Chapter 23

Source: Mankiw, Principles of Economics, Ch. 23

Blanchard, Macroeconomics, Ch. 3

GROSS DOMESTIC PRODUCT (GDP)

Definition:

Gross Domestic Product (GDP) is the market value of all final goods and services produced within a country in a given period of time

market value Goods are valued at their market prices, so:

- All goods measured in the same units (e.g., japanese yen in Japan)

- Things that don’t have a market value are excluded, e.g., housework you do for yourself.

of all GDP includes all items produced in the economy and sold legally in the markets

final GDP only includes final goods

final goods intended for the end user

intermediate goods used as components or ingredients in the production of other goods

The value of intermediate goods is not included in GDP because the value of intermediate goods is already included in the value of the final goods
If we included we would double count it
Exception: the intermediate good is produced and is added to a firm's inventory of goods for use or sale at a later date

goods and services GDP includes both

tangible goods (e.g. food, clothing, cars)
and
intangible services (e.g. haircuts, doctor visits, concerts)

produced GDP includes goods and services currently produced

within a country GDP measures the value of production within the geographic borders of a country
That is, items are included in a nations's GDP if they are produced domestically, regardless of the nationality of the producer

in a given period of time GDP measures the value of production that takes place within a specific interval of time (usually a year or a quarter - 3 months)

Seasonal adjustment Statistical procedure to remove from the data the seasonal component

NOTE: the definition given at the beginning focuses on GDP as total expenditure in the economy

However, since every dollar spent by a buyer for a good or services becomes a dollar of income to the seller of the good or service, GDP also measures the income of everyone in the economy

GDP can be also calculating by adding up all the incomes in the economy

For an economy as a whole, income must equal expenditure

Note that GDP computed as expenditure and as income can give values slightly different because data source are not perfect.
The difference between the two calculations of GDP is called the statistical discrepancy

The Components of GDP

Y = C + I + G + NX

Accounting treatment of housing

Y denotes GDP
In the national income and product accounts, a house is considered a piece of capital that is used to produce a flow of services—housing services.
C Consumption When a consumer (as a tenant) rents a house or apartment, the consumer is buying housing services.
These services are considered consumption, so the price paid for these services – rent – is counted in the “consumption” component of GDP .
I Investment When someone buys a new house to live in, she is both a producer and a consumer.
 As a producer, she has made an investment (the purchase of the house) that will produce a service.
G Government purchases She is also the consumer of this service, which is valued at the market rental rate for that type of house.
So, the accounting conventions treat this situation as if the person is her own landlord and rents the house to/from herself.
NX Net exports

This equation is an identity, i.e. C + I + G + NX needs to sum up to Y

Consumption spending by households on goods and services (g&s), with the exception of purchases of new housing

Investment total spending on goods that will be used in the future to produce more goods. It includes: Note on Investment

1 capital equipment (e.g., machines, tools) “Investment” does not mean the purchase of financial assets like stocks and bonds.
Buying financial products, such as the purchase of shares or debentures, is not an investment but a savings.
2 structures (factories, office buildings, houses) It is not included in GDP because it is just a legal document replacement.
The money is not converted into goods or services; therefore, it is not part of the real economy.
3 inventories (goods produced but not yet sold) It is just a transfer payment

Government purchases all spending on the g&s purchased by govt at the federal, state, and local levels.

transfer payments, such as Social Security or unemployment insurance benefits, are excluded because they are not purchase of g&s and to avoid double counting. Note on Inventories
Retired persons spend part or all of their Social Security benefits on food, rent, prescriptions, and so forth, all of which count in consumption.
If we also counted the Social Security check as part of G, then the same money would be counted twice, which would make GDP look bigger than it really is. In any given year, production and sales need not to be equal.
Some of the goods sold in a given year may have been produced
Net exports spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports) in an earlier year. The difference between goods produced and
goods sold in a given year - equivalently, the difference between
Export (X) - Imports (M) production and sales - is called inventory investment.
If production exceeds sales, firms accumulate inventories:
GDP per capita (or GDP per person) GDP divided by population inventory investment is positive.
If production is less than sales, firms decrease inventories:
inventory investment is negative.
Real vs Nominal GDP Shortly, we can write
Production - Sales = Inventory Investment
Issue: We compare the value of GDP of a country between two years and we observe that GDP has increased Production = Sales + Inventory Investment
Inventory Investment = Production - Sales
Is this increase due to:

1 a larger output of goods and services produced in the economy?

or
2 goods and services being sold at higher prices compared with the previous year?

We want to separate these two effects

Nominal GDP
values output using current prices Nominal vs Real GDP

not corrected for inflation Nominal GDP is also called dollar GDP or GDP in current dollars

Real GDP values output using the prices of a base year Real GDP is also called GDP in terms of goods, GDP in constant dollars, GDP Adjusted for inflation, or GDP in [base year] dollars

is corrected for inflation

Example
Price & Quantities
Year P Pizza Q Pizza P Latte Q Latte
2016 $ 10.00 400 $ 2.00 1000
2017 $ 11.00 500 $ 2.50 1100
2018 $ 12.00 600 $ 3.00 1200

1 Calculate Nominal GDP

% Change
2016 $ 6,000.00
2017 $ 8,250.00 37.5%
2018 $10,800.00 30.9%
 2 Calculate Real GDP (base year 2016)

2016 $ 6,000.00
2017 $ 7,200.00 20%
2018 $ 8,400.00 17%

In each year,
GDP Growth
nominal GDP is measured using the (then) current prices.
GDP growth in year t refer to the rate of change of real GDP in year t
real GDP is measured using constant prices from the base year (2016 in this example).
By denoting real GDP in year t as Yt, GDP growth equals
The change in nominal GDP reflects both prices and quantities.
𝑌 −𝑌
The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). 𝐺𝐷𝑃 𝑔𝑟𝑜𝑤𝑡ℎ =
𝑌
Hence, real GDP is corrected for inflation.

where t-1 refer to the previous period

GDP Deflator

The GDP deflator is a measure of the overall level of prices

Formula GDP deflator = Nominal GDP *100

Real GDP

Because nominal GDP and real GDP must be the same in the base year, the GDP deflator for the base year is always equal to 100

The GDP deflator for subsequent years measures the change in nominal GDP from the base year that cannot be attributable to a change in real GDP

The GDP deflator measures the current level of prices relative to the level of prices in the base year

One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next.

3 Calculate the GDP deflator from previous example

Year GDP Deflator% Change in GDP Deflator

2016 100.0
2017 114.6 14.6%
2018 128.6 12.2%

Recession two consecutive quarters of falling real GDP (not an official definition)

Expansion periods of positive GDP growth

OTHER MEASURES OF INCOME

GROSS NATIONAL PRODUCT GNP total income earned by a nation's permanent residents (called nationals )
it differs from GDP because it includes income that citizens of the reporting country earn abroad
and excludes income that foreigners earn in the reporting country

NET NATIONAL PRODUCT NNP GNP minus losses from depreciation

depreciation: wear and tear on the economy's stock of equipment and structures (also referred as "consumption of fixed capital")

NATIONAL INCOME total income earned by nation's residents in the production of goods and services

PERSONAL INCOME income that households and noncorporate businesses receive

DISPOSABLE PERSONAL INCOME income that households and noncorporate businesses have left after paying taxes

GDP PER CAPITA (PER PERSON) measures the economic output of a nation per person
GDP per capita = Real GDP/Population