The Gross Domestic Product (GDP) and National Accounting - PowerPoint Presentation

The Gross Domestic Product (GDP) and National Accounting

2 GDP and National Accounting Chapter 7 Vocabulary Nominal Gross Domestic Product (GDP)Real GDPIntermediate goodsFinal goodsDisposable incomeClosed economy Price index Consumer price index (CPI) Per capita GDP Expenditures approach Net exports

3 BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCES INPUTS e.g. labor $ COSTS $ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION $ REVENUE CIRCULAR FLOW MODEL GOVERNMENT

Creating the National Accounts The national accounts (GDP, National Income, Personal Income, etc.) owe their creation to the Great Depression. All government officials had were scattered statistics: like railroad freight car loadings, stock prices, and incomplete indexes of industrial production. Simon Kuznets developed a set of national income accounts. The first version of these accounts was presented to Congress in 1937 and in a research report titled National Income.The push to complete the national accounts came during World War II, when policy makers were in even more need of comprehensive measures of the economy’s performance. The federal government began issuing estimates of gross domestic product and gross national product in 1942.

5 Gross Domestic Product Gross domestic product ( GDP) is the total market value of all the final goods and services produced within an economy (a country) in a given year. (or the aggregate production in an economy).“ Total market value ” refers to the quantity of goods multiplied by their respective prices.

6 Future growth as a result of increase in productivity and productive resources. The change in the PPC would represent in increase in a nation's ability to increase GDP production . And remember from Chapter 1, the GDP should grow at 3.5% annually in the U.S. Approximately 2% of the growth comes from increases in productivity and 1-1.5% comes from an increase in productive resources (workers) Capital Goods Capital Goods Consumer Goods Consumer Goods Today’s new PPC GDP and Growth on the PPC

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8 Why is GDP Important GDP is the most important statistical measures of a nation’s prosperity and economic growth As GDP grows the burden of scarcity is lessened for a society. A country has more “stuff”. GDP per capita provides the best measure of economic well-being rather than Nominal or Real GDP.

9 Intermediate goods are excluded. They are goods that are used in the production process. It is not the final good or service. The totals for the intermediate goods are assumed to be included in the price of the final good. For example the cotton in a pair of blue jeans is NOT included but rather is part of the cost of the new pair of jeans.Only newly produced goods are included in GDP ( no used goods). We only count goods produced during a given year, so used goods have been previously counted. Non-market Transactions (e.g. sales of stocks, bonds, transfer payments, etc.). These activities involve payments of money and not the production of goods/services. What’s NOT Included in the GDP

10 U.S. Real GDP, 1930-2003 The graph shows that real GDP has grown substantially over this period. This is what economists call economic growth. The current GDP for the U.S. is approximately $15 Trillion Economic Growth : sustained increases in the real production of an economy over a long time. In the U.S., the optimum rate of GDP growth is about +3.5% per year. In China the GDP optimum GDP growth rate is about 8%.

11 The Components of GDP using the Expenditure Model Economists divide GDP into four broad expenditure categories:Consumption expenditures: purchases by consumers Private (gross) investment expenditures: purchases by firms + inventory changes + depreciation (consumption of fixed capital) + New Home Sales Government purchases: purchases by federal, state, and local governments. Net exports: net purchases by the foreign sector (domestic exports minus domestic imports).

12 The Expenditure Approach to Computing GDP GDP = C + I g + G + X n (or X – M) The front and back covers of your textbook contain the historical numbers for the data reflected above.

13 Consumption (or Personal Consumption) Expenditures Consumption expenditures are purchases of currently produced goods and services, either domestic or foreign. Historically is has been 60+% of GDP, but in reality it is now around 70%. We can break down consumption into durable goods , or goods that typically last 3+ years (like large appliances); nondurable goods that last for a short time (like clothing, food, etc.); and services, which reflect work done in which people play a prominent role in delivery(lawyer, manicure, etc.)

14 Private Investment Expenditures Private (Gross) investment ( Ig) expenditures (15-20% of GDP) includes: 1. Spending on new plants and equipment. 2. Newly produced housing (approximately 40% of investment expenditures) 3. Additions to inventories during the current year (goods produced but not sold during a given year). 4. Depreciation of fixed capital

15 Investment Expenditures (What is Depreciation) Total investment expenditures are called gross investment. During the year, some of the existing plant, equipment, and housing will deteriorate. This wear and tear is called depreciation . The true addition to the stock of capital of the economy is net investment . Gross Investment =net investment + depreciation (or Consumption of Fixed Capital)

16 Government Purchases Government purchases refer to purchases of newly produced goods and services by all levels of government. (15-20% of GDP) Transfer payments are funds paid to individuals but not associated with the production of goods and services. These are excluded from GDP computations. Consequently, a large part of the federal government budget is not part of GDP.

