Return

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 third and final estimate of real GDP released on March 26, 2010, for the fourth quarter  of 2009 (October-December.) 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. 

TASK

  • 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.

PROCESS

Headline: “U.S. Economy Grows 5.6 Percent”

What does it mean? Is the recession over? Does this mean millions of unemployed people are more likely to find jobs? Let’s see.

News Release: Gross Domestic Product: Fourth Quarter 2009 (Third Estimate)

U.S. Bureau of Economic Analysis
Released March 26, 2010

“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 5.6 percent in the fourth quarter of 2009, (that is, from the third quarter to the fourth quarter), according to the "third" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.2 percent.”

Remember, real GDP estimates for a quarter are released three times over three months. For the fourth quarter of 2009, the first estimate in January 2010 was 5.7 percent growth. The second estimate in February was slightly more growth. This estimate, the final estimate for the quarter, was 5.6 percent growth. The BEA explained, “The GDP estimate released today is based on more complete source data than were available for the "second" estimate issued last month. In the second estimate, the increase in real GDP was 5.9 percent.”

The BEA comments on the increase or decrease in real GDP citing two measurements of change. When they use the term “acceleration,” they refer to the rate of change. The real GDP announcement also cites the “increase” or the dollar value increase in the various sectors. The two following paragraphs from the news release identify the sectors that contributed to the total increase or subtracted from the increase in two ways. Imports, for example, increased as part of the total, but at a slower rate of change.

“The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, personal consumption expenditures (PCE), and nonresidential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.”

“The acceleration in real GDP in the fourth quarter primarily reflected an acceleration in private inventory investment, an upturn in nonresidential fixed investment, an acceleration in exports, and a deceleration in imports that were partly offset by decelerations in PCE and in federal government spending.”

Each month recently, the BEA has commented specifically on two important product groups – motor vehicles and computers. “Motor vehicle output added 0.45 percentage point to the fourth-quarter change in real GDP after adding 1.45 percentage points to the third-quarter change. Final sales of computers added 0.01 percentage point to the fourth-quarter change in real GDP after subtracting 0.08 percentage point from the third-quarter change.” Motor vehicle sales were stimulated in mid-2009 by the federal government “Cash for Clunkers” rebate program.

Figure 1, below, shows the growth rates of U.S. real GDP from 2000 through 2009. Note the “business cycles – periods of growth and decline. Business cycles are defined later in this lesson.

Figure 1 GDP

A Note About “Real” GDP Growth

To adjust for the effect of inflation and to determine “real” GDP, the BEA uses a price index. The price index for gross domestic purchases is the “percent change in the price index for gross domestic purchases. This index measures 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.”

In Q4 2009, “the price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 2.0 percent in the fourth quarter, 0.1 percentage point more than in the second estimate; this index increased 1.3 percent in the third quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 1.5 percent in the fourth quarter, compared with an increase of 0.3 percent in the third.”

  • Real personal consumption expenditures increased 1.6 percent in the fourth quarter, compared with an increase of 2.8 percent in the third. Real nonresidential fixed investment increased 5.3 percent, in contrast to a decrease of 5.9 percent. Nonresidential structures decreased 18.0 percent, compared with a decrease of 18.4 percent. Equipment and software increased 19.0 percent, compared with an increase of 1.5 percent. Real residential fixed investment increased 3.8 percent, compared with an increase of 18.9 percent.
  • Real exports of goods and services increased 22.8 percent in the fourth quarter, compared with an increase of 17.8 percent in the third. Real imports of goods and services increased 15.8 percent, compared with an increase of 21.3 percent.
  • Real federal government consumption expenditures and gross investment were unchanged in the fourth quarter, compared with an increase of 8.0 percent in the third. National defense decreased 3.6 percent, in contrast to an increase of 8.4 percent. Nondefense increased 8.3 percent, compared with an increase of 7.0 percent. Real state and local government consumption expenditures and gross investment decreased 2.2 percent, compared with a decrease of 0.6 percent.
    The change in real private inventories added 3.79 percentage points to the fourth-quarter change in real GDP, after adding 0.69 percentage point to the third-quarter change. Private businesses decreased inventories $19.7 billion in the fourth quarter, following decreases of $139.2 billion in the third quarter and $160.2 billion in the second.
  • Real final sales of domestic product -- GDP less change in private inventories -- increased 1.7 percent in the fourth quarter, compared with an increase of 1.5 percent in the third.

