GDP and the Standard of Living

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14
GDP and the Standard of Living
CHAPTER
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C H A P T E R C H E C K L I S T

• When you have completed your study of this
  chapter, you will be able to

• 1 Define GDP and explain why the value of
  production, income, and expenditure are the same
  for an economy.
• 2 Describe how economic statisticians measure
  GDP an distinguish between nominal GDP and real
  GDP.
• 3 Describe and explain the limitations of real
  GDP as a measure of the standard of living.

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14.1 GDP, INCOME, AND EXPENDITURE

• GDP Defined
• Gross domestic product or GDP
• The market value of all the final goods and
  services produced within a country in a given
  time period.
• Value Produced
• Use market prices to value production.

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14.1 GDP, INCOME, AND EXPENDITURE

• What Produced
• Final good or service is a good or service that
  is produced for its final user and not as a
  component of another good or service.
• Intermediate good or service is a good or service
  that is produced by one firm, bought by another
  firm, and used as a component of a final good or
  service.
• GDP includes only those items that are traded in
  markets.

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14.1 GDP, INCOME, AND EXPENDITURE

• Where Produced
• Within a country
• When Produced
• During a given time period.

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14.1 GDP, INCOME, AND EXPENDITURE

• Circular Flows in the U.S. Economy
• Consumption expenditure is the expenditure by
  households on consumption goods and services.
• Investment is the purchase of new capital goods
  (tools, instruments, machines, buildings, and
  other constructions) and additions to inventories.

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14.1 GDP, INCOME, AND EXPENDITURE

• Government expenditure on goods and services is
  the expenditure by all levels of government on
  goods and services.
• Net exports of goods and services is the value of
  exports of goods and services minus the value of
  imports of goods and services.

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14.1 GDP, INCOME, AND EXPENDITURE

• Exports of goods and services are the items that
  firms in in the United States produce and sell to
  the rest of the world.
• Imports of goods and services are the items that
  households, firms, and governments in the United
  States buy from the rest of the world.

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14.1 GDP, INCOME, AND EXPENDITURE

• Total expenditure is the total amount received by
  producers of final goods and services.
• Consumption expenditure C
• Investment I
• Government expenditure on goods and services G
• Net exports NX
• Total expenditure C I G NX

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14.1 GDP, INCOME, AND EXPENDITURE

• Income
• Labor earns wages.
• Capital earns interest.
• Land earns rent.
• Entrepreneurship earns profits.
• Households receive these incomes.

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14.1 GDP, INCOME, AND EXPENDITURE

• Expenditure Equals Income
• Because firms pay out everything they receive as
  incomes to the factors of production, total
  expenditure equals total income.
• That is
• Y C I G NX
• The value of production equals income equals
  expenditure.

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14.1 GDP, INCOME, AND EXPENDITURE

• Figure 14.1 shows the circular flow of income and
  expenditure.
• The table shows the U.S. data for 2007.

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14.2 MEASURING U.S. GDP

• The Expenditure Approach
• Measures GDP by using data on consumption
  expenditure, investment, government expenditure
  on goods and services, and net exports.
• Table 14.1 on the next slide shows the
  calculation for 2007.

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14.2 MEASURING U.S. GDP

• Expenditures Not in GDP
• Used Goods
• Expenditure on used goods is not part of GDP
  because these goods were part of GDP in the
  period in which they were produced and during
  which time they were new goods.
• Financial Assets
• When households buy financial assets such as
  bonds and stocks, they are making loans, not
  buying goods and services.

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14.2 MEASURING U.S. GDP

• The Income Approach
• Measures GDP by summing the incomes that firms
  pay households for the factors of production they
  hire.
• The U.S. National Income and Product Account
  divide incomes into two big categories
• Wages
• Interest, rent, and profits

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14.2 MEASURING U.S. GDP

• Wages
• Wages, called compensation of employees in the
  national accounts, is the payment for labor
  services.
• It includes net wages and salaries plus fringe
  benefits paid by employers such health care
  insurance, social security contributions, and
  pension fund contributions.

