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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 "final" or third estimate of real GDP released on September 30, 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.

TASK

  • Determine the current, recent 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

What Do You Think Is the Best Indicator of the Health of the U.S. Economy?

Inflation?   Employment?   Gross Domesting Product Growth?  The S&P 500 Index?

Everyone has their opinion abou the best sign of strength of weakness in the economy.  Of course, there ar emany pmore potenital answers to the "best indicvator" question.  Many say that output is the key - real output, that is, adjusted for the impact of inflation.  For some, the amout of putput per person (per capital real GD) is it.  Do the citizens have more goods and servies to satisfy their wants?

This lesson introduces the meaning of real gross domestic product growth as a measure of economic well-being.

A Quick Review of Gross Domestic Product

A nation's gross domestic product (GDP) is the total market value of all final goods and services produced within the country, usually measured over one year.  Nominal GDP measures the output of goods and services in current prices while real GDP measures the output of goods and services in constant prices, adjusted for the effects of inflation. 

Final goods and services means that all goods are counted as they are finally produced; that is, there is no need to count the output of the steel industry, which is an "intermediate" input, because the value of the steel will be counted in cars, refrigerators, buildings and all the other final uses of steel.

The reference to what is "produced" emphasizes that not all sales of goods represent new production. For example, a new house is included in GDP in the year it is built, but the sale price of a house that was built years ago and resold this year is not included in this year's GDP.

The components of the measurement of GDP are:

GDP =      C  (personal consumption expenditures or household spending) 
               + I    (net private investment or business spending) 
               + G  (government spending - all levels)
               + X  (net exports, calculated as exports minus imports)

U.S. Bureau of Economic Analysis Announcement
Gross Domestic Product: Second Quarter 2010 (Third Estimate)

Released September 30, 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 1.7 percent in the second quarter of 2010, (that is, from the first quarter to the second quarter), according to the "third" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 3.7 percent.  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 1.6 percent (see "Revisions")."

The final real GDP growth estimate for Q2 of 2010 was slightly higher than the second estimate released in August.  Though this estimate is a downward revision from the initial August estimate of 2.4 percent growth, it was not reduced from the September estimate (-1.6 percent) as some had predicted.

Is 1.7 percent real growth a good sign?   U.S. real GDP growth has averaged about 3 percent over the last several decades.

The BEA announcement identified the sectors of growth and decline that contributed to the overall estimate of Q2 2010 real GDP growth.

"The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures, nonresidential fixed investment, exports, private inventory investment, federal government spending, and residential fixed investment."

Areas of decline in the total included, "Imports, which are a subtraction in the calculation of GDP, increased. The deceleration 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, accelerations in nonresidential fixed investment and in federal government spending, and an upturn in state and local government spending.

Essentially, all sectors contributed in some positive way to the overall Q2 growth.  Is this good news?  In recent quarters, there have been more erratic patterns of growth and decline in government spending, investment and personal consumption.  While personal consumption was declining during the recesson, government spendiing was increasing.  Similarly, while private sector employment was decreasing during the recession, government spending was increasing (mostly census hiring.)

As usual, the BEA commented on two critical industries:

"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 0.06 percentage point from the second-quarter change in real GDP after adding 0.74 percentage point to the first-quarter change."

To ask the BEA a question about GDP data, go to the FAQ page and click on "Ask a Question ."

Measuring Real GDP - Adjusting for Inflation

The BEA does not use the cumsumer price index (CPI) to adjust fo rinflation.  The CPI measures only final consumer prices.  The BEA uses the "price index for gross domestic purchases." This measure if inflation is more broad in scope.

From the BEA FAQs: "BEA's featured measure of inflation in the U.S. economy 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."

From the September 30 announcement: "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 second 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."

Q2 Change in Real GDP by Sector

"Real personal consumption expenditures increased 2.2 percent in the second quarter, compared with an increase of 1.9 percent in the first."

"Real nonresidential fixed investment increased 17.2 percent, compared with an increase of 7.8 percent. Nonresidential structures decreased 0.5 percent, compared with a decrease of 17.8 percent. Equipment and software increased 24.8 percent, compared with an increase of 20.4 percent. Real residential fixed investment increased 25.7 percent, in contrast to a decrease of 12.3 percent."

