GS ECO 2301 CH 8 GDP : Measuring Total Production and Income

Nominal GDP

The value of final goods and services evaluated at current-year prices.

One drawback to calculating real GDP using base-year prices is that, over time

prices may change relative to each other. For example, the price of smartphones may fall relative to the price of milk. Because this change is not reflected in the fixed prices from the base year, the estimate of real GDP is somewhat distorted. The further away the current year is from the base year, the worse the problem becomes. To make the calculation of real GDP more accurate, in 1996, the BEA switched to using chain-weighted prices, and it now publishes statistics on real GDP in "chained (2009) dollars."

Profit includes the

profits of sole proprietorships, which are usually small businesses, and the profits of corporations.

Rent is

rent received by households.

Calculating Price Level Example :

2015 Nom GDP = 18,037 Real GDP = 16,397 2016 Nom GDP = 18,569 Real GDP = 16,662 Step 1. Apply deflator to each year (Nom / Real) x 100 2015 = (18037 / 16397) x 100 = 110 2016 = (18569 / 16662) x 100 = 111.4 Step 2. Price level increase = [ (111.4-110) / 110 ] x 100 = 1.3%

We can use values for nominal GDP and real GDP to compute a measure of the price level called the GDP deflator. We calculate the GDP deflator using this formula:

A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. GDP deflator= (Nominal GDP/Real GDP) ×100

4 of 4 Measures of production and income: Disposable Personal Income

Disposable personal income is equal to personal income minus personal tax payments, such as the federal personal income tax. It is the best measure of the income households actually have available to spend.

The circular-flow diagram shows that we can measure GDP either by calculating the total value of

expenditures on final goods and services or by calculating the value of total income. We get the same dollar amount of GDP with either approach.

intermediate goods and services become

part of other goods and services. A good or service that is an input into another good or service, such as a tire on a truck.

Cars have high prices and are durable goods, so when the economy suffers a downturn

sales decline as unemployment increases, incomes fall, and many people decide to keep their current cars rather than buy new ones.

Holding prices constant means that the purchasing power of a dollar remains

the same from one year to the next. Ordinarily, the purchasing power of the dollar falls every year as price increases reduce the amount of goods and services that a dollar can buy.

In the United States, the Bureau of Economic Analysis (BEA) in the Department of Commerce compiles the data needed to calculate GDP.

The BEA issues reports on the GDP every three months. GDP is a central concept in macroeconomics, so we need to consider its definition carefully.

A business cycle recession is

a period during which total production and total employment are decreasing.

Macroeconomic Issues : Linkages among economies

in the form of international trade and international finance.

Measuring GDP

• GDP Is Measured Using Market Values, Not Quantities • GDP Includes Only the Market Value of Final Goods • GDP Includes Only Current Production

Shortcomings of GDP as a Measure of Well-Being

(1) The value of leisure is not included in GDP (2) GDP is not adjusted for pollution or other negative effects on production (3) GDP is not adjusted for changes in crime and other social problems (4) GDP measures the size of the pie but not how the pie is divided up

Economists use gross domestic product (GDP) to measure total production.

GDP is the market value of all final goods and services produced in a country during a period of time, typically one year.

1 of 4 Measures of production and income: Gross National Product

Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. U.S. firms have facilities in foreign countries, and foreign firms have facilities in the United States. Ford, for example, has assembly plants in the United Kingdom, and Toyota has assembly plants in the United States. GNP includes foreign production by U.S. firms but excludes U.S. production by foreign firms. For the United States, GNP is almost the same as GDP. For example, in 2016, GDP was $18,569 billion, and GNP was $18,776 billion, or only about 1.1 percent more than GDP.

GDP Is Measured Using Market Values, Not Quantities

Instead, we measure production by taking the value, in dollar terms, of all the goods and services produced. When we measure total production in the economy, we can't just add together the quantities of every good and service because the result would be a meaningless jumble.

2 of 4 Components of GDP : Gross Private Domestic Investment, or "Investment"

Spending on gross private domestic investment, or simply investment, is also divided into three categories: 1. Business fixed investment is spending by firms on new factories, office buildings, and machinery used to produce other goods. Since 2013, this category of investment has included business spending on research and development. The BEA had previously considered such spending to be an intermediate good. 2. Residential investment is spending by households and firms on new single-family and multi-unit houses. 3. Changes in business inventories are changes in the stocks of goods that have been produced but not yet sold. If Ford has $200 million worth of unsold cars at the beginning of the year and $350 million worth of unsold cars at the end of the year, then the firm has spent $150 million on inventory investment during the year.

