Chapter 7 Taking the Nation s Economic Pulse 4 Learning Goals 1 Define gross domestic product and describe the key phrases of the definition Chapter heading GDP A Measure of Output Key term Gross domestic product The market value of all final goods and services produced within a county during a specific period Provide more details of the key phrases of the GDP definition GDP is a measure of output 1 Only final goods and services count Sales at intermediate stages of production are not counted by GDP because the value of the intermediate goods is embodied within the final user good 2 Only transactions involving production count Financial transactions and income transfers are excluded from GDP because they merely move ownership from one party to another They do not involve current production and are therefore not included in GDP 3 Only production within the country is counted GDP is a measure of domestic product Therefore it counts only goods and services produced within the geographic borders of the country When foreigners earn income within the US borders it adds to the GDP of the US 4 Only goods produced during the current period are counted GDP is a measure of output during the current period Transactions involving the exchange of goods or assets produced during earlier periods are omitted because they do not reflect current production 2 List the ways to measure gross domestic product and identify the source of higher income levels Chapter heading GDP as a Measure of Both Output and Income Key terms Personal consumption household spending on consumer goods and services during the current period Consumption is a flow concept Private investment The flow of private sector expenditures on durable assets fixed investment plus the addition to inventories inventory investment during a period These expenditures enhance our ability to provide consumer benefits in the future Net exports Exports minus imports Gross national product The total market value of all final goods and services produced by the citizens of a country It is equal to GDP minus the net income of foreigners What are the two ways to measure GDP Expenditure Approach and the Income Approach What is the source of higher income levels Higher income levels come from are caused by more output Components of the expenditure approach 1 Personal Consumption Household spending on consumer goods services during the current period The largest component of GDP 2 Gross Private Domestic Investment The production or construction of capital goods that provide a flow of future services 3 Government Consumption 4 Net Exports What is the difference between GDP and GNP GNP is equal to GDP minus the net income of foreigners GNP counts the income that Americans earn abroad but it omits the income foreigners earn in the US GDP includes the income foreigners earn in the US 3 Differentiate between real and nominal GDP Chapter heading Adjusting for Price Changes and Deriving Real GDP Key terms Nominal values Values expressed in current dollars Real values Values that have been adjusted for the effects of inflation Inflation an increase in the general level of prices of goods and services The purchasing power of the monetary unit such as the dollar declines when inflation is present Consumer price index an indicator of the general level of prices It attempts to compare the cost of purchasing the market basket bought by a typical consumer during a specific period with the cost of purchasing the same market basket during an earlier period GDP deflator a price index that reveals the cost during the current period of purchasing the items included in GDP relative to the cost during a base year currently 2000 unlike the CPI the GDP deflator also measures the prices of capital goods and other goods and services purchased by businesses and governments Because of this it is thought to be a more accurate measure of changes in the general price level than the CPI Why are nominal values adjusted for inflation Nominal values are adjusted for inflation because they do not give an accurate portrayal of prices when comparing them over time periods What s the difference between the GDP and the GDP Deflator GDP illustrate nominal values of a current period whereas the GDP deflator is designed to measure the change in the average price of goods services relative to the cost during a base year 4 Examine the limitations of using GDP as a measure of output and income Chapter heading Problems with GDP as a Measuring Rod Key term Underground economy unreported barter and cash transactions that take place outside recorded market channels some are otherwise legal activities undertaken to evade taxes others involve illegal activities such as trafficking drugs and prostitution Reasons why GDP is an imperfect measure 1 Nonmarket Production GDP does not count household production because it does not involve a market transaction As a result the household services of millions of people are excluded Omitting household production makes income comparisons across lengthy time periods less meaningful Mowing the yard repair your car paint your house etc 2 Underground Economy Even though underground activities are often productive they are not included in GDP because they are typically cash transactions which make it difficult for the gov t to trace 3 Leisure and Human Costs GDP excludes leisure and the human cost associated with the production of goods services No allowance is made for how long or how hard people work to generate outputs Simon Kuznets the inventor of GDP believed that these omissions substantially reduced the accuracy of GDP as a measure of economic well being 4 Quality Variation and the Introduction of New Goods New and improved products are constantly replacing old ones Most economists believe that price indexes including the GDP deflator overestimate the rate of inflation by approximately 1 percent annually because quality improvements aren t accounted for accurately 5 Harmful Side Effects and Economic Bads GDP makes no adjustment for harmful side effects that sometimes arise from production consumption and the destructive acts of man and nature If they do not involve market transactions economic bads are ignored in the calculation of GDP
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