Measuring GDP McCaffery S



Measuring GDP Mod. 10-11 s.2018

US Macro economic goals- full employment = 95%, price stability, low inflation=2% per yr,

Real GDP growth, growth of the economy = 3% per yr

*GDP = Total market value of all new, final goods and services produced with in a nation in a year.

GROSS, DOMESICALLY, PRODUCED

Ultimately measured at the market price, as produced a reasonable price is assigned to it, this leads to GDP revisions when the market price is found to vary from the assigned value.

New, produced this year, selling an old refrigerator for $50 is not part of GDP.

Final, intermediate goods are not counted, hamburger sold to McDonalds is not counted, it will be counted as part of the final good (Big Mac). Hamburger sold to a household is a final good as it will not be resold.

And, a house started in one year completed in the next is counted as the latter year’s production. This is fair as it happens to the same extent to each year’s GDP.

Produced, counted when it is produced, not when it is sold. (estimated prices of unsold adjusted when sold)

in a Nation’s borders, this is the domestic, in your house, we don’t care who produced it, we care where it was produced.

in a year, even if only one quarter year’s production is being measured, it will be expressed at a yearly rate.

To understand how we calculate GDP it is helpful to See the circular flow which shows Our National Accounts of Economic activity. See handout on Circular Flow.

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TWO MAIN WAYS TO APPROACH (Calculate) GDP (approach is a good term as getting it exact is not possible) From Krugman, Value Added approach not commonly used.

1. *INCOME APPROACH:

W + π + i + R + IBT + CCA = GDP NI = 13.713 (2012)

W = wages , salaries, benefits, pensions, health insurance etc. 9.574

π = Profits of business whether corporate or private, distributed or not pre-tax 3.103

i = Interest received

.533

R = Rents and Royalties received for use of patent or copyright .445

IBT = Indirect business tax,

CCA = Capital consumption allowance (aka depreciation – factories and equipment getting worn out) 2.004 trillion

Notice WπiR doesn’t include CCA or IBT. Both are included in the cost of what was produced. If the economy is in equilibrium then what was produced equals what is sold.

Calculating GDP using the Expenditure Approach

The Most Important Equation to remember for calculating GDP

GDP = C + I + G + (X – M)

2. *EXPENDITURE APPROACH: C + I + G + X - M = GDP =

$15.467 trillion Q1 2012 annualized

C = Consumption by households 11.007 12

+

I = Investment, planned and unplanned 2.04712

+

G = GP, Gov. purchases of goods and services 3.017 12

+

X = exports 2.152 12

-

M = imports 2.756 12

a. C =

b. I =

*Planned investment + unplanned investment = Total investments – CCA = Net Investments

Planned Investment = planned capital expansion + planned inventory change

Unplanned Investment = typically unplanned changes in the inventory level, either up or down.

“unsold” production is assumed to be purchased by the manufacturer for inventory, therefore it is “sold”.

+ + = PI

c. G or GS = (all government – federal, state, local)

GS = 5.409 trillion 2012 annualized

Transfer payments = $2.384 trillion 3% in food stamps

Non-military to foreign nations 3.6 billion .00026% 2007

GP = $2.609 trillion 07 GS-TP (-interest) = GP

*NATIONAL DEBT: Sum of all yearly Budget Deficits less sum of all Budget Surpluses

T > GS T < GS

SURPLUS (flow) + a negative number (DEFICIT) (flow) = NATIONAL DEBT (stock)

Flow is per time period. Amount per year. Stock is stationary, a lump sum, a total (period).

Current National Debt $16.582 trillion, Reagan started with just under 1 Trillion ended with 3 Trillion

Mid 1980’s, and again in early 2000’s deficits ran as high as 6.1% of GDP (unified), actual was higher

National debt has an average maturity of 5 years.

*BUDGET DEFICIT/surplus/balanced budget: Government borrowing ARROW

Transparency of 1967-07, Surpluses of Clinton turn into Bush deficits

*BUDGET DEFICIT = T < GS or net Taxes < GP Gov Purchases

NT < GP

T < G Net Taxes

Presidents like the Unified Budget

T + SS payroll tax – GS + SS benefits

SS payroll tax – SS benefits = $160 billion/yr

Makes the current budget deficit look smaller Gov. borrowing

*BUDGET SURPLUS = T > G, NT > GP

*BALANCED BUDGET = T = G

*CROWDING OUT see handouts on crowding out and Loanable funds market now?/after break?

THREE POTENTIAL SAVERS Households, Firms, and Government (as of yet, we ignore foreign)

Same THREE POTENTIAL BORROWERS approach financial markets to borrow money

Households are limited as to how much they can pay by their incomes, how high an interest rate

Firms are limited to profitability of the purpose of the loan, how high an interest rate

Government faces no limit to how much they can pay to borrow. Gov always gets what they want.

