Chapter 21 - Measuring GDP and Econommic Growth.pptx

ECONOMICS al Edition Chapter 21 Measuring GDP and Economic Growth Cop...

ECONOMICS al Edition Chapter 21 Measuring GDP and Economic Growth Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Chapter Outline and Learning Objectives 21.1 Define GDP and explain why GDP equals aggregate expenditure and aggregate income 21.2 Explain how GDP and real GDP are measured 21.3 Explain the uses and limitations of real GDP as a measure of economic well-being Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (1 of 21) GDP Defined ‒ GDP or gross domestic product is the market value of all final goods and services produced in a country in a given time period. ‒ This definition has four parts: ▪ Market value ▪ Final goods and services ▪ Produced within a country ▪ In a given time period Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (2 of 21) Market Value ‒ GDP is a market value—goods and services are valued at their market prices – in monetary term. ‒ To add apples and oranges, computers and popcorn, we add the market values so we have a total value of output in dollars. Physical unit: Apple (kg) + Computer (unit) = ? Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (3 of 21) Final Goods and Services ‒ GDP is the value of the final goods and services produced. final good ‒ A final good (or service) is an item bought by its final user during a specified time period. ‒ A final good contrasts with an intermediate good, which is an item that is produced by one firm, bought intermediate good by another firm, and used as a component of a final good or service. ‒ Excluding the value of intermediate goods and services avoids counting the same value more than once. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (4 of 21) Produced Within a Country ‒ GDP measures production within a country—domestic production. In a Given Time Period ‒ GDP measures production during a specific time period, normally a year or a quarter of a year. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (5 of 21) GDP and the Circular Flow of Expenditure and Income ‒ GDP measures the value of production, which also equals total expenditure on final goods and total income. ‒ The equality of income and value of production shows the link between productivity and living standards. ‒ The circular flow model - https://www.investopedia.com/terms/circular-flow-of-income.asp ‒ The circular flow diagram in Figure 21.1 illustrates the equality of income and expenditure. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (6 of 21) GDP and the Circular Flow of Expenditure and Income ‒ GDP measures the value of production, which also equals total expenditure on final goods and total income. ‒ The circular flow diagram in Figure 21.1 illustrates the equality of income and expenditure. ‒ The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (8 of 21) Households and Firms ‒ Households sell and firms buy the services of labor, capital, and land in factor markets. ‒ Firms pay wages for labor services, interest for the use of capital, and rent for the use of land. ‒ In the figure, the blue flow, Y, shows total income paid by firms to households. ‒ A fourth factor of production, entrepreneurship, receives profit. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (10 of 21) Firms sell and households buy consumer goods and services in the goods market. Consumption expenditure (C) is the total payment for consumer goods and services, shown by the red flow labeled. At the same time, firms buy and sell new capital equipment in the goods market and put unsold output into inventory. These purchases of new capital equipment and the additions to inventories are investment, shown by the red flow labeled I. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (12 of 21) Governments ‒ Governments buy goods and services from firms and their expenditure on goods and services is called government expenditure. ‒ Government expenditure is shown as the red flow G. ‒ Governments finance their expenditure with taxes and pay financial transfers to households, such as unemployment benefits, and pay subsidies to firms. ‒ These financial transfers are not part of the circular flow of expenditure and income. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (14 of 21) Rest of the World – exports and imports ‒ Firms in the United States sell goods and services to the rest of the world— exports—and buy goods and services from the rest of the world—imports. ‒ The value of exports (X ) minus the value of imports (M) is called net exports, the red flow (X – M). ‒ If net exports are positive, the net flow of goods and services is from U.S. firms to the rest of the world – trade surplus. ‒ If net exports are negative, the net flow of goods and services is from the rest of the world to U.S. firms – trade deficit. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (15 of 21) The blue and red flows are the circular flow of income and expenditure. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (16 of 21) The sum of the red flows equals the blue flow, implies that income = expenditure. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (17 of 21) That is: Y = C + I + G + X – M Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (18 of 21) The circular flow shows two ways of measuring GDP. Total expenditure on final goods and services equals GDP. GDP = C + I + G + X – M. Aggregate income equals the total amount paid for the use of factors of production: wages, interest, rent, and profit. Firms pay out all their receipts from the sale of final goods, so income equals expenditure, Y = C + I + G + (X – M). Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (19 of 21) Why “Domestic” and Why “Gross”? Domestic ‒ Domestic product is production within a country. ‒ It contrasts with national product (refer to GNP), which is the value of goods and services produced anywhere in the world by the residents of a nation – inside and outside. Gross ‒ Gross means before deducting the depreciation of capital. ‒ The opposite of gross is net, which means after deducting the depreciation of capital. