Economic Performance: Key Q’s

• What is gross domestic product (GDP)?• How is GDP calculated? (2 methods)• What is the difference between nominal and

real GDP?• What are the limitations of GDP measurements?• What are other measures of income and output?• What factors influence GDP?

• Key Concept: National income accounting provides a conceptual framework. Categories and vocab from nat’l income is used by economists in assessing the macroeconomy.

Factoids

• The United States has the highest Gross Domestic Product in the World. In 2009, it reached $14.1 TRILLION, up from $5.7 Trillion in 1990.

• Economists monitor the macroeconomy using national income accounting, a system that collects statistics on production, income, investment, and savings. The United States looks very good on paper, as you will find out.

Gross Domestic Product—The Measure of Domestic

Output• Gross domestic product (GDP) is the dollar

value of all FINAL goods and services produced within a country’s borders in a given year. Invented in 1930s to measure depression.

• GDP does not include the value of intermediate goods. Intermediate goods are goods used in the production of final goods and services. EX: Wood that’s cut into a baseball bat, but before it’s sanded, stamped, or the lacquer is put on is an intermediate good.

• Secondhand sales are excluded. Garage sales don’t count as GDP!

• Increase in GDP= Economic Growth• National Income and Product Accounts (NIPA)

are maintained by the Department of Commerce’s Bureau of Economic Analysis (BEA)

Top-10 World GDP Nations

2 Methods of Calculating GDP

The Expenditure Approach• The expenditure approach totals

annual expenditures on four categories of final goods or services. C+I+G+F1. consumer goods and services

2. business goods and services3. government goods and services4. net exports or imports of goods

or services.

Consumer goods include durable goods, goods that last for a relatively long time like refrigerators, and nondurable goods, or goods that last a short period of time, like food and light bulbs

The Income Approach

The income approach calculates GDP by adding up all the incomes in the economy.

The Income Approach: Add the following to get GDP

• Wages and Salaries

• Proprietors’ income

• Rental income

• Interest income

• Corporate Profits

• Indirect Business Taxes

• Depreciation

• DO NOT ADD TRANSFER PAYMENTS

Real and Nominal GDP• Nominal GDP is GDP

measured in current prices. It does not account for price level increases from year to year.

• Real GDP is GDP expressed in constant, or unchanging, dollars.

Nominal and Real GDP

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 = $150,000

+ 10 trucks at $20,000 each = $200,000

Total = $350,000

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.

In the second year, the economy’s output does not increase, but the prices of the cars and trucks do:

This new GDP figure of $370,000 is misleading. GDP rises because of an increase in prices. Economists prefer to have a measure of GDP that is not affected by changes in prices. So they calculate real GDP.

10 cars at $16,000 each = $160,000

+ 10 trucks at $21,000 each = $210,000

Total = $370,000

Year 2 Nominal GDP

10 cars at $15,000 each = $150,000

+ 10 trucks at $20,000 each = $200,000

Total = $350,000

To correct for an increase in prices, economists establish a set of constant prices by choosing one year as a base year. When they calculate real GDP for other years, they use the pricesfrom the base year. So we calculate the real GDP for Year 2 using the prices from Year 1:

Year 3 Real GDP

Real GDP for Year 2, therefore, is $350,000

Calculating Nominal GDP

• Suppose the following:• GDP 1990= $5.7 Trillion• GDP 2001= $8.1 Trillion• If inflation averaged 4%/year, had REAL GDP grown?• Real GDP grows if GDP increase > inflation rate• ($8.1 trillion/ $5.7 trillion)= 42.1% growth in GDP• Inflation rate 3%/year * 11 years= 33% increase• Real GDP increased during the 1990s. Got reasons?

Other Income and Output Measures

Gross National Product (GNP)--GNP is a measure of the market value of all goods and services produced by Americans in one year.

Net National Product (NNP)--NNP is a measure of the output made by Americans in one year minus adjustments for depreciation. Depreciation is the loss of value of capital equipment that results from normal wear and tear. NNP is always lower than GNP.

