Honors Economics Unit II Part B

•Gross domestic product (GDP) is the most commonly used NIPA—it calculates the total dollar value of all final goods & services produced within a country in a year
–Calculates total production, or output

•Final output
–To avoid counting products more than once, economists include only the value of final goods & services when calculating GDP
•Example: Table is final product of
–Woodcutter (cuts down tree)
–Sawmill (processes tree into lumber)
–Furniture manufacturer (makes table)
•Tree & lumber are intermediate products—goods & services used to make other products
–Intermediate product value is built into cost of table

•Current year
–Does not include products such as used cars or secondhand clothing
–GDP is a gauge of production—not sales
•Output produced within national borders
–Does not include products produced by U.S. companies in factories outside the U.S.
–Does include output of foreign workers & firms within the U.S.
•Example: Japanese-owned Nissan factory in Tennessee

•How is GDP determined?
–Economists add the output produced by
•Personal consumption expenditures (C)
•Gross investment (I)
•Government purchases of goods & services (G)
•Net exports of goods & services, or exports minus imports (X - M)
by using the output-expenditure model
•C + I + G + (X – M) = GDP
•C+I+G+NX=GDP

•Personal consumption expenditures
–Consumer purchases
•Durable goods
–Have a useful lifetime of more than a year, such as cars & computers
•Nondurable goods
–Have a short useful lifetime, such as groceries & cosmetics
•Services
–Such as medical care, entertainment & public education
–Fastest growing area of consumer expenditures

•Gross Investment
–True investment is the use of money to produce new capital goods
–Gross investment is the total value of all capital goods produced in a given nation during one year
•Includes changes in the dollar value of business inventories
•Does not include the purchase of financial assets—such as stocks, bonds, and land that do not result in the production of new goods or services

•Gross Investment
–2 subcategories
•Fixed investment
–Spending on residential structures, nonresidential structures such as office space & factories, & capital goods such as new machinery & office equipment
•Inventory investment
–Refers to the increase or decrease in the total dollar amount of the stock of raw materials, intermediate goods, and final goods of domestic businesses during a given period

•Government purchases
–Total dollar value that federal, state, & local governments spend on goods & services such as
•Highways
•Public education
•National defense
–Transfer payments, such as Social Security payments & government aid, expenditures for which the government receives no goods or services in exchange, are not included

•Net exports
–Total U.S. exports minus total U.S. imports
•Includes the value of goods & services produced domestically but sold in other countries (exports) & does not include goods & services produced in other countries but purchased locally (imports)
•As some goods & services included in GDP are produced in other countries, and some items produced in U.S. are sold in other countries & fail to get included in the other components of GDP, economists subtract total imports from total exports
•What if a product’s price increases during the year or into the next year?
–Nominal GDP, or current GDP, is GDP expressed in the current prices of the period being measured
–Real GDP is GDP adjusted for price changes (inflation)
•Calculating Real GDP helps economists to determine if production increased or decreased
–A price index is a set of statistics that allows economists to compare prices over time

•Accuracy & timeliness of data
–Economists use sampling techniques to determine prices & quantities
–Gathering data is slow & time-consuming
–GDP & NIPAs are only approximations of total output & income
•Nonmarket activities
–GDP does not measure exchanges of goods & services that are not market transactions (some output does not get paid for, or may begin payment for additional goods/services midway through year)

•Underground activity
–Underground activity is illegal activities & unreported legal activities (although it is illegal not to report it)
•“Goods” & “Bads”
–The value of many things that make for a better society are often not accounted for, while things that make a society worse, are
–GDP is an imperfect reporter of economic well-being
•Example: Car emissions standards & regulations that prohibit development in ecologically sensitive areas reduce GDP but improve the nation’s well-being
•Some economists propose assigning positive values to “goods” such as leisure & urban renewal, and negative dollar values to “bads” such as pollution & traffic congestion