Measuring GDP Using the Value-Added Method (example)

Suppose a cotton farmer sells $1 of raw cotton to a textile mill. If, for simplicity, we ignore any inputs the farmer may have purchased from other firms—such as cottonseed or fertilizer—then the farmer's value added is $1. The textile mill then weaves the raw cotton into cotton fabric, which it sells to a shirt company for $3. The textile mill's value added ($2) is the difference between the price it paid for the raw cotton ($1) and the price for which it can sell the cotton fabric ($3). Similarly, the shirt company's value added is the difference between the price it paid for the cotton fabric ($3) and the price it receives for the shirt from L.L.Bean ($15). L.L.Bean's value added is the difference between the price it pays for the shirt ($15) and the price for which it can sell the shirt on its Web site ($35). Notice that the price of the shirt on L.L.Bean's Web site is exactly equal to the sum of the value added by each firm involved in the production of the shirt.

Macroeconomic Issues : A business cycle expansion is

a period during which total production and total employment are increasing.

Interest is

net interest received by households, or the difference between the interest received on savings accounts, government bonds, and other investments and the interest paid on car loans, home mortgages, and other debts.

Is not counting household production or production in the underground economy a serious shortcoming of GDP? Most economists would answer

"no" because the most important use of GDP is to measure changes in how the economy is performing over short periods of time, such as from one year to the next. For this purpose, omitting household production and production in the underground economy doesn't matter because there is not likely to be much change in these types of production from one year to the next. We also use GDP to measure how production of goods and services grows over fairly long periods of a decade or more. For this purpose, omitting household production and production in the underground economy may be more important. For example, beginning in the 1970s, the number of women working outside the home increased dramatically. Some of the goods and services—such as childcare and restaurant meals—produced in the following years were not true additions to total production; rather, they were replacing what had been household production.

1 of 4 Components of GDP : Personal Consumption Expenditures, or "Consumption"

Consumption expenditures are made by households and are divided into three categories: 1. Expenditures on services, such as medical care, education, and haircuts 2. Expenditures on nondurable goods, such as food and clothing 3. Expenditures on durable goods, such as automobiles and furniture

3 of 4 Components of GDP : Government Consumption and Gross Investment, or "Government Purchases" Government purchases are spending by

federal, state, and local governments on goods and services, such as teachers' salaries, highways, and aircraft carriers. Again, government spending on transfer payments is not included in government purchases because the spending does not result in the production of new goods and services.

Banks and stock and bond markets make up the

financial system. The flow of funds from households into the financial system makes it possible for the government and firms to borrow. As we will see beginning in Chapter 10, the health of the financial system is vital to an economy. Without the ability to borrow funds through the financial system, firms will have difficulty expanding and adopting new technologies. In fact, no country without a well-developed financial system has been able to sustain high levels of economic growth.

One study found that during the slow recovery from the 2007-2009 recession, only 56 percent of students who graduated from college in the spring of 2010 had

found a job a year later. And salaries of graduates who did find jobs were typically lower than before the recession. By the time the class of 2016-2017 graduated, however, the job market was much stronger, and graduates were finding jobs at higher salaries.

Microeconomics is the study of how

households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. In microeconomic analysis, economists generally study individual markets, such as the market for smartphones.

The sum of wages, interest, rent, and profit is total

income in the economy. As noted at the top of Figure 8.1, we can measure GDP as the total income received by households. The diagram also allows us to trace the four ways that households use their income: to purchase domestically produced goods and services; to purchase imports, which are foreign-produced goods and services; to pay taxes to the government (note that firms also pay taxes to the government); and to save by making deposits in checking or savings accounts in banks or by buying stocks or bonds.

The underground economy is also called the

informal sector, as opposed to the formal sector, in which output of goods and services is measured. Although it might not seem to matter whether production of goods and services is measured and included in GDP or unmeasured, a large informal sector can be a sign of government policies that are holding back economic growth. Recent estimates put the size of the underground economy at 8 percent of measured GDP in the United States and 13 percent in Western Europe. The underground economy is much larger in many developing countries—perhaps 50 percent or more of measured GDP. According to one estimate, in 2016, as many as 2 billion people in developing countries worked in the underground economy.

