Measuring Total Production and Income: An Overview of Gross Domestic Product (GDP), Study notes of Introduction to Macroeconomics

Download Measuring Total Production and Income: An Overview of Gross Domestic Product (GDP) and more Study notes Introduction to Macroeconomics in PDF only on Docsity! NCSU EC-202 PRINCIPLES OF MACROECONOMICS Department of Economics Summer 2008 CHAPTER 7 GDP: Measuring Total Production and Income 1. Recall that economics can be divided into the subfields of microeconomics and macroeconomics:  Microeconomics is the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.  Macroeconomics is the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. 2. One of the most important aspects of macroeconomics is to understand how total production is measured. Total production is measured by gross domestic product. Gross domestic product (GDP) is defined as the market value of all final goods and services produced in a country during a period of time. Consider this definition in more details:  GDP is measured using market values, not quantities.  GDP includes only the market value of final goods.  Final good or service is a good or service purchased by a final user.  Intermediate good or service is 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. 3. Measuring GDP. 3.1. Expenditure method. The value of total production is equal to the value of total income. The circular-flow diagram shows that one can measure GDP by either calculating the total value of expenditures on final goods and services or by calculating the value of total income. The Bureau of Economic Analysis (BEA) divides its statistics on GDP into four major categories of expenditures: a) Consumption is the part of GDP purchased by households as final users. Almost everything households buy during the year is included as part of consumption spending when we calculate GDP. Excluding: ■ used goods ■ construction of new homes (counted as private investment). Including: ■ total value of all food products that farm families produce and consume themselves ■ total value of the housing services provided by owner-occupied homes. b) Private investment. Including: ■ Business Purchases of Plant, Equipment, and Software. A firm’s plant, equipment, and software are intended to last for many years - only a small part of them is used up to make the current year’s output. Thus, they are regarded as final goods, and firms that buy them as final users of those goods. ■ New Home Construction. ■ Changes in Inventories. The change in firms’ inventories is considered to be a part of investment in measuring GDP. It is important to include changes in business inventories, in order to adjust GDP for output sold this year that was produced in previous years, and to adjust GDP for output produced this year but not sold during the year. Excluding: ■ Government Investment. Total investment spending has two components: private investment spending and government investment spending ■ Consumer durables ■ Human capital c) Government Purchases: spending by federal, state, and local governments on goods and services. In Macro we make no difference between state and local governments’ purchases. Important to distinguish between ■ Government purchases, which are counted in GDP. ■ Government outlays, which are not counted in GDP. Transfer payments represent money redistributed from one group of citizens (taxpayers) to another (poor, unemployed, elderly). While transfers are included in government budgets as outlays, they are not purchases of currently produced goods and services, and so they are not included in government purchases or in GDP. d) Net Exports (NX) = Total Export (Ex)– Total Import (Im) Y = C + I + G + NX GDP and Its Components (2005) 3.2. An alternative way of calculating GDP is the Value-Added method, which refers to the market value a firm adds to a product. Then, GDP is a sum of values added by all firms in economy. 4. Does GDP Measure What We Want It to Measure? Although GDP is extremely useful, it suffers from measurement problems:  It doesn’t take quality changes into account. While BEA includes impact of quality changes for many goods and services (such as automobiles and computers), it does not have the resources to estimate quality changes for millions of different goods and services.  It can’t accurately measure underground production. Some production is hidden from government authorities either because it is illegal or engaged in it are avoiding taxes. Production in these hidden markets cannot be measured accurately and BEA must estimate it.  It does not include non-market production - goods and services that are produced, but not sold in the marketplace. Whenever a non-market transaction becomes a market transaction GDP will rise even though total production has remained the same Because of these problems, we must be careful when interpreting long-run changes in GDP. GDP is also not a perfect measure of well-being for several reasons:  The value of leisure is not included in GDP.  GDP is not adjusted for pollution or other negative effects of production.