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Section 12 Notes.doc

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University of Pittsburgh
ECON 0110

SECTION 12: GROSS DOMESTIC PRODUCT The market (dollar) value of all final goods and services produced in the U.S. in a given year. Not what was sold…what was produced MARKET VALUE: Output is valued at its selling price If output remains constant, but prices increase, then nominal GDP will increase Nominal GDP is influenced by changes in prices The fact that nominal GDP increased does not prove that output increased. FINAL GOODS AND SERVICES: Goods and services produced for final use by final users Example: New car New tires for my current car Apple that I buy to eat INTERMEDIATE GOODS Goods that are produced by one firm for use in further processing by another firm (purchased as an input to use as a final good) Examples: Apples purchased by a bakery to make a pie Steel or tires used in producing a new car PRODUCED IN THE U.S. All goods and services produced inside the boundaries of the U.S count in GDP Items produced in foreign countries by Americans or American owned firms do not count in GDP IN A GIVEN YEAR We can measure GDP on a monthly, quarterly, yearly basis GDP is a flow over time AVOID DOUBLE COUNTING THE VALUE OF INTERMEDIATE GOODS VALUE ADDED = value of output at end of a stage of production MINUS the cost of inputs at beginning of that stage of production Example: When producing a NEW car, a tire is an intermediate good. It is part of the final good, the car. To calculate the value of output, it would be incorrect to calculate the value of the tire and then add that to the final cost of the car. The value of the tire is already included in the cost of the car, so the value of the tire would have been counted twice. ITEMS NOT COUNTED IN GDP Sales of used goods Purely financial exchanges Government and private transfer payments GOVERNMENT TRANSFER PAYMENTS: Cash payments made by governments to people who do not provide goods or services in exchange for these payments Social security benefits Welfare payments Unemployment compensation Veterans’ benefits Subsidies to farmers Medicare and Medicaid payments to individuals PRIVATE TRANSFER PAYMENTS Gifts, inheritances, charitable contributions are not included in GDP Some productive activities are omitted from GDP because there was no market transaction Homemaker activities Do-it-yourself projects Barter transactions Underground economy (babysitting, black topping driveways in cash so they don’t have to claim it) NOMINAL GDP GDP measured in current dollars Example: NOMINAL GDP for 2008 measures the value of things produced during 2008 using 2008 prices CURRENT DOLLARS The current prices that people pay for goods and services during any specific year Nominal GDP can increase because the quantity of output increased Nominal GDP can increase because prices increased Economic growth requires an increase in the quantity of output, not an increase in the dollar value of output REAL GDP GDP for any year measured using the prices that existed during some selected base year BASE YEAR AND PRICE INDEX: Any year can be chosen as the base year, and then prices in other years are compared to the level of prices during the base year in order to create a price index. Example: Suppose we select 1996 as the base year. The goal is to compare the level of prices during any year to the level of prices during 1996. INTERPRETATION OF A PRICE INDEX: We arbitrarily always set the level of the price index during the base year to 100, so we set the index value to 100 in 1996. Now we want to determine how much things would have cost during other years if they cost $100 (or $1.00) during 1996. Example: Suppose that things that cost $100 (or $1.00) during 1996 cost $62.37 (or $0.6237) during 1981. Then the value of the price index for 1981 would be 62.37. Suppose that things that cost $100 (or $1.00) during 1996 cost $111.90 (or $1.1190) during 2003. Then the value of the price index for 2003 would be 111.90. CALCULATION OF REAL GDP WHEN GIVEN A PRICE INDEX: Real GDP = (Nominal GDP/Price index) x 100 Example: Base year = 1983 Price index for 2001 = 177.1 This means that what cost $100 (or $1.00) during 1983 cost about $177.10 (or $1.7710) during 2001) Assume Nominal GDP for 2001 = $10,082 billion Real GDP for 2001 = 10,082/177.1 x 100 = $5,692.8 billion This means that output which cost $10,082 billion during 2001 would have cost $5,692.80 billion during 1983. DEPRECIATION AND NET DOMESTIC PRODUCT (NNP) During the production process, firms typically use up or wear out lots of tools and equipment. (Buying 10 pizza ovens and 3 wore out) Sometimes we want to measure the value of the new output MINUS the amount of wear and tear on the tools and equipment. This would give us a measure of our NET new production. DEPRECIATION The amount by which the value of an asset falls in a given period Also cal
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