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (20 of 21) Depreciation is the decrease in the value of a firm’s capital that results from wear and tear and obsolescence. Gross investment is the total amount spent on purchases of new capital and on replacing depreciated capital. Net investment is the increase in the value of the firm’s capital. Net investment = Gross investment − Depreciation. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Gross Domestic Product (21 of 21) Gross investment is one of the expenditures included in the expenditure approach to measuring GDP. So total product measured by the expenditure approach is a gross measure. Gross profit, which is a firm’s profit before subtracting depreciation, is one of the incomes included in the income approach to measuring GDP. So total product measured by the income approach is a gross measure. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (1 of 14) The Bureau of Economic Analysis uses two approaches to measure GDP: ‒ The expenditure approach ‒ The income approach ‒ The production approach ‒ All countries use the similar approaches in measuring GDP – based on the System of National Account (SNA), an international statistical standard for national accounts, adopted by the United Nations Statistical Commission (UNSC). Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Expenditure Approach Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Alternative Approaches in National Income Accounting Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (2 of 14) The Expenditure Approach ‒ The expenditure approach measures GDP as the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports. GDP = C + I + G + (X − M) Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (3 of 14) The Expenditure Approach The expenditure approach measures GDP as the sum of the red flow: consumption expenditure, investment, government expenditure on goods and services, and net exports. GDP = C + I + G + (X − M) Table 21.1 on the next slide shows the expenditure approach with 2014 data. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (4 of 14) TABLE 21.1 GDP: The Expenditure Approach Amount in 2014 (billions of Percentage Item Symbol dollars) of GDP Personal consumption C 11,729 68.8 expenditures Gross private domestic I 2,714 15.9 investment Government expenditure G 3,139 18.4 on goods and services Net exports of goods X-M -538 -3.2 and services Gross domestic Y 17,044 100.0 product Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Composition of GDP by Type of Expenditure in Malaysia, 2021 NX I G C Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (5 of 14) The Income Approach The income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire. Two broad categories are ‒ Wages, salaries, and other labor income ‒ Other factor incomes Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (6 of 14) The payment for labor services is the sum of net wages plus benefits such as pension contributions and is shown by the blue flow W. Other factor incomes (OFI) include interest, rent, and profit and some labor income from self-employment. They are included in the blue flow OFI. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (7 of 14) The Income Approach ‒ The income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire—wages for labor, interest for capital, rent for land, and profit for entrepreneurship. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (8 of 14) The National Income and Expenditure Accounts divide incomes into two broad categories: Compensation of employees is the payments for labor services. It is the sum of net wages plus taxes withheld plus Social Security and pension fund contributions. Net interest, rental income, corporate profits, and proprietors' income earned by capital and land. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (9 of 14) The sum of all factor incomes is net domestic income at factor cost – refers to the cost for factors of production. The expenditure on final goods is valued at market prices. Two adjustments must be made to the net domestic income get GDP: ‒ Indirect taxes less subsidies are added to get GDP from factor cost to market prices. ‒ Depreciation is added to get GDP from net domestic income to gross domestic income. Table 21.2 on the next slide shows the income approach with data for 2014. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (10 of 14) TABLE 21.2 GDP: The Income Approach Amount in 2014 (billions of Percentage dollars) Item of GDP Compensation of employees 9,109 53.4 Net interest 685 4.0 Rental income 623 3.7 Corporate profits 1,514 8.9 Proprietors’ income 1,351 7.9 Net domestic income 13,282 77.9 at factor cost Indirect taxes less subsidies 1,244 7.3 Net domestic income 14,526 85.2 at market prices Depreciation 2,699 15.8 GDP (income approach) 17,225 101.1 Statistical discrepancy –181 –1.1 Notes: Statistical discrepancy is the difference between demand and supply in national GDP (expenditure approach) 17,044 100.0 accounts. Even though by definition the items should be equal in the national economy, they usually deviate from one another due to deviation in statistical sources Copyright © 2016 Pearson Education, Ltd. All Rights Reserved. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Statistics on GDP Income Approach for Selected Countries, 2020 Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  – The issue of interest Despite the positive outcomes, Malaysia’s growth quality was highly debatable due to the sluggish income growth. Targeted COE COE comparison COE and OS compositions in GDP, 2015-2022 (percentage, %) composition by 11MP end period 40% with other Asian countries, based on 2020 data 0.6 11MP (2016-2020) 4.7 5.2 4.7 3.3 3.7 2.7 2.3 2016 2017 2018 2019 2020 52.7% 60.2 59.3 59.7 60.9 60.5 59.9 62.6 67.0 35.6 35.5 35.8 35.9 37.4 48.2% Targeted COE 35.0 35.6 35.5 35.8 35.9 37.4 35.1 32.4 composition by 12MP end period 40% 45.0% 12MP (2021-2025) 42.8% 2015 2016 2017 2018 2019 2020 2021 2022 The COE share 2021 2022 reduced to 32.4% in Taxes less subsidies on production and imports 2022, thus enlarging Gross operating surplus the gap from 4.9% Compensation of employees 35.1 32.4 (2021) to 7.6% (2022). Notes: Computed based on current prices GDP for 2015- 2022. GDP amounts in 2021 and 2022 are based on the Notes: COE compositions for 2020-2022 are updated estimated and preliminary values, respectively. | Source: based on the latest version national account statistics DOSM (2022) released on July 26th, 2023. