Production, Income and Employment

1
Production, Income and Employment

• Two main concepts
• Gross Domestic Product (GDP)
• Unemployment Rate
• How does the government get these statistics?
• What do they tell us about the economy?
• What do they NOT tell us about the economy?
• How are they used (and sometimes misused)?

2
GDP A Definition

• The nations gross domestic product (GDP)
• Total value of all final goods and services
  produced for the marketplace during a given
  period within the nations borders

3
Production and Gross Domestic Product, GDP A
Definition

• The total value
• Add up dollar value of every good or servicethe
  number of dollars each product is sold for
• Using the dollar prices at which goods and
  services actually sell could create a problem
• If prices rise, then GDP will rise, even if we
  are not actually producing more
• GDP must be adjusted to take away the effects of
  inflation
• of all final
• We do not count every good/service produced in
  the economy
• Only those that are sold to their final users
• Avoids over-counting intermediate products when
  measuring GDP
• Value of all intermediate products is
  automatically included in value of final products
  they are used to create

4
Figure 1 Stages of Production
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Production and Gross Domestic Product, GDP A
Definition

• goods and services
• We all know a good when we see one
• Final services count in GDP in the same way as
  final goods
• produced
• In order to contribute to GDP, something must be
  produced
• During the period being considered

6
Production and Gross Domestic Product, GDP A
Definition

• for the marketplace
• GDP does not include all final goods and services
  produced in the economy, just those that are sold
• during a given period
• GDP measures production during some specific
  period
• Only goods produced during that period are
  counted
• GDP is actually measured for each quarter, and
  then reported as an annual rate for the quarter
• Once 4th quarter figures are in, government
  reports official GDP figure for entire year

7
Production and Gross Domestic Product, GDP A
Definition

• within the nations borders
• GDP measures output produced within U.S. borders
• regardless of whether it was produced by
  Americans
• Americans abroad are not counted
• However, foreigners producing goods or services
  within the country are

8
Who measures GDP?

• Bureau of Economic Analysis (BEA) www.bea.gov
• National Income and Product Accounts
• GDP in Billions. Quarterly, Seasonally Adjusted
  Annual Rates in 2000 dollars
• 2008-QI 11,646.0
• 2008-QII 11,727.4
• 2008-QIII 11,712.4
• 2008-QIV 11,599.4
• Actual GDP for 2008 is the last figure. The other
  three are projections.

9
How is GDP measured?

• The BEA calculates GDP in several ways
• The Expenditure Approach
• Sum of all expenditures on final goods and
  services in the economy
• The Value Added Approach
• Sum of all value added in the economy
• The Factor Payment (or Income) Approach
• Sum of all payments made to factors of production
  in the economy
• Different approaches are good for cross checking
• They also tells us something about the structure
  of the economy.

10
The Expenditure Approach

• Output is divided into four categories according
  to which group in the economy purchases it as
  final users
• Consumption goods and services (C)purchased by
  households
• Private investment goods and services
  (I)purchased by businesses
• Government goods and services (G)purchased by
  government agencies
• Net exports (NX)purchased by foreigners

11
The Expenditure Approach to GDP

• Everyone who purchases a good or service included
  in U.S. GDP must be either a
• U.S. household
• U.S. business
• U.S. government agency (including state and local
  government)
• Part of the foreign sector
• When we add up the purchases of all four groups
  we get GDP
• GDP C I G NX

12
Consumption Spending

• Consumption is the part of GDP purchased by
  households as final users
• Almost all goods and services bought by
  households during the year is included as part of
  consumption spending
• Except
• Construction of new private homes counted as
  private investment
• Non-market goods and services included in GDP
• Total value of all food products that farm
  families produce and consume themselves
• Total value of the housing services provided by
  owner-occupied homes

13
Consumption Spending

• All household spending is not part of GDP
• Purchase of a used car
• Purchase of a previously owned house
• Purchase of stocks and bonds
• Charitable donation
• Only expenditures on final goods and services are
  considered

14
Private Investment

• The three components of private investment
• Business Purchases of Plant, Equipment, and
  Software
• These are not intermediate goods-they last for
  several years
• Are regarded as final goods, and firms that buy
  them as final users of those goods
• New Home Construction
• House will continue to provide services into the
  future, so it is more like capital than like
  consumption.
• Changes in Inventories
• We count the charge in firms inventories as part
  of investment in measuring GDP
• Why?
• When goods are produced but not sold during the
  year, they end up in some firms inventory stocks
• Will provide services in the future, when they
  are finally sold and used
• If change in inventories is negative, some goods
  produced in the past are being sold now and
  should be subtracted from GDP

15
Other Investment

• In practice, apart from private investment, we
  also have
• Government Investment
• Capital stock owned and operated by
  governmentfederal, state, and local police
  cars, schools, military equipment etc.
• Measured in government expenditure
• Consumer durables
• Goods such as furniture, automobiles, washing
  machines, home computers are capital goods
• Provide services for many years. Measured in
  consumption expenditure
• Human capital
• To measure the increase in capital stock most
  broadly we include the additional skills and
  training acquired by workforce during the year.
• Measured in consumption expenditure.
• Some capital stock is used up every year
  (depreciation)
• That is subtracted from investment to get net
  investment

