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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 27, 2010, for the second quarter (April, May and June) of 2010. 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 2010, 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. 


Current Key Economic Indicators

  • Inflation: On a seasonally adjusted basis, the CPI-U increased 0.3 percent in July after falling 0.1 percent in June. The index for all items less food and energy increased 0.1 percent in July after increasing 0.2 percent in June. (August 13, 2010)
     
  • Employment and Unemployment: Total non-farm payroll employment declined by 131,000 in July, and the unemployment rate was unchanged at 9.5 percent. Federal government employment fell, as 143,000 temporary workers hired for the decennial census completed their work. Private-sector payroll employment edged up by 71,000. (August 6, 2010)
     
  • Real GDP: U.S. real gross domestic product increased at an annual rate of 1.6 percent in the second quarter of 2010, 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 3.7 percent. August 27, 2010)
     
  • Federal Reserve Monetary Policy: The Committee (FOMC) will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. (August 10, 2010)

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 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 value of final goods and services produced in the United States in a given period of time."

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.

While GDP is considered an indicator of economic progress, it is not necessarily a measure of well-being or quality of life, 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.

[NOTE: A more detailed definition of GDP and its components can be found later in this lesson.]

Bureau of Economics Analysis: Gross Domestic Product: Second Quarter 2010 (Second Estimate)

Announcement date: August 27, 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 1.6 percent in the second quarter of 2010, 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 3.7 percent."

The August 27 real GDP announcement was the second of three BEA estimates of GDP for the second quarter (Q2) of 2010. 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). In the advance estimate, the increase in real GDP was 2.4 percent." The US growth rate was, according to the August 27 estimate, less than the previous estimate. The U.S. economy grew more slowly than previously thought.

Discussion Question: 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. "The increase in real GDP in the second quarter primarily reflected positive contributions from nonresidential fixed investment, personal consumption expenditures, exports, federal government spending, private inventory investment, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased."

"The deceleration (change in the rate of growth) in real GDP in the second quarter primarily reflected a sharp acceleration in imports and a sharp deceleration in private inventory investment that were partly offset by an upturn in residential fixed investment, an acceleration in nonresidential fixed investment, an upturn in state and local government spending, and an acceleration in federal government spending."

Comments on two major spending categories: "Final sales of computers added 0.03 percentage point to the second-quarter change in real GDP after adding 0.10 percentage point to the first-quarter change. Motor vehicle output subtracted 0.08 percentage point from the second-quarter change in real GDP after adding 0.74 percentage point to the first-quarter change."

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 0.1 percent in the second quarter, the same increase as in the advance estimate; this index increased 2.1 percent in the first quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 0.8 percent in the second quarter, compared with an increase of 1.6 percent in the first."

The bottom line: Inflation remained low in Q2 2010. 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.

Discussion Question: How did inflation affect you in the past few 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 Components of GDP in Q2 2010

GDP is generally reported as the sum of four components. The August 27 BEA announcement reported:

  • Consumption: "Real personal consumption expenditures increased 2.0 percent in the second quarter, compared with an increase of 1.9 percent in the first."
     
  • Investment: "Real nonresidential fixed investment increased 17.6 percent, compared with an increase of 7.8 percent. Nonresidential structures increased 0.4 percent, in contrast to a decrease of 17.8 percent. Equipment and software increased 24.9 percent, compared with an increase of 20.4 percent. Real residential fixed investment increased 27.2 percent, in contrast to a decrease of 12.3 percent."
     
  • Net Exports: "Real exports of goods and services increased 9.1 percent in the second quarter, compared with an increase of 11.4 percent in the first. Real imports of goods and services increased 32.4 percent, compared with an increase of 11.2 percent."
     
  • Government Spending: "Real federal government consumption expenditures and gross investment increased 9.1 percent in the second quarter, compared with an increase of 1.8 percent in the first. National defense increased 7.3percent, compared with an increase of 0.4 percent. Nondefense increased 12.9 percent, compared withan increase of 5.0 percent. Real state and local government consumption expenditures and gross investment increased 1.2 percent, in contrast to a decrease of 3.8 percent."

    [NOTE: More detailed definitions of the four categories can be found later in this lesson.]

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 change in real private inventories added 0.63 percentage point to the second-quarter change in real GDP, after adding 2.64 percentage points to the first-quarter change. Private businesses increased inventories $63.2 billion in the second quarter, following an increase of $44.1 billion in the first quarter and a decrease of $36.7 billion in the fourth."

"Real final sales of domestic product -- GDP less change in private inventories -- increased 1.0percent in the second quarter, compared with an increase of 1.1 percent in the first."

