PRICE

Eye examinations 80 $40 100 $50

Pizzas 90 11 80 10 Textbooks 15 90 20 100

YOUR TURN: For more practice, do related problem 3.3 at the end of this chapter.



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Comparing Real GDP and Nominal GDP

FIGURE 19-3Nominal GDP and Real GDP, 1990–2008Currently, the base year for calculating GDP is 2005. In the years before 2005, prices were, on average, lower than in 2005, so nominal GDP was lower than real GDP. In 2005, nominal and real GDP were equal. After 2005, prices have been, on average, higher than in 2005, so nominal GDP is higher than real GDP.



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100Nominal GDPGDP deflatorReal GDP

= ×

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.



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FORMULA APPLIED TO 2007 APPLIED TO 2008

GDPDeflator

2007 2008NOMINAL GDP $14,078 billion $14,441 billion

REAL GDP $13,254 billion $13,312 billion

100GDP Real

GDP Nominal×= 106100

billion $13,254billion 078,14$

=×⎟⎠

⎞⎜⎝

⎛

The GDP Deflator

108100billion $13,312billion 441,14$

=×⎟⎠

⎞⎜⎝

⎛

%9.1100106

106108=×⎟

⎠⎞

⎜⎝⎛ −

From these values for the deflator, we can calculate that the price level increased by 1.9 percent between 2007 and 2008:



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Other Measures of Total Production and Total Income

Gross National Product (GNP)

Disposable Personal Income

National Income

Personal Income

Become familiar with other measures of total production and total income.

19.4 LEARNING OBJECTIVE

Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if theproduction takes place outside the United States.

National income is calculated as GDP minus the consumption of fixed capital, or depreciation.

Disposable personal income is equal to personal income minus personal tax payments.

Personal income is income received by households.


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FIGURE 19-4Measures of Total Production and Total Income, 2008The most important measure of total production and total income is gross domestic product (GDP). As we will see in later chapters, for some purposes, the other measures of total production and total income shown in the figure turn out to be more useful than GDP.




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The Division of Income

FIGURE 19-5The Division of IncomeWe can measure GDP in terms of total expenditure or as the total income received by households. The largest component of income received by households is wages, which are more than three times as large as the profits received by sole proprietors and the profits received by corporations combined.




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A Slowing Descent: Auto Sales Fell 37Percent, but Improved Slightly

Real GDP declined for three consecutive quarters beginning in the third quarter of 2008.

Falling Auto Purchases Lead to Lower GDP

>>AN INSIDE LOOK


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Business cycleConsumptionEconomic growthExpansionFinal good or service GDP deflatorGovernment purchasesGross domestic product (GDP)Inflation rate

Intermediate good or serviceInvestment

MacroeconomicsMicroeconomicsNet exportsNominal GDP

Price levelReal GDPRecessionTransfer paymentsUnderground economyValue added

KEY TERMS

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