Production, Income, and Employment © 2003 South-Western/Thomson Learning.

Production, Income, Production, Income, and Employmentand Employment

© 2003 South-Western/Thomson © 2003 South-Western/Thomson LearningLearning

Production and Gross Production and Gross Domestic ProductDomestic Product

•GDP: A DefinitionGDP: A Definition•The Expenditure Approach to The Expenditure Approach to

GDPGDP•Other Approaches to GDPOther Approaches to GDP

•Measuring GDP: A SummaryMeasuring GDP: A Summary•Real Versus Nominal GDPReal Versus Nominal GDP

•How GDP Is UsedHow GDP Is Used•Problems with GDPProblems with GDP

Gross Domestic Gross Domestic Product Product

Gross Domestic Product (GDP)Gross Domestic Product (GDP)

The total value of all final The total value of all final goods and services produced goods and services produced for the marketplace during a for the marketplace during a

given year, within the nation’s given year, within the nation’s bordersborders

Stages of ProductionStages of Production

$1.00 (Wood Chips)

$1.50 (Raw Paper)

$2.25 (Notebook

Paper)

$3.50 (Notebook

Paper)

$5.00 (Notebook

Paper)

Lumber Mill

Paper Mill

Office Supplies Manufacturer

Wholesaler Retailer

Gross Domestic Gross Domestic Product Product

Intermediate GoodsIntermediate Goods

Goods used up in producing Goods used up in producing final goodsfinal goods

Final GoodFinal Good

A good sold to its final userA good sold to its final user

Gross Domestic Gross Domestic Product Product

Flow VariableFlow Variable

A measure of a process that A measure of a process that takes place over a period of takes place over a period of

timetime

Stock VariableStock Variable

A measure of an amount that A measure of an amount that exists at a moment in timeexists at a moment in time

Expenditure Expenditure Approach to GDPApproach to GDP

Four categories of output:Four categories of output:•Consumption:Consumption: purchased by purchased by householdshouseholds•Private Investment:Private Investment: purchased purchased by businessby business•Government:Government: purchased by purchased by government agenciesgovernment agencies•Net Exports (NX):Net Exports (NX): purchased by purchased by foreignersforeigners

Expenditure Expenditure Approach to GDPApproach to GDP

Measuring GDP by adding the Measuring GDP by adding the value of goods and services value of goods and services

purchased by each type of final purchased by each type of final useruser

GDP = C + I + G + NXGDP = C + I + G + NX

Consumption SpendingConsumption Spending

Consumption Consumption (C)(C)

The part of GDP purchased The part of GDP purchased by households as final usersby households as final users

Private InvestmentPrivate Investment

Capital Stock:Capital Stock: The total value of The total value of all goods that will provide useful all goods that will provide useful

services in future yearsservices in future years

Private Investment (I):Private Investment (I): The sum of The sum of business plant and equipment business plant and equipment

purchases, new home purchases, new home construction, and inventory construction, and inventory

changeschanges

Net Investment:Net Investment: Total investment Total investment minus depreciationminus depreciation

Government PurchasesGovernment Purchases

Government Purchases (G)Government Purchases (G)

Spending by federal, state, and Spending by federal, state, and local governments on goods local governments on goods

and servicesand services

Transfer PaymentTransfer Payment

Any payment that is not Any payment that is not compensation for supplying compensation for supplying

goods or servicesgoods or services

Net ExportsNet Exports

Net Exports (NX)Net Exports (NX)

Total exports minus total Total exports minus total importsimports

To properly account for output To properly account for output sold to and bought from sold to and bought from

foreigners, net exports must be foreigners, net exports must be included as part of the included as part of the expenditure in GDP.expenditure in GDP.

Other Approaches to Other Approaches to GDPGDP

Value-Added ApproachValue-Added Approach

Measuring GDP by summing Measuring GDP by summing the value added by all firms in the value added by all firms in

the economythe economy

Value Added: Value Added: The revenue a The revenue a firm receives minus the cost of firm receives minus the cost of the intermediate goods it buys.the intermediate goods it buys.

Other Approaches to Other Approaches to GDPGDP

Value-Added ApproachValue-Added Approach

In any year, the value added In any year, the value added by a firm is equal to the by a firm is equal to the

total factor payments made total factor payments made by that firm.by that firm.

Other Approaches to Other Approaches to GDPGDP

Factor Payments ApproachFactor Payments Approach

Measuring GDP by summing Measuring GDP by summing the factor payments made by the factor payments made by

all firms in the economyall firms in the economy

Factor Payments: Factor Payments: Payments to the Payments to the owners of resources that are used owners of resources that are used

in productionin production

Other Approaches to Other Approaches to GDPGDP

Factor Payments ApproachFactor Payments Approach

GDP - the total output of the GDP - the total output of the economy - is equal to the total economy - is equal to the total income earned in the economy.income earned in the economy.

