Understanding the Concept of Gross Domestic Product (GDP), Study notes of Theatre

Download Understanding the Concept of Gross Domestic Product (GDP) and more Study notes Theatre in PDF only on Docsity! Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 1 Full Length Text — Macro Only Text Part: Part: Chapter: Chapter: Taking the Nation’s Economic Pulse 3 7 3 7 To Accompany “Economics: Private and Public Choice 12th ed.” James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson Slides authored and animated by: James Gwartney, David Macpherson, & Charles Skipton — Next page Copyright ©2009 Thomson South-Western. All rights reserved. GDP – A Measure of Output Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. • Gross Domestic Product (GDP): The market value of final goods and services produced within a country during a specific time period, usually a year. • GDP is the most widely used indicator of economic performance. GDP – A Measure of Output Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 2 Value added to the productSales Receipts What Counts Toward GDP? • Only final goods and services count. • Sales at intermediate stages of production are not counted as their value is embodied within the final-user good. • Including goods at intermediate stages of production would result in double counting. Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Stage of production (equals income created) (at each stage of production) Stage 1: farmer’s wheat Stage 2: miller’s flour Stage 3: baker’s bread (wholesale) Stage 4: grocer’s bread (retail) $.30 $.65 $.90 $1 by farmer $.30 by grocer $.10 by miller $.35 by baker $.25 Total consumer expenditure = $1 Total value added = $1 • What Counts Toward GDP? • Only transactions involving production count. • Financial transactions & income transfers are excluded because they do not reflect actual production. • Only production within the geographic What Counts Toward GDP? Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. borders of the country is counted. • Only those goods produced during the current period are counted. • Thus, the purchase and sale of goods produced during earlier years are not counted in this year’s GDP. • GDP is measured in dollars. • Each good produced increases output by the amount the purchaser pays for the good. • The total spending on all final-user goods and services produced during the year is summed, i d ll b i h l GDP Dollars are the Common Denominator for GDP Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. n o ar terms, to o ta n t e annua . Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 5 • Resource Cost - Income Approach: (cont.) • Not all cost components of GDP result in an income payment to a resource supplier. To get GDP, we need to account for 3 other factors: • Indirect business taxes: Taxes that increase the firm’s production Resource Cost-Income Method of Measuring GDP Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. costs and therefore final prices. • Depreciation: The cost of wear and tear on the machines and other capital assets used to produce goods and services. • Net Income of Foreigners: The income that foreigners earn producing goods within the borders of the U.S. minus the income Americans earn abroad. • national income, (employee compensation, self-employment income, rents, interest, corporate profits) • When derived by the Resource Cost - Income Approach, GDP is equal to the sum of Resource Cost-Income Method of Measuring GDP Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. • indirect business taxes, • depreciation, and, • net income of foreigners. Resource Cost-Income ApproachExpenditure Approach • The two methods of calculating GDP are summarized below: Personal consumption expenditures + G i t d ti i t t Aggregate income: Employee Compensation Income of self employed Two Ways of Measuring GDP: A Summary Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. ross pr va e omes c nves men + Government consumption and gross investment + Net exports of goods and services - Rents Profits Interest + Non-income cost items: Indirect business taxes and depreciation Net income of foreigners += GDP = GDP Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 6 Net exports - 5% Private investment 16% Gov’t 19% Rental income 1% Net interest 4%Indirect taxes 8% Corporate profits 11% 57% Depreciation 12% (a) Expenditure approach (b) Resource cost-income approach a U.S. GDP Components: 2003-2006 Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Personal consumption 70% Self-employed proprietor income 8% Employee compensation Source: http://www.economagic.com. a The net income of foreigners was negligible. • The relative sizes of the major components of GDP usually fluctuate within a fairly narrow range. • The average proportion of each U.S. component during the 2003-2006 period is shown above for both the expenditure and resource cost-income approach. Questions for Thought: 1. Which of the following is GDP designed to measure? (a) The total market value of goods and services produced in a year. (b) The income generated and costs incurred producing goods and services during a year. (c) Both (a) and (b) Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. 