Economic Performance: Key

Q’s
• What is gross domestic product (GDP)?
• How is GDP calculated? (2 methods)
• What is the difference between nominal and
real GDP?
• What are the limitations of GDP measurements?
• What are other measures of income and output?
• What factors influence GDP?

• Key Concept: National income accounting

provides a conceptual framework. Categories
and vocab from nat’l income is used by
economists in assessing the macroeconomy.
 Factoids
• The United States has the highest Gross
Domestic Product in the World. In 1997,
it reached $8.1 TRILLION, up from $5.7
Trillion in 1990.
• Economists monitor the macroeconomy
using national income accounting, a
system that collects statistics on
production, income, investment, and
savings. The United States looks very
good on paper, as you will find out.
 Gross Domestic Product—
The Measure of Domestic
Output
• Gross domestic product (GDP) is the dollar
value of all FINAL goods and services produced
within a country’s borders in a given year.
Invented in 1930s to measure depression.
• GDP does not include the value of intermediate
goods. Intermediate goods are goods used in
the production of final goods and services. EX:
Wood that’s cut into a baseball bat, but before
it’s sanded, stamped, or the lacquer is put on is
an intermediate good.
• Secondhand sales are excluded. Garage sales
don’t count as GDP!
• Increase in GDP= Economic Growth
• National Income and Product Accounts (NIPA)
are maintained by the Department of
Commerce’s Bureau of Economic Analysis (BEA)
 2 Methods of Calculating
GDP
The Expenditure Approach The Income
Approach
• The expenditure approach totals
annual expenditures on four The income
categories of final goods or approach
services. C+I+G+F calculates GDP by
adding up all the
1. consumer goods and services
incomes in the
2. business goods and services economy.
3. government goods and services
4. net exports or imports of goods
or services.

Consumer goods include durable

goods, goods that last for a
relatively long time like
refrigerators, and nondurable goods,
or goods that last a short period of
time, like food and light bulbs
 The Income Approach:
Add the following to get GDP
• Wages and Salaries
• Proprietors’ income
• Rental income
• Interest income
• Corporate Profits
• Indirect Business Taxes
• Depreciation
 Real and Nominal GDP
• Nominal GDP is GDP • Real GDP is GDP
measured in current expressed in
prices. It does not constant, or
account for price level unchanging, dollars.
increases from year to
year. Nominal and Real GDP
Year 1 Year 2 Year 3
Nominal GDP Nominal GDP Real GDP

Suppose an economy‘s entire In the second year, the economy’s To correct for an increase in
output is cars and trucks. output does not increase, but the prices, economists establish a set
prices of the cars and trucks do: of constant prices by choosing
This year the economy produces: one year as a base year. When
10 cars at $16,000 each = $160,000 they calculate real GDP for other
10 cars at $15,000 each = $150,000 years, they use the prices
+ 10 trucks at $21,000 each = $210,000
+ 10 trucks at $20,000 each = $200,000 from the base year. So we
Total = $370,000
Total = $350,000 calculate the real GDP for Year 2
This new GDP figure of $370,000 using the prices from Year 1:
Since we have used the current is misleading. GDP rises because 10 cars at $15,000 each = $150,000
year’s prices to express the of an increase in prices. + 10 trucks at $20,000 each = $200,000
current year’s output, the result Economists prefer to have a
is a nominal GDP of $350,000. measure of GDP that is not Total = $350,000
affected by changes in prices. So Real GDP for Year 2, therefore,
they calculate real GDP. is $350,000
 Calculating Nominal GDP

• Suppose the following:

