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### INTRODUCTION

Each month, the Bureau of Economic Analysis (BEA), an agency of the U.S. Department of Commerce, releases an estimate of the level and growth of U.S. gross domestic product (GDP), the output of goods and services produced by labor and property located in the United States.

This lesson focuses on the BEA's second estimate of real GDP released on August 26, 2011, for the second quarter (April, May and June) of 2011. The first estimate for Q2 2011 was made in July. Understanding the level and rate of growth of the economy's output (GDP) helps to better understand growth, employment trends, the health of the business sector, and consumer well-being.

GDP data is announced three times for each fiscal quarter. For Q2 2011, the first estimate is made in July, the second estimate is made in August, and the third (final) estimate for Q2 is made in September.

GDP data reports lag the reporting period - fiscal quarter. The current estimate is for Q2 (April-June, 2010). Each of the three estimates for a quarter will be based on more complete and comprehensive data, and may modify the growth rate reported previously.

• Determine the current and historical growth of U.S. real gross domestic product.
• Identify the components of the measurement of the nation's gross domestic product.
• Assess the relationship of real GDP data, the indexes of economic indicators, and business cycles.
• Speculate about the nature and impact of current economic conditions on consumers and producers, and implications for the future.

### PROCESS

First, What are GDP and Real GDP?

Simply put, gross domestic product (GDP) measures "the market value of the goods and services produced by labor and property in the United States."  This is the definition used by the U.S. Bureau of Economic Analysis. http://www.bea.gov/industry/iotables/glossary.htm

Real GDP, also in simple terms, is the nation's GDP adjusted for the effect of a change in the price level (inflation or deflation.)  Thus, it is a measure of "real" growth without the impact inflation.

Normally, GDP is measured in annual terms (the sum of four quarters) and the GDPs of various nations are compared on an annual basis.  U.S. GDP growth is reported quarterly and then on an annual basis.

While GDP is considered an indicator of economic progress, it is not necessarily a measure of well-being or quality of life (standard of living), because it does not account such factors as income distribution, rates of poverty, crime, or literacy. GDP measures the nation's output of goods and services - and is generally related to levels of employment, and income.

Real per capita GDP, the nation's GDP divided by the nation's population, may be a better indicator of people's well-being. A nation may have a very large GDP, but if the population is also very large, each individual may not benefit as much as if that nation has a smaller population.  China has a relatively large GDP, but it also has a very large population.  It may also matter is the nation's income is evenly or unevenly distributed among the population.  If a few are very rich and many are poor, the "average" may not be meaningful.

In 2010, U.S. per capita real GDP was about \$47,200, according to the CIA World Factbook (https://www.cia.gov/library/publications/the-world-factbook/geos/us.html) . Other sources estimate within a few hundred dollars of the CIA estimate.  Though the U.S. per capita GDP ranks just eleventh on the list of world nations' per capital GDP, a strong argument can be made that the "standard of living" of people in the United States ranks much higher.  Again, standard of living can be a very difficult concept to define.

[NOTE: A more detailed definition of GDP and its components can be found later in this lesson or at http://www.bea.gov/newsreleases/national/gdp/gdphighlights.pdf .

U.S. Bureau of Economic Analysis: Gross Domestic Product: Second Quarter 2011 (Second Estimate)

Announcement Date: August 26, 2011

"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.0 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the "second" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.4 percent."

The August 26 real GDP announcement was the second of three BEA estimates of GDP for the second quarter (Q2) of 2011. Each announcement is based on additional or more complete data than the prior estimate. The BEA reported, "The GDP estimates released today are based on more complete source data than were available for the "advance" estimate issued last month (July)." The advance estimate in July reported a 1.3 percent real GDP growth rate for Q2 2011. The U.S. growth rate was, according to the second estimate, slower than the first estimate.

Is it helpful for the BEA to make three announcements of the GDP growth of a quarter?

Where Did Q2 Growth Come From?

The BEA announcement identified the sectors of the economy that improved and those that slowed.

Increases:

• Exports of both goods and services increased.
• Consumer spending increased.
• Federal government spending increased.

