Economic Output. Economic Output. GDP: Definition. GDP: Definition. GDP: Definition. GDP: Definition. Agenda. Gross Domestic Product (GDP)

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1 Economic Output Economic Output Agenda Defining GDP Measuring Real GDP The Expenditure Side The Income Side Economic Output Gross Domestic Product (GDP) The official measure of a country s economic output. Why We Care about GDP 1 2 Market value of all final goods and services Goods can be re-sold Services are consumed immediately that are currently produced in the country during a given time period. Market value (sold through a market): Permits combining different goods & services. Prices serve as relative weights. Exclusions No value for non-paid personal time. No value for volunteer time. No value for externalities. No illegal activities. Even if a market exists. The underground economy. 3 4 All final goods and services: Final goods versus intermediate goods. Intermediate goods are used in the production of final goods. Avoids the problem of double counting. The special case of inventories (change in). Currently produced: No used goods. No financial transactions or capital gains/losses. No transfer payments. However, the services provided in the above transactions are counted in GDP

2 In the country: Gross Domestic Product. During a given time period: Usually a quarter or year. versus Gross National Product. Difference is Net Foreign Factor Income (NFFI). GNP = GDP + NFFI 7 8 Nominal GDP: Nominal GDP Dollar value of output at current market prices. Prices serve as relative weights. Price changes will change nominal GDP. Comparisons over time become irrelevant. Nominal GDP Calculating Nominal GDP Market Percent Percent Quantity, Price, Nominal Change, Change, Q X P = GDP Q GDP 100 $10 $1, $20 $2,000 0% 100% 200 $10 $2, % 0% 9 10 Real GDP: Real GDP Attempts to measure physical output. Dollar value of output at constant market prices. Prices are held constant at some base year. Prices serve as relative weights. Price changes will NOT change real GDP. Comparisons over time are relevant. 11 Real GDP Calculating Real GDP Market Percent Percent Quantity, Price, Real Change, Change, Q X P = GDP Q GDP 100 $10 $1, $10 $1,000 0% 0% 200 $10 $2, % 100% 12 2

3 Measuring Real GDP: The Expenditure Side Components of Real GDP Y = C + I + G + ( X - M ) = E Year-on- Billions of Share of Year 1996 $s GDP % Chg. The distinction between C, I, G, X, and M is based on the type of buyers, NOT on the type of product being bought. The exception of housing. GDP 9, Consumer Spending 6, Gross Domestic Private Invesment 1, Net Exports Exports 1, Imports 1, Government Purchases 1, Components of Consumption Components of Investment Share of Year-on- Billions of Consumer Year 1996 $s Spending % Chg. Consumer Spending 6, Durable Goods 1, Nondurable Goods 1, Services 3, Year-on- Billions of Share of Year 1996 $s Investment % Chg. Gross Domestic Private Investment 1, Fixed Investment 1, Nonresidential 1, Structures Equipment & Software Residential Inventory Investment Components of Net Exports Components of Government Purchases Share of Year-on- Billions of Exports, Year 1996 $s Imports % Chg. Net Exports of Goods & Services Exports 1, Goods Services Imports 1, Goods 1, Services Year-on- Billions of Share of Year 1996 $s Government % Chg. Government Purchases 1, Federal National Defense Nondefense State and Local 1,

4 A Closer Look at Investment A Closer Look at Investment Start with the expenditure equation: Y = C + I + G + ( X M ) Now, solve for I: I = Y C G ( X M ) Add and subtract T to the right hand side: I = Y C G ( X M ) + T T Re-arrange terms: I = ( Y C T ) + ( T G ) ( X M ) 19 I = ( Y C T ) + ( T G ) ( X M ) = S p + S g + S f This implies that all investment MUST be financed by either: Private domestic saving, S p, Government savings (budget balances), S g, or Foreign Savings (net foreign borrowing), S f. 20 A Closer Look at Investment A Closer Look at Investment This also implies that any increase in investment MUST be accompanied by: An increase in Sp (an increase in Y C T ), and/or An increase in Sg (an increase in T G ), and/or An increase in Sf (a decrease in X M ). Alternatively, I = (Sp + Sg + Sf) or = Sp + Sg + Sf 21 I = ( Y C T ) + ( T G ) ( X M ) = S p + S g + S f If ( X M ) declines, then I increases. This is generally good. If ( X M ) declines but is offset by a (identical) decline in Sp or Sg, then there is no change in I. This is generally bad. 22 Measuring Real GDP: The Income Side GDP includes some payments that are not payments to the factors of production. Capital Consumption Allowances, CCA Also called Depreciation Indirect Business Taxes, IBT National Income is the most comprehensive concept of income and measures factor payments. 23 GDP to National Income Billions of Share of Dollars GDP GDP 10, Plus: Net foreign factor income Equals: GNP 10, Less: Depreciation 1, Equals: NNP 9, Less: Indirect business taxes Statistical discrepancy Equals: National Income 8,

5 National Income Shares of National Income Billions Share of of Dollars NI National Income 8, Labor and Capital Shares of Income Labor Income Capital Income Labor Income 6, Capital Income 2, Rental income Net interest Proprietors' income Corporate profits Share of Total Income Q Q Q Q Q Q Q Q Q National to Personal Income Billions of Share of Dollars NI National Income $8, Less: Corporate retained earnings $ Contributions for social insurance $ Plus: Government transfer payments $1, Business transfer payments $ Net interest paid to persons $ Equals: Personal Income $9, Personal Income Billions Share of of Personal Dollars Income Personal Income 9, Wage and salary disbusements 5, Other labor income Proprietors' income Rental income Personal dividend income Personal interest income 1, Transfer payments to persons 1, less: Personal contributions for social insurance Real GDP and Social Welfare GDP is NOT a measure of social welfare. Value of non-work and leisure time. Legal non-market activities. Illegal activities. Resource-depleting activities. 29 Real GDP: Why We Care Real GDP is a measure of material standards of living. Lost output (income) reduces disposable income, corporate profits, and tax revenues, and raises unemployment. Average recession: GDP < potential GDP by 10% over 2 years. With GDP about $12T, about $1.2T in lost output. 30 5

6 Key Points Real GDP is how economic output is measured. Real GDP can be measured in 3 ways: Income, Expenditures (or spending), or Production (or value added). Income, Spending, and Production are alternative ways of measuring real GDP or Economic Output. Take Aways Investment MUST be financed by some combination of: Private savings, Sp. Public savings, Sg. Foreign savings, Sf. Investment ALWAYS equals Savings. If savings change, investment changes. We can (and do) use all of them interchangeably