•Gross national product
–Stopped being used in 1991
–GNP measures the total dollar value of all final output products with factors of production owned by residents of a country during one year
•Example: If production in Russia involves any capital owned by U.S. residents, it would be counted as part of the U.S. GNP
•GDP more accurately represents short-term resource use changes in the economy
–GDP used by the United Nations & most other countries—so the Commerce Department switched to GDP

•Net national product
–As GNP includes money invested in capital goods, it also includes money spent on replacing outdated or defective equipment
–When this depreciation is subtracted from GNP, the result is a nation’s net national product

•National income
–The sum of employees’ & proprietors’ income, real & estimated rental income, corporate profits, & net interest
–Economists subtract subsidies & indirect taxes from net national product
•Personal income
–To determine the amount of income people in a nation earn, economists will subtract income not given to people, such as profits that firms keep & reinvest & money spent on corporate income taxes & employee’s Social Security
–Economists then add money given from government transfer funds such as Social Security to determine income paid to individuals in a nation

•Disposable personal income
–Disposable income is the amount of money an individual has after deductions such as Social Security & income tax are taken out.
–Economists subtract personal taxes & nontax payments from personal income
•Personal taxes include:
–Income, estate, gift, property, and motor vehicle taxes
•Nontax payments include:
–Fines & passport fees

•Business cycles are changes in a market system’s economic activity
–These changes are measured in real GDP
–Durations of upswings or downswings can last for months or years

•Phases of the business cycle
–Expansion is a period of economic expansion & growth
•Example: occurred during WWII because of high levels of spending on military
–Peaks occur as the highest point of expansion—a time when the economy is the most prosperous
•Consumer demands calls for producers to increase plant capacity & hire more workers

•Phases of the business cycle
–Contraction, or recession, is the point at with businesses slowdown
–Recessions occur when there is a decline in real GDP for 2 or more consecutive quarters (6 months or more)
–Depressions are the next step, and are a prolonged & severe recession
•Example: Great Depression of 1930s
–Troughs are the final phase of the business cycle, at which businesses reach their lowest levels
•Troughs are usually followed by a period of economic recovery

•Business investment
–Businesses invest in capital goods to increase their production (Ex.: new machinery)
–High levels of business investment promote expansion
–Low levels of investment contribute to contractions
–Business investment creates:
•Demand for goods
•Efficiency as new capital promotes better production methods
•Stimulates technological change and higher output at lower production costs

•Money & credit
–Total output changes with the availability & affordability of credit
–Individuals & businesses tend to borrow when interest rates are low
•Public expectations
–Does the consumer believe the economy is heading toward a recession or expansion?—this will influence spending
–The same goes for business owners

•External factors
–Such as changes in the world’s economic or political climate
•Example: Increases in world oil prices in 1973-74 & 1979-80 contributed to recessions in 1974-75 & 1980-92
–Wars generally strengthen business activity in the U.S. as the government spends money on national defense
•Periods of expansion accompanied U.S. involvement in WWI, WWII, and both Korean & Vietnam Wars

•Leading indicators
–Leading indicators are used by economists that anticipate the direction the economy is headed
•Such as the number of building permits issued
•The number of orders of new capital & consumer goods
•The price of raw materials & stock prices

•Coincidental indicators
–Coincidental indicators are factors that change as the economy moves from one phase of the business cycle to another
–Tells economists is there is an upturn or downturn in economy
–Includes:
•Personal income
•Sales volume
•Industrial production levels

•Lagging indicators
–Lagging indicators are indicators that change monthly after an upturn or a downturn in the economy has begun
•Help economists predict the duration of an economic upturn or downturn
•Include:
–Use of consumer installment credit
–Number & size of business incomes

•As in the number of wins & losses a sports team has, the final outcome of more wins than losses is the most important factor, so is the final outcome—more ups than downs—for an economy
•If there are more ups than downs, an economy will experience growth