Real gross domestic product (GDP) during the first quarter (January through March) of 2005 increased at an annual rate of 3.5 percent. This is the preliminary estimate of the change in real GDP for the first quarter. It is a revision of the advance estimate of a 3.1 percent increase in real GDP in the first quarter. The increase in real GDP was primarily due to increases in consumption and inventory, software, equipment, residential housing investment, and exports. Imports did increase during the quarter.

KEY CONCEPTS

Exchange Rate, Exports, Imports

Current Key Economic Indicators

as of May 5, 2013

Inflation

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers decreased 0.2 percent in March after increasing 0.7 percent in February. The index for all items less food and energy rose 0.1 percent in March after rising 0.2 percent in February.

Employment and Unemployment

Total nonfarm payroll employment rose by 165,000 in April, and the unemployment rate was little changed at 7.5 percent. Employment increased in professional and business services, food services and drinking places, retail trade, and health care.

Real GDP

Real gross domestic product increased at an annual rate of 2.5 percent in the first quarter of 2013 (that is, from the fourth quarter to the first quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 0.4 percent.

Federal Reserve

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent...


Announcement

Real gross domestic product (GDP) during the first quarter (January through March) of 2005 increased at an annual rate of 3.5 percent. This is the preliminary estimate of the change in real GDP for the first quarter. It is a revision of the advance estimate of a 3.1 percent increase in real GDP in the first quarter.

The increase in real GDP was primarily due to increases in consumption and inventory, software, equipment, residential housing investment, and exports. Imports did increase during the quarter.

Have your students do this activity.

Investment rises is a good sign for the future.

 

The entire year increase is a relatively high 4.4 percent increase in real GDP.

 

 

 

 

Attention Teachers

Material that appears in italics is included in the teacher version only. All other material appears in the student version. Throughout the semester, the GDP cases will become progressively more comprehensive and advanced.

You may wish to use the following larger versions of the graphs and tables from this lesson for overhead projection or handouts in class:

Goals of Case Study

The goals of the GDP case studies are to provide teachers and students:

  • access to easily understood, timely interpretations of monthly announcements of rates of change in real GDP and the accompanying related data in the U.S. economy;
  • descriptions of major issues surrounding the data announcements;
  • brief analyses of historical perspectives;
  • questions and activities to use to reinforce and develop understanding of relevant concepts; and
  • a list of publications and resources that may benefit classroom teachers and students interested in exploring inflation.

Meaning of the Announcement

Real gross domestic product increased during the first quarter (January through March) of 2005 increased at an annual rate of 3.5 percent. This is the second release of the estimate and is described as the preliminary estimate. This increase compares to rates of 4.0 and 3.8 percent in the previous two quarters. The growth rates in 2001, 2002, 2003, and 2004 were .8 percent, 1.9 percent, 3.0 percent, and 4.4.

The U.S. economy experienced a recession in 2001 and had only modest growth in real GDP in 2002. Employment fell and unemployment increased for much of that time. Growth increased significantly in the middle of 2003, as real GDP increased at an annual rate of 5.8 percent over the last six months of the year, and has continued to grow at a relatively rapid pace.

The current announcement along with improving employment reports continues the good news. The major causes of the 3.5 percent increase in real GDP were the increases in investment, consumption, and exports. The effects of those increases in spending were somewhat offset by increases in imports.

Figure 1: Quarterly Changes in Real GDP at Annual Rates (1990-2004)

Interactive Question

GDP (in current prices) increased at an annual rate of 6.4 percent during the first three months. Given this information, what was the approximate increase in the level of prices in the economy during the quarter?

Have your students do this interactive activity.

If we know that real GDP increased at a rate of 3.5 percent and that the GDP price index increased at an annual rate of 3.1 percent, what was the approximate annual rate of increase in the GDP in the economy during the quarter? [Increased by 6.6 percent]

Definition of Gross Domestic Product

Gross domestic product (GDP) is one measure of economic activity, the total amount of goods and services produced in the United States in a year. It is calculated by adding together the market values of all of the final goods and services produced in a year.

