III MACROECONOMIC TOPICS


Growing the Economy

The most widely recognized measurements of economic growth are the real gross domestic product (GDP) and GDP per capita. Prospects for economic growth are enhanced by saving and investment, the efficient use of resources, entrepreneurship, technological advances, and a stable economic and political environment. Economic growth creates long-run prosperity for many people. Yet there are often unintended consequences of economic growth including income and wealth disparities and stresses on the natural environment.

THE GROSS DOMESTIC PRODUCT

The gross domestic product, or GDP, is an important macroeconomic concept because it relates to the aggregate (total) output of goods and services produced in an economy. Today the ups and downs in the GDP are a widely used barometer of a country's economic health. It was not until the depths of the Great Depression of the 1930s that economists started to look seriously at macroeconomic data, mainly to explain and correct economic downturns. During this time of distress economists developed a measurement of aggregate output, which they dubbed the gross national product (GNP). In more recent decades the gross domestic product has replaced the GNP as the primary gauge of an economy's performance.

GDP Defined

The gross domestic product is the total market value of final goods and services produced in a nation each year. This definition sets conditions about the types of goods and services that are counted in the GDP. First, GDP includes only final goods and services. Final goods are products produced and sold for direct consumption by consumers, producers, or the government. Excluded from the GDP are intermediate goods, or goods that will be further processed or used in the production of another good. For example, an automobile is a final good, while a windshield is an intermediate good. The exclusion of intermediate goods avoids the problem of double counting, that is, counting the same item twice in the GDP. Second, GDP includes only those products produced within the borders of a nation. Thus, the U.S. GDP includes the final output of all firms operating in the United States, whether domestic or foreign owned. Third, GDP includes only newly produced output in a given year. GDP excludes all transactions of used, or secondhand, items. Fourth, GDP excludes all paper transactions that do not result in new output, including the value of stock or bond transactions, mergers and acquisitions of existing firms, Social Security and other transfer payments, and the resale of existing residential properties.

The GDP and gross national product (GNP) are similar measurements of national output. Yet there is a key difference between the two measurements. The gross national product (GNP) calculates the total market value of final goods produced by a country's firms within the domestic economy and abroad. Thus, the U.S. GNP includes the market value of output produced by American firms that operate within the United States and by American transnational corporations, independent contractors, and other U.S.-based producers that operate in other countries. Simon Kuznets, an American economist and founder of the GNP, introduced this method of national income and product accounting in the 1930s. Today there is little difference between the size of the GDP and GNP in most countries. In 2012, for example, the U.S. GDP was $15,685 billion, and the GNP was $15,928 billion.[1]

The real GDP adjusts the current GDP, also called the nominal GDP, for inflation each year. Real GDP is a more accurate measurement of total national output than nominal GDP because it enables annual growth comparisons based on constant, inflationadjusted dollars. The GDP price deflator, a price index derived by the government, is used to convert the nominal GDP to the real GDP. The formula for the conversion to real GDP is nominal GDP divided by the price deflator, times 100, as shown in Figure 8.1. In 2012 the nominal GDP of the United States was $15,685 billion, and the GDP deflator was 115.39. In this calculation current dollars are adjusted to the dollar's value in 2005. Figure 8.1 shows how a $15.7 trillion nominal GDP is converted into a $13.6 trillion real GDP.[2]

The GDP per capita states the value of total national output per person in a country. The terms “GDP per capita” and “GNP per capita” are often used interchangeably with the term “per capita income.” The GDP per capita is calculated by dividing the GDP by the total population of a country. In 2011 the GDP per capita in the United States was $48,112, the eleventh highest per capita GDP among the world's advanced economies. The top five advanced economies ranked by per capita GDP are shown in Table 8.1.[3] When the GDP per capita is adjusted for inflation, it is called the real GDP per capita.

Economists often cite the GDP per capita to compare the relative well-being of people living in different countries. While this may be one broad-stroke way to compare people's well-being across national borders, there are limitations to this measure. For instance, GDP

Figure 8.1 Calculating the Real GDP, 2012 ($ billions)

Source: Bureau of Economic Analysis, “Table 3” and “Table 6,” News Release, June 26, 2013, 8, 11.