When government borrows it takes away money that other wise would have been used by HH or firms

d. X-M (Net Exports) -2.7% for 2009

X = $1.445 trillion 12% of GDP

23% of all goods produced in US

M =$2.204 trillion goods and services 17% of GDP

27% of all goods consumed in US $1.8 trillion

*BALANCE OF TRADE: Looking at X -M GOODS only is the Merchandise account. TRADE, like kids.

*Balance of trade X = M this is of the Merchandise account (goods)

*Trade deficit X < M

*Trade surplus X > M

Sourced from NIPA, Bureau of Economic Analysis, tables 1.1.5, and 3.1

LEAKAGES AND INJECTIONS = S+T+M = G+I+X

Example

A third approach, or method, is making a move to be included, VALUE ADDED. If a nation uses a Value Added Tax this is easy.

See text p. 107, figure 10.3.

Add up each step of production to get GDP.

*Per capita GDP not size of GDP determines standard of living.

What improves, how traditionally we have used GDP measures. Transparency

LIMITATIONS OF GDP

1. ONLY MEASURES MARKET ACTIVITY

2. PLACES NO VALUE ON LEISURE

3. REPAIRING DISASTERS COUNTS AS A POSITIVE

4. ECOLOGICAL COSTS ARE NOT SUBTRACTED

5. COSTS WHICH GIVE US NO PLEASURE ARE COUNTED

COUNTED NOT COUNTED

Farmer buys tractor student gets gov scholarship

Business inventories increased mechanic fixes own radiator

Gov. purchases new submarine plumber buys two year old truck

Hair cut at barber sale of shares of stock

Cost of a divorce lawyer cashing a US bond

Cost of burglar alarm Soc Sec check going to retiree

Prison building/ staffing Clean air

Day care for child Raising your own child

Meal at McDonalds Granma’s Thanksgiving day meal preparation

Clean up of oil spill Pleasure of a vacation day

MISSES: underground economy (drugs, extortion, prostitution), all products count equally, Income distribution, household work, Government services value are counted at cost, no producer surplus measure

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Our ultimate goal is to measure GDP. There are two methods used to approach GDP. But first a definition:

Expenditure method GDP = $15,540 Income method GNI = $15,717

GDP = total market value of all, new, final, goods and services produced in a year within a nation.

* GDP about 15.467 trillion (2012) per capita = $46,870(12)

- CCA Capital consumption allowance (depreciation) 2.004 trillion (2012)

NNP Called NNP for years because we used GNP, still called that

- IBT Indirect Business taxes (taxes paid by firms, property/excise/sales/X-M tax)

- S.D. Statistical discrepancy (things don’t all add up the same starting from top or bottom) 73 billion

*NP = NI we convert at this point from production to income $13.713 trillion (2012)

- Social security paid by both er and ee 950 billion

- Corporate profit taxes 2000 b

- Undistributed corporate profits INVESTMENT

+ Transfer payments 2.384 trillion (2012)

Personal Income 13.228 trillion (2012) IN

- Personal income taxes 1.118 trillion fed. (2012)

*Disposable Income about 11.686 trillion (income after taxes) MACRO

- Necessities of life

Discretionary Income IS

IMPORTANT TERMS BUYING

NNP or NDP

NP = NI CAPITAL

Disposable Income

EQUIPMENT

Do Circular Flow adding G, Financial Markets, and Exports and Imports

*CROWDING OUT see handouts on crowding out.

THREE POTENTIAL SAVERS Households, Firms, and Government (as of yet, we ignore foreign)

Same THREE POTENTIAL BORROWERS approach financial markets to borrow money

Households are limited as to how much they can pay by their incomes, how high an interest rate

Firms are limited to profitability of the purpose of the loan, how high an interest rate

Government faces no limit to how much they can pay to borrow. Gov always gets what they want.

When government borrows it takes away money that other wise would have been used by HH or firms

*BALANCE OF PAYMENTS: = Current account balance ( merchandise, services, transfers)

Now that we have Crowding out, Budget deficits/surpluses, National debt, and Trade deficits let us weave them together.

Graph shows the quantity of money available to be borrowed

It is a combination of household saving (about 5% of GDP)

and Inflows from foreigners (also about 5% of GDP exactly equal

to our current account deficit.).

In 1998 the only demanders of this were households and firms,

Government was silent as it was running a “balanced budget”.

The 10% of GDP available for saving was borrowed by HH and

Firms, no crowding out. 2000 the gov ran a 1% surplus which shifts the supply curve to the right.