Other Measures of Output

  • Gross domestic purchases - purchases by U.S. residents of goods and services wherever produced -- increased 5.2 percent in the fourth quarter, compared with an increase of 3.0 percent in the third.
  • Real gross national product -- the goods and services produced by the labor and property supplied by U.S. residents -- increased 5.0 percent in the fourth quarter, compared with an increase of 3.0 percent in the third. GNP includes, and GDP excludes, net receipts of income from the rest of the world, which decreased $14.5 billion in the fourth quarter after increasing $25.7 billion in the third; in the fourth quarter, receipts increased $20.6 billion, and payments increased $35.1 billion.
  • Current-dollar GDP - the market value of the nation's output of goods and services – increased 6.1 percent, or $211.7 billion, in the fourth quarter to a level of $14,453.8 billion. In the third quarter, current-dollar GDP increased 2.6 percent, or $90.9 billion.

Gross Domestic Product for the Year of 2009

“Real GDP decreased 2.4 percent in 2009 (that is, from the 2008 annual level to the 2009 annual level), in contrast to an increase of 0.4 percent in 2008.”

“The decrease in real GDP in 2009 primarily reflected negative contributions from nonresidential fixed investment, exports, private inventory investment, residential fixed investment, and personal consumption expenditures (PCE) that were partly offset by a positive contribution from federal government spending. Imports, which are a subtraction in the calculation of GDP, decreased.”

“The downturn in real GDP in 2009 primarily reflected downturns in nonresidential fixed investment and in exports and a larger decrease in private inventory investment that were partly offset by a larger decrease in imports and a smaller decrease in residential fixed investment.”

“The price index for gross domestic purchases was unchanged in 2009, compared with an increase of 3.2 percent in 2008.”

“Current-dollar GDP decreased 1.3 percent, or $185.1 billion, in 2009. Current-dollar GDP increased 2.6 percent, or $363.8 billion, in 2008.”

The figure below shows the current dollar and constant dollar GDP data from 2000 through 2009. The difference between the current dollar figure and the constant dollar figure is the rate of inflation. These figures are in billions of U.S. dollars.  The current dollar GDP at the end of 2009 was almost $14.5 billion.

U.S. Current and Constant Dollar GDP
2000 - 2009

Year Current Dollar GDP Constant Dollar
"Real" GDP
2000 9,951.5 11,226.0
2001 10,286.2 11,347.2
2002 10,642.3 11,553.0
2003 11,142.1

11,840.7

2004 11,867.8 12,263.8
2005 12,638.4 12,638.4
2006 13,398.9 12,976.2
2007 14,077.6 13,254.1
2008 14,441.4 13,312.2
2009 14,453.8 13,149.5

Business Cycles and Recessions

The BEA tracks changes in real GDP, the traditional measurement used to identify business cycles. Though it is a critical measure, real GDP is not the sole determinant in the identification of recessions. A recession, a "significant decline in economic activity spread across the economy, lasting more than a few months," is identified by the National Bureau of Economic Research (NBER) "Business Cycle Dating Committee." In addition to real GDP, the key measurements in the determination of a recession are real income, payroll employment, industrial production, and wholesale-retail sales. Recently, the NBER has identified payroll employment as the key criteria used to identify business cycles.

In its announcement of the beginning of the recession in December 2008, the NBER committee cited these trends in economic activity:

Payroll employment “reached a peak in December 2007 and has declined every month since then.”

