Gross Domestic Product

Chapter 12, Section 1

History• Used to think the

economy would automatically correct itself• Great Depression- 1929-

World War II• Must find a way to

monitor the economy’s performance to predict downturns and try to prevent them

National Income and Product Accounts

• National Income Accounting: collects statistics on production, income, investment, and savings• National Income and Product

Accounts (NIPA)• Used to determine economic policies

Gross Domestic Product• One of the measures included in the

NIPA• The dollar value of all final goods and

services produced within a country’s borders in a given year• Let’s break it down...

“Dollar value”• The total of the selling prices of all

goods and services produced in a country in one calendar year added up

• Products in the form sold to consumers• Not intermediate goods- used in the

production of final goods

“final goods and services”

“produced within a country’s borders”

• Cars produced in America and sold by a Japanese company• Cars produced in Brazil and sold in

America

For example:

• Sarah sells her house, which was built in 1982. What year’s GDP is that house included in?• What about the realtor fees?

For example:• James buys a

brand new house. Is this included in GDP?

• What about the costs of the lumber, nails, windows, doors, and shingles?

Expenditure Approach• Add together the amounts spent to

produce goods and services during the year• 4 categories:•Consumer goods and services•Business goods and services•Government goods and services•Net exports or imports of goods and services

Expenditure Approach: Example

• Calculate this country’s GDP using the expenditure approach.• This year, the country produced:•750 big screen televisions at $1,000 each•500 coffee tables at $50 each•Exported 75 sofas at $250 each

$81,250

Income Approach• More accurate• Add up all the incomes in the

economy• The prices goods are sold for is equal

to the amount of income earned by all of the people who helped, however indirectly, to produce the product

Income Approach: Example

• Calculate this country’s GDP using the income approach.• This country produces houses and

employs:•2 architects at $20,000 each•15 contractors at $18,000 each•4 interior designers at $15,000 each

$370,000

Nominal vs. Real GDP• Nominal GDP: use the current year’s

prices to calculate the value of the current year’s output

750 big screen TVs at $1,000 each = $750,000

+ 500 coffee tables at $50 each = $25,000

Total = $775,000

Nominal vs. Real GDP• The next year, prices rise but

productivity does not. This falsely inflates the GDP measure.

750 big screen TVs at $1,050 each = $787,500

+ 500 coffee tables at $75 each = $37,500

Total = $825,000

Nominal vs. Real GDP• To correct for this increase in prices,

economists choose one year as a base year and use the prices from that year to calculate real GDP.

750 big screen TVs at $1,000 each = $750,000

+ 500 coffee tables at $50 each = $25,000

Total = $775,000

Nominal vs. Real GDP 750 big screen TVs at $1,000 each =

$750,000+ 500 coffee tables at $50 each =

$25,000

Total = $775,000

745 big screen TVs at $1,000 each = $745,000

+ 513 coffee tables at $50 each = $25,650

Total = $770,650

Limitations of GDP• Nonmarket activities: goods or services

people make or do themselves• Underground economy: black market,

illegal gambling, selling a car to a friend, etc.• Negative externalities: value of clean

environment not counted in GDP• Quality of life: additional goods and

services to not necessarily make people any happier

Other Income and Output Measures

Influences on GDP• Aggregate supply•As price levels rise, there is an incentive for firms to increase their output (more profit)•As price levels drop, firms reduce their output (less profit)•Aggregate supply shows the relationship between prices and output supplied

• How does this affect GDP?

Influences on GDP• Aggregate demand• As price levels go up and down, individuals

and businesses change how much they buy•Lower price level = greater purchasing power [falling prices increase wealth and demand]•Higher price level = less goods and services demanded

• How does this affect GDP?

Influences on GDP• Aggregate supply/aggregate demand

equilibrium• See book: p. 308