Decreases:

• State and local government spending decreased.
• Imports increased (a reduction in GDP).
• Inventory investment declined.

Change from the First to Second Estimate

The second estimate of real GDP growth was 0.3 percent less than the first for Q2.  Why?  The BEA explained, “The 0.3 percentage point downward revision to real GDP growth in the second quarter mainly reflected downward revisions to inventory investment and to exports that were partly offset by upward revisions to business fixed investment and to consumer spending.”

For details of the U.S. real GDP data, go to the BEA's August 26, 2011, announcement, Table 1. Real Gross Domestic Product and Related Measures: Percent Change From Preceding Period, http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_2nd.pdf.

The Impact of Inflation and Measuring Real GDP

To adjust for inflation, the BEA uses the percent change in the price index for gross domestic purchases. The BEA defines this as the change in the "prices of goods and services purchased by U.S. residents, regardless of where the goods and services are produced. The gross domestic purchases price index is derived from the prices of personal consumption expenditures, gross private domestic investment, and government consumption expenditures and gross investment. Thus, for example, an increase in the price of imported cars would raise the prices paid by U.S. residents and thereby directly raise the price index for gross domestic purchases."

The BEA announcement added, "The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 3.3 percent in the second quarter, 0.1 percentage point more than in the advance estimate; this index increased 4.0 percent in the first quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 2.6 percent in the second quarter, compared with an increase of 2.4 percent in the first."

The bottom line: Inflation remained low in Q2 2011. Energy - usually the price level wild card - can significantly affect the overall rate of price level ups and downs. This month, energy was not a significant factor and lower energy prices somewhat kept overall inflation low.

For data on the the price level changes for the major industry groups, see the BEA announcement Table 4. Price Indexes for Gross Domestic Product and Related Measures: Percent Change From Preceding Period, http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_2nd.pdf .

How did inflation affect you in the past several months? Did you notice any price changes? For recent inflation data, go to the U.S. Bureau of Labors Statistics website - www.bls.gov .

The Major Components of GDP in Q2 2011

GDP is generally reported as the sum of four components: C + I + G + X = GDP.

• Personal Consumption Expenditures (C)
• Private Investment (I)
• Government (all levels) Expenditures (G)
• Net Exports (exports minus imports) (X)

The August 26, 2011, BEA announcement reported:

• Consumption: "Real personal consumption expenditures increased 0.4 percent in the second quarter, compared with an increase of 2.1 percent in the first." Consumers spent more on goods and services, not much.  Personal Consumption is normally about 70 percent of U.S. GDP (71 percent in Q2 2011).  Thus, slower growth of consumer spending is the major factor in determining overall real GDP growth.
• Investment: "Real nonresidential fixed investment increased 9.9 percent, compared with an increase of 2.1 percent. Nonresidential structures increased 15.7 percent, in contrast to a decrease of 14.3 percent. Equipment and software increased 7.9 percent, compared with an increase of 8.7 percent. Real residential fixed investment increased 3.4 percent, in contrast to a decrease of 2.4 percent."  Both business and residential investments increased.
• Net Exports: "Real exports of goods and services increased 3.1 percent in the second quarter, compared with an increase of 7.9 percent in the first. Real imports of goods and services increased 1.9 percent, compared with an increase of 8.3 percent."  Both imports and exports increased. A greater increase in imports (deficit) results in a subtraction from GDP.
• Government Spending: "Real federal government consumption expenditures and gross investment increased 2.0 percent in the second quarter, in contrast to a decrease of 9.4 percent in the first. National defense increased 7.1 percent, in contrast to a decrease of 12.6 percent. Nondefense decreased 7.5 percent, compared with a decrease of 2.7 percent. Real state and local government consumption expenditures and gross investment decreased 2.8 percent, compared with a decrease of 3.4 percent."

The Impact of Inventories

Inventory consists of the raw materials, intermediate goods, and finished goods that are ready for sale. Inventories represent one of the most important assets of a business. The turnover of inventory represents a sources of revenue generation and subsequent earnings for a company.