Real GDP “fell slightly in 2007 Q4, rose slightly in 2008 Q1, rose again in 2008 Q2, and fell slightly in 2008 Q3…the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity."

Real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment "all reached peaks between November 2007 and June 2008.”

Business cycles are fluctuations in aggregate economic activity in cycles of expansion, peak, contraction, and trough. In a business cycle, several macroeconomics variables will move together (not lock-step in short periods) in a general trend. The cycles recur, but there is no consistent pattern of depth or length of time. The NBER will not identify a business cycle downturn as a recession unless it meets these general qualities and the declines are sufficient enough to meet the description as a "significant decline in economic activity spread across the economy, lasting more than a few months."

Figure 2, below, illustrates a "typical" business cycle, with periods of expansion, peak, contraction, and trough.

Figure 2 GDP

Measuring Economic Activities – Economic Indicators

Much attention is paid in the media to the "Index of Leading Indicators," a composite index used to estimate future economic activity. The Index is determined by The Conference Board, "a global independent membership organization working in the public interest. It publishes information and analysis, makes economics-based forecasts and assesses trends, and facilitates learning by creating dynamic communities of interest that bring together senior executives from around the world." 

The Index consists of a variety of measures of economic activity that have historically turned downward before contractions and upward before expansions. The Conference Board created a single index value, a "composite index," composed of ten variables. Many economists believe that the Index of Leading Indicators can "provide an early warning system so that policymakers can shift toward macroeconomic stimulus when the index fails."

The Conference Board's most recent report on “Global Business Cycle Indicators ” was released on March 18, 2010.

“The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.1 percent in February, following a 0.3 percent gain in January, and a 1.2 percent rise in December.”

Ataman Ozyildirim, Economist at The Conference Board comments on the meaning of the LEI, “The LEI for the U.S. has risen rapidly for almost a year now and it has reached its highest level. But, the sharp pick up in the LEI appears to be stabilizing. As the economy moves from recovery into early phases of an expansion, the leading economic index points to moderately improving economic conditions in the near term. Correspondingly, the coincident economic index has been rising since July 2009, albeit slightly because of continued weakness in employment.”

Ken Goldstein, Economist at The Conference Board also comments, “The indicators point to a slow recovery this summer. Going forward, the big question remains the strength of demand. Without increased consumer demand, job growth will likely be minimal over the next few months. ”

“The Conference Board Coincident Economic Index® (CEI) for the U.S. rose 0.1 percent in February, following no change in January, and a 0.1 percent increase in December. The Conference Board Lagging Economic Index® (LAG) increased 0.3 percent in February, following a 0.2 percent decline in January, and a 0.4 percent decline in December.”

The various cyclical indicators used by the Conference Board are classified into three categories—leading, coincident, and lagging, based on their timing in relation to the business cycle. 

Coincident indicators, such as employment, production, personal income, and manufacturing and trade sales, measure current aggregate economic activity.

  • Employees on nonagricultural payrolls
  • Personal income less transfer payments
  • Index of industrial production
  • Manufacturing and trade sales

Leading indicators, such as average weekly hours, new orders, consumer expectations, housing permits, stock prices, and the interest rate spread, tend to change direction ahead of the business cycle

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders, consumer goods and materials
  • Vendor performance, slower deliveries diffusion index
  • Manufacturers’ new orders, nondefense capital goods
  • Building permits, new private housing units
  • Stock prices, 500 common stocks
  • Money supply, M2
  • Interest rate spread, 10-year Treasury bonds less Federal funds (%)
  • Index of consumer expectations

Lagging indicators tend to change direction after the coincident indicators. Lagging indicators represent costs of doing business, such as inventory-sales ratios, change in unit labor costs, average prime rate charged by banks, and commercial and industrial loans outstanding. Lagging indicators, such as the ratio of installment credit outstanding to personal income, the change in consumer prices for services, and average duration of unemployment reflect consumer behavior. The lagging indicators may confirm the trends identified with the leading and coincident indicators.

