This lesson focuses on the August 29, 2012, second estimate of U.S. real gross domestic product (real GDP) for the second quarter (Q2) of 2012, as reported by the U.S. Bureau of Economic Analysis (BEA). The current data and historical data are explained. The meaning of GDP and potential impacts of changes of GDP are explored. This lesson will also raise questions about the impact of the current level of growth on the U.S. economy and individuals.
- 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 and implications for the future.
How Big is the U.S. Economy?
For a variety of reasons, the size and growth rate of the U.S. economy are helpful to know. Measuring the size and growth of employment and output is critical to planners and policy makers. Measuring growth over time can help to assess the health of the economy and the development of growth strategies. Knowing the size and growth of the economy is important when developing budgets and tax policies. In the U.S. the primary measurement of the economy's output is the nation's gross domestic product or GDP.
What are GDP and Real GDP?
Simply put, gross domestic product measures "the value of final goods and services produced in the United States in a given period of time." Add the value of all of the final goods and services produced by businesses and governments within the U.S. in one year, including investment, and accounting for inventory changes and net exports, and you get the value of the nation's output - GDP.
The key to the definition of GDP is that it measures "final" goods and services that are produced within the U.S. and exchanged within markets over a specific time period (usually one year), at their market value. Intermediate goods, such as the steel that is used to produce an automobile, are not counted as part of the GDP. The final value of the automobile includes the resources used to produce it.
Note: Unless otherwise cited, all quoted materials in this lesson are from the August 29, 2012, BEA announcement, National Income and Product Accounts, Gross Domestic Product: Second Quarter 2012 (second estimate). http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Real GDP, also in simple terms, is GDP adjusted for the effect of a change in the price level - thus, a measure of "real" growth without inflation. Subtract any inflation during the year to measure only the "real" increase in output - not including increased (or decreased) prices.
While GDP is considered an indicator of economic progress, it is not necessarily a true measure of well-being, quality of life or standard of living, because it does not account for such factors as income distribution, health, quality, 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 - so it does give us a picture of the health of the overall economy.
Another way to look at GDP as a measure of well-being is to determine the nation's per capita GDP or per person. Divide the GDP by the population and you get per capita GDP. Per capital GDP is often used to compare the well-being and growth of different nations. Again, even per capita GDP does not account for many qualitative factors or income distribution.
Students: Do you think the size of the economy's output or GDP is a good measure of people's well-being or standard of living? What about per-capita GDP as an alternative - GDP divided by the population? Even if per-capita GDP is more meaningful, is the GDP evenly divided among the population?]
National Income and Product Accounts
Gross Domestic Product, 2nd quarter 2012 (second estimate)
Released: August 29, 2012
"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 1.7 percent in the second quarter of 2012 (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 2.0 percent."
Read more of the August 29, 2012, BEA announcement to learn more about recent U.S. real GDP growth. Remember, the BEA releases the estimate for each quarter three times. This was the second estimate for Q2 2011. http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Was the previous estimate “wrong”?
The BEA explains the difference. “The GDP estimate released today is based on more complete source data than were available for the "advance" estimate issued last month. In the advance estimate, the increase in real GDP was 1.5 percent.”
What sectors contributed to GDP growth in 2012 Q2?
"The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, nonresidential fixed investment, and residential fixed investment that were partly offset by negative contributions from private inventory investment and from state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased."
Why did the GDP growth rate decrease from Q1?
"The deceleration in real GDP in the second quarter primarily reflected decelerations in PCE, in nonresidential fixed investment, and in residential fixed investment that were partly offset by a smaller decrease in federal government spending, an acceleration in exports, and a smaller decrease in private inventory investment."
Figure 1, below, shows graphically the U.S. quarterly real GDP growth rates from 1999 through Q2 2012. Note the real GDP negative growth in late 2008 and early 2009. This is the period that looks like the traditional definition of a recession. According to the National Bureau of Economic Research (NBER), the recession began in December, 2007, and ended in June, 2009 (http://www.nber.org/cycles.html
Students: Can you identify the periods of recession during this time span? Information on Recessions and Recoveries
Remember, the simple formula to determine GDP (Y) is to add:
- Personal consumption expenditures (C) 71.0 percent of the total.
