Macro Gross Domestic product Module 4

Because real GDP is unaffected by changes in prices over time, a rise in real GDP shows an actual change in the amount of goods and services produced within a country for a given period of time.

EXAMPLE: In May 2011, the BEA reported that current-dollar, or nominal, GDP increased at a 3.8% annual rate in the first quarter of the year compared to the 1.8% annual rate of increase for real GDP. For this time period, both quantity and prices in the economy were rising.

The growth of real GDP will show changes in the amounts being produced and inflation.

False

The CPI is an imperfect measure of the cost of living because its construction results in four types of bias:

New Goods Changes in Quality Commidity Subsitution Outlet Subsitution

NOMINAL GDP:

Nominal GDP is the value of the final goods and services produced in a given year expressed in terms of the prices in that same year.

GNP measures the market value of all final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country.

True The definition is incomplete. GNP measures the market value of all final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country.

What's NOT included in the GDP?

Used Goods Financial Assets

Investment:

investment, contains all spending on equipment, inventories, and structures, including houses. This value includes all private investments in things such as equipment, including computers and printers, as well as buildings, such as offices and warehouses. Also included in this component are the purchases of new homes by households and the additions to inventories at businesses. For example, when a car dealer purchases a new car and parks it on the lot for sale, business inventories rise. When firms add unsold items to their inventory, the items are counted as part of the investment component of GDP.

These four categories are called the EXPENDITURE APPROACH for measuring GDP.

pie chart on pg 6 of Presentation

Disposable Personal Income

Another measure of our standard of living is disposable personal income (DPI). What households have to spend on goods and services is a good indicator of how well they can live. DPI is the income received by households less personal income taxes paid. Using DPI and adjusting for PPP, U.S. households are more wealthy than most other countries. In 2009, the Organization for Economic Cooperation and Development reported that only Norway and Switzerland had higher incomes than the United States after adjusting for the purchasing power of each country's currency.

Economic Decisions

As an economic indicator, the CPI can assess the effectiveness of different government policies or as a guide for households and businesses making economic decisions. The CPI is also used to adjust other economic data, such as income or wages, for price changes to compare these values over time.

Examples of Nominal Interest Rate

Average hourly wage rate measured in current dollars The rate that investors actually receive after the loan is paid or their deposit is returned

Examples of Real Interest Rate

Average hourly wage rate measured in dollars of a given reference year Percentage return on a loan or savings account after adjusting for the effects of inflation

GDP is divided into four main categories of spending:

Consumption Investment Government Purchases Net Exports

Consumption:

Consumption is spending by households, excluding the purchase of a house. These are called personal consumption expenditures. This GDP component includes both durable goods meant to last three or more years and nondurable goods. For example, spending by households on refrigerators and televisions constitutes durable goods purchases, whereas grocery items or restaurant meals are nondurable goods purchases.

GDP is the market value of all final goods and services produced by a country's citizens in a given period of time.

False

If real GDP for one country is higher than another, it must be true that the standard of living is also higher.

False

The value of new home construction is included in the consumption component of GDP.

False

Nominal GDP uses prices for a given base year to value the economy's production of goods and services, whereas real GDP uses current prices to value the economy's production of goods and services.

Falso

Survey

First, the BLS surveys consumers in urban areas to determine what these consumers regularly purchase in the marketplace each month. This survey determines a representative bundle of goods and services, or market basket, purchased by a typical consumer. In 2010, the BLS's basket of goods included food and beverages (14.8%), housing (41.5%), apparel (3.6%), transportation (17.3%), medical care (6.6%), recreation (6.3%), education (3.1%), communication (3.3%), and other goods and services (3.5%). Your spending patterns may or may not follow these ratios, but the BLS survey found that these goods and their corresponding percentages make up the monthly budget of the typical U.S. consumer living in an urban area.

New Goods

First, the CPI does not take into account increases in the purchasing power of the dollar attributable to the introduction of new goods. Although new goods are often more expensive than the goods they replace, consumers have a wider variety of goods and services from which to choose. This increase in choices makes every dollar more valuable, which lowers the cost of maintaining the same level of economic well-being. Because the market basket is fixed for some period of time, new goods are left out of the bundle of goods and services purchased by the typical consumer. For example, portable mp3 players were not introduced to the basket until well after they were very popular amongst consumers.

Used Goods

First, used goods, which are bought and sold in many markets, are not included in the calculation of GDP. Although many economic decisions are made when consumers shop for a used car or pick up a bargain at a garage sale, these items were not produced. We would be double counting if we included used goods. Used goods were part of GDP during the period in which they were produced.

