Countries need a measure to describe the productive capabilities of an economy. This measure should serve as a benchmark to compare overtime and across different countries.

Typically that measure is Gross Domestic Product

Gross Domestic Product (GDP) - The market value of all final goods and services produced in a country during a period of time.

• GDP Counts Only New Domestic Production
  • GDP does not count secondhand transactions
  • GDP does not count nonproductive financial transactions - Stock transactions and other transfer payments (SNAP, Social Security, Unemployment Benefits)
• GDP Counts Only Final Goods
  • Does not include Intermediate Goods

Circular Flow Model From Tucker

One way we can measure GDP is through the spending by various economic components:

• Consumer Spending (C)
• Investment (I)
• Government Spending (G)
• Net Exports (X-M)

Components of GDP

\[ Y = C + I + G + NX\]

Y = Income or GDP

C = Consumption (70%)

I = Investment (18%)

G = Government Spending (17%)

NX = Net Exports (-5%)

Personal Consumption Spending accounts for approximately two-thirds of GDP. This includes spending on durable goods, nondurable goods, and services. Services is the largest category and is composed of any purchase for which there is no tangible object.

Investment composes approximately 18% of GDP

• Fixed Investment - Expenditures for newly produced capital goods like new commercial and residential real estate, machinery, and equipment
• Change in Business Inventories

Government spending composes approximately 17% of GDP and includes spending by the government for infrastructure and services.

Net Exports is composed of the difference between exports and imports

• Exports - Foreign purchases for domestic goods
• Imports - Domestic purchases for foreign goods

• GPP Does not Count the Underground Economy
• GDP Does not Count Nonmarket Production
• GDP Does not Count Leisure
• GDP Does not Count Environmental Costs
• GDP Does not Measure the Distribution of Income
• GDP Does not Directly Measure Quality of Life

GDP does not Count the Underground Economy: underground economic transactions are not included in GDP. Tends to understate the true value of GDP. In the U.S. it is estimated that the underground economy is 10-20% of GDP

GDP does not count Nonmarket Production: Goods and services are provided but there is no Financial transaction to report to GDP. Tends to create biases over time and biases across countries. For example:

• Biases Over Time: More women in the labor force today then in 1950. Tends to overstate GDP over time.

• Biases Across Countries: The proportion of women in the labor force tends to be smaller in poorer countries.

People value leisure time but there is no market transaction to capture in GDP. Advances in technology have increased available leisure time while the average hours worked per week has gradually fallen since. These are improvements in welfare as people can enjoy more leisure time but it is not captured in GDP.

GDP does not include the release of CO2 in the atmosphere or reductions in the supply of natural resources. In some cases the U.S. has made improvements in environmental quality over time. Improvements or degradation in the environment are not captured in GDP.

Because GDP growth is a good measure of a country’s standard of living it is easy to forget that changes in GDP might disproportionately affect different income groups. The improvement in the economy might not be even across everyone.

Characteristics that are not included in GDP but are important when considering quality of life.

• Health
• Literacy
• Life Expectancy

• Nominal GDP - The market value of all final goods measured in current or today’s dollars

• Real GDP - The market value of all final goods adjusted for inflation

• GDP chain price index - Also known as the GDP deflator, the chained price index measures the relative changes in price compared to a base year that is indexed to a value of 100.

• Nominal GDP = $ 18 Trillion
• GDP Chain Price Index = 125

\[ \text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Chain Price Index}} 100 \] \[\begin{align*} \text{Real GDP} & = \frac{18}{125} 100 \\ & = 14.40 \end{align*} \]

Examining percentage changes in GDP quarterly or annually provides a picture into what is happening in the economy

\[ \%\Delta GDP = \frac{GDP_{2} - GDP_{1}}{GDP_{1}}100\]

Quarterly Change in Real GDP

Real GDP 2021 Q2 = 19368.31 %19216.224

Real GDP 2021 Q3 = 19465.19 %19544.248

\[ \begin{align*} \%\Delta GDP & = \frac{19465.19 - 19368.31}{19368.31}100 \\ & = 0.5 \end{align*} \]

Most Recent Quarterly Change in GDP from Q3-Q2 \[ \begin{align*} \%\Delta GDP & = \frac{19465.19 - 19368.31}{19368.31}100 \\ & = 0.5\% \end{align*}\]

Sometimes a better comparison value is an annualized rate. Because GDP is measured quarterly we can get an annualized rate by multiplying the quarterly percentage change by 4.

\[ \text{Annualized}\% \Delta(Q3-Q2) = 2\%\]

A recession occurs when there is two consecutive quarters of negative GDP growth.

Real GDP First Quarter 2020 = 18951.99

Real GDP First Quarter 2021 = 19055.65

Pct_Change = 0.547%

OECD G20

OECD G20