16
Government Purchases

• Can be consumption or investment
• Government purchases include
• Goods such as fighter jets, police cars, school
  buildings, spy satellites, etc.
• Services such as those performed by police,
  legislators, and military personnel
• Government is considered to be a purchaser even
  if it actually produces the goods or services
  itself

17
Government Purchases

• Important to distinguish between
• Government purchases
• Which are counted in GDP
• Government outlays
• As measured by local, state, and federal budgets
  Transfer payments represent money redistributed
  from one group of citizens (taxpayers) to another
  (poor, unemployed, elderly)
• Transfers are included in government budgets as
  outlays
• NOT AS GDP
• They are not purchases of currently produced
  goods and services

18
Net Exports

• We also trade with the rest of the world
• Many items we spend on are imported and some U.S.
  goods exported
• Deduct all U.S. imports during the year, leaving
  us with just output produced in United States
• Add U.S. exports during the year, including
  output produced in the U.S. but not consumed here
• Add Net Exports (exports-imports) to other
  expenditure.

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The Compositon of GDP 2009 Q2
20
The Value-Added Approach

• Value added
• Firms contribution to a product or
• Revenue it receives for its output
• Minus cost of all the intermediate goods that it
  buys
• GDP is sum of values added by all firms in economy

21
Figure 1 Stages of Production
22
The Factor Payments Approach

• In any year, value added by a firm is equal to
  total factor payments made by that firm
• GDP equals sum of all firms value added
• Each firms value added is equal to its factor
  payments
• GDP must equal total factor payments made by all
  firms in the economy
• All of these factor payments are received by
  households in the form of wages and salaries,
  rent, interest or profit
• GDP is measured by adding up all of the
  incomewages and salaries, rent, interest, and
  profitearned by all households in the economy
• Gives us an important insight into the
  macroeconomy
• Total output of economy (GDP) is equal to total
  income earned in the economy

23
Measuring GDP A Summary

• Different ways to calculate GDP
• Expenditure Approach
• GDP C I G NX
• Value-Added Approach
• GDP Sum of value added by all firms
• Factor Payments Approach
• GDP Sum of factor payments made by all firms
• GDP Wages and Salaries interest rent
  profit
• GDP Total household income

24
Real Versus Nominal GDP

• Since GDP is measured in dollars, a serious
  problem exists when tracking change in output
  over time
• Value of the dollarits purchasing poweris
  changing
• Usually need to adjust our measurements to
  reflect changes in the value of the dollar
• Nominalwhen a variable is measured over time
  with no adjustment for the dollars changing
  value
• Realwhen a variable is adjusted for the dollars
  changing value
• Most government statistics are reported in both
  nominal and real terms
• Economists focus almost exclusively on real
  variables

25
Real Versus Nominal GDP

• The distinction between nominal and real values
  is crucial in macroeconomics
• The public, the media, and sometimes even
  government officials have been confused by a
  failure to make this distinction
• Since our economic well-being depends, in part,
  on the goods and services we can buy
• It is important to translate nominal valueswhich
  are measured in current dollarsto real
  valueswhich are measured in purchasing power
• We will learn to do this next week

26
Real and Nominal GDP
27
How GDP Is Used

• Governments reports on GDP are used to steer the
  economy over both short-run and long-run
• In short-run, to alert us to recessions and give
  us a chance to stabilize the economy
• In long-run, to tell us whether our economy is
  growing fast enough to raise output per capita
  and our standard of living, and fast enough to
  generate sufficient jobs for a growing population
• Many (but not all) economists believe that, if
  alerted in time
• Government can design policies to help keep the
  economy on a more balanced course

28
Problems With GDP Quality Changes

• Quality changes
• While BEA includes impact of quality changes for
  many goods and services (such as automobiles and
  computers)
• Does not have the resources to estimate quality
  changes for millions of different goods and
  services
• By ignoring these quality improvements, GDP
  probably understates true growth from year to year

29
Problems with GDP The Underground Economy

• Some production is hidden from government
  authorities
• Either because it is illegal
• Drugs, prostitution, most gambling
• Because those engaged in it are avoiding taxes
• Production in these hidden markets cannot be
  measured accurately
• BEA must estimate it
• Many economists believe that BEAs estimates are
  too low
• As a result, GDP may understate total output

30
Problems with GDP Non-Market Production

• GDP does not include non-market production
• Goods and services that are produced, but not
  sold in the marketplace
• Childcare
• Housework
• Whenever a non-market transaction becomes a
  market transaction GDP will rise
• Even though total production has remained the
  same
• Can exaggerate the growth in GDP over long
  periods of time

