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Transcript of Spending, Income and GDP - cpb-us-west-2 … · Expenditure Approach for measuring GDP 4. Nominal...
Spending,
Income and GDP
Instructor: Xi Wang
UMSL, Summer 2015
Learning Objectives
1. What is Macroeconomics? Why study it
separately?
2. How do economists define and measure an
economy’s output?
3. Expenditure Approach for measuring GDP
4. Nominal GDP and Real GDP
5. Relationship between Real GDP and
economic well-being/standard of living
Slide
2
Where in the World is this?
Slide
3
Great Depression
During the Great Depression (1929-33) in the US
Factories cut production 31%
Number of people without jobs nearly tripled by
1933 when the unemployment rate hit 25%
Stocks lost a third of their value in 3 weeks
All across America shantytowns named
“Hoovervilles” sprang up.
President Herbert Hoover (1929-33) and his
economic advisors were clueless as to how to
help. He lost to Franklin D. Roosevelt in 1933 (4
terms, 1933-45). Slide
4
Why Macroeconomics?
President’s Hoover’s cluelessness was understandable.
Microeconomics - study of production and consumption decisions of individual producers and consumers; allocation of scarce resources among industries was well established.
Macroeconomics – study of the behavior of the economy as a whole – was in a state of infancy.
The study of Macroeconomics, as a separate branch of economics, was established during the Great depression.
It includes the study of economic recessions and how to avoid them; long run economic growth; inflation; open economy macroeconomics, etc.
Slide
5
Macroeconomics – Not Just a Simple
Addition of Microeconomics
Can Macroeconomics be understood by
simply adding up the answers to corresponding
Microeconomic problems?
No. Examples:
Paradox of Thrift – individually responsible thrifty
behavior during hard times is bad for the overall
economy. Conversely, seemingly profligate
behavior leads to good times for all.
Cash Circulation – An individual with more cash on
hand is richer. But if everyone has more cash on
hand, that simply raises the price level, leaving the
overall purchasing power the same as before. Slide
6
Macroeconomic Data
To understand economic developments and
to give useful advice to policymakers,
businesspeople and financial investors,
economists need up-to-date accurate data.
Attempts at measuring the economy dates
back to the early 1600s in Ireland. However
WWII provided the catalyst for the
development of accurate economic statistics
– Simon Kuznets of the US and Richard Stone of
UK developed comprehensive systems for
measuring a nation’s output.Slide
7
Measuring Output: GDP
Slide
8
Gross Domestic Product (GDP) is
The market value of
Final goods and services
Produced in a country in a given period of time (typically a year)
Real GDP: 1900-2007
Slide
9
2007 output of the U.S. economy was more than 33 times the 1900
level. Recessions: 1929-33; 1973-’75; 1981-’82; 1990-’91; Mar–Nov 01;
Dec 07-Jun 09. Expansions: 33-37; 41-’45; 61-’69; 75-’80; 82-’90; 91-
2001; Nov 01 – Nov 07; July 09 till date.
Per Capita Real GDP: 1900-2007
Slide
10
Except for the Great Depression, recessions are almost invisible
Fruits of Long term Growth in the US
Slide
11
Gross Domestic Product: A
Detailed Look: Market Value GDP is a weighted average:
Market value of the final goods and
services is used to add up the
quantities of different goods and
services into one measurement
Calculating GDP for Nation A
producing three goods: X, Y and Z
with prices PX, PY, and PZ, respectively
is
GDP = (XPX) + (YPY) + (ZPZ)Slide
12
Gross Domestic Product: A
Detailed Look: Market Value
Slide
13
Aggregate measure of quantities produced
Weighs more expensive items more
Logic: willingness to pay is an indication of
benefit derived from the good.
Orchardia’s GDP = $64.
GDP: Market Value
Observation about Market Value
A good or service that is not bought
and sold in the market is not a part of
GDP
An unpaid work of a homemaker is not
counted in GDP
But paid housekeeping and paid child
care services are added to GDP
How About used good transaction?Slide
14
Female labor Force Participation
Slide
15
Labor Force Participation
Slide
16
The labor force participation rate (LFPR) is
determined by comparing the actual labor
force with the potential labor force.
The potential labor force includes persons
16 years of age and older who are non-
institutionalized (i.e., not prison, mental
institution, etc.) – also called the working-
age population.
The actual labor force includes those
employed and unemployed (i.e., actively
looking for a job).