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (11 of 14) Nominal GDP and Real GDP ‒ Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year. ‒ Currently, the reference base year is 2009 and we describe real GDP as measured in 2009 dollars. ‒ Nominal GDP is the value of goods and services produced during a given year valued at the prices that prevailed in that same year. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (12 of 14) TABLE 21.3 Calculating Nominal GDP and Real GDP Calculating Real GDP Expenditure Quantity Price (millions Item (millions) (dollars) of dollars) Table 21.3(a) shows the (a) In 2009 quantities produced and C T-shirts 10 5 50 the prices in 2009 (the I Computer chips 3 10 30 base year). G Security services 1 20 20 Y Real GDP in 2009 100 Nominal GDP in 2009 is $100 million. Because 2009 is the base year, real GDP equals nominal GDP and is $100 million. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (13 of 14) TABLE 21.3 Calculating Nominal GDP and Real GDP Table 21.3(b) shows the Expenditure Quantity Price (millions quantities produced and Item (millions) (dollars) of dollars) (a) In 2009 the prices in 2014. C T-shirts 10 5 50 Nominal GDP in 2014 is I Computer chips 3 10 30 G Security services 1 20 20 $300 million. Y Real GDP in 2009 100 (b) In 2014 Nominal GDP in 2014 is C T-shirts 4 5 20 three times its value in I Computer chips 2 20 40 G Security services 6 40 240 2009. Y Nominal GDP in 2014 300 Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Measuring U.S. GDP (14 of 14) TABLE 21.3 Calculating Nominal GDP and Real GDP In Table 21.3(c), we Expenditure Quantity Price (millions calculate real GDP in Item (millions) (dollars) of dollars) (a) In 2009 2014. C T-shirts 10 5 50 The quantities are those I Computer chips 3 10 30 G Security services 1 20 20 of 2014, as in part (b). Y Real GDP in 2009 100 (b) In 2014 The prices are those in C T-shirts 4 5 20 the base year (2009), as I Computer chips 2 20 40 G Security services 6 40 240 in part (a). Y Nominal GDP in 2014 300 The sum of these (c) Quantities of 2014 valued at prices of 2009 C T-shirts 4 5 20 expenditures is real GDP I Computer chips 2 10 20 in 2014, which is $160 G Security services 6 20 120 Y Real GDP in 2014 160 million. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (1 of 15) Economists use estimates of real GDP for two main purposes: ‒ To compare the standard of living over time ‒ To compare the standard of living across countries Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  Real GDP vs. Nominal GDP Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (2 of 15) The Standard of Living Over Time ‒ Real GDP per person is real GDP divided by the population. ‒ Real GDP per person tells us the value of goods and services that the average person can enjoy. ‒ By using real GDP, we remove any influence that rising prices and a rising cost of living might have had on our comparison. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (3 of 15) Long-Term Trend ‒ A handy way of comparing real GDP per person over time is to express it as a ratio of some reference year. ‒ For example, in 1960, real GDP per person was $17,210 and in 2013, it was $49,658. ‒ So real GDP per person in 2013 was 2.9 times its 1960 level—that is, $49,658 ÷ $17,210 = 2.9. GDP per capita (constant 2015 US$): https://data.worldbank.org/indicator/NY.GDP.PCAP.KD?end=2020&start=2000 Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (4 of 15) Two features of our expanding living standard are ‒ The growth of potential GDP per person ‒ Fluctuations of real GDP around potential GDP The value of real GDP when all the economy’s labor, capital, land, and entrepreneurial ability are fully employed is called potential GDP. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (5 of 15) Figure 21.2 shows U.S. real GDP per person. Potential GDP grows at a steady pace because the quantities of the factors of production and their productivity grow at a steady pace. Real GDP fluctuates around potential GDP. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (6 of 15) Real GDP per person in the United States: Doubled between 1960 and 1987. Was 3 times its 1960 level in 2013. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (9 of 15) Real GDP Fluctuations—The Business Cycle ‒ A business cycle is a periodic but irregular up-and-down movement of total production and other measures of economic activity. ‒ Every cycle has two phases: ▪ Expansion ▪ Recession and two turning points: ▪ Peak ▪ Trough Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (10 of 15) Figure 21.4 illustrates the business cycle. An expansion is a period during which real GDP increases—from a trough to a peak. Recession is a period during which real GDP decreases—its growth rate is negative for at least two successive quarters. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (11 of 15) The Standard of Living Across Countries ‒ Two problems arise in using real GDP to compare living standards across countries: ▪ The real GDP of one country must be converted into the same currency units as the real GDP of the other country. ▪ The goods and services in both countries must be valued at the same prices. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (14 of 15) Limitations of Real GDP ‒ Real GDP measures the value of goods and services that are bought in markets. ‒ Some of the factors that influence the standard of living and that are not part of GDP are ▪ Household production ▪ Underground economic activity ▪ Leisure time ▪ Environmental quality Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.  The Uses and Limitations of Real GDP (15 of 15) The Bottom Line ‒ Do we get the wrong message about the level and growth of economic well-being and the standard of living by looking at the growth of real GDP? ‒ The influences that are omitted from real GDP are probably large. ‒ It is possible to construct broader measures that combine the many influences that contribute to human happiness. ‒ Despite all the alternatives, real GDP per person remains the most widely used indicator of economic well-being. Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.