Gross Domestic Product PDF

Gross Domestic Product (1 of 21) G D P Defined G D P 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...

Gross Domestic Product (1 of 21) G D P Defined G D P 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 Gross Domestic Product (2 of 21) Market Value G D P is a market value—goods and services are valued at their market prices. To add apples and oranges, computers and popcorn, we add the market values so we have a total value of output in dollars. Gross Domestic Product (3 of 21) Final Goods G D P is the and Services value of the final goods and services produced. 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 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. Gross Domestic Product (4 of 21) Produced Within a Country G D P measures production within a country— domestic production. In a Given Time Period G D P measures production during a specific time period, normally a year or a quarter of a year. Gross Domestic Product (5 of 21) G D P and the Circular Flow of Expenditure and G D PIncome 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 diagram in Figure 21.1 illustrates the equality of income and expenditure. Gross Domestic Product (6 of 21) The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world. Gross Domestic Product (7 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. A fourth factor of production, entrepreneurship, receives profit. In the figure, the blue flow, Y, shows total income paid by firms to households. Gross Domestic Product (8 of 21) The blue flow, Y, from firms to households through factor markets shows total income paid by firms to households. Gross Domestic Product (9 of Firms sell and 21) households buy consumer goods and services in the goods market. Consumption expenditure is the total payment for consumer goods and services. 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. Gross Domestic Product (10 of 21) Consumption expenditure is the red flow C from households to firms through goods markets. Investment is the red flow from firms to firms through goods markets. Gross Domestic Product (11 of 21) Governments Governments buy goods and services from firms and their expenditure on goods and services is called government expenditure. 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. Gross Domestic Product (12 of 21) Government expenditure is the red flow G from governments to firms through goods markets. Gross Domestic Product (13 of 21) Rest of the World 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. If net exports are negative, the net flow of goods and services is from the rest of the world to U.S. firms. Gross Domestic Product (14 of 21) Net exports is the from the rest of red flow ( X – M ) the world to U.S. firms through goods markets. Gross Domestic Product (15 of 21) The blue and red flows are the circular flow of expenditure and income. Gross Domestic Product (16 of 21) The sum of the red flows equals the blue flow. Gross Domestic Product (17 of 21) That is: Y  C I  G  (X  M) Gross Domestic Product (18 of 21) The circular flow shows two ways of measuring G D P. G D P Equals Expenditure Equals Income Total expenditure on final goods and services equals G D P. 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 ). Gross Domestic Product (19 of 21) Why “Domestic” and Why “Gross”? Domestic Domestic product is production within a country. It contrasts with national product, which is the value of goods and services produced anywhere in the world by the residents of a nation. Gross Gross means before deducting the depreciation of capital. The opposite of gross is net, which means after deducting the depreciation of capital. 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. Gross Domestic Product (21 of 21) Gross investment is one of the expenditures included in the expenditure approach to measuring G D P. 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 G D P. So total product measured by the income approach is a gross measure. Measuring U.S. G D P (1 of 13) The Bureau of Economic Analysis uses two approaches to measure G D P: The expenditure approach The income approach Measuring U.S. G D P (2 of 13) The Expenditure Approach The expenditure approach measures G D P as the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports. GDP  C  I  G  ( X  M ) Measuring U.S. G D P (3 of 13) The expenditure approach measures G D P as the sum of the red flows. GDP = C + I + G + ( X – M ) Table 21.1 on the next slide shows the expenditure approach with 2020 data. Measuring U.S. G D P (4 of 13) Table 21.1 G D P: The Expenditure Approach Item Symbol Amount in Percentage of G 2020 DP (billions of dollars) Personal consumption C 14,145 67.6 expenditures Gross private domestic I 3,605 17.2 investment Government expenditure G 3,831 18.3 on goods and services X M  645  3.1 Net exports of goods and X minus M minus 645 Minus 3.1 services Gross domestic product Y 20,936 100.0 Measuring U.S. G D P (5 of 13) The Income Approach The income approach measures G D P 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. Measuring U.S. G D P (6 of 13) The payment for labor services is the sum of net wages plus benefits and is shown by the blue flow W. Other factor incomes include interest, rent, and profit and some labor income from self- employment. They are included in the blue flow O F I. Measuring U.S. G D P (7 of 13) The National Income and Expenditure Accounts divide incomes into two broad categories: Measuring U.S. G D P (8 of 13) The sum of all factor incomes is net domestic income at factor cost. The expenditure on final goods is valued at market prices. Two adjustments must be made to the net domestic income to get G D P: 1. Indirect taxes less subsidies are added to get from factor cost to market prices. 2. Depreciation is added to get from net domestic income to gross domestic income. Table 21.2 on the next slide shows the income approach with data for 2020. Measuring U.S. G D P (9 of 13) Table 21.2 G D P: The Income Approach Measuring U.S. G D P (10 of 13) Nominal G D P and Real G D P Real G D P 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 2012 and we describe real G D P as measured in 2012 dollars. Nominal G D P is the value of goods and services produced during a given year valued at the prices that prevailed in that same year. Nominal G D P is just a more precise name for G D P. Measuring U.S. G D P (11 of 13) Calculating Real G D P Calculating Nominal G D P Table 21.3(a) shows and Real G D P the quantities produced and the prices in 2012 (the base year). Nominal G D P in 2012 is $100 million. Because 2012 is the base year, real G D P equals nominal G D P and is $100 million. Measuring U.S. G D P (12 of 13) Calculating Real G D P Calculating Nominal G D P and Real G D P Table 21.3(b) shows the quantities produced and the prices in 2021. Nominal G D P in 2021 is $300 million. Nominal G D P in 2021 is three times its value in 2012. Measuring U.S. G D P (13 of 13) Calculating Real Gwe In Table 21.3(c), DP Calculating Nominal G D P and Real G D P calculate real G D P in 2021. The quantities are those of 2021, as in part (b). The prices are those in the base year (2012), as in part (a). The sum of these expenditures is real G D P in 2021, which equals $160 million.