Participation Rates
LFPR =
actual labor force
potential labor force
* 100
LFPR = Employed + Unemployed
Non-institutional population 16 yrs. and older
* 100
For February 2007:
LFPR = 152,784,000
230,834,000* 100 = 63.6%
Female labor Force Participation
Slide
18
Women's labor force participation increased
since 1960 and peaked in 1999
Measured GDP increased for two reasons:
Working women's output measured and
counted
This output is a real addition to GDP
Paid workers provide previously unpaid
childcare - this increase in measured GDP
corrects a measurement problem
Not a net addition to goods and services
produced
Measured change in GDP due to increased female LFPR
probably overstates actual change
Some Non market Goods Are
Included Some non-market items are included:
wages in kind (health benefits etc.)
agricultural output for self-consumption
imputed rent from owner occupied housing; imputed values of renovations
Services (like checking account services) provided by financial
intermediaries free or for a nominal fee are given an imputed
value using differences in interest rates
Slide
19
Some Non market Goods Are
Included
Government (public) goods and services are not sold in the
market but included because
These goods have value
Increase overall output
Quantities are known
However, prices cannot be easily established
So, Government production is valued at cost
Overstates GDP if there is waste and inefficiency
Slide
20
Some Goods Are Excluded
Nonproduction transactions
public transfer payments (unemployment benefits, social security,
etc.)
private transfer payments, such as gifts
Capital Gains and Losses
Unpaid volunteer work for charities
Illegal market activities
Financial Market Transactions(i.e Capital Gain,
Defiition?)
Slide
21
Some Goods Are Excluded
Financial market transactions are excluded since securities
represent either ownership, such as with stocks, or they represent
loans, such as bonds. Financial securities do not represent real
production, but simply represent the means to finance
production.
Interest paid by Government or Consumers (except mortgages because a house provides housing services).
Slide
22
GDP: Final Vs. Intermediate
Goods and Services Final goods are consumed by the ultimate user
End products of production
Included in GDP
Intermediate goods are used up in the production
of final goods
Not included in GDP
Avoids double counting
A barber charges $10 for a haircut. He hires an assistant
who provides services such as shampooing and sweeping
Barber’s assistant is paid $2 for his services
Haircut's contribution to GDP is $10Slide
23
Final Vs. Intermediate Goods and
Services
Example of Final and Intermediate Goods
Bread - final good; Wheat and flour - intermediate goods
Milling Co. (produces flour) pays $0.50 for wheat
Bakery (produces bread) pays $1.20 for flour
Bakery sells bread for $2.00
Contribution to GDP = $2.00
The same good may be intermediate or final
Farmer B produces $100 worth of milk of which he sells $40 worth to his neighbor and uses the rest to feed his pigs, which he eventually sells to Farmer A for $120
GDP = $40 + $120 = $160Slide
24
Final Vs. Intermediate: Treatment of
Capital Goods
Capital Goods may be potentially difficult to classify as
intermediate or final:
A capital good is a long-lived good used in the production of other goods and services
Houses, apartments, hotels, etc
Stoves in restaurants and cooking
schools, but not homes
Delivery vehicles and taxis
Slide
25
Final Vs. Intermediate: Treatment of
Capital Goods
Capital Goods are not final goods as they are inputs in the production of final goods
not intermediate goods as they are not immediately used up during the production of other goods
Solution? Newly produced capital goods are classified as final goods & added
to GDP.
Money is NOT a capital good. Money is a means of payment and a unit of account – it is neither a good nor a service.(By the way, What is Money?)
) Slide
26
Final Vs. Intermediate: Treatment of
the Government Sector All Government spending is valued arbitrarily as there are no
markets for government services.
So they are valued at Cost.
For simplicity all government expenditure is considered to be on final goods and services although some are really on intermediate goods and services.
Slide
27
The Value Added Method of
Calculating GDP
Recall the bread example: Suppose that the grain and flour were produced in late 2008, but the bread was produced in 2009.
Should we add $2 to the GDP of 2008 or 2009 or both?
Solution? Value Added Method
Value added for any firm is the market value of its product or service minus the cost of inputs purchased from other firms
Slide
28
Value Added in Bread Production
Slide
29
Company Revenues – Cost of purchased inputs = Value added
ABC Grain(2008) $0.50 $0.00 $0.50
General Flour(2008) $1.20 $0.50 $0.70
Hot’n’Fresh(2009) $2.00 $1.20 $0.80
Total $2.00
The grain and flour are produced in 2008
Bread is produced in 2009
$1.20 is added to 2008 GDP
$0.80 is added to 2009 GDP
GDP: Production Within a Country
(domestic)
What do we mean by “domestic product”?
