55 terms

Gross Domestic Product

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Gross Domestic Product
is the total market value of all final goods and services produced in the economy in a given period of time, usually one year
A larger GDP means that
the economy has more goods and services that can be used to satisfy unlimited wants and needs and address the scarcity
Changes in GDP
are an excellent way of tracking business cycles. Contractions are marked by a decline in the economy's total production, or a fall in real GDP
GDP was in the $500 billion range in the 1960s and reached more than $8 trillion in the 1990s
This means the economy is growing, expanding, and becoming more prosperous.
The goal of GDP is
to measure ALL production of goods and services in the economy. If resources are transformed into goods and services, then the GDP number crunchers at the Bureau of Economic Analysis wants it in GDP.
Market price is
the best available indicator of a good's value. GDP seeks to measure value because this suggests how much satisfaction is provided, which is important for addressing the scarcity problem
Market Value =
P × Q
Let P equal the market price of a good and Q equal the quantity of the good exchanged.
Goods and services:
GDP measures the production of both tangible goods and intangible services.
Final:
measures the production of final goods and services, which is purchased by the four macro sectors
Final goods and services are
production that is available for purchase by their intended or ultimate users with no plans for use as inputs in the production of other goods or for further productive transformation
Intermediate goods and services
are used as inputs in the production of final goods and services.
GDP specifically excludes
market transactions for intermediate goods and services,
To include the market value of these intermediate inputs would count their values twice (or even more).
• Double counting is avoided if intermediate market transactions are excluded
GDP measures production over a given
period, usually one year
Flow variables
are measured over a period of time
Water coming out of the sink faucet is a flow. The amount of water flowing FROM the faucet is measured over time
GDP is a flow measure
stock variables
are measured at a specific point in time
The amount of water IN the sink is measured at an instant in time, with no time reference
money and employment
current production
the production of final goods and services that takes place during a given time period
The standard time period is one year, but three-month "quarters" are also common.
GDP is measured in both
nominal and real terms
Nominal gross domestic product (nominal GDP)
is the total market value, measured in CURRENT PRICES, of all final goods and services produced in the economy in a given period of time, usually one year
(another name for GDP)
Real gross domestic product (real GDP)
is the total market value, measured in CONSTANT PRICES, of all final goods and services produced in the economy in a given period of time, usually one year
Real GDP adjusts GDP (nominal GDP) for changes in prices and inflation.
Real GDP measures current production at constant prices.
Real GDP measures physical production, which is important to business cycles.
Real GDP is used to track
economic growth and business cycles
Suppose GDP (nominal GDP) increases by 10%. The possibilities are
Physical production has increased by 10%, with no change in prices.
• Prices have increased by 10%, with no change in physical production.
• Production and prices have both changed.
real GDP changes ONLY
from changes in physical production
A 10% increase in real GDP means that physical production has increased by 10%.
nominal GDP changes
from changes in both physical production and prices.
Gross national product (GNP) is
the total market value of all final goods and services produced by the CITIZENS OF AN ECONOMY in a given period of time, usually one year
The difference between GNP and GDP is
GDP measures total production within the political boundaries of a country, regardless of who does the production.
• GNP measures total production by citizens of a country, regardless of WHERE they do the production
The need to distinguish between GDP and GNP exists because
Some of the production generated from resources owned by the domestic citizens takes place in foreign countries. For example, a US citizen might be employed in a car factory in Germany. This person's productive activity is part of US GNP, but not part of US GDP.
• Some of the production generated from resources owned by foreign citizens takes place in the domestic economy. For example, a German citizen might be employed in a car factory in the United States. This person's productive activity is part of US GDP, but not part of US GNP.
Economic production is what
GDP seeks to measure.
Activity in the economic production circle is not measured easily (if at all) by market transactions.
• The two circles overlap somewhat, but not completely.
• Some market transactions do not involve economic production.
• Some economic production does not involve market transactions.
Do not include past and future production in the GDP
Past production: This is market transactions for used assets produced before the start of the current time period.
• Future production: This is market transactions for intermediate goods and services that have yet to reach the status of final production.

if counted it would lead to doublecounting
In kind payments and owner occupied housing are included in the GDP
In-kind payments: These are goods and services provided to business owners or employees in lieu of money payment.
• Owner-occupied housing: These are houses occupied by their owners, contrasted with houses or apartments rented to others.

Omitting Slice B would underestimate GDP.
Household activities are
not included in GDP due to the lack of accurate estimates of market value.
this should be included in GDP but is not
Illegal activities
• Illegal activities are economic production because they provide satisfaction.
• Illegal activities involve market transactions, but without accurate records.
• The primary difference between illegal and legal activities is legal status
not included in GDP
The process of measuring GDP is:
The starting point is ALL market transactions, areas A, E, and D.
• Market transactions with NO economic production, area A, are excluded.
• Estimated values in area B are added.
• Household production in area C cannot be satisfactorily measured and is excluded.
• Illegal activities in area D are also excluded due to measurement problems.

GDP is the combined areas of B and E
A typical market transaction, such as the for a hot fudge sundae purchase, includes:
The buyer - the demand side - receives a hot fudge sundae and gives up $2.
The seller - the supply side - receives $2 and gives up a hot fudge sundae.

The hot-fudge-sundae transaction results in $2 of gross domestic product.

GDP can be measured in two ways, one for each side of the market:
• From the Demand Side: GDP can be measured by adding the expenditures by the four macroeconomic sectors - household, business, government, and foreign.
• From the Supply Side: GDP can be measured by adding payments to the four factors of production - labor, capital, land, and entrepreneurship.