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14.2 MEASURING U.S. GDP

• Interest, Rent, and Profit
• Interest, rent, and profit, called net operating
  surplus in the national account, is the sum of
  the incomes earned by capital, land, and
  entrepreneurship.
• Interest is the income households receive on
  loans they make minus the interest they pay on
  their borrowing.
• Rent includes payments for the use of land and
  other rented inputs.
• Profit includes the profits of corporations and
  small businesses.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP

• Net domestic product at factor cost is the sum of
  wages, interest, rent, and profit.
• Net domestic product at factor cost is not GDP.
• We need to make two adjustments to arrive at GDP
• One from factor cost to market prices
• One from net product to gross product

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14.2 MEASURING U.S. GDP

• From Factor Cost to Market Price
• The expenditure approach values goods at market
  prices the income approach values them at factor
  cost.
• Indirect taxes (such as sales taxes) make market
  prices exceed factor cost.
• Subsidies (payments by government to firms) make
  factor cost exceed market prices.
• To convert the value at factor cost to the value
  at market prices, we must
• Add indirect taxes and subtract subsidies

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP

• From Gross to Net
• The expenditure approach measures gross product
  the income approach measures net product.
• Gross profit is a firms profit before
  subtracting the depreciation of capital.
• Net profit is a firms profit after subtracting
  the depreciation of capital.
• Depreciation is the decrease in the value of
  capital that results from its use and from
  obsolescence.

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14.2 MEASURING U.S. GDP

• Income includes net profit, so the income
  approach gives a net measure.
• Expenditure includes investment. Because some new
  capital is purchased to replace depreciated
  capital, the expenditure approach gives a gross
  measure.
• To get gross domestic product from the income
  approach, we must add depreciation to total
  income.
• After making these two adjustments the income
  approach almost gives the same estimate of GDP as
  the expenditure approach.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP

• Statistical Discrepancy
• The income approach and the expenditure approach
  do not deliver exactly the same estimate of
  GDPthere is a statistical discrepancy.
• Statistical discrepancy is the discrepancy
  between the expenditure approach and income
  approach estimates of GDP, calculated as the GDP
  expenditure total minus the GDP income total.

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14.2 MEASURING U.S. GDP
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14.2 MEASURING U.S. GDP

• GDP and Related Measures of Production and Income
• Gross national product or GNP is the market value
  of all the final goods and services produced
  anywhere in the world in a given time period by
  the factors of production supplied by residents
  of the country.
• U.S. GNP U.S. GDP Net factor income from
  abroad

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14.2 MEASURING U.S. GDP

• Disposable Personal Income
• Consumption expenditure is one of the largest
  components of aggregate expenditure and one of
  the main influences on it is disposable personal
  income.
• Disposable personal income is the income
  received by households minus personal income
  taxes paid.

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14.2 MEASURING U.S. GDP

• Figure 14.2 shows the relationship between GDP,
  GNP, and disposable personal income.

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14.2 MEASURING U.S. GDP

• Real GDP and Nominal GDP
• Real GDP is the value of the final goods and
  services produced in a given year expressed in
  the prices of the base year.
• Nominal GDP is the value of the final goods and
  services produced in a given year expressed in
  the prices of that same year.
• The method of calculating real GDP changed in
  recent years. Here we describe the essence of the
  calculation. The appendix gives the technical
  details.

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14.2 MEASURING U.S. GDP

• Calculating Real GDP
• The goal of calculating real GDP is to measure
  the extent to which total production has
  increased
• Real GDP removes the influence of price changes
  from the nominal GDP numbers.
• To focus on the principles and keep the numbers
  easy to work with, well calculate real GDP for
  an economy that produces only one consumption
  good, one capital good, and one government
  service.

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14.2 MEASURING U.S. GDP

• Table 14.3 shows the calculation with 2000 (base
  year) and 2008.
• To find the total expenditure in 2000 multiply
  the quantity of each item produced in 2000 by its
  price in 2000.
• Then sum the expenditures to find nominal GDP in
  2000.
• The next slide shows the data.

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Nominal GDP in 2000 is 100 million. Because
2000 is the base year, real GDP in 2000 is also
100 million.
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14.2 MEASURING U.S. GDP

• In part (b) of Table 14.3, we calculate nominal
  GDP in 2008.
• Again, we calculate nominal GDP by multiplying
  the quantity of each item produced by its price
  and then sum the expenditures to find nominal GDP
  in 2008.

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Nominal GDP in 2000 is 100 million. Nominal GDP
in 2008 is 300 million.
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14.2 MEASURING U.S. GDP
Nominal GDP in 2000 is 100 million and in 2008
it is 300 million.

• Nominal GDP in 2008 is three times its value in
  2000.
• But by how much has the quantity of final goods
  and services produced increased?

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14.2 MEASURING U.S. GDP

• The increase in real GDP will tell by how much
  the quantity of good and services has increased.
• Real GDP in 2008 is what the total expenditure
  would have been in 2008 if prices had remained
  the same as they were in 2000.
• To calculate real GDP in 2008 multiply the
  quantities produced in 2008 by the price in 2000
  and the sum these expenditures to find real GDP
  in 2008.
• Part (c) of Table 14.3 shows the details.