National Income (NI)--NI is equal to NNP minus sales and excise taxes. NI is lower than NNP.

Personal Income (PI)--PI is the total pre-tax income paid to U.S. households.

Disposable Personal Income (DPI)--DPI is equal to personal income minus individual income taxes. It’s what you have left after taxes that you can spend.

Measurements of the Macroeconomy

+ =Gross Domestic Product

Gross National Product

income earned outside U.S. by U.S. firms and citizens

– income earned by foreign firms and foreign citizens located in the U.S.

Key Macroeconomic Measurements

Gross National Product – depreciation of

capital equipment = Net National Product

Net National Product National Income– sales and excise taxes =

–• firms‘ reinvested profits• firms‘ income taxes• social security + other household income =National Income Personal Income

– individual income taxes =Personal Income Disposable Personal Income

The Output-Expenditure Model: A 2nd Way of Figuring GDP! Oh

boy!• GDP= C + I + G +F where:• C= Consumer Expenditures (rent, groceries, cars,

clothes, etc.) -- accounts for two-thirds of all economic activity in the United States

• I= Business Investment in plants, offices, equipment, inventories, and other capital goods

• G= Government Spending on national defense, income security, national debt interest, health care, roads, education, etc. Transfer payments DO NOT count. Why?????????

• F= NET Foreign Trade (Foreign purchases minus foreign imports—usually a negative number)

Limitations of GDP (What GDP fails to take into

account)• Nonmarket Activities--GDP does not measure goods and

services that people make or do themselves, such as caring for children, mowing lawns, or cooking dinner. Doesn’t measure “psychic income.”

• Negative Externalities--Unintended economic side effects, such as pollution, have a monetary value that is often not reflected in GDP. Externalities inflate GDP. WHY?

• The Underground Economy--There is much economic activity which, although income is generated, never reported to the government. Examples include black market transactions and "under the table" wages. GDP is undercounted here.

• Quality of Life--Although GDP is often used as a quality of life measurement, there are factors not covered by it. These include leisure time, pleasant surroundings, and personal safety. GDP tells us nothing about product quality.

Section Review—Nat’l Income Accounting

1. Real GDP takes which of the following into account?(a) changes in supply(b) changes in prices (c) changes in demand(d) changes in aggregate demand

2. Which of the following is an example of a durable good?(a) a refrigerator(b) a hair cut (c) a pair of jeans(d) a pizza

Inflation

• Inflation—A rise in the GENERAL PRICE LEVEL. Not a rise in the price of 1 good or a group of goods.

• Purchasing power, the ability to purchase goods and services, is decreased by rising prices.

• Price level is the relative cost of goods and services in the entire economy at a given point in time.

• Example: Cars, clothing, and most other consumer goods have increased in price since you were born.

• Some prices increase faster than others (milk prices per gallon have blown away gasoline prices when it comes to inflation—both were 79 cents in 1979)

Price IndexesA price index is a measurement that shows how the

average price of a standard group of goods changes over time.

• The consumer price index (CPI) is computed each month by the Bureau of Labor Statistics. May 2002 was 0.5%--6% annual inflation. Yikes!

• The CPI is determined by measuring the price of a standard group of goods meant to represent the typical “market basket” of an urban consumer. 1982-84 base.

• Changes in the CPI from month to month help economists measure the economy’s inflation rate--the percentage change in price level over time.

• The Producer Price Index (PPI) has a base year of 1982 and samples 100,000 commodities used as inputs.

• You may also hear of the “GDP Deflator.” It measures the same thing—inflation—so you can calculate real GDP. Base year 1996, compiled quarterly.

Calculating Inflation

To determine the inflation rate from one year to the next, use the following steps:

(CPI for Year A – CPI for Year B) /( CPI for Year B) *100

• For example:• If the CPI for 1998 (Year A) = 163 and the CPI

for 1997 (Year B) = 160.5….then

(163 – 160.5) = 2.5 ÷160.5 = 0.156 * 100 = 1.6

The inflation rate for 1998 was 1.6%.