Measuring GDPMeasuring GDP

Expenditure Approach:Expenditure Approach: C + I C + I + G + NX+ G + NX

Value-Added Approach:Value-Added Approach: Sum Sum of value added by all firmsof value added by all firms

Factor Payments Approach:Factor Payments Approach: Sum of factor payments by all Sum of factor payments by all firms =firms = Wages and salaries + Wages and salaries + interest + rent + profit = interest + rent + profit = Total household incomeTotal household income

Real vs. Nominal GDPReal vs. Nominal GDP

Nominal VariableNominal Variable

A variable measured A variable measured withoutwithout adjustment for the dollar’s adjustment for the dollar’s

changing valuechanging value

Real VariableReal Variable

A variable adjusted A variable adjusted for for changes in the dollar’s changes in the dollar’s

changing valuechanging value

How GDP is UsedHow GDP is Used

1.1. In the In the short runshort run, GDP alerts , GDP alerts us to recessions and gives us a us to recessions and gives us a chance to stabilize the chance to stabilize the economy economy

2.2. In the In the long runlong run, GDP tells , GDP tells us whether our economy is us whether our economy is growing fast enough to raise growing fast enough to raise output per capita and our output per capita and our standard of living, and fast standard of living, and fast enough to generate sufficient enough to generate sufficient jobs for a growing populationjobs for a growing population

How GDP is UsedHow GDP is Used

–3–2–1012345678

Year1960 1965 1970 1975 1980 1985

GDP growthneeded for constantunemployment rate

GDP growthneeded for constantoutput per capita

1990 1999 20011995

Actual GDP growth rateReal GDP

GrowthRate

(PercentChange

fromPreviousPeriod)

Problems with GDPProblems with GDP

Nonmarket ProductionNonmarket Production

Goods and services that are Goods and services that are produced, but not sold, in a produced, but not sold, in a

marketmarket

Short-Term ChangesShort-Term Changes

Short-term changes in real Short-term changes in real GDP are fairly accurate GDP are fairly accurate

reflections of the state of the reflections of the state of the economy. economy.

A significant short-term drop A significant short-term drop in real GDP virtually always in real GDP virtually always

indicates a decrease in indicates a decrease in production, rather than a production, rather than a measurement problem.measurement problem.

Employment and Employment and UnemploymentUnemployment

•Types of UnemploymentTypes of Unemployment•The Costs of UnemploymentThe Costs of Unemployment

•How Unemployment Is How Unemployment Is MeasuredMeasured

•Problems in Measuring Problems in Measuring UnemploymentUnemployment

Types of Types of Unemployment Unemployment

Frictional Unemployment Frictional Unemployment Joblessness experienced by people Joblessness experienced by people who are between jobs or who are who are between jobs or who are just entering or re-entering the just entering or re-entering the

labor market.labor market.

Seasonal Unemployment Seasonal Unemployment Joblessness related to changes in Joblessness related to changes in weather, tourist patterns, or other weather, tourist patterns, or other

seasonal factors.seasonal factors.

Types of Types of Unemployment Unemployment

Structural Unemployment Structural Unemployment Joblessness arising from Joblessness arising from

mismatches between workers’ mismatches between workers’ skills and employers’ skills and employers’

requirements, or workers’ requirements, or workers’ locations and employers’ locationslocations and employers’ locations

Cyclical Unemployment Cyclical Unemployment Joblessness arising from changes Joblessness arising from changes in production over the business in production over the business

cyclecycle

Full EmploymentFull Employment

In macroeconomics, In macroeconomics, full full employmentemployment is achieved when is achieved when

cyclicalcyclical unemployment unemployment has been has been reduced to zero. reduced to zero.

But the overall unemployment But the overall unemployment rate at full employment is > zero rate at full employment is > zero because there are still positive because there are still positive

levels of frictional, seasonal, and levels of frictional, seasonal, and structural unemployment.structural unemployment.

Cyclical Cyclical UnemploymentUnemployment

aa

1960 1965 1970 1975 1980 1985 1990 20011995

UnemploymentRate

(Percent)

Year

1

2

3

4

5

6

7

8

9

10

11

Economic Costs of Economic Costs of Unemployment Unemployment

When there is cyclical When there is cyclical unemployment, the nation unemployment, the nation

producesproduces less output, and so less output, and so some group or groups within some group or groups within society must society must consumeconsume less less

output.output.

Economic Costs of Economic Costs of Unemployment Unemployment

Potential OutputPotential Output

The level of output the The level of output the economy could produce if economy could produce if operating full employmentoperating full employment

How Unemployment How Unemployment Is Measured Is Measured

Labor ForceLabor Force

Those people who have a job or Those people who have a job or are looking for oneare looking for one

Unemployment RateUnemployment Rate

The fraction of the labor force The fraction of the labor force that is without a jobthat is without a job

How Unemployment How Unemployment Is Measured Is Measured

Employed

Worked one ormore hours

for pay?

Unemployed

Unemployed

Temporarylayoff?

Searched forwork?

Yes

Yes

Yes

Not inLabor Force

No

No

No

How Unemployment How Unemployment Is Measured Is Measured

Unemployment Rate

Employed) d(UnemployeUnemployedForce Labor

Unemployed

Problems in Problems in Measuring Measuring

UnemploymentUnemploymentInvoluntary Part-Time WorkersInvoluntary Part-Time Workers

Individuals who would like a full-Individuals who would like a full-time job, but who are working only time job, but who are working only

part timepart time

Discouraged WorkersDiscouraged Workers

Individuals who would like a job, Individuals who would like a job, but have given up searching for but have given up searching for

oneone

GDP after September GDP after September 1111

The destruction caused by The destruction caused by the terrorist attacks of 9/11 the terrorist attacks of 9/11

had almost had almost nono direct direct impact on the U.S. impact on the U.S.

economy or the U.S. GDP.economy or the U.S. GDP.

Indirect Impacts on Indirect Impacts on GDPGDP

Short-run impact: Short-run impact: substantialsubstantial

GDP declined more that it GDP declined more that it otherwise would, deepening otherwise would, deepening

a recession already in a recession already in progressprogress

Indirect Impacts on Indirect Impacts on GDPGDP

Long-run impact: Long-run impact: will be will be negativenegative

The nation will shift away The nation will shift away from production of other from production of other

goods/services and toward goods/services and toward security.security.

Potential output will grow Potential output will grow more slowly than it more slowly than it

otherwise would have.otherwise would have.