17 Net Exports Imports (M) are goods we buy from other countries. Exports (X) are goods made here and sold to other countries. Net exports (X – M) are total exports minus total imports When we buy more goods from abroad than we sell, we have a trade deficit (M > X)A trade surplus occurs when our exports exceed our imports (X > M)Net Exports ( Xn) has been a negative number since the 70s

18 Putting It All Together: The GDP Equation Letting symbols C, Ig, G, Xn stand for consumption, investment, government purchases, and net exports, respectively, we can write: GDP = C + I g + G + X n GDP = consumption + investment + government purchases + net exports

GDP Statistics from Bureau of Economic Analysis http://www.bea.gov/newsreleases/national/gdp/2010/pdf/gdp1q10_2nd.pdf See page 5 of release. 19

20 The Income Approach to Computing GDP (we will not use this approach) You do not need to know this method of computing the GDP, but need only be aware that this system exists. You can disregard any references to this method in this chapter.

21 Computing Disposable Income from GDP Other “National Income” accounts derived from the GDP. Table 7-4, Pg 125 in textbookGDP minus: consumption of fixed capital (depreciation) equals NDP (Net Domestic Product) minus: Net Foreign Factor minus: Indirect Business Taxes equals NI (National Income)

22 NI (National Income) Undistributed corporate profits Social security contributionsCorporate income Taxes+ Transfer payments equals PI (Personal income) - Personal taxes equals DI (Disposable income) How much spendable income the public holds (and remember, the public needs enough income to purchase 60-70% of the GDP (C+I+G+(X-M) Other National Income Accounting Measurements (continued)

23 Nominal v. Real GDP Nominal GDP is current GDP measured at current market prices Nominal GDP may overstate the value of production because of the effects of inflation, or an overall increase in prices.Real GDP is current GDP measured with a fixed dollar amount.Real GDP holds the value of the dollar constant and is useful for making year to year comparisons Real GDP is the IMPORTANT ONE!!!

Miracle in Venezuela?The South American nation of Venezuela has a distinction that may surprise you: in recent years, it has had one of the world’s fastest-growing nominal GDPs. Between 1997 and 2007, Venezuelan nominal GDP grew by an average of 28% each year—much faster than nominal GDP in the United States or even in booming economies like China. So is Venezuela experiencing an economic miracle? No, the inflation rate in Venezuela during this 10 year period averaged 20-240%>

Miracle in Venezuela? No, it’s just suffering from unusually high inflation. Currently, the inflation rate in Venezuela is about 37%. Nominal GDP (billions of bolivars), Real GDP (billions of 1997 bolivars) 1997 1999 2001 2003 2005 2007 Year VEB500,000 400,000 300,000 200,000 100,000

26 Real GDP Versus Nominal GDPWe can measure the change in prices over time using an index number called the GDP deflator (or the GDP Price Index). Keep in mind, the GDP index is an “Index” (or number), not a dollar amount or a percent. The formula for the GDP Index is: 100 X Price of market basket of goods in current year / Price of market basket of goods in base year. For Example: 100 X $20/$10 = 200 To find Real GDP: Nominal GDP / GDP Deflator in 100ths or $240/2.00 = $120

27 Computing Real GDP Real GDP = Nominal GDP Price Index (in 100ths) Assume the Nominal GDP is $15 Billion and the GDP Deflator is 103. Real GDP = $ 15 Billion 1.03 = $14.56 Billion

28 GDP as a Measure of Welfare GDP is our best measure of the value of output produced by an economy, but as a measure of welfare, it has several recognized flaws that you need to be aware of. It ignores transactions that do not take place in organized markets. Leisure time is not included in GDP. Like a shorter work week. 3. Ignores improvement in product quality 4. It ignores the underground economy. 5. It does not value changes in the environment that occur in the production of output (negative externalities) 6. It does not include population changes

29 Per Capita GDP Per Capita GDP : Real GDP divided by the population.GDP figures are useful for obtaining an estimate of the productive capabilities of an economy but they do not necessarily measure happiness or well being.Per Capita GDP is the best measure of economic progress

Global GDP http:// en.wikipedia.org/wiki/List_of_countries_by_GDP _%28nominal%29Per capita GDPhttp://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28PPP%29_per_capita 30

31 Other Price Indexes Consumer Price Index (CPI )All price indexes use the same formula, only the market basket changes. The CPI measures price changes for consumer goods (whereas the GDP price index measures ALL gods that comprise the GDP). Market Basket of goods in current year CPI = divided by X 100 Market Basket of goods in a base year The Producer Price Index (PPI) measures price changes at the production level.

Consumer Price Index