GDP Includes Only the Market Value of Final Goods A final good or service is one that is purchased by

its final user and is not included in the production of any other good or service. Examples of final goods are a hamburger purchased by a consumer and a computer purchased by a business. In calculating GDP, we include the value of a Ford truck but not the value of a tire. If we included the value of the tire, we would be double counting: The value of the tire would be counted once when the tire company sold it to Ford and a second time when Ford sold the truck, with the tire installed, to a consumer.

Figure 8.3 shows movements in nominal GDP and real GDP between 1995 and 2016. In the years before 2009, prices were, on average, lower than in 2009, so nominal GDP was

lower than real GDP. In 2009, nominal and real GDP were equal. Since 2009, prices have been, on average, higher than in 2009, so nominal GDP is higher than real GDP.

Since 2008, labor's share of national income has declined by several percentage points in the United States and most European countries. Economists debate the reasons for this decline, with some believing it can be accounted for by

measurement problems. David Autor, of the Massachusetts Institute of Technology, and colleagues argue that the decline may be due to the rise of "superstar firms," which account for an increasing fraction of sales in a number of industries. Because these firms have high levels of profit, they have relatively low shares of labor income relative to their revenue.

Notice that the definition of investment in this chapter is narrower than in everyday use. For example, people often say they are investing in the stock market or in rare coins. As we have seen, economists reserve the word investment for

purchases of machinery, factories, and houses. Economists don't include purchases of shares of stock or rare coins or deposits in savings accounts in the definition of investment because these activities don't result in the production of new goods.

We describe real GDP as being measured in "base-year dollars." For example, nominal GDP in 2016 was $18,569 billion, and, with a base year of 2009,

real GDP in 2016 was $16,662 billion in 2009 dollars. Because, on average, prices rise from one year to the next, real GDP is greater than nominal GDP in years before the base year and less than nominal GDP for years after the base year. In the base year, real GDP and nominal GDP are the same because both are calculated for the base year using the same prices and quantities.

GDP is also sometimes used as a measure of well-being. Although it is generally true that

the more goods and services people have, the better off they are, we will see that GDP provides only a rough measure of well-being.

National Income and Product Accounts (NIPA)

the national accounts that measure the overall production and income of the economy for the nation as a whole statistical tables containing this information

Macroeconomic Issues : Fluctuations in the inflation rate, which is

the percentage increase in the average level of prices from one year to the next. Like employment, inflation is affected both by the business cycle and by long-run factors.

When we measure the value of total production in the economy by calculating GDP, we are at the same time measuring

the value of total income. Suppose you buy a pair of New Balance running shoes for $149 at a Foot Locker store. All of that $149 must end up as someone's income. New Balance and Foot Locker will receive some of the $149 as profits, workers at New Balance will receive some as wages, the salesperson who sold you the shoes will receive some as salary, the firms that sell components to New Balance will receive some as profits, the workers for those firms will receive some as wages, and so on. So the amount that you spend on the shoes equals the amount of income received by the people who make and sell the shoes. Therefore, if we add up the values of every good and service sold in the economy, we must get a total that is exactly equal to the value of all the income in the economy.

3 of 4 Shortcomings of GDP as a Measure of Well-Being : GDP Is Not Adjusted for Changes in Crime and Other Social Problems

An increase in crime reduces well-being but may actually increase GDP if it leads to greater spending on police, security guards, and alarm systems. GDP is also not adjusted for changes in divorce rates, drug addiction, or other factors that may affect people's well-being.

Real GDP versus Nominal GDP

Because GDP is measured in value terms, we have to be careful about interpreting changes over time. To see why, consider interpreting an increase in the total value of pickup truck production from $40 billion in 2018 to $44 billion in 2019. Because $44 billion is 10 percent greater than $40 billion, did the economy produce 10 percent more trucks in 2019 than in 2018? We can draw this conclusion only if the average price of trucks did not change between 2018 and 2019. In fact, when GDP increases from one year to the next, the increase is due partly to increases in production of goods and services and partly to increases in prices. Because we are mainly interested in GDP as a measure of production, we need a way of separating the price changes from the quantity changes.

Figure 8.1 The Circular Flow and the Measurement of GDP We use it here to illustrate the flow of spending and money in the economy. Firms sell goods and services to three groups: domestic households, foreign firms and households, and the government.

Expenditures by foreign firms and households (shown as "Rest of the World" in the diagram) on domestically produced goods and services are called exports. For example, American Airlines sells many tickets to passengers in Europe and Asia. To produce goods and services, firms use factors of production: labor, capital, natural resources, and entrepreneurship. Households supply the factors of production to firms in exchange for income in the form of wages, interest, rent, and profit. The sum of wages, interest, rent, and profit is total income in the economy.

