Chapter 12

Gross Domestic Product and Growth

Standards

• Standard 18 – Students will understand that: A nations’ overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy

Macroeconomics

• Macroeconomics is the study of the economy of the nation as a whole.

• It examines the effects of events on the economy in aggregate.

• Aggregate means total, or with all elements taken together.

• Macroeconomic issues: Unemployment, GDP, Inflation, Economic growth, Monetary Policy, Fiscal Policy

Gross Domestic Product: Measuring Economic Growth

Economic Performance- Measurements are used to evaluate the performance of the economy

Ways that a nation’s income is calculated• National income- sum total of all income earned in

the country• National output- sum of all goods and services

produced in a country• Gross Domestic Product- total dollar value of all

goods and services produced within a country during one calendar year

• GDP can be a limited measuring tool because sometimes it is not accurate, the data is measured after the fact, there are non-market activities like the underground economy or black market.

Gross Domestic ProductHow do you calculate GDP:Measuring GDP is complicated, but at its most basic, the

calculation can be done in one of two ways: 1) adding up what everyone earned in a year (income approach)2) adding up what everyone spent (expenditure method).

Logically, both measures should arrive at roughly the same total.

GDP measures growth, but more money doesn’t mean more happiness

If there is an unequal distribution of wealth then people are less happier

France and Denmark = happierUnited States = unhappier

Gross Domestic Product

• GDP = C + I + G + (X-M)• G = Government spending• I = Investment• The largest sources of money is (C)

Consumer Sector• X = Exports

M = Imports• GDP adjusted for inflation is known as Real

GDP because inflation reduces the value

What is included in GDP?

CategoriesC- Personal Consumption Expenditure

Consumer purchases (largest part of GDP)

Durable & Nondurable goods

I- Gross Investment Total value of all capital goods.

Changes in the dollar value of business inventories.

G-Government Purchases of goods and services

I.e.- national defense, highways, public education.

X-M Net export of goods and services

Includes the value of goods and services made in the U.S. but sold elsewhere.

Does not include the value of goods made in other countries but consumed here. (These are subtracted out.)

Can be a positive or negative number.

Excluded from GDP• GDP does not take into account certain economic activities,

such as:

1. Nonmarket Activities: GDP does not measure goods and services that people make or do themselves, such as caring for children, housework, mowing lawns, or cooking dinner.

GDP ignores: household work, barter, financial transactions such as buying stock, and transfer payments such as Social Security.

2. Transfer payments: payments from the government like Social Security or welfare.

3. Securities payments: income on stocks or bonds.

4. Underground (black market): includes illegal activities as

well as questionable, or gray, ones (not quite legal, but not exactly illegal).

Ex. Cash only transactions that never get reported to the IRS: mowing lawns, babysitting, garage sales, flea markets, or unlicensed businesses working out of homes.

What it the economic effect of a recession on the underground economy? It tends to grow when the economy is weak. Cash transactions replace reported purchases and income.

5. Not sold this year or secondhand sales:

When a product is resold from one person to another no new wealth is created. If a product is not sold it cannot be included in this year’s GDP. Therefore, only the original sale is included in GDP.

6. Intermediate Products: products used to make other products

• Example: lumber to build a house

7. Also: a) income distribution, b) quality of life, c) standard of living, d) intangibles (feeling secure) – all of which are important factors to citizens

A business cycle is a macroeconomic period of expansion followed by a period of contraction.

What Is a Business Cycle?

• A modern industrial economy experiences cycles of good times, then bad times, then good times again.

• Business cycles are of major interest to macroeconomists, who study their causes and effects.

• There are four main phases of the business cycle: expansion, peak, contraction, and trough.

Phases of the Business

Cycle

Expansion- An expansion is a period of economic growth as measured by a rise in real GDP. Economic growth is a steady, long-term rise in real GDP.

Peak- When real GDP stops rising, the economy has reached its peak, the height of its economic expansion.

Contraction- Following its peak, the economy enters a period of contraction, an economic decline marked by a fall in real GDP. A recession is a prolonged economic contraction. An especially long or severe recession may be called a depression.

Trough- The trough is the lowest point of economic decline, when real GDP stops falling.

What Keeps the Business Cycle Going?

• Business cycles are affected by four main economic variables:

Business InvestmentWhen an economy is expanding, firms expect sales and profits to keep rising, and therefore they invest in new plants and equipment. This investment creates new jobs and furthers expansion. In a recession, the opposite occurs.

Interest Rates and CreditWhen interest rates are low, companies make new investments, often adding jobs to the economy. When interest rates climb, investment dries up, as does job growth.

Consumer ExpectationsForecasts of a expanding economy often fuel more spending, while fears of recession tighten consumers' spending.

External ShocksExternal shocks, such as disruptions of the oil supply, wars, or natural disasters, greatly influence the output of an economy.

Forecasting Business Cycles

• Economists try to forecast, or predict, changes in the business cycle.

• Leading indicators are key economic variables economists use to predict a new phase of a business cycle.

• Examples of leading indicators are stock market performance, interest rates, and new home sales.

Business Cycle Fluctuations

The Great Depression– The Great Depression was the most severe downturn in the nation’s history.– Between 1929 and 1933, GDP fell by almost one third, and unemployment rose to about 25 percent.

Later Recessions– In the 1970s, an OPEC embargo caused oil prices to quadruple. This led to a recession that lasted through the 1970s

into the early 1980s.

U.S. Business Cycles in the 1990s– Following a brief recession in 1991, the U.S. economy grew steadily during the 1990s, with real GDP rising each year.

The basic measure of a nation’s economic growth rate is the percentage change of real GDP over a given period of time.

Measuring Economic GrowthGDP 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.

Per Capita GDP- GDP of a country divided by the population. Is often a useful measurement of standard of living

• Standard of living is a rough estimation of the quality of life that people in a country are able to afford.

• GDP is not always an accurate measure of standard of living because some countries do not have an even distribution of wealth

SWI/GDPCountry

Basic Human Needs Rank

Well-Being Opportunity Life Expectancy

1/22. Sweden

5 3 2 83

2/6. England

6 2 5 81

4/11. Canada

3 11 4 82.5

6/1. United States

7 16 10 79.8

30/2. China

22 31 35 72.1

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.

How Saving Leads to Capital Deepening

Shawna’s income: $30,000

$25,000 spent $5,000 saved

Mutual-fund firm makes Shawna’s $3,000 available to firms

Bank lends Shawna’s money to firms in forms

such as loans and mortgages

$3,000 in a mutual fund (stocks and corporate bonds)

$2,000 in “rainy day” bank account

Firms spend money on business capital

investment

The Effects of Savings and Investing

• The proportion of disposable income spent to income saved is called the savings rate.

• When consumers save or invest, money in banks, their money becomes available for firms to borrow or use. This allows firms to deepen capital.

• In the long run, more savings will lead to higher output and income for the population, raising GDP and living standards.

The Effects of Technological Progress

• 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 GrowthPopulation 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 consumer goods.