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AP Macroeconomics

Gross Domestic Product12-4-2014

Introduction to GDP• “Gross”=total before adjustments

(inflation)• “Domestic product”=production in

the US, even if foreign owned• “National product”=production

owned by US companies

Intro to GDP (cont.)• GDP is officially measured in

quarters – Quarter 1 Jan/Feb/March– Quarter 2 April/May/June– Quarter 3 July/August/September– Quarter 4 Oct/Nov/Dec

• The main form is the “expenditures” approach (add up C, Ig, G, Xn)

Alternative Approach

• Income Approach– Add up Wages, Rent, Interest, and

Profit– Wages are earned from labor– Rent is earned from land– Interest is earned from capital– Profit is earned from entrepreneurial

services

Gross Domestic Product (GDP)

• GDP is the market value of all final goods and services produced within a nation in a year. (Production must take place ________)

• GDP measures Aggregate Spending, Income and Output. Related to Aggregate Demand.

GNP

• GNP is only introduced as a contrast

• GNP is the market value of all final G & S produced using US-owned capital (Production can take place anywhere

Counted or Not Counted?• GDP counts all final, domestic

production for which there is a market transaction in that year. – (Unsold inventory is an exception. It

DOES count as Ig)• Used and intermediate goods are not

counted in order to avoid double-counting.

Counted or Not Counted

• Gifts or transfers (private or public) not counted (i.e. unemployment compensation)

• Underground or ‘black market’ activity is not counted.

Aggregate Expenditures ($16 Trillion as of 2013)

• C = Consumption• IG = Gross Private Investment• G = Government Spending• XN= Net Exports

= Exports (X) – Imports (M)• GDP = C + IG + G + XN

• This is called the “Expenditures” Approach

(Consumption)• Consumer spending is the largest

component of U.S. GDP. (about 75%)• Consumer spending on

– Durable goods (cars, appliances…)– Non-durable goods (food, clothing…)– Services (plumbing, college…)– Does not include purchasing a house– Purchasing a brand new house would

count under Ig

Gross Private Investment • Spending in order to increase future

output or productivity (PPE)– Business spending on capital (new factory

equipment)– New construction– Unsold inventory of products built in a year– Construction of housing

Government Spending • All levels of government

spending on final goods and services and infrastructure count toward GDP.

• Government transfer payments do not count toward GDP (SS, Medicare, Medicaid, unemployment insurance)…WHY?

• Please have your homework out on your desk. Thank you.

Net Exports (Neg. # since about 1950)

• Exports – Imports • X – M• Post WWII, Xn has usually been a

negative number (indicates we have a trade deficit)

• Exports create a flow of money to the United States in exchange for domestic production.

• Imports create a flow of money away from the United States in exchange for foreign production.

What Else is Not Counted?• Stock/Equity purchases not counted

– Equity is the value of an asset after debt

• Unreported business activities (cash tips)

• Financial transactions between banks

• “Non market” activities like volunteer and family work

Counted or Not Counted?• Which of the following are counted or not

counted in U.S. GDP and why?– New U.S. manufactured Goodyear tire sold to

the General Motors Corporation (No, intermediate good)

– New U.S. manufactured Goodyear tires sold to Mr. Mitchell (Yes, final good)

– Child care services provided for my daughter by the neighbor’s kid (No, not a market transaction)

– How does the purchase of French cheese “count”? (as an import—would count NEGATIVELY towards GDP)

– A new Boeing 787 bought by American AirlinesBoeing is an American company (Yes, Ig)– New Tundra pick-up truck manufactured in San

Antonio by Japanese firm Toyota (Yes, domestic production)

Nominal v. Real GDP

• Nominal GDP is current GDP measured at current market prices– Nominal GDP may overstate the value of

production because of the effects of inflation

Nominal v. Real GDP

• Real GDP is current GDP measured with a fixed dollar– Real GDP holds the value of the

dollar constant and is useful for making year to year comparisons

• Real GDP is the IMPORTANT ONE!!!

Changes in GDP• GDP is a measure of a nation’s

prosperity and economic growth

• As GDP grows the burden of scarcity is lessened for a society

• GDP per capita (per person) provides a better measure of individual well-being than GDP

The Business Cycle

• The United States’ GDP is not constant from year to year.

• Instead, the GDP grows most years and then shrinks in some years or the growth lowers.

• The ups and downs in GDP over time is referred to as the business cycle.

The Business Cycle Illustrated:To be put on your list of graphs to

know

The Business Cycle Illustrated:

• Peak – temporary maximum in Real GDP. At this

point the unemployment rate (u%) is probably below the Natural Rate of Unemployment, and the inflation rate (π%) is probably increasing (“too high”).

• Recession– The contractionary phase of the

business cycle. A period of decline in Real GDP accompanied by an increase in u%. To be classified as a recession, the economic decline must last at least six months.

The Business Cycle Illustrated:

• Trough– The bottom of the business cycle. The u

% is probably above NRU and π% is probably low.

• Recovery– The phase of the business cycle where

the economy is returning to full employment (5% unemployment) also known as the Natural Rate of Unemployment (NRU)

The Business Cycle Illustrated:• Important notes

– The various phases of the business cycle last for different amounts of time.

– In recent history, expansions have lasted years longer than have recessions.

– The Great Depression is the most notable example of a long recession/trough

–Business cycle is measured from trough to trough

The Business Cycle Illustrated:• Causes

– Irregularity of Investment (Gross Investment Ig)

– Changes in productivity– Changes in total spending (aggregate demand)

• Durable goods manufacturing is most susceptible to the effects of the business cycle

• Business cycle has become less severe because of technological advancements in supply-chain management and structural changes in U.S. economy.