- Net private investment (I) 13.2 percent of the total.
- Government spending (G) 19.6 percent of the total.
- Net exports (X) - 3.7 percent of the total.*
C + I + G + X = Y
- When imports are greater than exports, the net export amount is a subtraction from GDP.
What is the BEA?
From the BEA webpage: "The BEA is an agency of the Department of Commerce. Along with the Census Bureau and STAT-USA, BEA is part of the Department's Economics and Statistics Administration.
BEA produces economic accounts statistics that enable government and business decision-makers, researchers, and the American public to follow and understand the performance of the Nation's economy. To do this, BEA collects source data, conducts research and analysis, develops and implements estimation methodologies, and disseminates statistics to the public." http://www.bea.gov/about/mission.htm
Read the full August 29, 2012, BEA announcement of U.S. real GDP growth at: http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf . The BEA breaks down the quarterly growth or decline by sector - personal consumption expenditures (PCE), private investment, government spending, and net exports.
Students: What sectors declined in Q2 2011? What sectors grew in Q2 2011?
The BEA also breaks down the GDP data by key industry groups. Go to http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf Scroll down to Table 2 to see industry group GDP data and the change for the previous quarter.
- Read gross domestic product increased 1.70 percent.
- Real personal consumption expenditures increased 1.20 percent.
- Real gross private fixed investment increased 0.40 percent.
- Net exports of goods and services increased 0.32 percent.
- government consumption expenditures/gross investment decreased 0.18 percent.
Students: Look at the detailed GDP Data by Industries to identify how well the key industries in your city or region are doing.
What was the current-dollar GDP in Q2 2012?
Current-dollar GDP Is the market value of the nation's output of goods and services produced within the United States. Current dollar GDP "increased 3.3 percent, or $127.8 billion, in the second quarter to a level of $15,606.1 billion. In the first quarter, current-dollar GDP increased 4.2 percent, or $157.3 billion."
$15,606,100,000,000. That is approximately $49,543 per person or per capita GDP. This is based on the U.S. population estimate in July, 2012, of 315 million. A nation's per capita GDP is the current dollar GDP divided by the nation's population
Note that the current dollar GDP estimate of 3.3 percent growth for Q2 2012 is greater than the reported real growth rate of 1.7 percent. What's the difference?
The BEA explains, “Current dollar estimates are expressed in current prices. Chained dollar (real) estimates are adjusted for inflation using the price index for gross domestic purchases.”
Current dollar GDP was $15,606,100,000,000 in Q2, and real GDP was $13,564,500,000,000. This tells us that just over $2 trillion of the GDP growth since 1983-85 has resulted from an increase in the price level (inflation).
Students are you clear about the difference between the nominal (current dollar) GDP and the real (chained dollar) GDP measurements?
CIA World Factbook: Guide to Country Comparisons Remember, a high per capita GDP doesn't necessarily mean that all people in a country have high incomes or a high standard of living. In many instances, GDP figures for a nation do not accurately reflect the well-being of all individuals in that nation. If purchasing power varies among nations, the term “purchasing power parity” (PPP) is used to reflect economic data that has been adjusted by varying national price levels.
Quarterly GDP Estimates and Revisions
As previously cited, there are revisions of the quarterly estimates made three times for each quarter. For Q2 2012, the first estimate, made in June, 2012, was a 1.5 percent (annualized) rate of real GDP growth. The second monthly estimate, this estimate made in August, is a 1.7 growth rate. In September, the final estimate, base on even more and sometimes revised data will be made. It may be revised upward, downward, or kept the same.