Index Level

Fourth, the BLS chooses the base period and computes the index level. The level of the CPI in any given month is equal to 100 mulpilied by the ratio of the basket's cost in the current month to the cost in the base period. As an index, the CPI is defined to equal 100 during some yearly period called the reference base period. The BLS is currently using 1982-1984 as the reference base period. That is, the index is set to 100 for the average CPI over those years. The base year period will likely be updated in the future as more census data are collected.

Outlet Sub

Fourth, the CPI has an outlet substitution bias. When prices rise, people use discount stores more frequently and convenience stores less frequently. Consumers are here again substituting toward relatively cheaper goods. Because the basket doesn't correct for the substitution, the CPI often overstates the increase in the cost of living over time. Because of these measurement problems, the CPI overstates annual inflation by appromiately one percentage point. A 1996 study estimated that the bias overstates the inflation rate by approximately 1.1% per year. This overestimation in the rate of inflation can lead to real problems in the economy.

GDP is a measure of Domestic Production

GDP measures the production that takes place within the geographical boundaries of a particular country. If a foreign citizen comes to the United States and works temporarily, the value of that worker's output is included in the U.S. GDP. Conversely, if a U.S. citizen works in another country, the value of that production is not included in U.S. GDP. Only what is produced in the United States counts.

Real GDP is not the only measure of our nation's income. There are two other ways to measure the standard of living in our country:

Gross National Product aka GNP Dispolable Personal Income

Gross National Product

Gross national product (GNP) is the market value of all final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country. A U company producing airplane parts in Asia would be part of U.S. GNP but not its GDP. GNP considers the value of production based on ownership, not location.

US real GDP in 1971

In 1971, real GDP was approximately $4.5 trillion, and the population stood at 209 million people. Real GDP per person in 1971 was then approximately $21,500.

EXAMPLE:

In the summer of 1983, the CPI stood at 100.1. By 2011, the CPI had risen to 224.8. Prices more than doubled over this 28-year period. Workers should question whether their wages kept up with this price increase. According to the Bureau of Labor Statistics, the average hourly wage for a worker in 2011 was approximately $19 compared to $8.25 in 1983. If we use the 2011 CPI level of 224.8, the $19 nominal wage is equivalent to a real wage of approximately $8.45. Since the early 1980s, the real wage of workers is approximately the same.

NEgative Real Returns

Investors can also face negative real returns after taxes. Taxes are generally calculated on the current dollar value of return received. For example, if you earn 5% on your savings account at the bank, you must report this as taxable income. It may be true, however, that after adjusting for inflation, your savings account did not help you; inflation reduced the purchasing power of your savings. In this case, you would be paying taxes on something that didn't earn you any real income.

GDP is measured for a particular Time Peroid

Just as your personal income is measured over some set time period, like weeks or months, the value of GDP is stated for a given time period. In the United States, GDP is estimated quarterly and stated in annual terms.

Most people see the problem caused by inflation as a result of the following:

Less Purchasing Power Direct Costs Negative real Returns

First GDP measures market value

Market Value:That is, only goods sold in the marketplace are counted as part of an economy's GDP. GDP does not include illegal goods or any services that are not sold in clearly identified and measurable markets. Many other items and services are never actually sold. When you pay someone to clean your house, it is included in GDP, but it is not counted when you do the work yourself.

INCOME APPROACH

Measuring GDP using the income approach begins with wage income, interest, rental income, and profit income. These income measures are then adjusted to remove the affect of government taxes and transfers. Another item, depreciation, which is the decrease in the value of capital that results from its use and obsolescence, is added back to income to yield GDP.

Measured by the GDP:

Personal consumption expenditures Spending on equipment, inventories, and structures Net exports Payments by the government for services, or the purchase of things such as military equipment

CPI Measures:

Price Estimates Inflation Economic Decisions

REAL GDP:

Real GDP is the value of final goods and services produced in a given year expressed in terms of the prices in a base year. Real GDP allows the quantities of production to be compared across time.

REAL GDP PER PERSON

Real GDP per person is the standard of living measured by the value of goods and services people enjoy on average. By dividing real GDP by a given population, we get an idea as to how well the average citizen is doing compared to previous periods, called real GDP per person.

Determing Prices

Second, prices for each of the goods and services in the basket must be determined each month. The BLS has a group of shoppers that travel around recording prices for the goods and services in the market basket. The basket is kept the same for as many consecutive months as possible.

Changes In Quality

Second, the CPI is biased by unmeasured changes in the quality of goods and services. Many times a rise in the price of product reflects quality improvements. For example, cars become safer, and drugs become more effective at treating diseases. If the quality of a good or a service is increasing, the value of the dollar used to purchase it also rises. That is, the cost of living is actually going down. If quality increases, the cost of living, which the CPI tries to measure, does not necessarily rise. Therefore, the price index does not rise directly with higher quality. The BLS tries to correct prices for changes in quality, but this is difficult because quality is hard to measure.