31
Interpret with Caution!!

• What do these problems tell us about value of
  GDP?
• For certain purposesespecially interpreting
  long-run changes in GDPwe must exercise caution
• GDP works much better as a guide to short-run
  performance of economy
• A significant quarter-to-quarter change in real
  GDP virtually always indicates a change in actual
  production rather than a measurement problem
• This is why policy makers, business people, and
  the media pay such close attention to GDP as a
  guide to the economy from quarter to quarter

32
Types of Unemployment

• In United States, people are considered
  unemployed if they are not working and actively
  seeking a job
• Unemployment can arise for a variety of reasons,
  each with its own policy implications
• Useful to classify unemployment into four
  different categories
• Frictional unemployment
• Seasonal unemployment
• Structural unemployment
• Cyclical unemployment
• Each arises from a different cause and has
  different consequences

33
Frictional Unemployment

• Short-term joblessness experienced by people who
  are between jobs or who are entering the labor
  market for first time or after an absence
• Because frictional unemployment is, by
  definition, short-term, it causes little hardship
  to those affected by it
• By spending time searching rather than jumping at
  the first opening that comes their way
• People find jobs for which they are better suited
  and in which they will ultimately be more
  productive

34
Seasonal Unemployment

• Joblessness related to changes in weather,
  tourist patterns, or other seasonal factors
• Is rather benign
• Short-term
• Workers are often compensated in advance for
  unemployment they experience in off-season
• To prevent any misunderstandings, government
  usually reports the seasonally-adjusted rate of
  unemployment
• Rate that reflects only those changes beyond
  normal for the month

35
Structural Unemployment

• Joblessness arising from mismatches between
  workers skills and employers requirements
• Or between workers locations and employers
  locations
• Generally a stubborn, long-term problem
• Often lasting several years or more

36
What can the government do?

• These types of unemployment are due to
  microeconomic causes, i.e. changes in
  particular markets.
• Job training programs
• Programs to match job seekers with employers
• Unemployment Benefits
• Solutions are changes in labor policy, not
  macroeconomic policy

37
Cyclical Unemployment

• When the economy goes into a recession and total
  output falls, the unemployment rate rises
• Since it arises from conditions in the overall
  economy, cyclical unemployment is a problem for
  macroeconomic policy
• Macroeconomists say we have reached full
  employment when cyclical unemployment is reduced
  to zero
• But the overall unemployment rate at full
  employment is greater than zero
• Because there are still positive levels of
  frictional, seasonal, and structural unemployment
• How do we tell how much of our unemployment is
  cyclical?
• Many economists believe that today, normal
  amounts of frictional, seasonal, and structural
  unemployment account for an unemployment rate of
  between 4 and 4.5 in United States

38
Figure 3 U.S. Monthly Unemployment Rate,
19502009
39
The Costs of Unemployment Economic Costs

• Chief economic cost of unemployment is the
  opportunity cost of lost output
• Goods and services the jobless would produce if
  they were working
• But do not produce because they cannot find work
• The unemployed are often given government
  assistance
• Costs are spread among citizens in general
• Potential output
• Level of output economy could produce if
  operating at full employment
• Actual output-potential output is the measure of
  the cost of unemployment

40
Figure 4 Actual And Potential Real GDP,
19502009
41
Broader Costs

• Unemploymentespecially when it lasts for many
  months or years
• Can have serious psychological and physical
  effects
• Also causes setbacks in achieving important
  social goals
• Burden of unemployment is not shared equally
  among different groups in the population
• Tends to fall most heavily on minorities,
  especially minority youth and/or on people with
  low education

42
How Unemployment is Measured

• The unemployed are those willing and able to
  work, but who do not have jobs
• Others were able to work, but preferred not to
• Including millions of college students,
  homemakers, prisoners and retired people
• Still others were in the military and are counted
  in the population
• But not counted when calculating civilian
  employment statistics
• To be counted as unemployed, you must have
  recently searched for work
• But how can we tell who has, and who has not,
  recently searched for work?

43
The Census Bureaus Household Survey

• Every month, thousands of interviewers from
  United States Census Bureauacting on behalf of
  the U.S. Bureau of Labor Statistics (BLS)conduct
  a survey of 60,000 households across America
• Household members who are under 16, in the
  military, or currently residing in an institution
  like a prison or hospital are excluded from
  survey
• Official unemployment rate
• Percentage of the labor force that is unemployed

44
Figure 5 How BLS Measures Employment Status
45
Problems In Measuring Unemployment

• The official measure underestimates extent of
  unemployment in our society due to
• Treatment of involuntary part-time workers
• Should be regarded as partially employed and
  partially unemployed?
• Treatment of discouraged workers
• Individuals who would like to work but, because
  they feel little hope of finding a job, have
  given up searching
• How many discouraged workers are there?
• No one knows for sure
• Still, the unemployment rateas currently
  measuredtells us something important
• Number of people who are searching for jobs, but
  have not yet found them

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Broader Measures of Unemployment (1994-2009)
47
Figure 6 Employment Status of the U.S.
Population (Millions)Aug 2009
48
Of the Total Population