Holding a large amount of inventory over time is not usually good for a business. Holding inventory means that the business has paid the costs to produce good that have not been sold. Holding too little inventory may be bad because the business risks of losing potential sales and potential market share.

The BEA identifies the impact of changes in inventories - "Changes in inventories are the smallest component of the GDP, usually less than 1% of GDP but they are much more important than their absolute size. In fact, large changes in inventories signal changes in aggregate demand and, thus, are indicators of future economic activity. As the change in inventories is a flow equal to the change in the stock of unsold goods, they are a form of investment, often referred to as involuntary investment."

On August 26, the BEA reported, "The change in real private inventories subtracted 0.23 percentage point from the second-quarter change in real GDP, after adding 0.32 percentage point to the first-quarter change. Private businesses increased inventories \$40.6 billion in the second quarter, following increases of \$49.1 billion in the first quarter and of \$38.3 billion in the fourth  ."

Gross Domestic Purchases

"Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- increased 0.9 percent in the second quarter, compared with an increase of 0.7 percent in the first." This BEA data differs from GDP in that some goods and services may have been produced in other countries. Were we purchasing more imports in Q2?

Gross National Product

In 1991, the United States switched from using gross national product (GNP to gross domestic product GDP) as the primary measurement of production or output GDP is product produced within a country's borders. GNP is product produced by enterprises owned by a country's citizens. Using GDP essentially factors out the production from firms outside the US and the impact of trade.

"Real gross national product -- the goods and services produced by the labor and property supplied by U.S. residents -- increased 1.7 percent in the second quarter, compared with an increase of 1.5 percent in the first. GNP includes, and GDP excludes, net receipts of income from the rest of the world, which increased \$24.3 billion in the second quarter after increasing \$36.6 billion in the first; in the second quarter, receipts increased \$29.0 billion, and payments increased \$4.7 billion."

Current-Dollar GDP

Current dollar GDP (also called nominal GDP) reflects the prices currently paid by consumers, businesses and governments. For a true measurement of the value of output in "today's" dollars, use the current-dollar GDP.

The BLS reported, "Current-dollar GDP -- the market value of the nation's output of goods and services -- increased 3.5 percent, or \$129.0 billion, in the second quarter to a level of \$14,996.8 billion. In the first quarter, current-dollar GDP increased 3.1 percent, or \$112.8 billion."

Revisions from the Advance Estimate for Q2 2011

There was a significant downward revision for real GDP date between the first and second estimates for Q2, 2011.

"The 'second' estimate of the second-quarter increase in real GDP is 0.8 percentage point, or \$25.0 billion, lower than the advance estimate issued last month, primarily reflecting an upward revision to imports and downward revisions to private inventory investment and to exports that were partly offset by an upward revision to personal consumption expenditures."

 Advance Estimate  (July, 2011) Second Estimate (August, 2011) Real GDP, Q2 2011 1.3% 1.0% Current Dollar GDP, Q2 2011 3.7% 3.5% Gross Domestic Purchases Price Index, Q2 2011 3.2% 3.3% *Percent change from preceding quarter.

Why is GDP a better measure of a nation's economic growth than GNP?

The 2007-2009 Recession - A Review

In December 2008, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) declared that a recession had begun in the U.S. economy in December 2007. At that time, U.S. output had slowed considerably from the previous quarters. More serious slowing (negative growth) accelerated in Q4 of 2008. Although the NBER's declaration that a recession had begun did not fit the commonly held definition of a recession - two consecutive quarters or negative or no growth - overall economic conditions had deteriorated enough for the NBER to make the decision that a recession had begun. In September, 2010, the BEA declared that the business cycle had hit a trough in June, 2009, and the recession was over.  "the committee determined that a trough in business activity occurred in the U.S. economy in June 2009. The trough marks the end of the recession that began in December 2007 and the beginning of an expansion. The recession lasted 18 months, which makes it the longest of any recession since World War II."

