Gross Domestic Product Chapter 4 Measuring GDP and Economic Growth GDP The market value of the final goods and services produced within a country in a given time period The definition has 4 parts 1 Market Value The prices at which items are traded in markets 2 Final Goods and Services In order to calculate GDP we need to value the final goods and services produced By using market prices to value production we can add apples and oranges together Final Good or service is an item that is ought by its final user during a specified timer period Included in GDP Intermediate Good or service item that is produced by one firm bought by another firm and used as a component of a final good or service Not included in GDP If we were to add the value of intermediate goods and services produced to the value of final goods and services we would count the same thing twice AKA double counting Some goods can be an intermediate good in some situations and a final good in other situations The purchase of a secondhand good for example a used car or existing home isn t part of GDP It was part of the GDP in the year in which it was produced 3 Produced Within a Country Only goods and services produced within a country count as part of that country s GDP EX Nike is a U S firm produces sneakers in Vietnam and the market value of those shoes is part of Vietnam s GDP not part of the US 4 In a Given Time Period GDP measures the value of production in a given time period normally either a quarter of a year quarterly GDP or a year annual GDP data Circular Flow Model Players 1 households 2 firms 3 governments 4 the rest of the world Trade in a factor markets b goods and services markets 2 Firms buy services of labor capital and land Sell consumer goods and services in goods markets 1 Households sell services of labor capital and land Buy consumer goods and services Receive wages for labor services interest for the use of capital and rent for the use of land Consumption Expenditure The total payment for consumer goods and services Pay with wages for labor services interest for the use of capital and rent for the use of land The retained earnings profits that are not distributed to households are part of the household sectors income When a firm adds unsold output to inventory we can think of the firm as buying goods from itself Investment The purchase of new plant equipment and buildings and the additions to inventory Finance expenditures with taxes and make financial transfers to households such as Social Security benefits and unemployment benefits and pay subsidies to firms Taxes and financial transfers are not a part of the circular flow of expenditure and income 3 Governments buy goods and services from firms Government Expenditure 4 Rest of the World Exports sell goods and services to the rest of the world Imports Buy goods and services from the rest of the world Net Exports The value of exports X minus imports M If net exports are positive the net flow is from US firms to the rest of the world If net exports are positive the net flow is from the rest of the world to US firms GDP Aggregate Expenditure Aggregate Income Total expenditure aggregate expenditure consumption expenditure investment government expenditure net exports Aggregate income total amount paid for services of the factors of production used to produce final goods and services wages interest rent and profit Why Domestic and why Gross Domestic Product production within a country In contrast with National Product which is the value of goods and services produced anywhere in the world by residents of a nation Ex Nike s income from shoe factories it owns in Vietnam is part of the US national product GNP Gross National Product GDP Net income from factors of production owned in other countries Gross means before subtraction the depreciation of capital Opposite of gross is net which means after subtracting the depreciation of capital Depreciation the decrease in the value of a firms capital that results from wear and tear and obsolescence Gross Investment The total amount spent both buying new capital and replacing depreciated capital Net Investment The amount by which the value of capital increases Chapter 4 pg 1 Measuring U S GDP The Expenditure Approach GDP C I G X M Personal consumption expenditures C Expenditures by US households on goods and services produced in US and the rest of the world Normal things like soda books banking etc Does not include purchase of new homes Gross Private domestic investment I expenditure on capital equipment and buildings by firms and the additions to business inventories Government Expenditure on goods and services G expenditure on all levels of government on goods and services such as national defence and garbage collection Does not include transfer payments which include unemployment benefits b c they are not expenditures on goods and services Net Exports of goods and services X M value of exports minus value of imports The Income Approach GDP the incomes that firms pay households for the services of the factors of production they hire Divide incomes into two big categories 1 Compensation of Employees Payment for labor services Includes net wages and salaries taxes withheld on earnings fringe benefits such as Social Security and pension fund contributions 2 Net operating surplus sum of all other factor incomes It has 4 components 1 Net Interest interest households receive on loans they make interest households pay on their own borrowing 2 Rental Income Payment for the use of land and other rented resources 3 Corporate Profits Profits of corporations Some is paid to households in dividends some is retained by the company is undistributed profits 4 Proprietors Income income earned by owner operator of a business Includes compensation for the owners labor the use of the owners capital and profit Nominal GDP and Real GDP Standard of Living Over Time Real GDP the value of final goods and services produce in a given year when valued at the prices of a reference base year Nominal GDP fancy word for GDP It is the value of the goods produced in a given year based on that years prices Basically you value the goods produced now at the price they would have been in a previous year The Uses and Limitations of Real GDP One method of comparing the standard of living over time is to calculate real GDP per person in different years Real GDP Per Person real GDP divided by the population Potential GDP the maximum level of real