The BEA explained the Q2 2012 change: "The “second” estimate of the second quarter percent change in GDP is 0.2 percentage point, or $6.5 billion, more than the advance estimate issued last month, primarily reflecting a downward revision to imports and upward revisions to personal consumption expenditures, to exports, and to state and local government spending that were partly offset by downward revisions to private inventory investment and to nonresidential fixed investment.”
Annual GDP Estimates
The BEA also publishes annual GDP estimates, usually completed and revised in the September announcement. According to the BEA, annual revisions to GDP estimates are made each year in order to:
- Incorporate most complete and reliable source data.
- Provide a more detailed picture of the economy.
- Make improvements to methods used for preparing the estimates.
Figure 2, below, shows the U.S. current dollar and real GDP for the years 2000 through Q2 2012. Note the years when the GDP adjustment was significant and when the adjustment was small (compare the difference between the growth of the nominal and real GDP numbers. Those years with a decrease in annual GDP reflect the most recent recession.
What is the U.S. Potential GDP?
A nation’s maximum or potential GDP or its potential output is the highest level of output that can be maintained over the long term, given any constraints on the nation’s productive resources. A limited supply of labor, capital, or natural resources creates a limit to potential output of goods and services, investment or government spending.
Another interpretation of this concept is that it is the output that can be achieved with no increase in inflation. This potential output can be illustrated through the production possibilities frontier. The difference between a nation’s potential GDP and actual GDP is the called the “output gap” or “recessionary gap.”
If an economy is at full employment (the natural rate of unemployment (NAIRU), no more workers can be hired to use the available capital and other resources to produce. Given the currently high U.S. unemployment rate, the U.S. GDP maybe far below its potential. A change in technology or some other improvement in productivity can increase the actual and potential GDP.
Economist Arthur Okun proposed in 1962 that a 1 percent change in unemployment results in a 2 to 2 ½ percent change in output. “Okun’s law” is a general “rule of thumb” subject many variables. Other have suggest similar relationships. This is, perhaps, as close as is possible to measure the real recessionary gap.
Students: Have you seen evidence of the U.S. economy "not living up to it's potential"? Are there signs of slow growth and unused capacity? What about unemployment?
How is GDP Measured?
There are two basic ways to determine a nation’s GDP.
The Expenditure Approach
This method of determining GDP adds up the market value of all domestic expenditures made on final goods and services in a single year, including consumption expenditures, investment expenditures, government expenditures, and net exports. Add all of the expenditures together and you determine GDP.
The Income Approach
This method of determining GDP is to add up all the income earned by households and firms in the year. The total expenditures on all of the final goods and services are also income received as wages, profits, rents, and interest income. By adding together all of the wages, profits, rents, and interest income, you determine GDP.
NOTE: The two methods of measuring GDP should result in the same number, with some possible small difference resulting from statistical and rounding differences.
The Business Cycle
Real GDP growth is just one, but one of the critical measures used by the National Bureau of Economic Research (NBER) to determine the beginning and end of recessions.
Figure 3, below, illustrates a business cycle - a period of growth, followed by a peak (top), a period of decline (possibly a recession), and a trough (bottom.)
Even though the unemployment rate remains very high, the recession has been over for some time. The NBER uses GDP growth, the unemployment rate and several other measures to identify the peaks and troughs of the business cycles. The NBER definition of a recession can be found at: http://www.nber.org/cycles/general_statement.html. ]
What is the NBER?
From the NBER website: "Founded in 1920, the National Bureau of Economic Research is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works. The NBER is committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community.
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 for Q4 2011 added, "The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 0.8 percent in the second quarter, 0.1 percentage point more than in the advance estimate; this index increased 2.5 percent in the first quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 1.4 percent in the second quarter, compared with an increase of 2.4 percent in the first."
Students: How has inflation affected you in the past few months? Did you notice any price changes?
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."
The BEA mentions the impact of inventory increase or decline in the final determination of the nation's GDP. "The change in real private inventories subtracted 0.23 percentage point from the second-quarter change in real GDP, after subtracting 0.39 percentage point from the first-quarter change. Private businesses increased inventories $49.9 billion in the second quarter, following increases of $56.9 billion in the first quarter and $70.5 billion in the fourth."