Domestic - production that takes
place within a country’s border
Nationality of the owners or company
is irrelevant.
Cars produced in the U.S. by foreign
owned companies are counted.
Car produced in Mexico by U.S.
owned companies are not counted.Slide
30
GDP: Production Within a Year
Value must be produced in the year
considered
A 20-year old house is sold in 2008 for $200,000
Commission is 6% = $12,000
Value added is $12,000
House was not produced in the period of
time studied
Amount included in 2008 GDP = $12,000
Slide
31
GDP vs. GNP
Gross national product – GNP – is the total factor income that is
earned by the citizens of a country.(Now it is very hard to
identify the citizenship of a company)
Includes factor incomes earned abroad by Americans
Profits from IBMs European operations accruing to American
shareholders and wages of Americans working abroad
Excludes factor incomes earned by foreigners
Dividends (profits) paid to foreign holders of US stocks and
wages of foreign workers who temporarily work in the US
In 2007, US GNP was about 0.7% larger than GDP because of
overseas profits of US companies.
For smaller countries GNP and GDP can diverge significantly.Slide
32
The Expenditure Approach for
Measuring GDP
There are 4 groups that buy final goods and
services:
Households, Firms, Government and Foreign buyers
Total Expenditure = Total Market Value of goods and services = GDP
www.bea.gov
Slide
33
Consumption
Expenditure Household spending on goods and services,
such as food, clothing, and entertainment is called Consumption Expenditure, or simply Consumption
Three categories of consumption expenditure Consumer durables - long lived, e.g., cars, refrigerators etc.
Consumer non-durables - short lived, e.g., food, clothing, etc.
Services - legal, financial, educational, domestic, services
Slide
34
Investment Expenditure
Spending by firms on final goods and services, primarily capital goods and by households on housing, is called Investment expenditure, or simply, Investment
Three categories of Investment expenditures:
Business fixed investment includes sum of non-residential and residential investment.
Non-residential Investment - purchase of new capital goods like factories, machinery etc. (now includes R&D)
Residential investment - construction of new housing, this number decreases 80% during the Great Recession 2008-2009
Inventory investment - goods that a firm produces but doesn’t sell during the accounting period
Slide
35
Government Expenditure
Government expenditure includes
Purchases by federal, state, and local governments of final goods and services like buying fighter planes, paying public school teachers, etc.
Government expenditure does not include transfer payments or the interest paid on government debt.
Transfer payments are payments by the govt. for which no current goods or services are received in exchange.
Examples: Unemployment benefits, Social Security payments, Pensions, Other Welfare payments, etc. And we can avoid double counting problem, Why? Slide
36
Government Expenditure
Government expenditure does not include the interest paid on
government debt.
Interest paid on government bonds is NOT
counted as part of GDP; the argument is that
the interest is not usually on a loan for
purchasing capital equipment, and therefore
is not connected to production; whereas net
business interest paid is typically for a loan
used to purchase capital equipment and is
counted as part of GDP since it is related to
production.
Slide
37
Expenditure by Domestic and
Foreign Buyers
Add Exports - these are domestically
produced goods that are sold abroad
Subtract imports - these are foreign
made goods that are purchased by
domestic buyers
Net Exports = Exports - Imports
Slide
38
The Expenditure Approach for
Measuring GDP
Y = gross domestic product, or output
C = consumption expenditure
I = investment expenditure
G = government purchases
NX = net exports
Slide
39
NXGICY
GDP Example Total production is 1 million cars, $15,000 each.
700K sold to consumers; 200K sold to
businesses; 50K to Govt., and 25K to foreign
countries.
