GDP

PAGE PAGE 1 Econ 144 ? Spring ?09 C. Morris Overview of Macro & Two Methods of Calculating GDP (Handout 1 for Ch. 4 & 5) 3 Important Macro Goals - To have a ?healthy economy? we need to have: 1. Economic growth 2. Full employment 3. Stable Prices (low inflation rate) How are each of these measured? Economic Growth - Full employment - Price Stability - Economic Growth ? Why is economic growth desirable? ?Standard of Living? means: Thus, economic growth is a goal of policy makers, economist, and individual citizens because our society as a whole is better off because of it. High Employment (low unemployment) ? What are the costs of unemployment? 1. Personal level - 2. Society level - Unemployment varies with the business cycle. Business cycle ? Expansion (a phase of the business cycle) ? Recession (a phase of the business cycle) ? Stable Prices (Low Inflation Rate) ? Why are stable prices a goal? Gross Domestic Product (GDP) = the market value of all final goods and services currently produced within a country in a given period of time. Algebraically, GDP = p1q1 + p2q2 + p3q3 + ?.+ pnqn where pi = price of good i, for i = 1,2,3, ?n goods and services Two Approaches to Calculating GDP: When goods and services are produced, the individuals whose resources are used to produce those goods receive income. Production generates income. In fact, for every $1 of a good or service produced, $1 of income is generated. Two Methods of Calculating GDP, both of which are used by the Dept. of Commerce. 1) Expenditure Approach: With this approach you add up everything consumers, firms, the government, and foreign sector spent on final goods and services to get GDP. 2) Factor Payments Approach: You add up all the wages, salaries, rents, interest payments, and profits earned while producing these final goods and services to get GDP. These two approaches give the same value for GDP. Expenditure Approach: There are four components to add together to get GDP. 1. ___________________________ 3. __________________________ 2. ___________________________ 4. ___________________________ Consumption (C) = spending by households on goods and services This is divided into 3 categories: Non-durable goods ? Durable goods ? Services ? Private Investment (I) = spending primarily by firms on goods that will be used in the future to produce more goods and services. These are primarily capital goods. It is divided into 3 categories: Plant, Equipment & Software ? businesses? purchases of new capital goods such as plants, office buildings, warehouses, tools, machinery, equipment and software. New Home Construction? Households? expenditures on new homes Changes in Inventories ? is the additions to or declines in businesses? inventory stocks. If it is positive then these are the goods that a firms produce but didn?t sell during the current period. If it is negative then ? Government Purchases (G) = are purchases by federal, state, and local governments on final goods & services Examples: Transfer Payments = what the government spends on social security benefits, welfare payments, & unemployment compensation. These are paid for with tax dollars. Are these included in Government Purchases? Net Exports (NX) = Exports ? Imports Exports = domestically produced final goods and services that are sold abroad Imports = purchases by domestic buyers of goods and services that were produced abroad Why are imports subtracted out of GDP? Note: NX can be positive or negative in any given year. FACT: Net Exports for the U.S. has been negative since the late 1970?s. Thus, Aggregate Expenditure = GDP = C + I + G + NX Factor Payments Approach: The following types of income are added to get GDP by the Factor Payments Approach: Wages & salaries - earned by labor Rent - earned by households owning land, buildings, and other rented inputs Interest - earned by households that made loans (ex. By buying firms? bonds) less the interest households paid on their debts Profit - what is leftover after corporations have paid all of their explicit costs like wages, rent, and interest These two approaches give the same value for GDP. How? Firms produce goods and services. They sell these to households, firms, the government and foreign countries. The total amount spent on these goods and services equals aggregate expenditure (AE). Firms use the revenues from the sale of these goods and services (which added up over all firms, equals aggregate expenditures) to pay income to the factors of production that were used to produce all the goods and services. Since profits are defined as Aggregate Expenditure minus wages, rent, & interest, the value of total output (AE) must equal factor income. Thus, both methods of calculating GDP give the same value.