"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 33.5 percent, compared with an increase of 11.2 percent."

"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 7.4 percent, compared with an increase of 0.4 percent. Nondefense increased 12.8 percent, compared with an increase of 5.0 percent. Real state and local government consumption expenditures and gross investment increased 0.6 percent, in contrast to a decrease of 3.8 percent." 

"The change in real private inventories added 0.82 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 $68.8 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 0.9 percent in the second quarter, compared with an increase of 1.1 percent in the first.
Gross domestic purchases Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- increased 5.1 percent in the second quarter, compared with an increase of 3.9 percent in the first."

Although a small percentage increase in personal consumption may be larger in total dollars, the increase in net private investment was a very significant part of the Q2 2010 growth.  Real nonresidential fixed investment increased 17.2 percent in Q2, compared with an increase of 7.8 percent in Q1.  This seems to bode well for future growth as businesses may be adding to productive capacity.  Housing construction, or residential fixed investment, was still a lag on the economy in Q2.

Gross National Product

The BEA has used the measurement of "gross domestic product" as the key growth measurement since 1991, replacing the measurement gross national product (GNP).  The change to GDP factored out production by U.S. comapanies located outside the United States and provides a more true measure of "national" output.  The BEA continues to report GNP data.  

"Real gross national product -- the goods and services produced by the labor and property
supplied by U.S. residents -- increased 1.8 percent in the second quarter, compared with an increase of 4.4 percent in the first. GNP includes, and GDP excludes, net receipts of income from the rest of the world, which increased $3.7 billion in the second quarter after increasing $22.9 billion in the first; in the second quarter, receipts increased $2.0 billion, and payments deceased $1.7 billion." 

Current-Dollar GDP - Not Adjusted for Inflation

"Current-dollar GDP -- the market value of the nation's output of goods and services -- increased 3.7 percent, or $132.3 billion, in the second quarter to a level of $14,578.7 billion. In the first quarter, current-dollar GDP increased 4.8 percent, or $169.1 billion."

Revisions

Ther BEA announcement explained the difference between the second estimate made in August and the third (final) estimate in September.  "The third estimate of the second-quarter increase in real GDP is 0.1 percentage point, or $3.4 billion, higher than the second estimate issued last month, primarily reflecting upward revisions to private inventory investment and to personal consumption expenditures that were mostly offset by an upward revision to imports."  GDP growth estimates are adjsuted as new economic data becomes available.  The first estimate of Q2 growth made in July was a 2.4 percent grwth rate.

Advance Estimate Second Estimate Third Estimate
(Percent change from preceding quarter)
  July August September
Real GDP Growth (%) 2.4 1.6 1.7
Current-dollar GDP Growth (&)   4.3 3.6 3.7
Gross domestic purchases price index  0.1 0.1 0.1


Figure 1, below, shows the categories of U.S. GDP for 2007-2009 and the first two quarters of 2010.  Notice how the percentage of GDP that comes from personal consumption expenditures has increased recedntly.  Notice also that the percentage of GDP coming from net private investment decreased well into 2009 and then increased.   A smaller loss from negative net exports and increased government spending (stimulus) have also contributed to the growth of GDP.

Figure 1:  Change in Real Gross Domestic Product Data
(2007, 2008, 2009, August 2010, and September 2010)
  2007 2008 2009 Aug. Sept.
Total Gross Domestic Product (GDP) 1.9 .0 -2.6 3.7 1.7
 Personal Consumption Expenditures  2.4  -.3  -1.2  1.9  2.2
      Goods  2.8  -2.5  -2.0  5.7  3.4
         Durable Goods  4.2  -5.2  -3.7  8.8  6.8
         Nondurable Goods  2.0  -1.1  -1.2  4.2  1.9
      Services  2.2  .9  -.8  .1  1.6
 Gross Private Domestic Investment  -3.1  -9.5  -22.6  29.1  26.2
       Fixed Investment  -1.8  -6.4  -18.3  3.3  18.9
         Nonresidential  6.7  .3  -17.1  7.8  17.2
           Structures  14.1  5.9  -20.4  17.8  -.5
           Equipment and software  3.7  -2.4  -15.3  20.4  24.8
        Residential  -18.7  -24.0  -22.9  -12.3  25.7
 Net Exports of Goods and Services
      Exports 9.3  6.0  -9.5  1.4  9.1
        Goods  9.8  6.3  -12.0  14.0  11.5
        Services  8.3  5.3  -3.9  5.8  3.9
      Imports  2.7  -2.6  -13.8  11.2  33.5
        Goods  2.9  -3.5  -15.8  12.0  40.5
        Services  1.4  2.4  -4.2  7.8  4.3
 Government Consumption Expenditures
& Gross Investment
 1.3  2.8  1.6  -1.6  3.9
      Federal Government  1.2  7.3  5.7  1.8  9.1
        National Defense  2.2  7.5  5.4  .4  7.4
        Nondefense  -.8  6.7  6.5  5.0  12.8
     State and Local Governments 1.4 .3 -.9 -3.8 .6