The Division of Income Figure 8.1 illustrates the important fact that we can measure GDP in terms of total expenditure or as the total income received by households. GDP calculated as the sum of income payments to households is sometimes called gross domestic income.

Figure 8.5 shows the division of total income among • wages, • interest, • rent, profit, and •certain non-income items. The non-income items are included in gross domestic income because sales taxes, depreciation, and a few other items are included in the value of goods and services produced but are not directly received by households as income. Figure 8.5 shows that the largest component of gross domestic income is wages, which are more than three times as large as profits.

business cycle

Fluctuations in economic activity, such as employment and production alternating periods of economic expansion and economic recession. Production and employment increase during expansions and decrease during recessions.

1 of 4 Measures of production and income: Gross National Product (continued)

For many years, GNP was the main measure of total production compiled by the federal government and used by economists and policymakers in the United States. However, in many countries other than the United States, a significant percentage of domestic production takes place in foreign-owned facilities. For those countries, GDP is much larger than GNP and is a more accurate measure of the level of production within the country's borders. As a result, many countries and international agencies had long preferred using GDP to using GNP. In 1991, the United States joined those countries in using GDP as its main measure of total production.

GDP Includes Only Current Production

GDP includes only production that takes place during the indicated time period. For example, GDP in 2018 includes only the goods and services produced during that year. In particular, GDP does not include the value of used goods. If you buy a Blu-ray of The Avengers: Infinity War from Amazon.com, the purchase is included in GDP. If six months later you resell the Blu-ray on eBay, that transaction is not included in GDP.

Household Production With few exceptions, the BEA does not attempt to estimate the value of goods and services that are not bought and sold in markets. If a carpenter makes and sells bookcases, the value of those bookcases will be counted in GDP. If the carpenter makes a bookcase for personal use, it will not be counted in GDP.

Household production refers to goods and services people produce for themselves. The most important type of household production is the services a homemaker provides to the homemaker's family. If a person has been caring for children, cleaning the house, and preparing the family meals, the value of such services is not included in GDP.

1 of 4 Shortcomings of GDP as a Measure of Well-Being : The Value of Leisure Is Not Included in GDP

If an economic consultant decides to retire, GDP will decline even though the consultant may value increased leisure more than the income she was earning from running a consulting firm. The consultant's well-being has increased, but GDP has decreased. If Americans still worked 60-hour weeks, GDP would be much higher than it is now, but the well-being of a typical person would be lower because less time would be available for leisure activities.

Comparing Real GDP and Nominal GDP Real GDP holds prices constant, which makes it a better measure than nominal GDP of changes in the production of goods and services from one year to the next.

In fact, growth in the economy is almost always measured as growth in real GDP. If a headline in the Wall Street Journal states "U.S. Economy Grew 2.3% Last Year," the article will report that real GDP increased by 2.3 percent during the previous year.

To see why the GDP deflator is a measure of the price level, think about what would happen if prices of goods and services rose while production remained the same.

In that case, nominal GDP would increase, but real GDP would remain constant, so the GDP deflator would increase. In reality, both prices and production usually increase each year, but the more prices increase relative to the increase in production, the more nominal GDP increases relative to real GDP, and the higher the value for the GDP deflator. Increases in the GDP deflator allow economists and policymakers to track increases in the price level over time.

2 of 4 Measures of production and income: National Income In the production of goods and services, some machinery, equipment, and buildings wear out and have to be replaced. The value of this worn-out machinery, equipment, and buildings is called depreciation.

In the NIPA tables, depreciation is called the consumption of fixed capital. If we subtract this value from GDP, we are left with national income. In Section 19.1, we stressed that the value of total production is equal to the value of total income. This point is not strictly true if by "value of total production" we mean GDP and by "value of total income" we mean national income because national income will always be smaller than GDP by an amount equal to depreciation. In practice, though, the difference between the value of GDP and the value of national income does not matter for most macroeconomic issues.

Macroeconomic Issues : Fluctuations in the total level of employment in an economy.

In the short run, the level of employment is significantly affected by the business cycle, but in the long run, the effects of the business cycle disappear, and other factors determine the level of employment. A related question is why some economies are more successful than others at maintaining high levels of employment over time.

The Underground Economy Individuals and firms sometimes conceal the buying and selling of goods and services, in which case their production isn't counted in GDP.

