Econ 341/441

Prof. Sylwester
Gross Domestic Product: Definition

Gross Domestic Product – Total value of all final goods and services produced for the
marketplace within a country during a year.

“final” – sold to the ultimate user, not intermediate inputs.

“intermediate input” – used up to produce final good or service

McDonalds
Beef patties are intermediate inputs
Hamburgers are the final good

Note: labor service in private sector is an intermediate input

“produced” – No pre-existing goods. Not entire stock of assets.

Land is valuable but is not produced so not counted in GDP

“for the marketplace” – GDP misses lots of production such as home production but GDP
measure must be practical. In other words, we would ideally want to count this production but
cannot because it is not practical to monitor it. Would need observer in your home.

“within a county” – No imports. But still count part of a good if that part is produced here and
other parts are produced outside the country.

GDP can be calculated by summing up expenditure: whatever is produced is eventually bought

by someone.

Consumption: Bought by households

Durable goods: Cars, appliances, electronics
Nondurables: Food and clothing
Services: Restaurants, movies, utilities, legal services, etc.

Government Purchases
1) Not all of government spending constitutes purchases. Transfer payments are not
purchases because government is not buying anything.
2) Labor services bought by the government are counted because they will not be
“double-counted” in the future.
Investment – Not stocks and bonds. These are not produced but only involve transfers of wealth
Buildings and machines used to produce output.

Nonresidential Fixed: Buildings/Factories and Machines/Equipment

Residential: Houses and apartment buildings

Inventories – What Wal-Mart has on 12/31/14 was produced in 2014 but not sold then. It
is counted as part of year 2014 GDP

Why is investment counted when intermediate inputs are not? Investment is not “used up” when
making the product. The McDonalds building is not used up when making a hamburger.

Investment tends to be large and expensive as a general rule.

Why are houses a part of investment? Keep with apartment buildings (business). House
provides housing services to the occupant regardless of who owns it. You never rent a house to
yourself but this is the thought experiment.

Net exports – Add in what is produced here even if sold elsewhere while subtracting the C, I, and
G that we buy from somewhere else.

Net Exports = Exports – Imports

Note: the same good can be included in all four categories. Ford builds a car. It is counted as:
Consumption when you buy it
Investment when Hertz buys it
Government purchase when SIU buys it
Export when someone in Mexico buys it

GDP = C + I + G + NX

Note: Calculating GDP is an accounting exercise and should not be given a normative
interpretation. Adding in production (especially due to government purchases) does not mean
that production would not have been higher under some other policy.

GDP: Where was it produced? In America

GNP: Who produced it? By Americans

Also, GDP = wages + interest + profit + rent Whatever is produced, someone gets paid for it
so GDP can also be thought of as a measure of income. (Book gives more detail)
Econ 341/441
Prof. Sylwester
Gross Domestic Product – How to measure it

Nominal GDP – Use current prices for each year.

2013 2014 2015

P Q P Q P Q
Beer $4 10 $5 12 $5 9
Pizza $20 4 $21 5 $30 4

NGDP in 2013 = 4(10) + 20(4) = $120

NGDP in 2014 = 5(12) + 21(5) = $165
NGDP in 2015 = 5(9) + 30(4) = $165

What is “wrong”? Look at 2014 – 15. Quantities decreased but NGDP stayed the same. That
is, we have less production but our GDP measure is saying that production stayed constant.

Solution: Compute Real GDP

Pick a base year. Any year will do but be consistent. Let’s pick 2013.

Use current year quantities but base year prices:

RGDP in 2013 = = 4(10) + 20(4) = $120 In base year: NGDP = RGDP

RGDP in 2014 = 4(12) + 20(5) = $148
GDP in 2015 = 4(9) + 20(4) = $116

This makes more sense.

The advantage of Real GDP: We use GDP to measure production. However, changes in prices
can also cause NGDP to change so when you see NGDP increase by 3% is this because
quantities increased? Prices increased? Both? But only changes in quantities will cause Real
GDP to change because we use the same year’s prices in all calculations.

In practice, economists use Real GDP to calculate how fast output is growing over time. When
you hear: “The economy grew at 3.2% last quarter” the person is basing this upon the growth
rate of Real GDP.
Purpose of Real GDP is to better compare over time – turn “apples to oranges” to “apples to
apples”

Other applications of GDP:

Real GDP per Worker = Real GDP/# of workers

Real GDP per Hour Worked = Real GDP/# of hours worked by all workers

Both are measures of productivity – how much output is a unit of labor providing

Real GDP per capita (or per person) = Real GDP/ Population

How much does each person get on average?

But these measures are not perfect!!!!!

What production is missing?

Home production – What you produce for yourself

Underground Economy – Unreported including illegal market transactions
Distribution of output – Sometimes averages are not representative. Is there a few haves and
many have nots or is output distributed more uniformly across population
Leisure can be thought of something produced but is not counted. Could be important in
comparing livings standards in U.S. versus Western Europe

Still, GDP per Person still highly correlated with other measures of well-being: literacy and
education; life expectancy and other health indicators; cultural events (art, sports, etc.).