The forecast for 2004 is a Federal budget deficit of $450 Billion

That is roughly 4.5% of GDP. This estimate does not include the cost

of the war and rebuilding in Iraq. This will

increase the demand for saved money by 4.5% of GDP. Interest rates

should rise due to the increased demand. Let us just say with no

research that interest rates move from 5% to 6% due to the

increased demand.

Now it gets interesting. With a National debt of 6 trillion watch what happens, ceteris paribus.

6,000 billion 6,300 billion 6,678 billion

x 5% x 6% x 6.25 % Could be called the un-virtuous cycle.

$300 billion $380 billion $417 billion W/o a single additional toy for taxpayers

GS and borrowing increase.

Oh gosh… $6,000 billion plus 300b (interest) plus 150b (revenue loss and increased gs)

6,000 billion 6,450 billion 387 + 150 + 6,450 billion = 6,987

x 5% x 6% x 7%

300 billion 387 billion 489 billion

How lucky was Bill Clinton? He found himself in a virtuous cycle. W/o cutting any programs or raising taxes, he found declining interest rates helping to balance the budget and pushing it into surplus.

6,000 billion 6,000 billion 6,000 billion

x 8% x 7% x 6%

$480 $ 420 $360

Current Account now equals the shortage in US savings needed to finance the budget deficit.

TRY: adding foreign savings to the mix

KEY LEVEL OF UNDESTANDING

X – M determines inflows and outflows.

UNPLANNED INVESTMENTS ARE UNEXPECTED CHANGES IN INVENTORY LEVELS,

EITHER R/M OR FINISHED PRODUCT (unplanned inventory accumulation or depletion)

GOVERNMENT BORROWING INCREASES INTEREST RATES BEYOND WHAT PRIVATE PARTIES WOULD HAVE CREATED

CAPITAL INFLOWS AND OUTFLOWS AFFECTED BY X and M

A recession, contrary to all the popular belief, is defined by the National Bureau of Economic research (NBER) as “ a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.”

THE INTERNATIONAL SECTOR

Looking at the circular flow diagram’s X, M, and Capital inflows and outflows tells you the story

BEA numbers again 2/29/08

Balance of Trade is the Merchandise Account GOODS -837 billion 07

Balance of payments is the Current Account balance, goods, services, earnings, transfers

CURRENT ACCOUNT (hmmm, will be used up now or currently) Table 1. US international Transactions

All except what is in the Capital account

Exports of goods and services +$1,446 billion (2007)

Imports of goods and services -$ 2,204 billion 07

Dividends, Interest , other profits +650 - 613 + 37 billion 07

Remittances ? (Money sent home) ??

Unilateral Transfers (Red Cross, Soc. Sec., military

spending, gov. grants/pensions) - 89 billion 07

CURRENT ACCOUT BALANCE - 707 billion 07

FINANCIAL + CAPITAL ACCOUNT (hmmm, things that will last)

Debt forgiveness, foreign workers’ transfers

Purchases of stocks, bonds, real estate,

buying or building factories +1.860 – 1.055 + 705 billion 07

(direct foreign investment is building factories)

Errors and Omissions ??

Official reserve account

( Central banks exchanging currencies) + 2.4 billion 07

Financial + Capital ACCOUNT BALANCE + 707 billion 07

SUM OF CURRENT, AND FINANCIAL BALANCES $ 0

The BALANCE OF PAYMENTS = $0

Our ultimate goal is to measure GDP. There are two methods used to approach GDP. But first a definition:

MISSES: underground economy (drugs, extortion, prostitution), all products count equally, Income distribution, household work, Government services value are counted at cost, no producer surplus measure

Ten items to review

1. Crowding out

2. Budget deficit, (flow). National Debt, (stock) (income is a flow, savings is a stock)

(river is a flow, lake is a stock)

3. Two methods of approaching GDP, INCOME and EXPENDITURE, maybe if time permits VA.

4. Balance of Trade (merchandise, goods), Balance of Payments (goods and services, current account)

5. Current Account Balance + Financial Account Balance = ZERO

6. Total Investments = Planned Investments + Unplanned Investments

- minus CCA

Net Investments

7. Two methods of approaching GDP, INCOME and EXPENDITURE, maybe if time permits VA.

8. Leakages v. Injections

9. Investments are by Firms/ Households, come from savings

10. Households EARN income, NP=NI

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S = 10% of GDP

S = 11% of GDP

D = hh + Firms

S = 10% of GDP

D’= h+f+g

D = h + f

GOV

Once again, the business cycle can be used to show how we get budget surpluses/deficits, inflation and unemployment, how GDP swells and shrinks, and how imports and exports are affected by cycles of counties.

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Planned Investment in Raw materials inventory

Investment in Plant, land, machinery, equipment

Planned Investment in finished product inventory

THIS IS NOT NECESSARY FOR THE AP EXAM

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