Econ 303 UIUCIntermediate Macro Zhao 1Section I: Growth theoryChapter 2: Three approaches to measure GDPGross Domestic Product (GDP) is the “market value” of an economy's domestically produced goods and services over a specified period of time. GDP= sum of value added in all production units= value of all final goodsMeasured by product approachEcon 303 UIUCIntermediate Macro Zhao 2Economists’ very abstract view of production process• Output: GDP• Inputs:– Intermediate goods (materials) – any other goods and services used – Labor – any hired personnel– Capital – any structure, equipment, and software used–Land• Value added = total sales – cost of intermediate goods– Value added is generated by factors of production factorsProducedGoods and services, Capital or Labor?a) Meals cooked by Applebeeb) Oven at Applebeec) Busboy at Applebee d) cars on dealer’s lot e) cars bought by Jimmy Johns’ for deliveryf) Professor Zhao got a hair-cutg) Hair stylist June works 6 days a weekh) John works for Papa Johns as accountanti) Papa Johns use Price-Waterhouse-Cooper to balance its book.FactorsEcon 303 UIUCIntermediate Macro Zhao 3Why value-added? – double countingMeasure GDP (page 11)Econ 303 UIUCIntermediate Macro Zhao 42006 2010 Gross domestic product100 100Private industries87.5 86.4 Agriculture, forestry, fishing, and hunting0.9 1.1 Mining1.7 1.6 Utilities1.8 1.8 Construction4.9 3.5 Manufacturing12.3 11.7 Motor vehicles, bodies and trailers, and parts0.80.4 Wholesale trade5.8 5.5 Retail trade6.5 6.1 Transportation and warehousing2.9 2.8 Information4.4 4.3 Finance and insurance8.2 8.5 Real estate and rental and leasing12.5 12.2 Professional and business services11.7 12.3 Educational services11.1 Health care and social assistance6.6 7.6 Arts, entertainment, and recreation11 Accommodation and food services2.9 2.9 Other services, except government2.5 2.5Government12.5 13.6 Federal3.9 4.5 State and local8.5 9.1Value Added by Industry as a Percentage of GDPCivilian Non-Farm Payroll Employment by Sector, Nov. 2009Econ 303 UIUCIntermediate Macro Zhao 5The Circular-Flow Diagram MoneyFactorsGoodsandservicesFactorsHouseholdsFirmsFactor MarketsGoodsandservicesMoney MoneyMoneyProduct approachExpenditure approachIncome approachWhat is capital?• Households (includes non-profit organizations)Buildings and structures, i.e. houses•FirmsBuildings and structuresEquipment and machineriesSoftware Inventory: produced but not sold yet, bought but not used yet Fixed capital New guideline: R&D counted as investment, hence an increase of fixed capitalEcon 303 UIUCIntermediate Macro Zhao 6Is it Capital?A. Dorm building of University of Chicago B. Oil rigs C. Headquarter of Coca-Cola in AtlantaD. Automatic data processing equipment and software E. Professor Zhao's washing machine F. Interior decoration of MacDonald's G. Plates and eating utensils of a restaurant H. Car on dealer's lot that hasn't been sold yet Goods and services has to be bought by someoneBuyers• Households – (Private) consumption, C– New houses, Residential investment, part of I•Firms– Intermediate goods (not included in GDP)– Non-residential investment, the other part of I (fixed and inventory)• Governments – Government consumption expenditures and gross investment, aka Public consumption or Government spending, G• Foreigners – ExportEcon 303 UIUCIntermediate Macro Zhao 7Which is which? Part I1. New house built for Mr. and Mrs. Jones 2. New headquarter built for coke-cola3. New office building for the state government of Georgia4. New Church 5. New highwayA. ConsumptionB. InvestmentC. Government spending and gross investmentD. ExportWhich is which? Part II 1. Refrigerators bought by Mr. and Mrs. Smith2. Refrigerators bought by Chick-fil-A 3. Refrigerators bought by White house4. Refrigerators bought by Women’s Shelter5. Refrigerators bought by Mr. Sanchez, a Mexican visiting the US. A. ConsumptionB. InvestmentC. Government spending and gross investmentD. ExportEcon 303 UIUCIntermediate Macro Zhao 8Which is which? Part III 1. Flour bought by Mrs. Williams2. Flour bought by Sweet and Delightful (a bakery)3. Flour in Great Mill 4. Flour bought by the White House for a state dinner5. Flour bought by salvation army and shipped to Africa6. Flour bought by COFCO in ChinaA. ConsumptionB. InvestmentC. Government spending and gross investmentD. ExportE. None of the aboveMeasuring GDP using expenditure approach• But some of C, I, G may not come from domestically produced goods. Goods market equilibrium: Quantity supplied = Quantity demanded• Market value of goods and services produced = expenditure on them • National account identityNet exportEcon 303 UIUCIntermediate Macro Zhao 9Factor payment• Labor services provided by households– Paid through wages and benefits• Capital services provided by household (A firm can use capital without owning it)right to useWays a firm obtain the right to use a piece of capitalForm of payment a firm pays out to the owner of the capitalPurchased using money from owners or shareholdersProfitsPurchased using borrowed money Interests Rented RentsWhy value-added? – double countingEcon 303 UIUCIntermediate Macro Zhao 10NIPA system, three approaches to calculate GDP• Product approachGDP= sum of value added in all production units• Expenditure approach (national account identity)GDP = consumption + investment + government spending + net export• Income approach GDP= wage + interests, rents, and profits + indirect taxes + depreciation Net value of productionMeasure GDP (page 12)Econ 303 UIUCIntermediate Macro Zhao 11GDP vs. GNP (Gross National Product) Location vs. OwnershipGNP = GDP – compensation to foreign owned factors + compensation by foreign countries to factors owned by domestic country. [Billions of dollars]2009 2010Gross domestic product 13,939.0 14,526.5Plus: Income receipts from the rest of the world 639.8 702.9Less: Income payme nts to the rest of the world 487.5 513.5Equals: Gross national product 14,091.2 14,715.9Less: Consumption of fixed capital 1,866.2 1,874.9Equals: National income12,147.6 12,840.1US NIPA tables from BEAMeasuring GDP using income method (2003 revision)GNP = GDP – compensation by home firms to foreign owned factors+ compensation by foreign firms to factors owned by home country. GNP - depreciation = National