  • It is a gross measurement because it includes the total amount of goods and services produced, some of which are simply replacing goods that have depreciated or have worn out.
  • It is domestic production because it includes only goods and services produced within the U.S.
  • It measures current production because it includes only what was produced during the year.
  • It is a measurement of the final goods produced because it does not include the value of a good when sold by a producer, again when sold by the distributor, and once more when sold by the retailer to the final customer. We count only the final sale.

Changes in GDP from one year to the next reflect changes in the output of goods and services and changes in their prices. To provide a better understanding of what actually is occurring in the economy, real GDP is also calculated. In fact, these changes are more meaningful, as the changes in real GDP show what has actually happened to the quantities of goods and services, independent of changes in prices.

Why are Changes in Real Gross Domestic Product Important?

The measurement of the production of goods and services produced each year permits us to evaluate our monetary and fiscal polices our investment and saving patterns, the quality of our technological advances, and our material well-being. Changes in real GDP per capita provide our best measures of changes in our material standards of living.

While inflation and unemployment rates and changes in our income distribution provide us additional measures of the successes and weaknesses in our economy, none is a more important indicator of our economy's health than the rate of change in real GDP.

Changes in real GDP are discussed in the press and on the nightly news after every monthly announcement of the latest quarter's data or revision. The current increase in real GDP is discussed in news reports as a sign that the economy is growing and may well continue to do so.

Real GDP trends are prominently included in discussions of potential slowdowns and economic booms. They are featured in many discussions of trends in stock prices. Economic commentators use decreases in real GDP as indicators of recessions. The most popular (although inaccurate) definition of a recession is at least two consecutive quarters of declining real GDP. The most widely used definition by policy makers and economists includes measures of changes in industrial production, retail trade, employment, and real income.

Data Trends

The growth in real GDP at the end of the 1990s has been relatively high when compared with the early part of the 1990s. However, during the third quarter of 2000 and the first and third quarters of 2001, the rate of growth of real gross domestic product was actually negative as the U.S. economy entered a recession in March of 2001. The changes in real GDP were actually negative for the first time since the 1991 recession.

The Federal Reserve responded to slowing growth and the recession by reducing the target federal funds rate twelve times from January 2001 to January 2003. (See the Federal Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy and the resulting low interest rates helped increase investment and consumer spending during and since the recession.

As the economy recovered, the growth of real GDP increased and beginning in June 2004, the Federal Reserve began to be concerned with potential inflationary pressures. The target federal funds rate was raised eight times to a current level of 3.0 percent.

Figure 2: Annual Percentage Changes in Real GDP (1970-2004)

The rate of increase in real GDP has been not only higher in the last several years than in the first part of the 1990s, but also when compared to much of the 1970s and 1980s. Economic growth, as measured by average annual changes in real GDP, was 4.4 percent in the 1960s. Average rates of growth decreased during the 1970s (3.3%), the 1980s (3.1%), and the first half of the 1990s (2.3%).

In the last five years of the 1990s, the rate of growth in real GDP increased to 3.9 percent, with the last three years of the 1990s equaling an average of 4.4 percent per year.

The upward trend in economic growth over the past decade has been accompanied by increases in the rates of growth of consumption spending, investment spending, and exports, somewhat offset by increases in imports. That pattern is identical to the results for this quarter. Productivity increases, expansions in the labor force, decreases in unemployment, and increases in the amount of capital have allowed real GDP to grow at the faster rates. The changes in productivity have had the most lasting effects on our average incomes.

 

 

[Economic growth is a function of technological innovation and the amount and quality of labor and capital in the economy:

As more people are employed, the amount of capital increases, education levels increase, the quality of capital improves, or technology increases, the productive capacity of the economy increases. Therefore, the economy can increase its output. As a result, consumers have more disposable income and can increase consumption spending. Businesses have more resources to use for investment and government can provide more public goods and services.

