Gross Domestic Product (GDP)
The market value of the final goods and services produced in an economy over a certain period of time
National Income Accounting
Method of aggregating the production of diverse goods into a single measure of overall economic activity
National Accounting
State of an economy at a given time
Production Approach
the value of production of final goods and services; calculated at the point of production
Expenditure Approach
- A method of computing GDP that measures the total amount spent on all final goods and services during a given period.
- Most common approach used by economists
- PRODUCTION = EXPENDITURE
Income Approach
A method of computing GDP that measures the income-wages, rents, interest, and profits-received by all factors of production in producing final goods and services. PRODUCTION = EXPENDITURE = INCOME
Economic Profits
- total revenue minus total cost, including both explicit and implicit costs
- unless there is some market power by which firms charge prices above marginal cost, economic profits are 0
National Income Identity
Y = C + I + G + NX
GDP = Consumption + Investment + Government Purchases + Net Exports (exports - imports)
Consumption
- All household goods and services purchases by members of society (not including government)
- Includes durable and non-durable goods
Investment
- Purchasing capital goods
- Purchases by businesses of structures like office buildings, factories, and equipment that produces capital for the business such as computers and machinery
Residential Investment
Also counted as part of investment, it is the construction of new houses (old houses need consumption)
Government Spending
- Government purchases + "transfer" payments + interest payments
- It is only government purchases that are directly involved in new production and are properly recorded as GDP
Durable Goods
Life expectancy of more than 2 years (car, furniture, etc)
Non-Durable Goods (Perishables)
Life expectancy of less than 2 years - disposable (clothing, food, etc)
Transfer Payments
Cash payments made by the government to people who do not supply goods, services, or labor in exchange for these payments. They include Social Security benefits, veterans' benefits, and welfare payments.
Exports
Goods and services produced by US businesses that are shipped abroad and sold to foreigners
Imports
Goods and services produced outside of the US that are imported into the country
Trade Balance
Another word for Net Exports = Exports - Imports
Trade Deficits
- The rest of the world sends more goods to the United States than we send in return
- A way to borrow goods and services from another economy
Capital
- Refers to the inputs into production other than labor that are nor completely used up in the production process.
Ex. Structures like office buildings and factories and equipments like computers and copying machines
- Investments are a way for a firm to
Depreciation
- The cost forgone on a given good or service AKA "wear and tear"
- Part of a businesses income goes towards compensating for depreciation
Net Domestic Product
GDP - Depreciation
The Fraction of GDP Earned by Labor
Two-Thirds (L^2/3)
The Fraction of GDP Earned by Capital
One-Third (K^1/3)
A steel company produces $10M worth of steel that is then used by an automobile company to make $100M worth of trucks
The GDP goes up by $100M because the production approach states that there is no double counting, it is only the cost of final goods and services
Value Added
The gross value of the product minus the costs of raw materials and energy.
GDP per Capita
GDP / Total Population
Nominal GDP
GDP measured in current prices
Price level x real GDP
Increases with price level or real GDP
Pt x Qt = NGDP
Real GDP
GDP adjusted for inflation
Nominal GDP / Price Level
Pbaseyear x Qt = RGDP
Laspeyres Index
the method of computing the change in real GDP with the INITIAL prices
Paasche Index
the method of computing the change in real GDP with the FINAL prices
Fisher Index (Chain Weighting)
The calculated average between Laspeyres and Paasche
Finding Inflation Rate using Laspeyres
1. Find the change in NGDP from year t to year t+1
gNGDP(t+1)-(t)) = NGDP(t+1)-NGDP(t) /NGDP(t)
2. RGDP(t+1) = RGDP(t+1)t - RGDP(t)t / RGDP(t)t
3. Laspeyres Inflation = NGDP(t+1) - RDGP(t+1)
Finding Inflation Rate using Paasche
1. Find the change in NGDP from year t to year t+1
2. RGDP(t+1) = RGDP(t+1)t+1 - RGDP(t)t+1 / RGDP(t)t+1
3. Paasche inflation = NGDP(t+1) - RGDP(t+1)
GDP Deflator
100 X (nominal GDP/real GDP)
Exchange Rate
The price at which one currency is exchanged for another.
Formula for determining exchange rate
$1 = 100 yen
470,000,000,000 yen = $1/100yen = 470,000,000,000 yen / 100 yen = $4,700,000,000
So $ = x yen * exchange rate
Determining how much bigger or smaller a countries economy is compared to the US
US GDP in $ / Countries GDP in US $
US GDP = $7 Trillion
Japan GDP in US $ = 4.7 Trillion
4.7Trillion/7Trillion = .67 x 100 = 67%
The US economy is 67% larger than Japans
The Law of One Price
In an efficient market, all identical goods must have only one price
Purchasing Power Parity (PPP)
A measure of how many units of currency are needed in one country to buy the amount of goods and services that one unit of currency will buy in another country
Exchange Rate of PPP
Price Level US / Price Level of China = PPP
Big Mac in US = $2.50
Big Mac in Japan = 450 yen
Big Mac in Japan in US $ = $2.50 = 450 Y x 1/Ex Rate
= 450 Y / $2.50 = 180Y/$
So the LOP says that $1 = 180 Yen
Japans GDP in US $ = 470 Tril x 1/180 = $2.61 Tril
A car company buys parts from a local distributor for $250,000, assembles the parts and sells the resulting cars for $189,000,000
The GDP would increase by $189,000,000 because it is the final sale price of the cars
A real estate agent sells a house for $400,000 that the previous owners had bought 10 years earlier for $160,000. The agent earns a commission of $24,000
The GDP would only increase by $24,000 because the house being sold was not built that year so the capital gains made by the agent wouldn't count
A new US Airline purchases and imports $50 million worth of airplanes from the European Company Airbus
The GDP would remain unchanged because the purchase of the airplanes would count as an investment of +$50 million but also count as a net export of -$50 million
During the Great recession, the government raised unemployment benefits by $340 million
The GDP would remain unchanged because transfer purchases do not count towards the GDP
A chocolate factory buys $100,000 worth of chocolate form Switzerland and sells it in American stores for $140,000
The GDP would increase by $40,000 because the purchase of chocolate from Switzerland would count as a net export of -$100,000 but the sale of chocolate for $140,000 would count as a positive investment.
On January 1, you purchase 10 gallons of gasoline at $3.82 per gallon. The gas station purchase the gasoline the previous week at a wholesale price of $3.42 per gallon
The GDP would increase by $4 because the gas stations investment of 10 gallons of gas for $3.42 = $34.2 and my consumption of 10 gallons of gas for $3.82 = $38.2 and 38.2-34.2 = $4.