Measuring the Nation’s Ouptut

GDP Calculation:

 

Consumption $300   –       Imports  $30

 Government Purchases  $150    –        Exports  $80 

GNP $700  

Gross Private Dom. Invest.  $100

a. Using the data in the table above, GDP is equal to _______.

b. Using the data in the table above, NX (Net exports) is equal to ________.

c. Using the data in the table above, PCE (Personal Consumption Expenditure) is equal to __________.

d. If the dollar amounts of the items above are the nominal amounts in year 2009, and the quantities of units are identical in years 2000 and 2009 but prices in 2000 were 30% less than 2009, Real GDP in 2009 using 2000 as the base year is equal to __________.

(At least 150 Words)

How is GDP a measure of both output and income? How is it possible that both measures of GDP – income and expenditure approach – can end up with the same n

umber? 

Gross Domestic Product

How does a country measure what is has produced within its borders during a specified period?

Economists and government entities use what’s called “Gross Domestic Product” or GDP to measure the market value of all goods and services produced within a country, most usually within a year.

· Although by itself, GDP is not going to tell much, other than what was produced within the borders of the country in a specified period, it is used also as a measure of the relative standard of living of a country’s inhabitants.

We have established that markets inherently seek equilibrium. Due to scarcity, finite resources, and unlimited consumer wants and needs, markets bring together consumers and producers to an equilibrium point where both parties agree on price and quantity.

The Circular Flow Diagram of Economic Activity exemplifies this process of consumers and firms coming together to make possible markets and the exchange process: Households, which are the individuals within an economy or market, provide the factor resources (factors of production) to firms to produce the goods and services households need and want; compensation or rewards for those resources to households come in the form of income, wages, interest, or rent, from which the consumption and purchase of the goods and services transpires.

Leakages to the circular flow manifest when taxes are imposed, imports from foreign markets, and savings; injections to the circular flow occur with exports to foreign markets, consumption, and investment. See diagram below. There are two ways to calculate GDP: 1) Expenditure Approach, and 2) Resource Cost Income Approach.

The expenditure approach to calculating GDP will be concentrating the upper half of the Circular Flow Diagram where consumption, business investment, government expenditures, and exports and imports will be occurring in product markets. GDP = personal consumption + gross private investment + government purchases of goods and services + net exports (exports – imports).

The resource cost – income approach to calculating GDP will be concentrating mostly on the bottom half of the Circular Flow Diagram where firms pay households with income, wages, interest, and rent for their factors of production.

· Included with the income, wages, interest, and rent is depreciation, indirect business taxes, and income from foreigners.

Some of the drawbacks of using a raw GDP number is its relative importance. Although, for example, Canada may have a lower nominal GDP than China, the per capita GDP (nominal GDP/number of inhabitants of the country) will indicate how much wealthier Canada is than China on a per capita or per person basis.

Moreover, when one uses a base year to convert nominal numbers from different years into real GDP quantities, a better comparison of changes from year to year can be achieved. Similar to real GDP is the GDP Deflator in which changes in GDP prices from year to year is calculated and compared.

In summary, GDP (Gross Domestic Product) measures the market value of the goods and services produced within the borders of a country within a specific time period, and that is most normally going to be a year.

Two approaches to calculating GDP are used: Expenditure Approach and Resource-Income Approach; both will arrive at the same quantity, with the Resource-Income Approach requiring a statistical discrepancy quantity.

Using the raw, nominal GDP number can be misleading when comparing it to the nominal GDP number of another country. Adjusting for inflation and price changes by establishing a real GDP number or GDP deflator will allow for more effective comparison and contrast.

Market and Government Failure

Market failure and government failure can occur simultaneously.

One of the best examples of that is the Great Depression. In our history books, most historians have the Great Depression as starting with the stock market crash in 1929. However, there were actually multiple stock market crashes between the dates of 10-24-1929 and 10-29-1929.

· Moreover, the stock market crashes and subsequent depressed economic conditions were actually symptoms of government and market failures and policies starting back in the early 1920’s, following global decisions made by governments after the end of World War I.

Following the end of World War I in November of 1918, countries around the world sought to be independent and close its borders to trade. That isolation globally actually led to countries incurring contracting economies.

· As a result of the isolationism, countries, specifically the U.S. in relation to the Great Depression, began to impose tariffs to close trade with other countries. In 1922, the United States passed the Fordney-McCumber Tariff Act. That could be considered the start of economic decline in the U.S.

The Fordney-McCumber Tariff Act was an attempt to protect American jobs and farmers. At the time of the advent of the tariff, the U.S. was experiencing its highest real GDP, and unemployment was at full employment of 3%. Inherently, a tariff leads to higher prices, reduced output, deadweight losses, reduced consumer surplus, and increased market power of firms.

Eight months into Herbert Hoover’s term, the stock market crashed on 10-24-29. The crash of securities markets exemplified the downturn in markets. Bank collapses soon after ensued, resulting from corruptive and risky ventures, which eventually would lead to Hoover initiating the Glass-Steagall Act in 1932.

Another tariff enacted that was implemented to restrict trade was the Smoot-Hawley Tariff Act in 1930. That tariff imposed restrictions on 20,000 imported goods, and attempted to protect American commerce further. The timing of this act was very destructive, as it ultimately exacerbated the stock market crash at the time, sending the U.S. economy deeper into a severe recession.

The Fordney-McCumber Tariff Act and Smoot-Hawley Tariff Act both severely reduced trade with other countries and shifted the production possibilities frontier inward in the U.S. Other actions taken by the U.S. government to mitigate the recessionary and contracting movements of the U.S. economy but actually exacerbated it were things like taxes being raised on the top tax brackets, corporate taxes raised, as well as price floors set on wages.

· Ultimately, real GNP (Gross National Product) per capita fell by 30%, deflation rose by 30%, unemployment was at 25%, construction almost came to a halt, and farm prices fell by half, destroying farmers who made up a sizable part of the U.S. economy at the time.

In summary, the Great Depression of the 1930’s exemplifies both market and government failure. After WWI, countries sought economic independence and isolationism. That ultimately contracted world markets and economies. In the U.S., the Country was thrusted into a contracting economy via tariff acts Fordney-McCumber and Smoot-Hawley.

Government policies such as raising taxes, imposing price floors on labor, increasing government programs with a declining tax base, and seeking to balance government budgets amidst a receding economy moved the economy from a recession to a depression. It would not be until World War II that the U.S. would increase aggregate demand and supply and achieve growth and expansion in the 1940’s.

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