Chapter 12 Gross Domestic Product and Growth

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1 Chapter 12 Gross Domestic Product and Growth 1. Gross Domestic Product 2. Business Cycles 3. Economic Growth How do we know if the economy is healthy... Economists measure Gross Domestic and Gross National Product! Yes: Money paid by shoppers in New York for corn grown in Iowa. Yes: Money paid by buyers in Indiana for cars made by a Japanese company at a factory in Kentucky. Yes: Fees charged to patients by a dentist in Texas No: Money paid by a computer factory in New Mexico for computer chips produced in California. No: Cost of processing wood pulp into paper at a factory in Maine. No: Money paid by shoppers in Florida for jeans manufactured in Mexico by a company headquartered in North Carolina.

2 National Income Accounting System to collect and organize macroeconomic statistics on production, income, investment, and savings Under the Department of Commerce Cabinet position in the Executive Branch of government whose main focus to promote economic growth. Hello, I am Gary Locke, the Secretary of Commerce in President Obama s Cabinet. I am the first Chinese-American Secretary. I was two term governor of Washington, the nation s most trade-dependent state.

3 1. Gross Domestic Product Dollar Value - cash value of all goods and services Final Goods and Services - All goods/services offered to consumers Within a Country s s border - American and foreign within U.S. tracks the exchange of money DOLLAR VALUE YES: Cash value of all goods and services sold NO: Cost of producing goods and services FINAL GOODS AND SERVICES YES: Goods and services offered to consumers NO: Intermediate goods used to produce other goods and services WITHIN A COUNTRYS BORDER YES: American or foreign companies producing in the United States NO: American companies producing overseas

4 Calculated Two Ways Expenditure Approach -what we spend Consumer, business, and government goods and services as well as net exports Durable goods - goods that last awhile Non durable goods - short period of time Income Approach -what we make firm sells a product or service, the selling price minus the dollar value of goods/services In theory, they should give us same total

5 Expenditure Approach Suppose an economy s entire output is cars and trucks. This year the economy produces: 10 cars at $15,000 each = $150, trucks at $20,000 each = $200,000 total = $350,000 The economy s GDP for this year is $350,000! Income Approach Suppose an economy s entire output is cars and trucks. All employed citizens, therefore, would work in the car and truck industry, or for its suppliers. The combined selling price of all the cars and trucks reflects the money paid to all the people who helped build the vehicles. The economy s GDP for this year, then, is the sum of the income of all its working citizens, or $350,000 (This includes the combined income of all engineers, designers, planners, assembly-line workers, managers, suppliers, etc.)~ The economy s GDP for this year is $350,000!

6 Nominal Versus Real GDP Nominal - GDP measured in current prices Real - GDP measured in constant, unchanging prices Year 1: Nominal GDP Suppose an economy s entire output is cars and trucks. This year the economy produces: 10 cars at $15,000 each = $150, trucks at $20,000 each = $200, ,000 Since we have used the current year s prices to express the current year s output, the result is a nominal GDP of $350,000 Year 2: Nominal GDP In the second year, the economy s output does not increase, but he prices of the cars and trucks do: 10 cars at $16,000 each = $160, trucks at $21,000 each = $210, ,000 This new GDP figure of $370,000, is misleading. GDP rises because of an increase in prices. Economists prefer to have measure of GDP that is not affected by changes in prices. So they calculate real GDP. Year 3: Real GDP To correct for an increase in prices, economists establish a set of constant prices by choosing one year as a base year. When the y calculate real GDP for other years, they use the prices from the base year. So we calculate the real GDP for Year 2 using the prices from Year 1: 10 cars at $15,000 each = $150, trucks at $20,000 each = $200, ,000 Real GDP is $350,000

7 Limitations of GDP Non-market activities -wash car, mow lawn The Underground economy - black market Negative Externalities - power plants polluting Quality of Life - leisure time What do you mean I m not counted toward the GDP Look at the Pollution!