Economic Growth: Focus Questions

• How do economists measure economic growth?

• What is capital deepening?• How are saving and investing related to

economic growth?• How does technological progress affect

economic growth?• What other factors can affect economic

growth?

Measuring Economic Growth

The basic measure of a nation’s economic growth rate is the percentage change of real GDP over a given period of time.

GDP and Population Growth• In order to account for population increases in an

economy, economists use a measurement of real GDP per capita. It is a measure of real GDP divided by the total population.

• Real GDP per capita is considered the best measure of a nation’s standard of living.

GDP and Quality of Life• Like measurements of GDP itself, the measurement of

real GDP per capita excludes many factors that affect the quality of life.

Capital Deepening

• The process of increasing the amount of capital per worker is called capital deepening. Capital deepening is one of the most important sources of growth in modern economies.

• Firms increase physical capital by purchasing more equipment. Firms and employees increase human capital through additional training and education.

How Saving Leads to Capital Deepening

The Effects of Savings & Investing

• The proportion of disposable income spent to income saved is the savings rate.

• When consumers save or invest money in banks, their money becomes available for firms to borrow or use. This allows firms to deepen capital. In the long run, more savings will lead to higher output and income for the population, raising GDP and living standards.

Shawna’s income: $30,000

$25,000 spent $5,000 saved

Mutual-fund firm makes Shawna’s $3,000 available to firms

Bank lends Shawna’s money to firms in forms

such as loans and mortgages

$3,000 in a mutual fund (stocks and corporate bonds)

$2,000 in “rainy day” bank account

Firms spend money on business capital

investment

The Effects of Technology• Besides capital deepening, the other key source of

economic growth is technological progress.• Technological progress is an increase in efficiency gained

by producing more output without using more inputs. • A variety of factors contribute to technological progress:

Innovation When new products and ideas are successfully brought to market, output goes up, boosting GDP and business profits.

Scale of the Market Larger markets provide more incentives for innovation since the potential profits are greater.

Education and Experience Increased human capital makes workers more productive. Educated workers may also have the necessary skills needed to use new technology.

Other Factors Affecting Economic Growth

Population Growth--If population grows while the supply of capital remains constant, the amount of capital per worker will actually shrink.

Government--Government can affect the process of economic growth by raising or lowering taxes. Government use of tax revenues also affects growth: funds spent on public goods increase investment, while funds spent on consumption decrease net investment.

Foreign Trade--Trade deficits, the result of importing more goods than exporting goods, can sometimes increase investment and capital deepening if the imports consist of investment goods rather than consumer goods.

Section 3 Review

1. Capital deepening is the process of (a) increasing consumer spending.(b) selling off obsolete equipment. (c) decreasing the amount of capital per worker.(d) increasing the amount of capital per worker.

2. Taxes and trade deficits can contribute to economic growth if the money involved is spent on (a) consumer goods.(b) investment goods. (c) additional services.(d) farming.

Population in the United States

• Remember our buddy Malthus?• Census Bureau performs constitutionally-mandated

Census every 10 years since 1790. It also conducts monthly surveys.

• The Bureau tabulates data in 2 classifications: urban and rural.

• Population continues to grow in the U.S., but the rate of growth has fallen since 1860. 2000 rate= 0.9%. Smaller households, especially among white Americans.

• Population center has also shifted—to the south & west.• Debate in 2000—sampling or count? Politically charged!• Democrats say sampling is more scientific, would count

more minorities and homeless in inner cities• Republicans want “count,” win in court

Factors Affecting Population Growth

• Fertility rate: Number of births per 1000 women during their lifetime. Currently about 2,119 (2.12/woman). Vastly different for whites, blacks, and hispanics. Why so low nowadays?