• GDP 1990= $5.7 Trillion
• GDP 2001= $8.1 Trillion
• If inflation averaged 4%/year, had REAL GDP grown?
• Real GDP grows if GDP increase > inflation rate
• ($8.1 trillion/ $5.7 trillion)= 42.1% growth in GDP
• Inflation rate 3%/year * 11 years= 33% increase
• Real GDP increased during the 1990s. Got reasons?
 Other Income and Output
Measures
Gross National Product (GNP)--GNP is a measure of the
market value of all goods and services produced by
Americans in one year.
Net National Product (NNP)--NNP is a measure of the
output made by Americans in one year minus
adjustments for depreciation. Depreciation is the loss
of value of capital equipment that results from normal
wear and tear. NNP is always lower than GNP.
National Income (NI)--NI is equal to NNP minus sales and
excise taxes. NI is lower than NNP.
Personal Income (PI)--PI is the total pre-tax income paid
to U.S. households.
Disposable Personal Income (DPI)--DPI is equal to
personal income minus individual income taxes. It’s
what you have left after taxes that you can spend.
 Key Macroeconomic
Measurements
Measurements of the Macroeconomy

–
income earned outside income earned by foreign
Gross Domestic
Product + U.S. by U.S. firms and
citizens
firms and foreign citizens
located in the U.S. = Gross National
Product

–
Gross National depreciation of Net National
Product
capital equipment
= Product

Net National
Product – sales and excise taxes
= National Income

• firms‘ reinvested profits

National Income
– • firms‘ income taxes
• social security + other household income
= Personal Income

Personal Income – individual income taxes

=
Disposable
Personal Income
 The Output-Expenditure Model:
A 2nd Way of Figuring GDP! Oh
boy!
• GDP= C + I + G +F where:
• C= Consumer Expenditures (rent, groceries, cars,
clothes, etc.) -- accounts for two-thirds of all
economic activity in the United States
• I= Business Investment in plants, offices,
equipment, inventories, and other capital goods
• G= Government Spending on national defense,
income security, national debt interest, health
care, roads, education, etc. Transfer payments
DO NOT count. Why?????????
• F= NET Foreign Trade (Foreign purchases minus
foreign imports—usually a negative number)
 Limitations of GDP
(What GDP fails to take into
account)
• Nonmarket Activities--GDP does not measure goods and
services that people make or do themselves, such as caring
for children, mowing lawns, or cooking dinner. Doesn’t
measure “psychic income.”
• Negative Externalities--Unintended economic side effects,
such as pollution, have a monetary value that is often not
reflected in GDP. Externalities inflate GDP. WHY?
• The Underground Economy--There is much economic activity
which, although income is generated, never reported to the
government. Examples include black market transactions
and "under the table" wages. GDP is undercounted here.
• Quality of Life--Although GDP is often used as a quality of
life measurement, there are factors not covered by it.
These include leisure time, pleasant surroundings, and
personal safety. GDP tells us nothing about product quality.
 Section Review—Nat’l
Income Accounting
1. Real GDP takes which of the following into
account?
(a) changes in supply
(b) changes in prices
(c) changes in demand
(d) changes in aggregate demand

2. Which of the following is an example of a

durable good?
(a) a refrigerator
(b) a hair cut
(c) a pair of jeans
(d) a pizza
 Inflation
• Inflation—A rise in the GENERAL PRICE LEVEL. Not
a rise in the price of 1 good or a group of goods.
• Purchasing power, the ability to purchase goods
and services, is decreased by rising prices.
• Price level is the relative cost of goods and services
in the entire economy at a given point in time.
• Example: Cars, clothing, and most other consumer
goods have increased in price since you were born.
• Some prices increase faster than others (milk
prices per gallon have blown away gasoline prices
when it comes to inflation—both were 79 cents in
1979)
 Price Indexes
A price index is a measurement that shows how the
average price of a standard group of goods changes
over time.
• The consumer price index (CPI) is computed each
month by the Bureau of Labor Statistics. May 2002
was 0.5%--6% annual inflation. Yikes!
• The CPI is determined by measuring the price of a
standard group of goods meant to represent the
typical “market basket” of an urban consumer. 1982-
84 base.
• Changes in the CPI from month to month help
economists measure the economy’s inflation rate--the
percentage change in price level over time.
• The Producer Price Index (PPI) has a base year of
1982 and samples 100,000 commodities used as
inputs.
• You may also hear of the “GDP Deflator.” It measures
the same thing—inflation—so you can calculate real
 Calculating Inflation

To determine the inflation rate from one year to

the next, use the following steps:

(CPI for Year A – CPI for Year B) /( CPI for Year B)

