Chapter 7 – GDPWhat is GDP?Where things are producedGross Domestic ProductThe market value of all final goods and services produced in a country during a specific time period (only counts final goods)What is GNP?Who produces thingsGross National ProductThe market value of all final goods and services produced by citizens of a country (either produced domestically or in another country)I.e.Disney World in Japan – counts for US GNP and counts for Japan’s GDPGDP Per Capita (Per Person)Annual incomeUS in 8th in the worldwe have a lot of national GDP but individually our production isn’t great(GDP/Population)*(100) = GDP/CapitaGDP/Capita = Average income for a countryHow do we calculate GDP?Two ways:1. Expenditures Approach:Market value of all final goods and services produced in the US in a given accounting period (sum of everything purchased)Y = C + I + G + (X – M)GDP = Consumers + Business + Government – (Exports – Imports)GDP = (What people buy) + (What businesses buy) + (What government buys) + (Exports – Imports)C = Consumption Expenditures (What people buy)Counts everything the typical consumer buys except for New Home Sales – those are included in I (business)Also you only count homes the year they are build, you don’t count the sale of used home unless you are counting the commission made by the realtor, etc.I = Business Expenditures (What businesses buy)G = Government SpendingMainly national defense and labor(X – M) = Net ExportsGreater than or equal to 0 means we export moreLess than or equal to 0 means we import morePeople thing when the net exports is less than 0 that’s bad but it’s really not, remember trade creates value2. Income/Cost ApproachMeasures income generated by productionAdd up all of the income generated in the production of all goods and services or the cost of what is producedSee Figure 1AggregateGDP focuses on the sum total of all marketsAggregate DemandSum total of what people are spendingC + I + G + (X-M)Aggregate SupplyCost approach/income generatedR + W + i +πRent + Wages + Interest + πWhat does GDP include?1. Market value ($$) of final goods and services not intermediate goodsI.e.Value Added (VA)Final GoodFarmer’s Cotton+$5 (start)$5 (cotton)Textile Mill+$12$17 (cloth)Designer’s Dress+$20$37 (dress)Retail @ Macy’s+$50$87 (dress on shelf)$87 is the number/amount that counts towards GDP2. Only goods and services produced during the accounting periodDoes not include second hand salesHowever, it does count salesman’s commission, because that is a current production/serviceDoes not count financial transactions and transfer paymentsI.e.Stocks, welfare, social security, etc.Broker fees do count thoughValue Added Tax (VAT)The VAT is a tax that taxes the good every time value is addedSince the VAT is assessed on things people buy, not income, it falls heavily on the middle classCauses:Market values will rise and prices will riseSince it is on expenditures and not income consumption decreases (note: when something costs more we do less of it)Many times VATs start out small and then will grow to much moreNon-taxable goodsI.e. – medicine, bandages, etc.These tax free goods become taxed (not visibly, but since their production is taxed they producer ends up raising the price)Problems with using GDP to measure our output1. Doesn’t count non-market production2. Doesn’t count underground economyIllegal activities and paymentsBarter or cash trades3. Doesn’t reflect leisure time activities (human cost)I.e. if the average work weeks hours change from 40 hours/week to 20 hours/week GDP does not account for this4. Doesn’t account for product qualityI.e. pocket calculators in 1950 and pocket calculators now5. Doesn’t subtract out for our economic negativesI.e. pollution6. Doesn’t not account for introduction of new goodstherefore, its hard to use GDP as a comparison with a lot of years in betweenI.e. typewrites (1900) vs. computers (2010)7. Doesn’t account for inflationWhy do we need to adjust prices to reflect inflationTo make sensible comparisons year to yearI.e.Year 1:P x QP1 ($)Q1(P)*(Q) ($)Movie Tickets$101000$10,000Bballs$205000$20,000Pens$.5010,000$5,000Total GDP$25,000Year 2:P x QP2 ($)Q2(P)*(Q) ($)Movie Tickets$12900$10,800Bballs$22400$8,800Pens$.7510,000$7,500Total GDP$27,100Initially we assume year 2 is more productive just by looking at the Nominal GDP, $27,100, but really year 2 is less production but we don’t see that because inflation tricks usTo adjust:P x QP1 ($)Q2(P)*(Q) ($)Movie Tickets$10900$9,000Bballs$20400$8,000Pens$.5010,000$5,000Total Real GDP$22,000All you do is take the price from year 1 (P1) and multiply it by the quantity from year 2 (Q2) and you get the Real GDP, $22,000, and you compare that to the real GDP form year 1 to see after we adjust for inflation year 2 is less productive than year 1Nominal GDP – Number ofReal GDP – Purchasing powerThe measurement of the year measured is the nominal GDP, if you want to compare that year to another year you must take the inflation out and you get a real value/GDP, (there are as many real values as your want, there is only 1 nominal value per year)How to correct for inflationNominal output – value the year the good/service is producedReal output – value when measured by other dollar’s standard (using other year’s dollar (p))CPIConsumer Price IndexMarket basket of goods consumers would buyList of things consumers buyCompare the price of things on the list and the sum of the list month-to-month to determine inflation/monthCPI – 100 = inflationGDP InflatorC + I + G … but a borader measureGDP is a poor measure of our well-beingWhy do we use GDP?It does one thing very wellNational Y AccountingIt gives us the comparison of our productivity from year-to-yearTerrible in regards to measuring – but great in regards to comparingTells us our productivity is changing and in which directionIts biased but its biased in the same direction every year (this is why its bad at measuring, but good at comparing)Especially good at comparing if the years are close togetherAlso, helps us establish more goals for growthChapter 16 & 17What makes a nation wealthy?1. Natural Resources?Sufficient natural resources is helpful but not necessary2. Size of labor force?Overabundance? Is too big a problem?3. Democracy vs. non-democracy?US was founded as a Republic, but we are starting to move toward a democracyRepublic – is an economy/government that rules by law
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