• Life expectancy: average remaining life span of people who reach a certain age. Currently 75.9, will rise to 82.1 by 2050.

• Net immigration (About + 880,000 people/year)• Who cares? Well, businesses and government need

to plan.• What might be some demographic trends that need

to be noticed? Need for more medical supplies and drugs, less need for police protection if majority of pop is older?

Population Projections/Demographics

• The aging “baby boomer” population will drive most characteristics (baby boom was 1946-64).

• Trouble is coming as baby boomers retire starting in 2011. In 2012, Social Security will be paying out more money than it takes in.

• The Dependency ratio will increase—from 63.9 in 1998 to 80.0 by 2040. DR= # of children and elderly per 100 persons 18-64.

• More widows as people life longer, but women live way longer. If anyone mentions “Tadpole,” I will hit you.

• By 2050, whites will be a bare majority (52.7%). Asian population will grow 5X, Hispanic will double

Immigration in the U.S.• Old immigrants—from N. and W. Europe. Blended

easily. Came before 1880. Most were Protestant.• New Immigrants—from S. and E. Europe, came 1880-

1924. Spoke different languages, darker, had different religions, took longer to blend but were successful

• It is true immigrants helped build this country. EX: Chinese laborers and Transcontinental RR

• Significant immigrants include: Albert Einstein, Bob Hope, Joseph Pulitzer, Felix Frankfurter, Enrico Fermi, Samuel Gompers, Madeleine Albright, John Audubon, Cary Grant, Sonja Henie, Werner von Braun, and Alexander Hamilton. Immigration has been good.

• BUT, We must look at this academically and realize there is a downside. Diversity in other countries has posed severe problems—Yugoslavia, even Quebecois in Canada. As the US changes, ethnic conflict will result

Section Review--Population

• 1. What will likely happen to the percentage of the population of the United States that lives in Michigan over the next 20-50 years?

• 2. Why is knowing population demographics important to the average businessman or politician?

More on Economic Growth• Now, we know that not every country has the

U.S.’s standard of living, or quality of life• Compare U.S. and India Nominal GDP• U.S.= $8.1 Trillion. India= $500 Billion. (It’s

that big? $500 Billion is nothing to shake a stick at)

• Real GDP stats are still not perfect. To get the true picture, you need to determine

• Real GDP per capita• In other words, divide Real GDP by the # of

people• U.S.=$29,000 per capita• India: $500 per capita

Why Economic Growth is Not Only Important, But Actually A Cure-All

• Economic growth in the U.S. helps everyone in the world—not just Americans.

• Tax revenues increase with more earnings. Healthier tax bases mean government can provide more services or tax cuts. During the 1980s, revenue doubled in 8 years with tax cuts. You need investment for growth—why do you think we love British and Japanese capital? The British know they get a good return on their investments! And then we tax the growth and play the game all over again IF WE DON’T TAX TOO MUCH.

• Economic growth solves domestic problems (poverty is the source of so many social problems—drugs, unsupervised kids, wages rise because demand for labor increases)

• We can help other nations more if we are well-off.• A healthy U.S. capitalistic system is an excellent role

model for the world, especially for China, a definite threat

Factors Influencing Growth:What do we do to get that

growth??• Land—Conserve our own natural resources, make use of

renewable resources, and use everyone else’s resources• Capital—Keep capital-to-labor ratio high. Capital

investments are a better choice than immediate consumption

• Labor—Educate labor force and keep population growing. Much 1900s economic growth is due to women working outside the home, although society has paid for that

• Entrepreneurs—create incentives for entrepreneurs (low government regulation, low taxes) Best example of why this works: The Internet

• Improve productivity so we can shift resources to other areas. EX: Mazda plant in Japan makes cars robotically, allows release of labor to make whatever else.

Section Review—Peculiarities of Economic

Growth• Which U.S. President was hurt by going

along with a tax increase, and a recession that actually cleared up by election day?

• In layman’s terms, define “standard of living”