*100
• For example:
• If the CPI for 1998 (Year A) = 163 and the CPI
for 1997 (Year B) = 160.5….then

(163 – 160.5) = 2.5 ÷160.5 = 0.156 * 100 = 1.6

The inflation rate for 1998 was 1.6%.
 Economic Growth: Focus
Questions
• How do economists measure economic
growth?
• What is capital deepening?
• How are saving and investing related to
economic growth?
• How does technological progress affect
economic growth?
• What other factors can affect economic
growth?
 Measuring Economic
Growth
The basic measure of a nation’s economic growth rate is
the percentage change of real GDP over a given period
of time.
GDP and Population Growth
• In order to account for population increases in an
economy, economists use a measurement of real GDP
per capita. It is a measure of real GDP divided by the
total population.
• Real GDP per capita is considered the best measure of
a nation’s standard of living.
GDP and Quality of Life
• Like measurements of GDP itself, the measurement of
real GDP per capita excludes many factors that affect
the quality of life.
 Capital Deepening
• The process of increasing the amount of
capital per worker is called capital
deepening. Capital deepening is one of
the most important sources of growth in
modern economies.

• Firms increase physical capital by

purchasing more equipment. Firms and
employees increase human capital
through additional training and education.
 The Effects of Savings &
Investing
• The proportion of How Saving Leads to Capital Deepening

disposable income spent to Shawna’s income: $30,000

income saved is the savings

rate. $25,000 spent $5,000 saved

• When consumers save or

$3,000 in a mutual
invest money in banks, their
$2,000 in “rainy day”
fund (stocks and bank account
corporate bonds)

money becomes available

for firms to borrow or use.
Bank lends Shawna’s
Mutual-fund firm makes
money to firms in forms
Shawna’s $3,000
such as loans and
available to firms
This allows firms to deepen mortgages

capital. In the long run,

Firms spend money
more savings will lead to on business capital
investment

higher output and income

for the population, raising
GDP and living standards.
 The Effects of Technology
• Besides capital deepening, the other key source of
economic growth is technological progress.
• Technological progress is an increase in efficiency gained
by producing more output without using more inputs.
• A variety of factors contribute to technological progress:

Innovation When new products and ideas are successfully

brought to market, output goes up, boosting GDP and
business profits.
Scale of the Market Larger markets provide more
incentives for innovation since the potential profits are
greater.
Education and Experience Increased human capital makes
workers more productive. Educated workers may also
have the necessary skills needed to use new technology.
 Other Factors Affecting
Economic Growth
Population Growth--If population grows while the
supply of capital remains constant, the amount of
capital per worker will actually shrink.
Government--Government can affect the process of
economic growth by raising or lowering taxes.
Government use of tax revenues also affects growth:
funds spent on public goods increase investment,
while funds spent on consumption decrease net
investment.
Foreign Trade--Trade deficits, the result of importing
more goods than exporting goods, can sometimes
increase investment and capital deepening if the
imports consist of investment goods rather than
 Section 3 Review
1. Capital deepening is the process of
(a) increasing consumer spending.
(b) selling off obsolete equipment.
(c) decreasing the amount of capital per worker.
(d) increasing the amount of capital per worker.

