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Mizzou AG_EC 1042 - Gross Domestic Product

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AG_EC 1042 1st Edition Lecture 4 Outline of Last Lecture I. Competitive MarketsII. Demanda. Law of demandb. Non-price determinant of demandIII. Supplya. Law of supplyb. Non-price determinant of supplyOutline of Current LectureI. Gross Domestic ProductII. The Expenditure ApproachIII. Real GDP Vs. Nominal GDPa. GDP Deflatorb. GDP Per Capita IV. GDP Limitations Current LectureI. Gross Domestic ProductAt the beginning of this lecture Dr. B started out with a quote. According to Wayne Gretsky, “You never want to skate where the puck is, but where it’s going to be.” Dr. B used this quote to explain how economists must look where the money is going instead of where is it is. Since macroeconomics is the study of the national, international and global economy and its problems like unemployment and inflation there needs to be a way to measure economic value. However, there are two issues that must be dealt with when measuring the value of an economy. First, economists mustfigure out how to add up unique goods and services that do not correlate at all into a single measuring system. Secondly, the intermediate costs of the goods and services cannot be added in. The measurement that is known to be the most common measuring system is known as gross domestic product. Gross domestic product is the sum of all the market values of the final goods produced in a country during a specific period of time. Something very important to remember when calculating gross domestic product is that even if there is an American owned firm in a different country, the goods and services produced in that factory are not counted in the United States’ gross domestic product. There aretwo ways to calculate the gross domestic product of a country, they are the expenditure approach and the income approach.II. The Expenditure ApproachThere are four categories to the expenditure approach: consumptions, investment, government purchases and bet exports. To use the expenditure approach you add up consumption, investments, government purchases and net exports. In this equation, expenditure and production are interchangeable. In order to include the correct market values it is necessary to know what goods and services are included in each category.Consumption goods and services are goods and services that are bought by households and individuals that are private. These goods and services must be new in order to be included in the gross domestic product. If bought used goods are included then that would be doubling counting. Then, investment includes the spending of firms on necessary inputs like machines and inventory. Inventory is counted in the gross domestic product value of the time that it was bought and not when it is sold. Thirdly, government purchases are any purchases made by any level of government, whether it is paying a company to fix roads or buying paint for street lanes. And lastly, net exports is an equation in itself. Net exports equals the money made from exports minus the cost of imports. Therefore, this number could end up positive or negative.III. Real GDP vs. Nominal GDPSince gross domestic product takes output and prices into account, it often increases due to a growth or decline in both that amount of output and the change in market value. There are two devices used to determine which factor, output or prices, caused the change in the gross domestic product. These devices are nominal gross domestic product and real gross domestic product. Nominal gross domestic product, or nominal GDP values the goods and services at their current prices. So it is used to see how prices contributed to the change in gross domestic product. In order to calculate nominal GDP one must multiply the output of each good in a stated year by its price in that year. Real gross domestic product, or real GDP values goods and services at a constant price to see how the output quantity changed and contributed in the change of gross domestic product. And to calculate this a base year must be selected and then the output of each good is multiplied by the price it was in the selected base year.In order to calculate the overall change in the prices of an economy the GDP deflator is used. It is a ratio between the real and nominal GDP that compares base year value of output to current yearoutput to help summarize price change in a whole economy. Inflation, which describes how fast prices have changed overall, can be determined by looking at the percentage change in the GDP deflator between and two years.Then there is the GDP per capita ratio. This ratio compares GDP and population to give an estimate of how much money is produced per person in a country. However, it does not take income inequality or the worth of a dollar for that country into account. Also, using GDP the change of an economy over time can be calculated by using the GDP growth rate equation. Which is the GDP of the current year minus the GDP of the last year all divided by the GDP of the last year. And to turn that into a percentage, multiply the dividend by one hundred. The growth rate tracks a business cycle, so a recession and a depression can be predicted by growth rate changes.IV. GDP LimitationsThere are three main major things that GDP calculations leave out: home production, underground economy and environmental externalities. Home production is the production and consumption of goods and services within a private household, therefore they are not bought or sold. This occurs all households all over the world. For example, a parent will prepare food for their young child and the child does not have to pay for that service. The underground economy includes any illegal sale and consumption of drugs, weapons, endangered animals and other things. However, it also includes things like babysitting younger family members or tending to your neighbor’s garden. Lastly, environmental externalities include the costs the environment from things like pollution and oil spills. However there is the green GDP that is an alternative calculation of GDP that subtracts the environmental costs of production from positive outputs that are normally counted. While GDP tells a lot about a country’s standard of living it is not always accurate when it comes to living


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