Individuals and firms conceal what they buy and sell for three main reasons: (1) They are dealing in illegal goods and services, such as drugs or prostitution; (2) they want to avoid paying taxes on the income they earn; or (3) they want to avoid government regulations. This concealed buying and selling is called the underground economy Estimates of the size of the underground economy in the United States vary widely, but it is at most 10 percent of measured GDP, and probably less. The underground economy in some low-income countries, such as Zimbabwe or Peru, may be more than 50 percent of measured GDP. Recently, countries in Western Europe have decided to include estimates of spending on illegal drugs and prostitution in their measures of GDP. To this point, the BEA has decided not to follow this approach. If it did, estimates are that measured U.S. GDP would increase by about 3 percent.

Governments also make transfer payments to households. Transfer payments include

Payments by the government to households for which the government does not receive a new good or service in return. Social Security payments to retired and disabled people and unemployment insurance payments to unemployed workers. These payments are not included in GDP because they are not received in exchange for production of a new good or service.

3 of 4 Measures of production and income: Personal Income

Personal income is income received by households. To calculate personal income, we subtract the earnings that corporations retain rather than pay to shareholders in the form of dividends. We also add the payments households receive from the government in the form of transfer payments or interest on government bonds.

4 of 4 Shortcomings of GDP as a Measure of Well-Being : GDP Measures the Size of the Pie but Not How the Pie Is Divided

When a country's GDP increases, the country has more goods and services, but those goods and services may be very unequally distributed. Therefore, GDP may not provide good information about the goods and services consumed by a typical person.

2 of 4 Shortcomings of GDP as a Measure of Well-Being : GDP Is Not Adjusted for Pollution or Other Negative Effects of Production

When a dry cleaner cleans and presses clothes, the value of this service is included in GDP. If the dry cleaner uses chemicals that pollute the air or water, GDP is not adjusted to compensate for the cost of the pollution. We should note, though, that increasing GDP often leads countries to devote more resources to pollution reduction. Developing countries often have higher levels of pollution than high-income countries because the lower GDPs of the developing countries make them more reluctant to spend resources on pollution reduction.

An Equation for GDP and Some Actual Values A simple equation sums up the components of GDP: equation

Y=C+I+G+NX. The equation tells us that GDP (denoted as Y) equals consumption (C) plus investment (I) plus government purchases (G) plus net exports (NX).

Wages include

all compensation received by employees, including fringe benefits such as health insurance.

The details of calculating real GDP using chain-weighted prices are more complicated than we need to discuss here, but the basic idea is straightforward: Starting with the base year, the BEA takes

an average of prices in that year and prices in the following year. It then uses this average to calculate real GDP in the year following the base year (currently the year 2009). For the next year—in other words, the year that is two years after the base year—the BEA calculates real GDP by taking an average of prices in that year and the previous year. In this way, prices in each year are "chained" to prices from the previous year, and the distortion from changes in relative prices is minimized.

Shortcomings of GDP as a Measure of Well-Being The main purpose of GDP is to measure a country's total production. GDP is also frequently used, though, as a measure of well-being. For example, news stories often include tables that show for different countries the levels of GDP per person, which is usually called GDP per capita. GDP per capita is

calculated by dividing the value of GDP for a country by the country's population. These articles imply that people in the countries with higher levels of GDP per capita are better off.

Calculating Real GDP The BEA separates price changes from quantity changes by calculating a measure of production called real GDP. Real GDP is calculated by

designating a particular year as the base year and then using the prices of goods and services in the base year to calculate the value of goods and services in all other years. For instance, if the base year is 2009, real GDP for 2019 would be calculated by using prices of goods and services from 2009. By keeping prices constant, we know that changes in real GDP represent changes in the quantity of goods and services produced in the economy.

Gross domestic product (GDP) is a measure of an

economy's total production of goods and services, so one factor in your decision is likely to be the growth rate of GDP in each country.

4 of 4 Components of GDP : Net Exports of Goods and Services, or "Net Exports" Net exports are equal to

exports minus imports. Exports are goods and services produced in the United States and purchased by foreign firms, households, and governments. We add exports to our other categories of expenditures because otherwise we would not be including all spending on new goods and services produced in the United States. We subtract imports from total expenditures because otherwise we would be including spending that does not result in production of new goods and services in the United States. For example, if U.S. consumers buy $1 billion worth of furniture manufactured in China, that spending is included in consumption expenditures. But the value of those imports is subtracted from GDP because the imports do not represent production in the United States.