2. What is the largest component of GDP when it is derived by the expenditure approach? What is the largest component of GDP when it is derived by the income-cost approach? Real and Nominal GDP Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 7 Real and Nominal GDP • The term "real" means adjusted for inflation. • Price indexes are use to adjust income and output data for the effects of inflation. • A price index measures the cost of purchasing a market basket (or “bundle”) of goods at a point in time relative to the cost of purchasing Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. the same market basket during an earlier reference (or base) period. Two Key Price Indexes: (1) Consumer Price Index (2) GDP Deflator Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Two Key Price Indexes: • Consumer Price Index (CPI): measures the impact of price changes on the cost of a typical bundle of goods and services purchased by households. • GDP Deflator: designed to measure the change in the average i f th k t b k t f d i l d d Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. pr ce o e mar e as e o goo s nc u e in GDP. • The GDP deflator is a broader price index than the CPI. Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 10 Questions for Thought: 1. What do price indexes measure? 2. What is the difference between the CPI and the GDP deflator? Which would you use if you wanted to measure whether your own earnings this year were higher than they were last year? Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. 3. The CPI was 210 in 2007 compared to 100 in 1983. Suppose that the price of a ticket at a local movie theater rose from $4 to $8 between 1983 and 2007. Did the real ticket price increase or decrease? Calculate the 1983 ticket price measured in 2007 dollars. Questions for Thought: 4. Use the following data to answer this question. Nominal GDP (trillions of $) GDP deflator (2000=100.0) 2004 2005 2006 $11.69 12.43 13 19 109.4 112.7 116.0 Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. a. Calculate the real GDP in 2004, 2005, and 2006 measured in 2000 dollars. b. What was the percent change in real GDP between 2004 and 2005? What was the percent change between 2005 and 2006? c. What was the inflation rate as measured by the GDP deflator in 2005 and 2006? . Shortcomings and Strengths of GDP as a Measuring Rod Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 11 Shortcomings of GDP as a Measuring Rod • Shortcomings of GDP: • It does not count non-market production. • It does not count the underground economy. • It makes no adjustment for leisure. • It probably understates output increases b f h bl f i i Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. ecause o t e pro em o est mat ng improvements in the quality of products. • It does not adjust for harmful side effects. Differences in GDP Over Time $13,840 $22,666 $11 717 $18,391 $35,769 $28,429 U.S. Per Capita GDP (in 2000 U.S. dollars) $38,687 Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. • Per capita GDP is GDP divided by population. • As shown here, the real 2006 GDP per capita of the U.S. was more than six times the figure for 1930. • How meaningful is this comparison? $7,827$6,418 , 1930 1950 1970 1990 20001940 1960 1980 Source: derived from U.S. Department of Commerce data. 2006 Per Capita GDP Comparisons Across Time Periods • As was shown in the previous exhibit, real U.S. per capita GDP has increased substantially over the past 76 years. • Compared to earlier periods, current GDP is probably biased upward because more output now takes place in the market sector and less Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. in the household sector. • However, it is also probably biased downward because of failure to adjust for increased leisure, improvements in the work environment, and the introduction of improved products and new technologies. • The direction of the overall bias is uncertain. Gwartney, Stroup, Sobel, and Macpherson “Economics: Private and Public Choice” 12th ed. 12 GDP as a Measuring Rod • In spite of its shortcomings, the evidence indicates that real GDP per person is a broad indicator of living standards. • As real per capita GDP in the United States has increased through time, the quality of most goods has increased while the amount of work ti i d f th i h h d li d Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. me requ re or e r purc ase as ec ne . • Similarly, as real per capita GDP has risen in the United States and other countries, life expectancy and leisure time have gone up, while literacy and infant mortality rates have gone down. The Great Contribution of GDP • However, the “great contribution” of GDP is its ability to measure short-term fluctuations in output. • Year-to-year (and quarter-to-quarter) changes in real GDP provide a reasonably precise measure of what is happening to the rate f t t Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. o ou pu . Questions for Thought: 1. When making income and GDP comparisons across time periods, why is it important to adjust for changes in the level of prices? 2. If nominal GDP during a year increased by 7% while the GDP deflator rose by 10 %, what happened to real GDP? Jump to first page Copyright ©2009 Thomson South-Western. All rights reserved. 4. GDP does not count services such as child care, food preparation, cleaning, and laundry within the household. Why not? Is GDP a sexist measure? Does it understate the productive contributions of women relative to men? 3. If the GDP deflator is currently 130 compared to the 2000 base year of 100, what does the 130 during the current year mean?