Financial Assets

Second, when investors purchase financial assets, such as stocks or bonds, these expenditures are not part of GDP. Although money is changing hands, these investment decisions are not expenditures on goods and services.

NOT measured by the GDP

Spending on used goods Investments in financial assets, such as stocks or bonds

Contructing the CPI

Survey Determining of Prices Cost of the Basket Index Level

Price Estimates

The CPI is an estimate of the prices paid for all goods and services purchased for consumption by urban wage earners, such as professionals, clerical workers, laborers, self-employed people, and retired people. The index includes user fees, such as utility bills, and sales taxes paid by the consumer. Income taxes and investments, such as stocks, bonds, and life insurance, are not included.

Inflation

The CPI is the most widely cited and studied measure of a rise in the cost of living, or inflation. Inflation is a rise in the overall price level for an economy. If the level of the CPI is rising, the cost of living is going up, or the value of a dollar's worth of goods and services is declining.

Net Exports:

The fourth category of expenditures, net exports, measures the spending on the goods and services a country exports less the spending by residents here on goods and services they import. Exports of goods and services are anything U.S. firms produce and sell to the rest of the world. Imports are anything that households, firms, and governments buy from the rest of the world. For example, U.S. farmers produce a large amount of wheat, much of which is sold to other countries. These export sales add to GDP. In contrast, U.S. households purchase a large amount of clothing made in China and other countries. These imports subtract from GDP.

Calculating Real Wages Like gross domestic product, wages are adjusted for inflation to make comparisons over time and to better understand the purchasing power of an average worker.

The nominal wage rate is the average hourly wage rate measured in current dollars. The real wage rate is the average hourly wage rate measured in dollars of a given reference year. The real wage rate is calculated by dividing the nominal wage rate by the consumer price index (CPI) and multiplying by 100. The real wage rate tells us the quantity of goods and services that an hour's work can purchase.

Government Purchases

The third category, government purchases, includes spending by all levels of government: local, state, and federal. These expenditures include payments by the government for services or the purchase of things such as military equipment. For example, when the government purchases a new submarine for service in the navy or a new limousine for the president, the government purchase component of GDP rises. Only what the government buys are included here. Transfer payments made by the government, such as Social Security benefits and unemployment insurance, are not included in this category.

GDP counts ONLY final goods.

The wheat sold by the farmer and used to make flour for baking your bread is not included in GDP. However, the value of this wheat has not been lost. This value is included in the market price of the bread that is finally bought and consumed. Wheat is just one example of an intermediate good. Even if a final good, like the bread, is made but not sold, it will be counted in GDP. These final goods are said to be in inventory. When businesses buy up goods to store on their shelves, economists say they have made an investment for later sale. Investments are included in GDP.

Direct Costs

There are, however, direct costs to businesses if prices rise rapidly. Businesses may have to change the listed prices for their products and services more frequently if prices rise, and inflation can cause businesses to hoard commodities or put off new investments.

Commodity Sub

Third, the CPI does not take into account consumers' ability to substitute goods for ones that become relatively cheaper over time. This is called commodity substitution bias. The typical consumer will choose not to buy goods and services with large relative price increases. The CPI does not allow for this substitution. The index is again calculated using a fixed basket of goods and services.

Cost of the Basket

Third, the cost of the basket is computed. With a fixed basket, only prices are being allowed to change. This allows the BLS to isolate the effects of price changes over time.

Changes in real GDP better gauge the change in economic well-being than changes in nominal GDP.

True

GDP measures two things at once: the total income of everyone in the nation and the total expenditure on this nation's output of goods and services.

True

If real GDP rises in value, then only the amount of goods and services produced has risen.

True

GDP omits things that are very important for a nation's standard of living

True Health and Politics

U.S. Real GDP per person 2010

U.S. real GDP in 2010 was approximately $13.4 trillion, using 2005 prices. The U.S. population in 2010 was just over 311 million people. Thus, real GDP per person was approximately $43,000. That is, the average income for a U.S. citizen in 2010 was approximately $43,000.

Less Purchasing Power

When prices rise, incomes generally rise as well. Inflation itself will not reduce the purchasing power of incomes if wages are also rising. Remember that the price paid for goods and services involves both buyers and sellers. Higher prices paid by consumers are exactly offset by a higher income earned by the sellers. As we discussed previously, wage increases are often tied to increases in the price level.

Standard of living is a measurement of the financial well-being of a given country based on how well its citizens are doing economically.

You can use GDP, GNP, and disposable income figures to measure standard of living. GDP or GNP per person will give you an idea of standard of living based on national productivity. Measuring standard of living against disposable income provides the standard of living based on how much money individuals have to spend on goods and services.

The Bureau of Economic Analysis measures GDP in the United States using:

expenditure information, income information, and similar economic data to reach its conclusions.