25,000 cars are unsold
Investment in inventories increases by $0.375 billion
GDP Contribution
$10.500 billion
$3.000 billion
$0.750 billion
$0.375 billion
$14.625 billion
Sector # Cars Purchased
Consumers 700,000
Businesses 200,000
Government 50,000
Net exports 25,000
Total 975,000
Businesses 225,000 $3.375 billion
Total 1,000,000 $15.000 billion
GDP Data
Expenditure Approach for calculating GDP
from the Bureau of Economic Analysis (US Dept
. of Commerce):
http://www.bea.gov/iTable/iTable.cfm?ReqID
=9&step=1#reqid=9&step=3&isuri=1&903=6
From the Economic report of the President:
http://www.gpoaccess.gov/eop/tables08.htm
l
Slide
41
Income Approach to GDP When a good is sold, its proceeds are distributed to workers or
business owners
GDP = labor income + capital income
Labor income is wages, salaries, benefits, and incomes of the self-
employed
About ⅔ of GDP
Capital income pays for physical capital and intangibles
All income is measured before taxes
▪ Profits for business owners incl
dividends
▪ Rent for land
▪ Interest includes the total sums paid
by private businesses for loans,
including the interest paid on
savings, certificates of deposits, and
corporate bonds.
▪ Royalties
The Three Faces of GDP
Slide
43
= =
Market
value of
final
goods
and
services
Production Expenditure Income
Investment =
20% of GDP
Consumption =
60% of GDP
Government
purchases =
20% of GDP
Net exports
Capital Income
= 25% of GDP
Labor Income =
75% of GDP
Nominal GDP versus Real
GDP Nominal GDP = GDP valued at current prices
Nominal GDP measures the current dollar value of
production
Real GDP = GDP valued at some base year prices rather than current prices
Real GDP measures the actual physical volume of
production
Slide
44
Prices and Quantities in 2000 and 2004
Slide
45
Quantity of
pizzas
2000 10 $10 15 $5
2004 20 $12 30 $6
Price of
pizzas
Quantity of
calzones
Price of
calzones
Nominal GDP
2000 = (10)($10) + (15)($5) = $175
2004 = (20)($12) + (30)($6) = $420
Real GDP, Base year = 2000
2004 Real GDP = (20)($10) + (30)($5) = $350
Nominal GDP overstates Economic Growth
Nominal GDP versus Real
GDP
Slide
46
Usually, nominal and real GDP increase each year
Nominal GDP can go up and real GDP go down (happens
during recessions and stagflations; happened in the US
during 1990-91 recession)
Fewer goods and services produced AND
Prices increase faster than output decreases
Nominal GDP will be smaller than real GDP if the prices in
the current year are less than in the base year
Usually true for years before the base year
Although rare, Real GDP could rise and nominal GDP
could fall
Prices are falling faster than output is increasing
(happened in Japan during several years in the 1990s)
Real GDP and Economic Well-Being
- Leisure
Is Real GDP a good measure of economic well being? It is an imperfect measure because many things that determine
economic well being are not bought and sold in markets
Leisure Time - We enjoy shorter work week, start working much later in life and often retire earlier than our forefathers did. However these extra leisure hours are not priced in markets and hence don’t get reflected in a higher GDP.
Real GDP understates the true extent of well being.
Slide
47
Real GDP and Economic Well-Being
– Non Market Activities
Real GDP does not include Non-market
Economic Activities
Unpaid household activities
Volunteer services - fire service
Underground economy - legal and illegal from
informal babysitting to organized crime
Non-market activities can be quite significant
in poor countries(So why do they poor?)
Real GDP will understate true economic well-
being.Slide
48
Real GDP and Economic Well-Being –
Environment and Resource Depletion
Real GDP numbers typically do not reflect :
the cost of lower environmental quality and greater resource
depletion that occurs with growth; e.g., China, India
Quality of Life - Crime rates, Traffic congestion, Civic organizations,
Open space
Poverty and Economic Inequality - GDP does not capture the effects
of income inequality.
Real GDP overstates the true well-being
Slide
49
GDP and the Well-being
of Life
Slide
50
GDP and the Meaning of Life
The Life Satisfaction Index was from a Gallup
World Survey that asked people to rate how
they feel about their lives on a scale of 0 to
10.
Rich is better
However money is neither necessary (Brazil,
Venezuela) nor sufficient (Hong Kong, Kuwait,
etc.)
Money matters less as you get richer
Slide
51
Spending, Income and GDP Slide 52
Real GDP: Is It Related to Economic
Well Being
Robert Kennedy in 1968:
“[GDP] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry…, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.”
Real GDP Is Related to Economic
Well Being
While Real GDP can be useful when
comparing labor productivity between
countries, it has, as we have seen, serious
limitations as a measure of a country’s living
standards.
An increase in Real GDP implies an expansion
of a nation’s PPF. With increased productive
capacity a nation can achieve more.
A larger GDP affords us a better chance at
enjoying a better life; it does not guarantee it.
Slide
53
End of
Section
Let’s Summarize what we have learnt