Real Gross Domestic Product (GDP) during the fourth quarter (October through December) of 2002 increased at an annual rate of 0.7 percent. For the entire 2002 year, real GDP increased at a rate of 2.4 percent. This is the advance release of the data for the quarter and will be updated in the February 28th release of the GDP data. This compares to rates of 5.0 percent in the first quarter, 1.3% in the second quarter of year, and 4.0% in the third quarter. During 2001, real GDP increased by .3 percent - a year in which real GDP fell during the first three quarters. Annual growth rates in 1999 and 2000 were 4.1 percent and 3.8 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 rates of inflation and unemployment and changes in our income distribution provide us additional measures of the successes and weaknesses of our economy, none is a more important indicator of our economy's health than rates 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. This current increase in real GDP will be discussed in news reports both as a sign that the economy continues to recover from a recession in 2001 and that the recovery is somewhat slower than many observers expected, especially following several quarters of strong growth. This latest quarter will almost certainly be viewed as a sign that the economy may not be recovering as well as thought or that a second recession may even be on the way.
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 falls 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. See below for a discussion of the 2001 recession.
The Federal Reserve is concerned with the slow growth that is exhibited in the last quarter. The President in the State of the Union address discussed economic policy to ensure that the economy returns to more rapid growth.
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 last two quarters of 2000, the rate of growth of real gross domestic product slowed significantly and during the first three 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 negative for the first time since 1993.
The Federal Reserve responded to slowing growth and the recession by reducing the target federal funds rate by 475 basis points (4.75%) from January 2001 to December 2001 (and then again by another .5 percent in November 2002). (See the Federal Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy and the resulting low interest rates have helped increase consumer spending during and since the recession.
The price index for GDP increased at a rate of 1.8percent during the fourth quarter of 2002, compared to an increase of 1.2 percent during the third quarter of 2002. It increased at an annual rate of 1.1 percent for 2002, compared to 2.4 percent for 2001.
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 (3.0%), and the first half of the 1990s (2.2%). In the last five years of the 1990s, the rate of growth in real GDP increased to 3.8 percent, with the last three years of the 1990s being at or over 4.1 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. 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.
Details of the Fourth-Quarter Changes in Real GDP
Real GDP increased at an annual rate of 0.7 percent in the fourth quarter of 2002 compared to a rise of 4.0 percent in the third quarter of 2002. The causes of the slowing growth were a decrease in the rate of growth of consumption spending and declines in inventory investment and exports. The contributors to the increase in real GDP were increases government spending, consumption, equipment and software, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.
Remember that the reported number is the advance number and is likely to be revised by at least a moderate amount in February. The preliminary number incorporates more data to ensure accuracy and is often different from the advance numbers.
On November 26, 2001, the National Bureau of Economic Research announced though its Business Cycle Dating Committee that it had determined that a peak in business activity occurred in March of 2001. That signals the official beginning of a recession.
The NBER defines a recession as a "significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade." The current data show a decline in employment, but not as large as in the previous recession. Real income growth has slowed but not declined. Manufacturing and trade sales and industrial production have both declined and have been doing so for some time.
As seen during this quarter, consumers are increasing their spending and businesses are increasing inventories. Government spending continues to increase and investment spending is increasing, all of which contribute to speculation that we are currently coming out of the recession.
While it most surely has ended, the Business Cycle Dating Committee has not yet declared the end of the recession. The end of the previous recession occurred in March of 1991, but was not declared until December 1992. If the 2001 recession actually ended in the late fall of 2001, it may not be until at least next summer (of 2003) before the end of the 2001 recession is declared.
Two of the primary indicators used by the NBER committee are employment and real income. Employment reached a peak in March of 2001 and decreased through April of 2002. Employment increased from May to August and then declined again during September and October of this fall. Real income (minus transfer payments) reached a peak in November and December of 2000, declined through October of 2001, and has climbed back almost to its peak level as of August of this year. These two indicators alone would lead to the conclusion that the recession may have ended somewhere between October of 2001 and May of 2002.