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Real GDP in 2000 is 100 million. Real GDP in
2008 is 160 milliononly 1.6 times real GDP in
2000.
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14.3 THE USE AND LIMITATIONS OF REAL GDP

• We use estimates of real GDP for two main
  purposes
• To compare the standard of living over time
• To compare the standard of living among countries
• The Standard of Living Over Time
• To compare living standards we calculate real GDP
  per personreal GDP divided by the population.
• Table 14.4 shows two calculations

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• In 1967, real GDP in the United States was
  3,485 billion and the population of the United
  States was 198.7 million.
• Real GDP per person 3,485 billion 198.7
  million
• Real GDP per person 17,536
• In most years, real GDP per person increases,
  but sometimes it doesnt change.

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Long-Term Trend
• Figure 14.3 shows the long-term trend in U.S.
  real GDP per person.

Real GDP per person doubled in the 36 years from
1967 to 2002.
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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Short-Term Fluctuations
• Fluctuations in the pace of expansion of real GDP
  is called the business cycle.
• The business cycle is a periodic irregular up-and
  down movement of total production and other
  measure of economic activity.
• The four stages of a business cycle are
  expansion, peak, recession, and trough.

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• The shaded periods show the recessionsperiods of
  falling production that lasts for at least six
  months.

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Standard of Living Across Countries
• To compare living standards across countries, we
  must convert real GDP into a common currency and
  common set of prices, called purchasing power
  parity.
• Goods and Services Omitted from GDP
• Household production
• Underground production
• Leisure time
• Environment quality

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Household Production
• Real GDP omits household production, it
  underestimates the value of the production of
  many people, most of them women.
• Underground Production
• Hidden from government to avoid taxes and
  regulations or illegal.
• Because underground economic activity is
  unreported, it is omitted from GDP.

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Leisure Time
• Our working time is valued as part of GDP, but
  our leisure time is not.
• Environment Quality
• Pollution is not subtracted from GDP.
• We do not count the deteriorating atmosphere as a
  negative part of GDP.
• If our standard of living is adversely affected
  by pollution, our GDP measure does not show this
  fact.

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14.3 THE USE AND LIMITATIONS OF REAL GDP

• Other Influences on the Standard of Living
• Health and Life Expectancy
• Good health and a long life do not show up
  directly in real GDP.
• Political Freedom and Social Justice
• A country might have a very large real GDP per
  person but have limited political freedom and
  social justice.
• A lower standard of living than one that had the
  same amount of real GDP but in which everyone
  enjoyed political freedom.

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APPENDIX MEASURING REAL GDP

• The Problem with Base-Year Prices
• Well calculate real GDP in 2008 using 2000 as
  the base year and found that real GDP in 2008 was
  1.6 percent greater than in 2000an increase of
  60.
• But if we had used 2008 prices rather than 2000,
  real GDP would have increased from 150 million
  (2008 dollars) in 2000 to 300 million in 2008an
  increase of 100.
• So did real GDP increase by 60 or 100?

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APPENDIX MEASURING REAL GDP

• The BEA method uses the prices of both years.
• The three steps in the method are
• Value production in the prices of adjacent
  years.
• Find the average of the two percentage changes.
• Link (chain) back to the base year.

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APPENDIX MEASURING REAL GDP

• Value Production in the Prices of Adjacent Years
• Lets take as the two adjacent years 2008 and its
  preceding year 2007.
• Value the quantities produced in 2007 and 2008 at
  both the prices of 2007 and the prices of 2008.
• Table A14.1 shows the calculations.

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APPENDIX MEASURING REAL GDP

• The table gives
• Value of production in 2007 at 2007 prices is
  145.
• Value of production in 2008 at 2007 prices is
  160.
• Value of production in 2007 at 2008 prices is
  158.
• Value of production in 2008 at 2008 prices is
  172.
• The next step is the find the percentage
  increases using 2007 prices and 2008 prices and
  then average these two percentages.

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APPENDIX MEASURING REAL GDP

• Find the Average of Two Percentage Changes
• Table A14.1 sets out the calculation
• Value of production in 2007 at 2007 prices is
  145.
• Value of production in 2008 at 2007 prices is
  160.
• Using 2007 prices, production increased by 10.3.
• Value of production in 2007 at 2008 prices is
  158.
• Value of production in 2008 at 2008 prices is
  172.
• Using 2008 prices, production increased by 8.9.
• The average percentage increase in production is
  9.6.

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APPENDIX MEASURING REAL GDP
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APPENDIX MEASURING REAL GDP

• Link (Chain) Back to the Base Year
• Starting in the base year, apply the calculated
  average percentage increase each year to obtain
  the chained-dollar real GDP.
• Figure A14.1 illustrates the calculation with
  assumed data.

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