Because firms in the informal sector are operating illegally, they tend to be

smaller and have less capital than firms operating legally. The entrepreneurs who start firms in the informal sector may be afraid the government could someday close or confiscate their firms. Therefore, the entrepreneurs limit their investments in these firms. They also are reluctant to apply to banks for loans because they would have to provide information to the bank that might come to the attention of the government. As a consequence, workers in these firms have less machinery and equipment to work with and so can produce fewer goods and services and are paid low wages. Entrepreneurs in this sector also have to pay the costs of avoiding government authorities. For example, construction firms operating in the informal sector in Brazil have to employ lookouts who can warn workers to hide when government inspectors come around. Many economists believe taxes in developing countries are so high because these countries are attempting to pay for government sectors that are as large relative to their economies as the government sectors of industrial economies. Including transfer payments, government spending in Brazil, for example, is 41 percent of measured GDP, compared to 36 percent in the United States. In the early twentieth century, when the United States was much poorer than it is today, government spending was only about 8 percent of GDP, so the tax burden on U.S. firms was much lower. In countries such as Brazil, bringing firms into the formal sector from the informal sector may require reductions in government spending and taxes. In most developing countries, however, voters are reluctant to see government services reduced.

Macroeconomic Issues : Economic growth, which refers to

the ability of an economy to produce increasing quantities of goods and services. Economic growth is important because an economy that grows too slowly fails to raise living standards.

Measuring GDP Using the Value-Added Method We have seen that GDP can be calculated by adding together all expenditures on final goods and services. An alternative way of calculating GDP is the value-added method. Value added refers to

the additional market value a firm gives to a product and is equal to the difference between the price for which the firm sells a good and the price it paid other firms for intermediate goods. We can calculate GDP by adding up the market value of every final good and service produced during a particular period. Or, we can arrive at the same value for GDP by adding up the value added by every firm involved in producing those final goods and services.

The GDP Deflator Economists and policymakers are interested not just in the level of total production, as measured by real GDP, but also in the price level. The price level measures

the average prices of goods and services in the economy. One of the goals of economic policy is to maintain a stable price level.

Macroeconomics is the study of

the economy as a whole, including topics such as inflation, unemployment, and economic growth. In macroeconomic analysis, economists study factors that affect many markets at the same time. Macroeconomics analyzes both what determines a country's rate of economic growth and the reasons growth rates differ so greatly across countries.

National income accounting refers to

the methods the BEA uses to track total production and total income in the economy.

Shortcomings in GDP as a Measure of Total Production When the BEA calculates GDP, it does not include

two types of production: • production in the home and • production in the underground economy.

Profit is the income that remains after a firm has paid

wages, interest, and rent. Profit is the return to entrepreneurs and other business owners for bearing the risk of producing and selling goods and services.

We divide income into four categories:

wages, interest, rent, and profit. Firms pay wages to households in exchange for labor services, interest for the use of capital, and rent for natural resources such as land.

Firms use the factors of production

—labor, capital, natural resources, and entrepreneurial ability—to produce goods and services. Households supply the factors of production to firms in exchange for income.

An Equation for GDP and Some Actual Values A simple equation sums up the components of GDP:

• Consumer spending on services is more than double the spending on durable and nondurable goods combined. There has been a continuing trend in the United States and other high-income countries away from the production of goods and toward the production of services. As the populations of these countries have become, on average, both older and wealthier, their demand for services such as medical care and financial advice has increased faster than their demand for goods. • Business fixed investment is the largest component of investment. As we will see in later chapters, spending by firms on new factories, computers, and machinery can fluctuate. For example, a decline in business fixed investment contributed to the severity of the 2007-2009 recession. • Purchases made by state and local governments are greater than purchases made by the federal government. This result shouldn't be surprising because basic government activities, such as education and law enforcement, occur largely at the state and local levels. • Imports are greater than exports, so net exports are negative. We will discuss in Chapter 18, Section 18.4 why imports have typically been larger than exports for the U.S. economy.

Components of GDP The BEA divides its statistics on GDP into four major categories of expenditures:

• consumption, • investment, • government purchases, and • net exports. Economists use these categories to understand why GDP fluctuates and to forecast future GDP.

In addition to computing GDP, the BEA computes the following four measures of production and income:

• gross national product, • national income, • personal income, and • disposable personal income. The most important measure of total production and total income is gross domestic product (GDP). As we will see in later chapters, for some purposes, the other measures of total production and total income shown in the figure turn out to be more useful than GDP.