Chapter 5

1. Chapter 5 Measuring GDP and Economic Growth

2. You will learn • How GDP is measured • The difference between real and nominal GDP • Aggregate income and aggregate expenditures • How real GDP is used to compute economic growth • Problems with interpreting real GDP

3. GDP or gross domestic product, is the market value of all final goods and services produced in a country in a given time period • Market value • Final goods • Produced domestically • In a given time period (usually a year or quarter)

4. Market value

5. Final goods • The materials($8,000) used in producing a new car are included in the price to dealer • The price to the dealer is $12,000 • The price to the customer is $20,000 • Should the value of the car be • $20,000+$12,000+$8,000=$40,000 • The value of the car is $20,000 (avoid double counting).

6. Produced domestically – within a country In a given time period –usually a year or quarter

7. AE—aggregate expenditure Who can buy output? • Consumers (C) • Businesses (I—investment spending) • Government (G) • Foreigners (X-M net exports)

9. AE—one way to compute GDP • AE=GDP • AE=C+I+G+(X-M) • C+I+G+(X-M)=GDP

10. Aggregate Income (Y)—another way to compute GDP • GDP=what firms take in when they sell output. What do firms do with these funds. • Pay employees (wages) • Pay lenders (interest) • Pay owners of land and buildings (rent) • Pay stockholders (corporate profits--interest) • Profits—to entrepreneurs (sole proprietors and partnerships) Recall these are payments to the factors of production

11. Y=factor income • Y=Wages+Interest+Rent+Profits

12. Y=factor income • What can you do with income • Pay taxes (T) • Consume some (C) • Save what is left (S) Y=C+S+T

13. Two ways of computing GDP • Aggregate expenditures approach • AE=GDP=C+I+G+(X-M) • Factor income appoach • GDP=Y=wages+interest+rent+profits • Y=C+S+T

15. Government deficit • If the government runs a deficit it must borrow the money to finance the deficit. • The Treasury borrows money by selling bonds in the bond market. • Who buys the bonds? Anybody that wants to. • Businesses also borrow by selling bonds.

16. International trade deficits • (X-M)=current account=balance of trade • X=what we sell to foreigners (exports) • M=what we buy from them (imports) • If M>X we buy more than we sell (a trade deficit) • What do foreigners do with these dollars? • They buy government bonds and corporate stocks and bonds.

17. Total U.S. borrowing • U.S. government debt (G-T) • Plus • U.S. private debt—domestic + (X-M)

18. Two ways to estimate prices • Directly by constructing price indexes • Consumer Price Index (CPI) • Not in book • Indirectly by computing the implicit price deflator

19. Price index for groceries • Market basket (in base year of 1960) • 1 dozen eggs • 2 chickens • 3 pounds hamburger • Other things a typical family might buy Price of basket =$100 in 1960 Price of basket = $200 in 1970

20. Price index • The market basket does not change so any difference must be due to prices. • Price indexes however miss • Substitution effect • New goods • Quality changes • Discount stores

21. Computing real GDP using price index

22. Implicit price deflator • Can get good estimate of Nominal GDP • Nominal GDP = Sum of Value Added • Estimate real GDP by determining what people buy now using base year prices • If year 2000 is the base year compute real GDP by determining what year 2003 GDP would have cost in 2000

23. Implicit price deflator

24. See spreadsheet • GDP calculations.xls

25. Economic growth • Economic growth is the percent change in real GDP from one time period to the next time period • If real GDP is 100 one year and 105 next year, the percent change is 5%. We would say that real GDP grew by 5%

26. Economic growth • Using the numbers on the previous slide

27. Economic growth We measure economic growth so we can make: • Economic welfare comparisons • International welfare comparisons • Business cycle forecasts

28. Economic growth • Rule of 72

29. Economic growth

30. Economic welfare comparisons • Compare GDP now with GDP in some other year to determine how much output has changed. • Does GDP measure economic welfare?

31. GDP and economic welfare • GDP computed using CPI overstates real GDP • Computed GDP ignores non market activities • Household work • Underground economy 9—30% of real output

32. GDP and economic welfare • GDP ignores changes in heath and life expectancy • GDP ignores leisure time (early retirement) • GDP ignores environmental quality • GDP ignores political freedom and social justice

33. International comparisons • You can compare GDP values between two countries. • Need to be careful • In 2003 US GDP per person = $39,000 • In 2003 China’s GDP per person = Y9,500 • Exchange rate $1=Y8.276 • China GDP =Y9,500*($1/Y8.276)=$1147.90 • US GDP per person 34 times greater than China

34. International comparisons • The US—China comparison is misleading • The Chinese government keeps the exchange rate deliberately low to encourage exports • Use purchasing power parity to make comparisons.

35. Purchasing power parity (PPP) • The McDonald’s hamburger index • What does a McDonald’s hamburger cost in the US. • What does it cost in China. • The real purchasing price parity index using a number of goods • Adjusting for PPP indicates US GDP per person is approximately 6 times that of China

36. GDP and business cycle forecasting • Declining GDP for 2 quarters is a commonly used measure for recession. • Compare GDP growth rates for time periods.