Lecture Outlines - Week 2

Recent Trends and Relationships in the US Economy

Overview:

• Answer the "What, How, and For Whom" questions for the U.S. economy
• Learn more economic fundamentals, such as measurement of economic output and inflation

1. What does the U.S. produce?

What is Gross Domestic Product (GDP)?

GDP is a measure of the monetary value of a country's output of final goods and services. How is GDP different from GNP? Essentially, GDP is measured by multiplying price times quantity for all final goods and services in produced within a country's borders in a given year.

There are two ways of measuring GDP:

• Nominal GDP: GDP measured in current dollars.
• Real GDP: GDP adjusted for inflation.

First let's talk about nominal GDP. As of the middle of 2000, nominal GDP was $9,942.9 billion. In the middle of 1999 nominal GDP was $ 9,191.5 billion. By what percentage did nominal GDP increase in that year?

100*[GDP(00) - GDP(99)]/GDP(99) = 100*[9,942.9-9191.5]/9191.5 = 75,100/9191.5 = 8.175 percent.

Data source, nominal GDP: http://www.economagic.com/em-cgi/data.exe/feddal/gdp+1 (Economagic.com)

What caused nominal GDP to increase? An increase in overall prices or an increase in output?

Why should we care whether GDP increases due to an increase in overall prices or an increase in output?

Inflation is the term used for an increase in the overall price level. Inflation can be measured across the economy as a whole (GDP deflator), consumer goods and services (consumer price index), intermediate goods (producer price index), or sectors (healthcare, higher ed., etc.).

Inflation reduces the purchasing power of a given amount of money. A dollar used to buy four candy bars, now it barely buys one.

Increases in nominal GDP due to inflation does not indicate growth in the economy, and therefore does not indicate increases in aggregate material prosperity. How can we remove the effects of inflation from GDP?

Real GDP measures current domestic output of goods and services, but holds prices constant by using prices from a past base year, such as 1996. Increases in real GDP indicates economic growth because prices have been held constant, and therefore real GDP cannot increase due to the effects of inflation.

How do we measure inflation and real GDP?

I. Inflation: Recall that inflation is the annual rate at which the average price level in an economy increases. Here is how inflation can be measured:

1. Select a fixed bundle of goods and services (e.g., a pound of tofu, a 4-door sedan, a loaf of bread, a pair of running shoes, a sweatshirt, tax preparation services, 100 tablets of aspirin).

2. Determine the price of this bundle of goods and services in a base year, such as 1996.

3. Determine the price of this same bundle of goods and services in each subsequent year.

4. Determining the annual rate of inflation for a given year, such as 1999, can be done in several ways.

4.a. One way is to take the difference between the price of the bundle at the end of 1998 by the price of the bundle at the end of 1999, and divide this difference by the price of the bundle at the end of 1998. Finally, multiply this figure by 100:

4.b. The federal government computes a price index, and uses this price index to derive the inflation rate.

II. Back to real GDP. We can compute real GDP by taking 2000's quantity of goods and services and multiplying them by what they would have cost in a base year, such as 1996. We can also compute real GDP by dividing nominal GDP by the price index. Note that recently the federal government has started using a more complicated "chain-weighted" price index.

The most recent estimate (second quarter estimate) for real GDP for 2000 is $ 9,311.5 billion. According to the http://www.whitehouse.gov/fsbr/output.html (Economic Statistics Briefing Room), real GDP increased by 5.3 percent. This is the rate of economic growth.

Recall that nominal GDP increased by about 8.2 percent. The difference between the growth rate in nominal GDP and the growth rate in real GDP provides a rough indication of the inflation rate.

Components of GDP: In the circular flow of a market economy, all spending (by consumers, business, government, and net export sales) becomes income for owners of the factors of production (land, labor, capital). Therefore GDP measures both spending and income.

Which category of spending do you think is largest? Consumption spending by consumers is approximately 68 percent of all spending in the economy. Next is spending by government on goods and services (not transfers of income from one to another) at 18 percent, followed by business spending at 15 percent. Net exports are (exports - imports) and have been slightly negative for some time.

Per-capita real GDP: Provides a rough indication of living standards.

In 2000, per-capita real GDP in the U.S. was $9,311,500,000,000/275,372,000 = $33,814.26.

Comparison: Mexico's per-capita real GDP in 1999 was $8,500, Russia's per-capita real GDP in 1999 was $4,200, Sweden's was $20,700, Switzerland's was $27,100, Nepal's was $1,100, and Tanzania's was $550. Source: http://www.cia.gov/cia/publications/factbook/index.html (CIA Factbook)

Problem: If incomes are quite unequal (Bill gates vs. you), then to what extent does per-capita real GDP indicate the average person's living standards?

If real GDP grows faster than a country's population, then per-capita real GDP rises. Therefore countries with rapid population growth, such as Iran, must have very rapid rates of economic growth in order to raise the average standard of living.

What do we produce? In a market economy, the question of what to produce is answered by consumer demand in the marketplace. But what do we produce domestically, rather than import? Services represent about 50 percent of the economy in the U.S. The U.S. Dept of Labor estimates that 98 percent of total job growth in the U.S. through 2008 will be in services.

What has been the trend in services vs. manufacturing in the U.S.? California? Humboldt County?

How do we produce? In a market economy, the question of how to produce depends on the production technology that minimizes production costs, and therefore allows firms to seek maximum profit. Production refers to the process of transforming factors of production (land, labor, capital) into goods and services.

What is the source of economic growth and material prosperity? Primarily due to increases in productivity (quantity of output per unit of input). For example, labor productivity (output per hour worked) has been rising much more rapidly in the last few years than at any time since before the mid-1970s. Computers? Rising labor productivity means that firms can afford to increase real pay to workers without raising prices. Why?

For whom do we produce? In a market economy, goods flow to those with the preferences and the income to participate as consumers in the market.