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12 Other Output and Income Measures Gross National Product - the annual income earned by a nation s firm and citizens Does not account for depreciation - loss of the value or a good

13 Measurements of the Macro economy Gross Domestic Product + income earned outside the U.S. by U.S. firms and citizens income earned by foreign firms and foreign citizens located in the U.S. = Gross National Product Gross National Product depreciation of capital equipment = Net National Product Net National Product + minor statistical adjustments - = National Income National Income - Firms reinvested profits, Firms income taxes, Social Security Taxes + other household income = Personal Income Personal Income - individual income taxes = Disposable Personal Income

14 Influences on GDP Price Level - the average of all prices Aggregate Supply - total amount of all goods and services in the economy available at all price levels Aggregate Demand - the total amount of all goods and services in the economy that will be purchased at all possible price levels Equilibrium Aggregate Supply /Demand Aggregate Supply Aggregate Demand Price level Real GDP

15 2. Business Cycles A periods of macroeconomic expansion followed by one of contraction Where do you suppose we are? Why?

16 Phases of Business Cycles Expansion - economic growth measured by by rise in GDP economic growth - long term increase peak - the height of economic growth Contraction - economic decline marked by a fall in GDP trough - the lowest point recession - prolonged economic contraction depression - recession that is long and severe Stagflation - decline in real GDP - combined with rise in the price level

17 What Keeps a Business Going Business Investments when economy is expanding, business expect sales and profits to keep rising, therefore businesses invest heavily; however sometimes too much expansion Interest Rates and Credit credit for big purchases, cars and homes, the cost is the interest rate financial institutions charge Consumer Expectations consumer spending is determined by consumer expectations. If consumers expect economy to contract, they reduce spending and vice a versa External Shocks disruptions in oil, wars, droughts and hurricanes

18 Business Cycle Forecasting Prediction is quite difficult Leading indicators - set of key economic variables that economists use to predict future market trends stock market The Conference Board In my opinion the wealth of the country is bound to increase at a very rapid rate... Anyone who believes that opportunities are now closed and that from now on the country will get worse instead of better is welcome to the opinion-and whatever increment it will bring. I think that we have scarcely started... I am firm in my belief that anyone not only can be rich but ought to be rich. -John Jakob Raskob, interview in the Ladies Home Journal, August 1929

19 Business Cycles throughout history The Great Depression - the U.S. stock market crash in 1929 John Maynard Keynes - Theory of Employment, Interest, and Money -the government should intervene to pull an economy out of the market Some later recessions 1970 s s OPEC - oil market shortage 1980 s s recession - high interest rates brief recession - unemployment

20 3. Economic Growth Economic rise in the nation Americans have seen a fairly steady rise in their standard of living Real GDP per capita,

21 Measuring Economic Growth Real GDP per capita - real GDP divided by the total population of a country Capital Deepening - increasing the amount of capital per worker Savings and Investments - income not used for consumption Capital Deepening Human Capital + Physical Capital Increased Labor Productivity Increased Output Increased Wages Increased Labor Demands

22 Population, Government and Foreign Trade Population Growth - leads to lower standards Government - raising taxes to pay for government services, households will have less money but will have more services Foreign Trade - trade deficit - importing more than exporting When the economy is on the upswing, financial institutions are more likely to lend money. A strong economy means you have a greater access to loans that help pay for education. Many economists see teen spending as a huge source of future economic growth. When you spend money responsibly, you help expand the economy.

23 Technological Progress An increase in efficiency gained by producing more output without using more inputs Causes scientific research innovation The Government aids innovation

24 Important Measures of Economic Growth Gross Domestic Product Gross National Product Net National Product National Income Definition Dollar value of all final goods and services produced within a country s borders in a year Annual income earned by U.S. owned firms and U.S. citizens GNP with the cost of replacing the physical capital How much pretax income businesses actually pay to U.S. household Does Not Include Products made in another country by American manufacturer Depreciation Taxes How Compiled Expenditure and Income Approach Variations: Nominal and Real GDP plus income earned outside U.S. by U.S. firms and citizens minus income earned by foreign firms and foreign citizens located in the U.S. GNP minus cost of depreciation MNP minus taxes

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