Chapter 7: Taking the Nation’s Economic Pulse

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ECO 2013
Joseph Calhoun

Chapter 7: Taking the Nation’s Economic Pulse I. GDP – A Measure of Output a. Gross domestic product- the market value of all final good and services produced within a country during a specific period (usually a year) i. Most widely used measure of economic performance ii. In the U.S., the numbers are prepared and reported quarterly iii. GDP measures the market value of production that “flows” through the economy’s factories and shops each year (or quarter) b. What Counts Toward GDP? i. Only final goods and services count 1. Intermediate goods- goods purchased for resale or use in producing another good or service 2. Final market goods and services- goods and services purchased by their ultimate user 3. Sales at intermediate stages of production are not themselves counted in GDP because the value of the intermediate good is embodied within the final-user good 4. E.g. steak sold by wholesaler to restaurant (intermediate)  final purchase price of steak dinner in restaurant (final market GDP) ii. Only transactions involving production count 1. Financial transactions and income transfers are excluded because they merely move ownership from one party to another (unless there is commission involved) (e.g. stocks, bonds, welfare, social security) 2. Must produce good in return for a transfer iii. Only production within the country is counted 1. Goods and services produced within the U.S. (e.g. would not include an American working in England) iv. Only goods produced during the current period are counted 1. E.g. a used car or a home built 5 years ago or resale of these items would merely mean change of ownership and would not be considered part of GDP for that current period; no production of new good/service present c. Dollars Are The Common Denominator For GDP i. Each good produced increase output by the amount the purchaser pays for the good. The total spending on all goods and services produced during the year is then summed, in dollar terms, to obtain the annual GDP II. GDP as a Measure of Both Output and Income a. 2 ways of looking at and measuring GDP: i. Expenditure approach- the GDP of an economy can be reached by totaling the expenditures on goods and services produced during the year ii. Resource cost-income approach- GDP can be calculated by summing the income payments to the resource suppliers of the things used to produce these goods and services b. The link between the market value of a good and the income (including the profit/loss) earned by resource suppliers occurs for each good or service produced: i. The dollar flow of expenditures on final goods = the dollar flow of income (and indirect cost) from final goods c. Thus, GDP is a measure of both 1.) the market value of the output produced, and 2.) the income generated by those who produced the output. This highlights a very important point: Increases in output and growth of income are linked. An expansion in output – that is, the additional production of goods and services that people value – is the source of higher income levels d. Deriving GDP By The Expenditure Approach i. GDP has 4 components: personal consumption expenditures, gross private domestic investment, government consumption and gross investment and net export to foreigners 1. Consumption purchases a. Largest component of GDP b. Personal consumption- household spending on consumer goods and services during the current period. Consumption is a flow concept c. Mostly nondurable goods and services d. Does include some durable items, though (e.g. cars, fridges) 2. Gross private investment a. Private investment- the flow of private-sector expenditures on durable assets (fixed investment) plus the inventories (inventory investment) during a period. These expenditures enhance our ability to provide consumer benefits in the future b. Not immediately used (e.g. business plants, equipment, houses, increase in business inventories) c. Gross investment- includes expenditures for both 1.) the replacement of machinery, equipment, and buildings worn out during the year and 2.) net additions to the stock of capital assets d. Net investment- gross investment minus an allowance for depreciation and obsolescence of machinery and other physical assets during the year e. Depreciation- the estimated amount of physical capital (e.g. machines and buildings) that is worn out or used up producing goods during a period f. Net investment is an important indicator of the economy’s future productive capability i. Increases net investment = outward shift in production possibilities curve; and vice versa = stagnating economy g. Because GDP is designed to measure current production, allowance must be made for goods produced but not sold during the year (inventory investment) h. Inventory investment- changes in the stock of unsold goods and raw materials held during a period i. If business firms have more goods on hand at the end of the year than they had at the beginning, inventory investment will be positive. This inventory investment must be added to GDP. Conversely, a decline in inventories would indicate that the purchases of goods and services exceeded current consumption. In this case inventory disinvestment would be a subtraction from GDP 3. Government consumption and gross investment a. Federal, state, and local government consumption + investment = 20% of total GDP b. Purchases of state and local government > purchases made by federal government c. Government component includes: i. Expenditures on items like office supplies, law enforcement, and the operation of veteran’s hospitals, which are “consumed” during the current period ii. The purchase of long-lasting capital goods (e.g. missiles, highways, dams etc.) d. Government’s total expenditures > consumption + investment e. Government purchases are counted as their cost to taxpayers rather than their value to those receiving them f. In cases in which the value of the item to citizens is low relative to the tax cost of producing it, the government expenditures will overstate the value derived from the item 4. Net exports a. Net export- exports minus imports b. Exports- goods and services produced domestically but sold to foreigners c. Imports- goods and services produced by foreigners but purchased by domestic consumers, businesses, and governments d. GDP is a measure of domestic production, therefore when measuring it by the expenditure approach: i. Add exports ii. Subtract imports
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