Gross Domestic Purchases

BEA data: "Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- increased 4.9 percent in the second quarter, compared with an increase of 3.9 percent in the first." This 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 4.4percent in the first. GNP includes, and GDP excludes, net receipts of income from the rest of the world,which increased $2.1 billion in the second quarter after increasing $22.9 billion in the first; in the second quarter, receipts increased $13.7 billion, and payments increased $11.6 billion."

Current-Dollar GDP

"Current-dollar GDP -- the market value of the nation's output of goods and services -- increased 3.6 percent, or $128.6 billion, in the second quarter to a level of $14,575.0 billion. In the first quarter, current-dollar GDP increased 4.8 percent, or $169.1 billion."

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.

Revisions from the Advance Estimate for Q2 2010

"The “second” estimate of the second-quarter increase in real GDP is 0.8 percentage point, or $25.0billion, 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 (July) Second (August)*
  Estimate Estimate
Real GDP 2.4 1.6
Current Dollar GDP 4.3 3.6
Gross Domestic Purchases Price Index 0.1 0.1
*Percent change from preceding quarter

Overview of the 2008-2010 Recession

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. Though the real GDP growth rate has been positive since third quarter of 2009, the NBER has yet to identify the trough (bottom and end) of the recession, since unemployment has remained very high and other indicators of future growth are not clear.

Table 1, below, shows the rates of change of real GDP from 2007 to the present. Note the erratic pattern of declines and growth. If you refer back to the real GDP data reported in January of 2009 (January 30, 2009) "Focus on Economic Data" Lesson), you will see that these figures have been adjusted by the BEA to reflect slower growth in 2007 than had been reported earlier. According to the BEA revised data, the real decline - negative growth - began in Q1 of 2008. The third estimate for Q2 of 2009 shows a dramatic reversal from the trend of bigger decreases in 2008 and Q1 of 2009. More recently, U.S. growth has slowed considerably since Q4 of 2009.

Table 1: U.S. Real GDP Growth Rate
2007-2010
Year Quarter Growth Rate*
2007 Q1 0.9%
  Q2 3.2%
  Q3 2.3%
  Q4 2.9%
2008 Q1 -0.7%
  Q1 0.5%
  Q3 -4.0%
  Q4 -6.8%
2009 Q1 -4.3%
  Q2 -0.7%
  Q3 1.6%
  Q4 5.0%
2010 Q1 13.7%
  Q2 1.6%

Figure 1, below, shows the changes in U.S. real GDP growth from 1990 through Q2 2010. Note the "business cycles" or periodic fluctuations in the growth rate. The times when growth has been negative for two or more quarters (1990-91 and 2001) have typically been declared recessions by the National bureau of Economic Research (NBER).

GDP Figure 1

A recession is often the downward or declining segment of the business cycle. Cycles are measured from peak (top) to peak or trough (bottom) to trough. The upward segment of the cycle is a period of expansion. Figure 2 shows a typical business cycle: expansion (growth) - peak (top) - contraction (slowing or recession) - trough (bottom).

The NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion." A decline in growth of, say, 5 percent to 2 percent will not be identified as a recession. It is only the slowing growth period of a normal business cycle. Figure 3 is an illustration of the concept of the business cycle.

GDP Figure 2

Discussion Question: How does the chart illustrate a recession? If you overlay a chart of unemployment rates over this one (same time period), what will you see?

More Information About the National Income and Product Accounts (NIPAs)

[The following definitions and examples are summarized or quoted from "Measuring the Economy: A Primer on GDP and the National Income and Product Accounts," an online BEA publication. http://www.bea.gov/national/pdf/nipa_primer.pdf ]

The Bureau of Economic Analysis produces the national income and product accounts (NIPAs), a set of economic measurements that provide information on the value and composition of output produced in the United States during a given period, and on the distribution and uses of the income generated by that production.

The primary measurement of the NIPAs is gross domestic product (GDP), which measures the value of the goods and services produced by the U.S. economy in a given time period. Thus, while GDP is the primary and most commonly used measurement of the economy’s output, it is only one of the BEA's measurements. Other NIPA's include personal income, corporate profits, and government spending.

The NIPAs help to answer questions such as: How fast is the economy growing or slowing? What industries are growing or slowing down? How does the trade deficit affect economic growth? How is the pattern of spending on goods and services in the economy changing?