The Federal Open Market Committee at its most recent meeting decided to lower the target federal funds rate because of its concern that the economy may not be recovering from the recession at a sufficient pace. (See the latest FOMC case study.)
For the full press release from the National Bureau of Economic Research see:
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 2002.
- 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 15 percent of GDP, but varies significantly from year to year. It is currently down as falls in investment spending have been a major cause of the recession and decrease in growth.
- 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 (11%).
- Residential investment is the building of a new homes or apartments (5%).
- 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 defense spending now accounts for approximately 4 percent of GDP. 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 goods and services produced in the U.S. and purchased by foreigners (10%). Imports are items produced by foreigners and purchased by U.S. consumers (14%). Thus, net exports (exports minus imports) are negative, about -4% of the GDP. (For more information on the balance of trade, see the Trade Report case study.)
GDP as a Measure of Well-being
Changes in real GDP are a more accurate representation of meaningful economic growth than changes in nominal GDP, because changes in real GDP represent changes in quantities produced, while prices are held constant. Real GDP per capita is even more relevant because it measures goods and services produced per person and thus approximates the amount of goods and services each person can enjoy. If real GDP grows, but the population grows faster, then each person, on average, is actually worse off than the change in real GDP would indicate.
Consider the table below. While the mainland part of China has a GDP of $991 billion, its GDP per capita is only $791.30. Hong Kong has a much smaller GDP of $159 billion. However, its GDP per capita is much higher at $23,639.58. Other nations, such as France and Germany, may have quite different GDPs, but GDPs per capita that are very close.
|Country||Population||GDP (billions)||Per Capita GDP|
GDP per capita is not a perfect estimate of well-being. When individuals grow their own food, build their own houses and sew their own clothes, they are not producing goods and services to be sold in a marketplace and therefore GDP does not change. As a result, many countries South America and Africa have a low GDP per capita that underestimates their well-being.
The U.S. as a Wealthy Country
Country Percentage of Global GDP Population Percentage of World Population
An alternative way of comparing the size of world economies is to calculate the percentage of the world GDP (approximately $32 trillion) produced in each country and compare that to the percentage of the world's population living in each country. As seen in the table above, the top ten countries in terms of gross domestic product comprise 75 percent of the global GDP with only 35 percent of the world’s population. The U.S. alone produces a third of the goods bought and sold around the world with only 4.7 percent of the world’s population. There are significant differences in the wealth of nations and the income of its citizens.
Revisions in GDP Announcements
Real GDP for each quarter is announced three times. The month following the end of the quarter is described as the advance GDP; the second announcement or revision is described as the preliminary announcement; and the third month is the final. While labeled as the final version, even it will eventually be revised after the final data for the year are published. Since 1978, the advance estimates of the rate of growth in real GDP have been revised an average of 0.5 percent in the next month's preliminary estimate. The preliminary estimates have been revised by an average of an additional 0.3 percent.
Revisions in inventory investment and the international trade data are often the causes of changes in the GDP figures. Because changes in inventories and international trade data make up significant portions of the current report, one should be particularly cautious in using the “advance” (that is, this month's figures) and “preliminary” figures.
|Social security payments||500|
|Income tax receipts||1,000|
|Business purchases of new factories and equipment and changes in inventories||1,800|
|Federal government spending on goods and services||550|
|Construction of new homes||200|
|State and local spending on goods and services||1,300|
|Changes in inventories||- 300|
Given the following data (in billions of current dollars),
- what is the level of government spending in the calculation of GDP?
- what is the level of investment?
- what is the level of net exports?
- calculate the level of gross domestic product.
- If GDP has increased by 5 percent and inflation is 3 percent, what has happened to real GDP?
- If GDP increases by 5 percent and real GDP decreased by 2 percent, what has happened to the average price level?