When identifying the end of the recession in June, 2009, the NBER concluded that "the behavior of the quarterly series for real GDP and GDI indicates that the trough occurred in mid-2009. Real GDP reached its low point in the second quarter of 2009, while the value of real GDI was essentially identical in the second and third quarters of 2009. The average of real GDP and real GDI reached its low point in the second quarter of 2009. The committee concluded that strong growth in both real GDP and real GDI in the fourth quarter of 2009 ruled out the possibility that the trough occurred later than the third quarter."  GDP growth had increased in June and employment began to increase several months afterward.

For more details about the NBER's determination of the end of the recession, see the Business Cycle Dating Committee's September 20, 2010 announcement at: http://www.nber.org/cycles/sept2010.html

U.S. economic growth and the recovery are slow, and the U.S. unemployment rate remains very high by historical standards.  Despite the NBER's "official" declaration of the business cycle trough in June, 2009, are we still in a recession?  Students may want to offer their own definitions of the beginning and end of period of recession. How important is the unemployment rate?  How important is real GDP growth?  Is the old adage true? "When your neighbor is out of work, it is a recession.  When you are out of work, it is a depression."

Recent History of U.S. Real GDP Growth

Figure 1, below, shows the recent history of U.S. real GDP growth rates by quarter.  Note the "cycles" of increase and decrease.  The period of December, 2007 through June, 2009 is the recession.

Recent real GDP growth has not been consistent among the states.  Figure 2, below, shows the percent change in real GDP by state, the change from 2009 to 2010.  Note the regions and states with faster and slower real GDP growth.

Source:  Bureau of Economic Analysis news release, "Economic Recovery Widespread Across States in 2010," June 7, 2011.  http://www.bea.gov/newsreleases/regional/gdp_state/2011/gsp0611.htm

Where does your state stand?  What characteristics of your state may have caused real GDP growth to be greater or less than the average?

Some Key GDP Definitions

• Gross domestic product (GDP). The market value of goods and services produced by labor and property in the United States, regardless of nationality.
• Nominal gross domestic product.  GDP expressed in current dollars.
• Real gross domestic product (real GDP). GDP adjusted for the effect of a change in the price level.
• Gross national product (GNP). The market value of goods and services produced by labor and property supplied by U.S. residents, regardless of where they are located.
• Full Employment GDP. The nation's potential output when all of the nation's productive resoruces (natural, human, and capital resources) are fully utilized.  If all of the nation's factories were working at full capacity and there was full employment, what would the GDP be?
• Potential GDP: The highest level of real gross domestic product that could be reached without putting pressure on the price level - inflation.
• Per Capita GDP. The nation's (nominal) GDP divided by its population.
• Real per capita GDP:  The nation's real GDP divided by its population.

### CONCLUSION

In Q2 of 2011, the U.S economy continued to grow, but at a much slower pace than previously estimated, and at an even slower rate than the previous two years. Economists and financial analysts' opinions are mixed as to the meaning of this growth pattern. Some predict a slow, but steady, growth rate after the short period of growth resulting from various stimulus programs.  A more negative view is that of a "double dip" recession - decline - some growth - and further decline.

The U.S. annualized growth rate was 1.0 percent in Q2 2011. Unemployment has remained historically high during this period, still at 9.1 percent in July, 2011.

The Federal Reserve has kept the federal funds rate target at almost zero to keep other interest rates low and encourage borrowing and lending.

What data do you look for as a sign of a real recovery?

### ASSESSMENT ACTIVITY

1. How is a nation's per capita real GDP determined?

2. What data from the BEA announcement supports the NBER decision that the U.S. is no longer in a recession?

### EXTENSION ACTIVITY

The August 26, 2011, BEA real GDP announcement provides a breakdown of U.S. gross domestic product growth by quarter from Q2 2007 to the present. Take a good look at the data over the time period. What are the areas of growth and decline?  Was the data (growth rates) consistent throughout the period of time?

See Table 1: Table 1. Real Gross Domestic Product and Related Measures: Percent Change From Preceding Periodhttp://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_2nd.pdf

Summarize your interpretation of the data in Table 1.

Take a look at the other tables. What information do they give you about the health of the economy?