Gross Domestic Product - Expanded definitions

GDP measures "the value of final goods and services produced in the United States in a given period of time. While GDP is used as an indicator of economic progress, it is not necessarily a measure of well-being or quality of life. It does not account for rates of poverty, crime, or literacy. The determination of GDP is not simply measuring production or sales." Measurement of GDP is base on these constraints:

  1. "Measurement of GDP includes market production, goods and services that are produced for sale in private sector and sold through markets, and some non-market production, such as defense services provided by the Federal Government, education services provided by local governments, emergency housing or health care services provided by nonprofit institutions serving households, such as the Red Cross, and housing for persons who own and live in their home." "Not all "productive" activities are included in GDP. Some activities, such as caring for your own children, unpaid volunteer work for charities, or illegal or black-market activities, are not included. It is difficult to measure the value of these kinds of services."
     
  2. "GDP is valued at market prices. The NIPAs value market goods and services using prices set by the market. This provides a common unit of measurement (dollars) that facilitates comparisons of the various goods and services that make up economic activity.

    In some cases, market prices do not fully reflect the value of a good or service, and may include some types of services where an actual exchange has not occurred. In these cases, the value of the good or service produced is “imputed” from similar market transactions. Imputations measure the value of goods and services that are not fully reflected in market prices, such as the value of compensation-in-kind, such as meals provided by employers, and the value of owner-occupied housing."
     
  3. "GDP is a measure of current production, not sales. In the NIPAs, output measures when a good or service is produced, not when that good or service is sold. For example, an automaker may produce a car in one period and sell it in a later period. In the first period, the production of the car is recorded in GDP as an addition to inventories, a component of investment. In the later period, the sale of the car is recorded as a consumer expenditure and is offset by the withdrawal of the car from inventories."
     
  4. "GDP includes the value of “final” goods and services only. In the measurement of GDP, final products are those that are consumed and not used in a later stage of production, those that are sold to foreign residents, those that are durable goods and structures used to produce other goods and last more than a year, and those that may be inventoried for future consumption.

    When measuring the production of the whole economy, intermediate products, that is, goods and services that are used as inputs in the production process and will not contribute to future production, are excluded, so that the measure of output is an unduplicated total. The value of inputs is included in the price of the final good or service.
     
  5. "GDP captures output produced in the United States. GDP is a measure of the goods and services produced by labor and property located within the United States (in the NIPAs, the United States comprises the 50 states and the District of Columbia). Thus, GDP includes the output of U.S. offices or establishments of foreign companies located in the United States, and it excludes the output of foreign offices or establishments of U.S. companies located outside the United States. This treatment aligns GDP with other key U.S. statistics associated with the domestic economy, such as population and employment."
     
  6. "GDP is a “gross” measure. GDP reflects production in a given time period, regardless of whether that production is used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. Economic depreciation, or the consumption of fixed capital (CFC), is a measure of the amount that would need to be “set aside” to cover the aging, wear and tear, accidental damage, and obsolescence of existing fixed assets."
     
  7. Subtracting CFC from GDP leaves “net domestic product,” which is a measure of current production that excludes the investment that is necessary to replace fixed assets as they wear out. Thus, net domestic product is a measure that indicates how much of the nation’s output is available for consumption or for adding to the nation’s wealth. 

GDP Can Be Measured in Three Ways.

  1. Expenditure Approach: "GDP can be measured as the sum of expenditures, or purchases, by final users. This is known as the expenditures approach (and is illustrated by the formula familiar to students of economics: GDP = Consumption + Investment + Government spending + eXports – iMports) and is used to identify the final goods and services purchased by persons, businesses, governments, and foreigners."
     
  2. Income Approach: "Because the market price of a final good or service will reflect all of the incomes earned and costs incurred in production, GDP can also be measured as the sum of these charges. This is known as the income approach and is used to examine the purchasing power of households and the financial status of business income."
     
  3. Value Added Approach: "GDP can also be measured either as total sales less the value of intermediate inputs or as the sum of the “value added” at each stage of the production process. The value-added approach to measuring GDP is central to the U.S. industry accounts and is used to analyze the industrial composition of U.S. outputs."

GDP is the Sum of Four Basic Components

  • Personal consumption expenditures (PCE) consist of purchases of goods and services by households and by nonprofit institutions serving households (NPISHs). PCE represents, by far, the largest portion of GDP - typically about two-thirds. They are the largestThese goods and services include imputed expenditures on items such as the services of housing by a homeowner (the equivalent of rent), financial and insurance services for which there is no explicit charge, and medical care provided to individuals and financed by government or by private insurance.
     
  • Gross private domestic investment consists of purchases of fixed assets (equipment, software, and structures) by private businesses that contribute to production and have a useful life of more than one year, of purchases of homes by households, and of private business investment in inventories. Inventory investment, which is shown as “change in private inventories,” includes the value of goods produced during a period but not sold, less sales of goods from inventories that were produced in previous periods. It is measured as ending period less beginning period inventories valued at current prices (and is equivalent to additions to, less withdrawals from, inventories), Intermediate inputs, which become an integral part of the final product and do not contribute to future production, are not included in investment.
     