Good Bye to 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. In Q4 U.S. GNP was $15.443 trillion. The BEA did not specifically mention the GNP in this announcement, as it did previously. This will be the last mention of GNP in the "Focus on Economic Data" lessons. GNP data can be found in the announcement, Table 9.
Review: Some Key GDP Definitions (from the BEA Glossary)
- Gross domestic product (GDP). The market value of goods and services produced by labor and property in the United States, regardless of nationality.
- 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 resources (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 - current dollar - GDP divided by its population.
- Real Per Capita GDP: The nation's real GDP divided by its population.
BEA Glossary link: http://www.bea.gov/glossary/glossary.cfm
One More Data Point
Along with GDP, the BEA announcements also include corporate profits.
"Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $10.4 billion in the second quarter, in contrast to a decrease of $53.0 billion in the first quarter. Current-production cash flow (net cash flow with inventory valuation adjustment) -- the internal funds available to corporations for investment -- decreased $11.3 billion in the second quarter, compared with a decrease of $169.8 billion in the first."
Once again,"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 1.7 percent in the second quarter of 2012 (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 2.0 percent." (U.S. Bureau of Economic Analysis, Gross Domestic Product: Second Quarter 2012 (second estimate, August 29, 2012.)
The economy is growing at a modest – slightly less than average - pace. Unfortunately, this growth has not resulted in the creation of enough new jobs to significantly reduce the unemployment rate to anywhere near a normal level. The U.S. unemployment rate remains at 8.3 percent (as of July, 2012).
It is generally clear that if unemployment is high, the economy will not be producing at its full or normal output. Since people who are not working, their labor resources are not being used effectively. What is the relationship between unemployment and output?
In 1962, economist Arthur Okun theorized that there is a predictable relationship between unemployment and national output (GDP). Okun's Law correlates changes in real GDP and changes in the unemployment rate. He said that real GDP grows at about 3% per year when unemployment is normal.
For every point above 3.0 percent unemployment, the nation’s GDP decreases by 2%. And, it also works in reverse – each percentage point under 3.0 results in an additional 2 percent in GDP growth. For example, if the U.S. unemployment rate is 9.0 percent, 6.0 percent over the 3.0 average, GDP is reduced by 12 percent.
Many suggest that this historic relationship between unemployment and the “GDP gap” no longer exists – at least to the degree that Professor Okun suggested. The economy grew at a greater rate in late 2009, despite an even higher unemployment rate. The new concept is the “jobless recovery,” made possible by technology and greatly improved productivity.
Are we in a "new economy," one where the relationship between employment and output has changed?
Keep an eye on the employment and GDP data for the rest of the year.
Short Answer Essay Question:
1. If gross domestic product increases by 10 percent over a year, are we better off? Why or why not?
[Possible Answer: Perhaps we are better off. Maybe not. The answer depends upon what is happening to prices and what is happening to population. If prices and population together are rising by more than 10 percent per year, than we, on average, are worse off. We have fewer goods and services per person. If the nation's real per capita GDP increases, we may be "better off."]
2. How is the nation's GDP determined?
[GDP is the sum of personal consumption expenditures (c), net private investment (I), government spending (G), and net exports (X).]
The BEA provides a history of U.S. gross domestic product (nominal GDP and real GDP) growth annually since 1930 and by quarter since 1947, to the present year.
Take a good look at the GDP data over the time period. Gross Domestic Product: Percent Change From Preceding Period, www.bea.gov/national/index.htm#gdp
- What are the periods of growth and decline? Was the data (growth rates) consistent throughout the period of time?
- Can you identify the periods of the recessions (and the Great Depression)?
- Compare the nominal growth rates and the real growth rates. Can you find periods of high inflation?
[Note to teachers: Assign pairs or small groups to look at different time periods. They can summarize the data and suggest their meanings to the other groups.]