Increased labor force participation increases output. Expanded, improved education creates more productive workers. Business and government spending on research and development enhance our abilities to produce and allow each worker to become more productive, increasing incomes for all. Finally, to achieve a higher level of real GDP in the future, consumers need to limit consumption spending and increase savings today, permitting businesses to invest more in capital goods. If resources are invested in building an economy now, future generations will enjoy a higher level of economic growth; our businesses will produce more goods and consumers can purchase more goods. Expansion of output at rates faster than our population growth is what gives us the opportunity to enjoy increased real GDP per capita and thus, higher standards of living.]

Details of the First-Quarter Changes in Real GDP

Real GDP increased at an annual rate of 3.5 percent in the first quarter of 2005 compared to a rise of 3.8 percent in the fourth quarter of 2004. The major contributors to the increase in real GDP were the increase in overall investment of 10 percent, the increase in consumption spending of 3.6 percent, and the rise in exports of 7.2 percent. Government spending decreased by .2 percent.

Increases in imports were 9.1 percent. This means that a portion of the increases in investment and consumption were not spent on goods and services produced in the U.S. and thus did not add to real GDP here.

The price index for GDP increased at an annual rate of 3.1 percent during the first quarter of 2005, compared to increases at annual rates of 1.4 and 2.3 percent during the third and fourth quarters of 2004. The price index for GDP for all of 2004 increased by 2.1 percent.

This gradually increasing rate of change in prices is becoming of some concern as the Federal Reserve continues to increase the target federal funds rate. (See the most recent Federal Reserve case study.)

GDP, Productivity, and Unemployment

A major factor in the continued growth in the American economy, as seen in the increase of 3.5 percent in real GDP growth in the first quarter, is the continued improvement in productivity. (See the most recent Productivity case study).

Productivity, defined as the amount of output per hour of work, increased at an annual rate of 2.6% in the first quarter and 2.5 percent over the previous twelve months. The Federal Reserve has stated in its recent releases that continued productivity growth is a key component in the continued growth in the American economy. Businesses are able to keep costs low by reducing the need to hire new employees to create growth. Real output and therefore real income per person is able to increase. The most important cause of this productivity growth has been investment in information technology and software.

This growth allowed the Federal Reserve to cut the target federal funds rate more than it otherwise would have during and following the 2001 recession and has reduced inflationary pressures in the recovery since.

The number of hours worked increased by 1.4 percent over the last 12 months. If productivity did not change, real GDP would have increased by 1.4 percent. However, with the 2.5 percent increase in output per hour, total output was able to increase by 3.9 percent (slightly different from the actual increase in real GDP due to rounding and inclusion of a slightly different collection of goods and services in the productivity figures).

A Hint About News Reports

Many news reports simply use "gross domestic product" as a term to describe this announcement. The actual announcement focuses on the real gross domestic product, and that is the meaningful part of the report. In addition, newspapers will often refer to the rate of growth during the most recent quarter and will not always refer to the fact that it is reported at annual rates of change. This is contrasted to the reports of the consumer price index, which are reported at actual percentage changes in the index for a single month, and not at annual rates.

Explanations of GDP and its Components

It is common to see the following equation in economics textbooks:

GDP = C + I + G + NX

Consumption spending (C) consists of consumer spending on goods and services. It is often divided into spending on durable goods, non-durable goods, and services. These purchases accounted for 70 percent of GDP in 2004.

  • Durable goods are items such as cars, furniture, and appliances, which are used for several years (8%).
  • Non-durable goods are items such as food, clothing, and disposable products, which are used for only a short time period (20%).
  • Services include rent paid on apartments (or estimated values for owner-occupied housing), airplane tickets, legal and medical advice or treatment, electricity and other utilities. Services are the fastest growing part of consumption spending (41%).

Investment spending (I) consists of non-residential fixed investment, residential investment, and inventory changes. Investment spending accounts for 16 percent of GDP, but varies significantly from year to year.