Table 8.1 Top 5 Advanced Countries Ranked by GDP Per Capita, 2011

World Rank

Country

GDP per Capita ($ US)

1

Luxembourg

114,232

2

Norway

98,081

3

Switzerland

83,326

4

Australia

61,789

5

Denmark

59,889

Source: World Bank, World Development Indicators (data), 2013.

per capita states the average income of people but does not account for the distribution of income within economies. In virtually all economies the poorest segment of society subsists on a tiny fraction of the national income and wealth, while the richest segment of the population is far more prosperous. Another limitation is that the GDP per capita deals only with reported business activity. It therefore excludes barter and the unreported productive enterprise that takes place in the informal economy. Third, GDP per capita may not adjust data to reflect the actual purchasing power of money within an economy. One U.S. dollar, for example, buys more goods in a poorer country such as Haiti than it does in the United States. Finally, GDP per capita does not consider the size or power of economies. None of the seven “major advanced countries,” for example, are included in the top five ranking. The major advanced economies, often called the G-7 countries, include Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.[4]

Calculating the GDP

The most commonly used method of calculating GDP is the expenditures approach, which tallies the total spending on final goods and services in four areas: consumption (C), investment (I), government (G), and net exports (Xn). The expenditures approach to calculating the GDP can be stated as an equation: C + I + G + Xn = GDP.

ECONOMICS IN HISTORY: The Birth of the Gross National Product

Simon Kuznets (1901–1985), a twentieth-century American economist, is widely hailed as the father of the gross national product (GNP). Born in Kharkiv, Russia, Kuznets immigrated to the United States in 1922. The following year he entered Columbia University, where he earned a doctorate degree in 1926. He joined the staff of the National Bureau of Economic Research (NBER) in 1927. His professional career included prestigious teaching positions at the University of Pennsylvania, Johns Hopkins University, and Harvard.

Kuznets is best known for his meticulous collection of macroeconomic data related to national output and national income, and the application of this data to economic growth, business cycles, and economic development. In National Income and Its Composition, 1919–1938 (1941), Kuznets identified key features of national income and product accounts. He stressed the need to determine national income with “consistency and explicitness” yet recognized that limitations existed in estimating aggregate output—the gross national product (GNP). For example, excluded from GNP were goods and services provided “outside of the market system,”[5] such as the services of homemakers and unreported business activity in the informal sector of the economy. Still, the pioneering work of Kuznets provided the foundation of GNP calculations, the primary framework for measuring economic performance in the United States during the post–World War II era.

Table 8.2 Calculating the Nominal Gross Domestic Product, 2012

Components of the GDP

Dollar Value ($ billions)

Consumption spending

11,120

Investment spending

2,062

Government spending

3,063

Net exports

-560

Gross domestic product

15,685

Source: Bureau of Economic Analysis, “Table 3,” News Release, June 26, 2013, 8–9.

In this equation, “C” represents spending by individuals on consumer goods and services. Consumer goods include items such as automobiles and other motor vehicles, clothing and footwear, food and beverages, furnishings, and gasoline and other forms of energy. Services include people's productive activities in fields such as health care, banking and finance, insurance, real estate, and recreation. In 2012 American consumers spent $11.1 trillion on consumer goods and services, as shown in Table 8.2.[6] “I” represents investment spending by firms and households on new capital, including factories, office buildings, equipment, inventories of products, and houses or apartment buildings. Investment goods accounted for $2.1 trillion in spending. “G” represents government spending at the federal, state, and local levels. Government goods include school buildings, submarines, and libraries, while services are often expressed as salaries of teachers, airport security guards, public officials, and so on. In 2012 about $3.1 trillion was spent on government goods and services.

“Xn” represents net exports, the difference between the dollar value of the nation's imports and exports. Note in Table 8.2 that net exports is a negative number. This occurs when the value of U.S. imports is greater than the value of its exports—about $560 billion more in this case. This $560 billion is called the trade deficit and is subtracted from the U.S. GDP because it represents spending by Americans on foreign-produced goods rather than American-made goods.

  • [1] U.S. Department of Commerce (DOC), Bureau of Economic Analysis (BEA), “Table 3: Gross Domestic Product and Related Measures; Level Changes From Preceding Period,” News Release, June 26, 2013, 8-9.
  • [2] Ibid.; DOC/BEA, “Table 6: Price Indexes for Gross Domestic Product,” News Release, June 26, 2013, 11.
  • [3] World Bank, “GDP per Capita (Current US$),” World Development Indicators, 2013, 1-11
  • [4] Ibid.; International Monetary Fund (IMF), “Table B: Advanced Economies by Subgroup,” World Economic Outlook, April 2013 (Washington, DC: IMF Publication Services, 2013), 139-140
  • [5] Simon Kuznets, National Income and Its Composition, 1919–1938 (New York: National Bureau of Economic Research, Inc., 1941), 9.
  • [6] DOC/BEA, “Table 3: Gross Domestic Product and Related Measures; Level Changes From Preceding Period,” News Release, June 26, 2013, 8-9.
 
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