Both methods result in exactly the same measure.
Measuring GDP from two different perspectives ensures a more accurate measure.
Adding the expenditures by all four sectors results
• Aggregate expenditures are the total expenditures on gross domestic product undertaken in a given time period by the household, business, government, and foreign sectors.
The four expenditures that make up aggregate expenditures are:
Consumption expenditures (C): These are expenditures by the household sector for wants-and-needs-satisfying durable goods, nondurable goods, and services.
• Investment expenditures (I): These are expenditures by the business sector for production-enhancing buildings and structures, equipment and machinery, and inventory changes.
• Government purchases (G): These are expenditures by the government sector on the final goods and services.
• Net exports (X − M): These are the net expenditures by the foreign sector on final goods, which are the difference between exports (X) and imports (M)
The summary equation for these four aggregate expenditures is:
AE = C + I + G + (X − M)
GDP= " "
Factor payments are
payments made to scarce resources, or the factors of production (labor, capital, land, and entrepreneurship), in return for productive services
33a: Payments made to resource owners in exchange for the use of productive services
The specific factor payments are:
Wages: Wages are considered the payment for the services of labor.
• Interest: Interest is generally considered the payment for the services of capital.
• Rent: Rent is the term that captures the payment for the services of land.
• Profit: The payment for entrepreneurship is considered profit.
• Proprietors' income: This is the income received by proprietorships (and many partnerships) that includes wages, interest, rent, and profit.
Three additional items are part of measuring GDP from the supply side.
Indirect Business Taxes (IBT)
• This is the official term for sales taxes.
• Sales taxes are part of the price paid by buyers, but not part of the price received by sellers.
• IBT is added to factor payments to derive GDP.

Net Foreign Factor Income (NFFI)
• This is the difference between income earned from foreign production by domestic citizens and income earned from domestic production by foreign citizens.
• NFFI is the difference between GDP and GNP.
• Some revenue generated by GDP is claimed by foreign resources and domestic resources receive factor payments from foreign production.
• NFFI is subtracted from factor payments to derive GDP.

Capital Consumption Adjustment (CCA)
• Capital consumption adjustment is an accounting allowance set aside to compensate for capital depreciation.
• Capital depreciation is an inherent consequence of production.
• A portion of GDP revenue is set aside to replace depreciated capital.
The equation for measuring GDP from the resource side is:
• GDP = Factor Payments + IBT − NFFI + CCA
Net domestic product (NDP)
is the total market value of all final goods and services produced within the political boundaries of an economy during a given period of time, usually one year, after adjusting for the depreciation of capital

Net domestic product measures production NET of capital depreciation.

NDP indicates the amount of current production that can be used for extra consumption or capital goods.
• Suppose that GDP is $10 billion. This could be $10 billion worth of new or extra production.
• If $2 billion worth of capital is depreciated during production, then only $8 billion worth of extra production is generated.

The equation which summarizes the relation between net and gross domestic product is:
• NDP = GDP − CCA
National income (NI)
is the total income earned by citizens of a national economy as a result of their ownership of resources used to produce final goods and services during a given period of time, usually one year.

• It is the broadest measure of income for an economy.
• It is the income earned by resources.
• It is measured as the sum of factor payments
National income (NI) is the sum of wages (Wg), interest (Int), rent (Rnt), profit (Prf), and proprietors' income (PrIn):
• NI = Wg + Int + Rnt + Prf + PrIn
National income is found by subtracting capital consumption adjustment (CCA) and indirect business taxes (IBT) from, and adding net foreign factor income (NFFI) to, GDP:
• NI = GDP − CCA − IBT + NFFI
National income also can be derived from NDP:
• NI = NDP − IBT + NFFI
Personal income (PI)
is the total income received by members of the domestic household sector, which may or may not be earned from productive activities during a given period of time, usually one year.

It is income received by households.
• National income is income earned, personal income is income received.
• Some income earned is not received.
• Some income received is not earned.
This equation relates personal income (PI), national income (NI), income earned but not received (IEBNR), and income received but not earned (IRBNE).
• PI = NI − IEBNR + IRBNE
The three key components of IEBNR (Income earned but not received) are:
Social Security taxes: This is part of the income earned by workers subject to the Social Security payroll tax, and not received by the workers.
• Corporate profits taxes: This is part of corporate profits earned by the entrepreneurs and capital owners that is paid to government, and not received by the owners.
• Undistributed corporate profits: This is part of corporate profits earned by the entrepreneurs and capital owners that is kept by the firm, and not received by the owners
The three transfer payments that make up IRBNE are:
Social Security benefits: These are the payments made to the elderly and disabled with no expectations of productive activity.
• Welfare payments: The recipients of these payments are the poor, especially families with parents are unable to earn income.
• Unemployment compensation: This income transfer system is directed at workers who have become unemployed.
Disposable income (DI)
is total income that can be used by the household sector for either consumption or saving during a given period of time, usually one year.
Disposable income (DI) is derived by subtracting personal taxes (PT) from personal income (PI):
• DI = PI − PT
Two reasons to study gross domestic product are:
Scarcity- When real GDP is greater, there is more production used to satisfy wants and needs and scarcity is lessened.
• Instability-If the economy is expanding, then real GDP is increasing. If the economy is contracting, then real GDP is decreasing.
The Highlights of GDP
GDP is only an indicator: GDP needs interpretation and analysis, and is subject to misinterpretation and misanalysis.

GDP does not indicate distribution: GDP is an aggregate measure of production that does not indicate who receives it.

GDP does not measure satisfaction: GDP measures production and only suggests welfare by measuring of market value.

also requires a theoretical basis for interpretation

GDP is a good measure, when used properly.
When misused, GDP can be a really bad measure.
proprietors' income
33h: The income received by owner-operated business firms that typically include payments for all four factors of production is termed
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