1. 1. The Three Approaches To Measuring
2. 2. OBJECTIVES Definition of GDP Explain the three ways of measuring GDP Real V Nominal GDP GDP deflator Explain how we use real GDP to measure economic growth Limitations of our measures of GDP
3. 3. DEFINITIONS FOR GDP I. GDP is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time (usually a 365-day year). II. III. GDP is equal to the sum of the value added at every stage of production (the intermediate stages) by all the industries within a country, plus taxes less subsidies on products, in the period. IV. V. GDP is equal to the sum of the income generated by production in the country in the period that is, compensation of employees, taxes on production and imports less subsidies, and gross operating surplus (or profits)
4. 4. CALCULATING (GDP): EXPENDITURE APPROACH GDP = C + I + G + (EX IM) where: C = Personal Consumption expenditures household spending on consumer goods I = Gross Domestic Investment spending by firms and households on new capital, plant, equipment, inventory and new residential structures G = government consumption and investment EX IM = net exports net spending by rest of the world or exports minus imports
5. 5. C = PERSONAL CONSUMER EXPENDITURES CATEGORIES 1. Durable goods goods that last a relatively long time such as cars and household appliances 2. 3. Nondurable goods goods that are used up fairly quickly such as food and clothing 4. 5. Services things we buy that do not involve the production of physical things such as legal and medical services and education
6. 6. I = GROSS PRIVATE DOMESTIC INVESTMENT TYPES OF INVESTMENT 1. Gross Private Investment total investment in capital, it is the purchase of new housing, equipment and plants by private sector 2. 3. Nonresidential Investment expenditures by firms for machines, tools, plants and so on 4. 5. Residential Investment expenditures by firms and on new houses and buildings 6. 7. 8. Change in Business Inventories amount by which firms inventories change during a period, inventories are goods that firms produce now but intend to sell later
7. 7. GOVERNMENT CONSUMPTION AND INVESTMENT refers to federal, state and local governments for final goods and services. NET EXPORTS (EX IM) is the difference between exports and imports, figure can be negative or positive Example: G + (EX IM)
8. 8. CALCULATING (GDP): INCOME APPROACH GDP = National Income + Depreciation + (indirect taxes Subsidies) + Net factor payments to the rest of the world 1. NATIONAL INCOME - is the total income earned by the factors of production owned by countrys citizen a) Compensation of employees includes wages, salaries and various supplements b) Proprietors income income of unincorporated businesses c) Corporate profits income of corporate businesses d) Net interest interest paid by business e) Rental income income received by property owners in from of rent
9. 9. 2. DEPRECIATION is the amount by which assets value falls in a given period 3. 4. INDIRECT TAXES are taxes like sales tax, customs duties and license fee 5. 6. SUBSIDIES are payments made by the government for which it receives no goods or services in return 7. 8. NET FACTOR PAYMENTS TO THE REST OF THE WORLD payments of factor income to the rest of the world minus receipt of factor income from the rest of the world Example: CALCULATING (GDP): INCOME APPROACH
10. 10. CALCULATING (GDP): THE PRODUCTION APPROACH Value Added: VA = total revenue the value of intermediate goods Total GDP is the sum of gross value added by institutional units that are resident in the economy (in different economic activities) plus taxes on products and import (VAT, excise tax and customs duties) less subsidies on products. Calculation scheme is as follows: Total output (goods and services) by types of activities in market prices - intermediary consumption for generating goods and services = GDP at market prices + taxes on products and import - subsidies on products = Total GDP at market prices Example:
11. 11. Real V Nominal GDP Real GDP is the value of final goods and services produced in a given year when valued at constant prices. Calculating Real GDP The first step in calculating real GDP is to calculate nominal GDP, which is the value of goods and services produced during a given year valued at the prices that prevailed in that same year. http://www.emanuelecolombo.it/portfolio/portfolio/euronews-2/
12. 12. GDP DEFLATORS
13. 13. USE REAL GDP TO MEASURE ECONOMIC GROWTH We use real GDP to calculate the economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next. 1. We measure economic growth so we can make: Economic welfare comparisons Economic welfare measures the nations overall state of economic well-being. Real GDP is not a perfect measure of economic welfare for seven reasons: a. Quality improvements tend to be neglected in calculating real GDP so the inflation rate is overstated and real GDP understated. b. Real GDP does not include household production, that is, productive activities done in and
14. 14. USE REAL GDP TO MEASURE ECONOMIC GROWTH International welfare comparisons Real GDP is used to compare economic welfare in one country with that in another. Two special problems arise in making these comparisons. 1. Real GDP of one country must be converted into the same currency units as the real GDP of the other country, so an exchange rate must be used. 2. The same prices should be used to value the goods and services in the countries being compared, but often are not. Business cycle forecasts Real GDP is used to measure business cycle fluctuations. These fluctuations are probably accurately timed but the changes in real GDP probably overstate the changes in total production and peoples welfare caused by business cycles.
15. 15. Limits of GDP Measure 1. Leisure time 2. 3. Nonmarket economic activities 4. 5. Environmental quality and resource depletion 6. 7. Quality of life 8. 9. Poverty and economic inequality 10. 11. International GDP comparisons based on exchange rates, which can introduce bias