  • Exports consists of goods and services that are sold or transferred by U.S. residents to residents of the rest of the world.

    Imports, which is deducted in the calculation of GDP, consists of goods and services that are sold or transferred by the rest of the world to U.S. residents. The value of imports is already included in the other expenditure components of GDP, because market transactions do not distinguish the source of the goods and services. Therefore, imports must be deducted in order to derive a measure of total domestic output

    Deducting total imports purchased by all sectors from total exports, rather than deducting each sector’s imports from its total expenditures, provides an analytically useful measurement of net exports that enables one to examine the effects of foreign trade on the economy.
  • "Government consumption expenditures and gross investment” consists of government purchases of investment measures final expenditures by Federal,state, and local governments. “Government consumption expenditures” represents the value of goods and services provided to the public by governments (such as defense or eucation). “Gross investment” consists of government purchases of equipment, software, and structures to use in producing those goods and services. These expenditures do not include government spending for social benefit programs (such as Medicaid), interest payments, and subsidies.

The Formula for Determining GDP

GDP = C + I + G + X

C = Personal Consumption Expenditures

I = Gross Private Domestic Investment

G = Government Consumption Expenditures

X = Net Exports (Exports minus Imports)

Real GDP

The BEA reports the level and growth rate of "current" GDP, expressed in the current prices in the period being measured - 2010 Q2 in this announcement. This is also referred to as "nominal GDP." To factor out the effect of inflation, growth in the dollar amount that does not reflect additional output or "real" growth, GDP can be adjusted for inflation to result in real GDP. To factor out inflation, the growth rate is "chained" to prices in a base year. Calculating real GDP growth allows economists and planners to determine if production actually increased or decreased, without the impact of a change in the purchasing power of the dollar. If GDP increased by five percent and the rate of inflation was also five percent, "real" GDP growth was actually zero.

What is the Q2 2010 Real GDP?

In Q2 2010, the current dollar, or "nominal" GDP, increased 1.6 percent or $456 billion, to a level of $14,575 billion. The BEA also reported that the Q2 real GDP (chained dollars) was $12,901.5 billion and the decrease in real GDP was 0.7%. The difference is the rate of inflation from the preceding year. Figure 4, below, shows the reported GDP in current and in chained or real (adjusted for inflation) dollars.

Figure 4: U.S. GDP and Real GDP
2000-2009
Year GDP in Current
(billions)

GDP in Chained 2005
(billions)

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 12,263.4
2005 12,638.4 12,638.4
2006 13,398.9 12,976.2
2007 14,061.8 13,228.9
2008 14,368.1 13,228.8
2009 14,119.0 12,880.6
2010
Q2
14,575.0 12,901.5

Per Capita Real GDP

Even real GDP doesn’t adequately measure what happened to each individual's share of the economic output. A more meaningful measurement for individuals may be “per capita real GDP,” or the real GDP divided by the nation's population. Given that the U.S. population has increased, any increase in output is less "per capita. There are more people to consume the output, so the increase in output must exceed the growth of the population for there to be an increase in per capita GDP.

U.S. per capita real GDP reached a high of $47,138 in 2008, declined in 2009 and has risen thus far in 2010. The cahrt below shows the growth and then decline of nominal and per capita real GDP over the last three years. Note that while nominal GDP continued to increase in 2008, real growth was negative, -3.8 percent.
 

U.S. Per Capita Nominal and Real GDP
2008-2010 (Q2)
Year Nominal GDP Real GDP
2008 $47,138 $43,397
2009 $45,700 $41,890
2010 $47,058 $42,591

Discussion Question: Which is better - a very large GDP that is unevenly divided among the population or a smaller GDP that is more evenly divided among the population?

CONCLUSION

In Q2 of 2010, 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 year. 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 1.6 percent in Q2. Unemployment has remained historically high during this period, still at 9.5 percent in June and July.

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

Are we still in the recession, even though GDP has increased in recent months? Check the NBER web page for an explanation of the signs of recession. http://www.nber.org/cycles/recessions_faq.html

ASSESSMENT ACTIVITY

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


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

2. What data from the BEA announcement supports the NBER decision that the U.S. is in a recession?

EXTENSION ACTIVITY

The BEA announcement provides a breakdown of U.S. gross domestic product growth by quarter from Q3 2006 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?

Real Gross Domestic Product and Related Measures: Percent Change From Preceding Period, http://www.bea.gov/newsreleases/national/gdp/2010/pdf/gdp2q10_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?