  • Average duration of unemployment
  • Inventories to sales ratio, manufacturing and trade
  • Change in labor cost per unit of output, manufacturing (%)
  • Average prime rate charged by banks (%)
  • Commercial and industrial loans outstanding
  • Consumer installment credit outstanding to personal income ratio
  • Change in consumer price index for services (%)

CONCLUSION

Continued growth is critical for the U.S. economy.   What can be done?

Current Economic Policy Goals

Figure 3, below, shows the components of U.S. gross domestic product at the end of 2009. Note that personal consumption expenditures are, by far, the largest component of GDP. Many analysts say that the true recovery from the recession will happen only when consumers increase their spending to previous levels. Others add that it will take increased business investment that results in job creation.

Figure 3 GDP

Recent government policy decisions to promote growth in the economy are aimed at stimulating one or more of the components - consumer spending, investment, government spending, or exports. The overall goal is to stimulate aggregate demand.   Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate-demand curve, which illustrates the relationship between price levels and the quantities of output that are demanded. Aggregate demand can also be called total spending.  

Aggregate demand can also be illustrated by the formula AD = C + I + G + (X-M):

    C = Consumers' expenditures on goods and services
     I = Investment spending by companies on capital goods
    G = Government expenditures on publicly provided goods and services
    X = Exports of goods and services
    M = Imports of goods and services

By direct government spending, creating jobs, promoting investment, and increasing output, employment is increased and income is created.  As those with new jobs earn income, they increase their spending - increasing aggregate demand.  The $787 billion federal stimulus (American Recovery and Reinvestment Act of 2009) is intended to do just that. The U.S. government’s Recovery.Gov web site reports that between October 1 and December 31, 2009, stimulus programs created 608,317 new jobs.

For more information about the goals and impact of stimulus programs, go to Recovery.Gov , the U.S. government’s official website providing easy access to data related to Recovery Act spending.

ASSESSMENT ACTIVITY

Next, answer the essay question on the below interactive notepad.

 

  1. If gross domestic product increases by 10 percent over a year, are we better off? Why or why not?

EXTENSION ACTIVITY

The U.S. Central Intelligence Agency (CIA) “World Factbook” ranks the nations of the by various economic measures, including gross domestic product. The “top ten” nations in the current edition are listed below. [NOTE: The CIA GDP data is reported using “purchasing power parity” a process that determines the relative values of two currencies. It equates the purchasing power of various nations’ currencies and lists them as equivalent to U.S. dollars.] 

Rank Country Per Capita GDP  
1 Lietchtenstein $118,000 2007 est.
2 Qatar $110,700 2008 est.
3 Luxembourg $81,000 2008 est.
4 Bermuda $69,900 2004 est.
5 Norway $59,300 2008 est.
6 Kuwait $57,400 2008 est.
7 Jersey $57,000 2005 est.
8 Brunei $53,100 2008 est.
9 Singapore $51,500 2008 est.
10 United States $46,900 2008 est.

 In terms of total size of GDP, the U.S. ranks second, just behind the European Union nations’ total:

Rank Country GDP  
1 European Union $14,910,000,000,000 2008 est.
2 United States $14,260,000,000,000 2008 est.
3 China $7,973,000,000,000 2008 est.
4 Japan $4,329,000,000,000 2008 est.
5 India $3,297,000,000,000 2008 est.
6 Germany $2,918,000,000,000 2008 est.
7 Russia $2,266,000,000,000 2008 est.
8 United Kingdom $2,226,000,000,000 2008 est.
9 France $2,128,000,000,000 2008 est.
10 Brazil $1,993,000,000,000 2008 est.

Take a look at the economic data for the world’s nations available from the CIA World Factbook . What does the data tell you about the various nations?

Choose one nation. Summarize what you perceive is that nation’s “standard of living,” according to its per capita GDP and other measures of social welfare.