2. Taxes and trade deficits can contribute to

economic growth if the money involved is spent
on
(a) consumer goods.
(b) investment goods.
(c) additional services.
 Population in the United
States
• Remember our buddy Malthus?
• Census Bureau performs constitutionally-mandated
Census every 10 years since 1790. It also conducts
monthly surveys.
• The Bureau tabulates data in 2 classifications: urban
and rural.
• Population continues to grow in the U.S., but the rate of
growth has fallen since 1860. 2000 rate= 0.9%. Smaller
households, especially among white Americans.
• Population center has also shifted—to the south & west.
• Debate in 2000—sampling or count? Politically charged!
• Democrats say sampling is more scientific, would count
more minorities and homeless in inner cities
• Republicans want “count,” win in court
 Factors Affecting Population
Growth
• Fertility rate: Number of births per 1000 women
during their lifetime. Currently about 2,119
(2.12/woman). Vastly different for whites, blacks,
and hispanics. Why so low nowadays?
• Life expectancy: average remaining life span of
people who reach a certain age. Currently 75.9, will
rise to 82.1 by 2050.
• Net immigration (About + 880,000 people/year)
• Who cares? Well, businesses and government need
to plan.
• What might be some demographic trends that need
to be noticed? Need for more medical supplies and
drugs, less need for police protection if majority of
 Population
Projections/Demographics
• The aging “baby boomer” population will drive
most characteristics (baby boom was 1946-64).
• Trouble is coming as baby boomers retire starting
in 2011. In 2012, Social Security will be paying
out more money than it takes in.
• The Dependency ratio will increase—from 63.9 in
1998 to 80.0 by 2040. DR= # of children and
elderly per 100 persons 18-64.
• More widows as people life longer, but women live
way longer. If anyone mentions “Tadpole,” I will
hit you.
• By 2050, whites will be a bare majority (52.7%).
Asian population will grow 5X, Hispanic will double
 Immigration in the U.S.
• Old immigrants—from N. and W. Europe. Blended
easily. Came before 1880. Most were Protestant.
• New Immigrants—from S. and E. Europe, came 1880-
1924. Spoke different languages, darker, had different
religions, took longer to blend but were successful
• It is true immigrants helped build this country. EX:
Chinese laborers and Transcontinental RR
• Significant immigrants include: Albert Einstein, Bob
Hope, Joseph Pulitzer, Felix Frankfurter, Enrico Fermi,
Samuel Gompers, Madeleine Albright, John Audubon,
Cary Grant, Sonja Henie, Werner von Braun, and
Alexander Hamilton. Immigration has been good.
• BUT, We must look at this academically and realize
there is a downside. Diversity in other countries has
posed severe problems—Yugoslavia, even Quebecois
in Canada. As the US changes, ethnic conflict will
result
 Section Review--
Population
• 1. What will likely happen to the
percentage of the population of
the United States that lives in
Michigan over the next 20-50
years?
• 2. Why is knowing population
demographics important to the
average businessman or politician?
 More on Economic Growth
• Now, we know that not every country has the
U.S.’s standard of living, or quality of life
• Compare U.S. and India Nominal GDP
• U.S.= $8.1 Trillion. India= $500 Billion. (It’s
that big? $500 Billion is nothing to shake a
stick at)
• Real GDP stats are still not perfect. To get the
true picture, you need to determine
• Real GDP per capita
• In other words, divide Real GDP by the # of
people
• U.S.=$29,000 per capita
Why Economic Growth is Not Only
Important, But Actually A Cure-All
• Economic growth in the U.S. helps everyone in the world
—not just Americans.
• Tax revenues increase with more earnings. Healthier tax
bases mean government can provide more services or
tax cuts. During the 1980s, revenue doubled in 8 years
with tax cuts. You need investment for growth—why do
you think we love British and Japanese capital? The
British know they get a good return on their
investments! And then we tax the growth and play the
game all over again IF WE DON’T TAX TOO MUCH.
• Economic growth solves domestic problems (poverty is
the source of so many social problems—drugs,
unsupervised kids, wages rise because demand for labor
increases)
• We can help other nations more if we are well-off.
• A healthy U.S. capitalistic system is an excellent role
model for the world, especially for China, a definite
 Factors Influencing Growth:
What do we do to get that
growth??
• Land—Conserve our own natural resources, make use of
renewable resources, and use everyone else’s resources
• Capital—Keep capital-to-labor ratio high. Capital
investments are a better choice than immediate
consumption
• Labor—Educate labor force and keep population
growing. Much 1900s economic growth is due to women
working outside the home, although society has paid for
that
• Entrepreneurs—create incentives for entrepreneurs (low
government regulation, low taxes) Best example of why
this works: The Internet
• Improve productivity so we can shift resources to other
areas. EX: Mazda plant in Japan makes cars robotically,
allows release of labor to make whatever else.
 Section Review—
Peculiarities of Economic
Growth
• Which U.S. President was hurt by going
along with a tax increase, and a recession
that actually cleared up by election day?
• In layman’s terms, define “standard of
living”