  • Non-residential fixed investment is the creation of tools and equipment to use in the production of other goods and services. Examples are the building of factories, the production of new machines, and the manufacturing of computers for business use (10%).
  • Residential investment is the building of a new homes or apartments (6%).
  • Inventory changes consist of changes in the level of stocks of goods necessary for production and finished goods ready to be sold (less than 1%).

Government spending (G) consists of federal, state, and local government spending on goods and services such as research, roads, defense, schools, and police and fire departments. This spending (19%) does not include transfer payments such as Social Security, unemployment compensation, and welfare payments, which do not represent production of goods and services.

  • Federal spending now accounts for approximately 7 percent of GDP. Five percent of GDP is federal spending on defense.
  • State and local spending on goods and services accounts for 12 percent of GDP.

Net Exports (NX) is equal to exports minus imports.

  • Exports are items produced in the U.S. and purchased by foreigners (10%).
  • Imports are items produced by foreigners and purchased by U.S. consumers (15%).
  • Thus, net exports (exports minus imports) are negative, about 5% of the GDP.

Revisions in GDP Announcements

Real GDP for each quarter is announced in each of three months and often the revisions are significant. The month following the end of the quarter is described as the advance GDP; the next is a revision described at the preliminary announcement; and the third announcement is a revision labeled the final announcement. Even this final announcement will likely be revised in year end announcements and periodic reexaminations of the accuracy of the data.

The causes of the changes are often changes in inventory and international trade data – two particularly difficult estimates to make accurately in a quick fashion. This month is the preliminary estimate and is .4 percent higher than the advance estimate of one month ago. The average revision of the advance estimate to the preliminary estimate is .5 percent. This revision occurred primarily due to a downward adjustment in the increase in imports and an increase in the estimate of inventory investment. Changes in these two areas are the most common causes of revisions.

Interactive questions

Have your students answer the following questions. Revisions in GDP Announcements

Real GDP for each quarter is announced in each of three months and often the revisions are significant. The month following the end of the quarter is described as the advance GDP; the next is a revision described at the preliminary announcement; and the third announcement is a revision labeled the final announcement. Even this final announcement will likely be revised in year end announcements and periodic reexaminations of the accuracy of the data.

The causes of the changes are often changes in inventory and international trade data – two particularly difficult estimates to make accurately in a quick fashion. This month the advance estimate and is normally subject to the largest revisions. The average revision of the advance estimate to next month's preliminary estimate is .5 percent. (This ignores the sign of the change.)

Use this table in order to help answer the following questions. (Note: Data is given in billions of current dollars.)

Consumption spending:

$9,000

Federal and state and local spending on goods:

$1,500

Federal and state and local spending on seervices:

$1,000

Federal and state and local spending on social security:

$1,000

State and local spending on goods, serviecs, and all other expenses:

$1,200

Sales of existing homes:

$700

Goods produced during the year but not sold:

$500

Goods produced in the U.S. and sold abroad:

$2,500

Business purchases of new factories and equipment:

$2,500

Goods produced abroad and sold in th U.S.

$1,500

 

 

[1. Investment equals $3,000 ($2,500 + 500).

New factories and equipment and construction of new homes are included in investment. Sales of existing homes are not. Goods that are produced but not sold are additions to inventories and are counted as increases in investment.

2. Net exports equal $1,000 ($2,500 - 1,500).

Net exports are exports minus imports. In this case, the economy has a balance of trade surplus. Exports are goods produced in the U.S. and sold abroad and imports are goods produced abroad and sold here.

3. Government spending equals $2,500 ($1,000 plus $1,500).

Government spending is equal to the sum of federal spending on goods and services and state and local spending on goods and services. All federal and state and local spending on goods and services are included. Social security payments are transfers of income from tax payers to social security recipients and do not represent the production of goods and services.

4. GDP equals $15,500 billion ($9,000 + 3,000 + 2,500 + 1,000).

GDP equals consumption spending plus investment spending plus government spending on goods and services plus net exports.]