Some GDP Component Definitions:

  • Durable goods. Tangible products that can be stored or inventoried and that have an average life of at least three years.
  • Nondurable goods. Tangible products that can be stored or inventoried and that have an average life of less than three years.
  • Fixed Investment.  Assets that are used repeatedly, or continuously, in processes of production for an extended period of time. They consist of equipment and software and structures , including owner-occupied housing.
  • Nonresidential fixed investment. Consists of purchases of both nonresidential structures and equipment and software.
  • Nonresidential structures. Investment in nonresidential structures consists of new construction (including own-account production), improvements to existing structures, expenditures on new mobile structures, brokers' commissions on sales of structures, and net purchases of used structures by private businesses and by nonprofit institutions from government agencies. New construction includes hotels and motels and mining exploration, shafts, and wells. Nonresidential structures also includes equipment considered to be an integral part of a structure, such as plumbing, heating, and electrical systems.
  • Equipment and software. Investment in equipment and software consists of capital account purchases of new machinery, equipment, furniture, vehicles, and computer software; dealers' margins on sales of used equipment; and net purchases of used equipment from government agencies, persons, and the rest of the world. Own-account production of computer software is also included.
  • Residential fixed investment. Consists of purchases of private residential structures and residential equipment that is owned by landlords and rented to tenants.
  • Change in private inventories. The change in the physical volume of inventories owned by private business, valued at the average prices of the period. It differs from the change in the book value of inventories reported by many businesses; the difference is the inventory valuation adjustment (IVA).

Figure 3, below, shows the monthly changes in real GDP from 1990 through Q2 2010.  Note the 1990-91, 2001, and 2008-2009 recessions with some periods of negative GDP growth.

Figure 2

The U.S. GDP expanded at an annual rate of 1.70 percent in Q2 of 2010, well below the historical average.  From 1947, when GDP data was first reported, until the present, the U.S. average GDP growth has been 3.31 percent.  The historical high growth rate of 17.20 percent was in March, 1950.  The historical low rate of  -10.40 percent was in March, 1958.

Figure 3, below, shows the concept of the business cycle - recurring periods of growth, peak, decline and trough (sometimes a recession.)  Can you see the same pattern in the numbers for 2008-2010 in Figure 2?

Figure 3

Real GDP and Seasonal Adjustment

The BEA noted in the announcement that the "Quarterly estimates are expressed at seasonally adjusted annual rates, unless otherwise specified. Quarter-to-quarter dollar changes are differences between these published estimates. Percent changes are calculated from unrounded data and are annualized. “Real” estimates are in chained (2000) dollars. Price indexes are chain-type measures."

The determination of real GDP from the current dollar GDP is impacted by a change in the price level - as measured by the price index for gross domestic product. During the quarter, the price level did not significantly change. For the GDP data to be meaningful, a reported change in the measurement of output produced at a higher price level has to be increased to reflect constant prices.  Thus, we have a figure called "real GDP growth."

This illustrates the difference between nominal (current dollar) and real (constant dollar) GDP. In a period of inflation, the nominal GDP figure may overstate the level of output.  It may be that the same number of goods were produced, but at higher prices. Thus, the basic GDP measurement, number of goods times their prices, would show a bigger GDP number. In this case, the price level dropped. Even if the same number of goods and services had been produced, the nominal GDP measurement would have decreased. The change in GDP measurement has to be adjusted upward to represent constant prices.

Seasonal adjustments remove recurring seasonal variations (variations that occur in the same month or quarter each year) from economic series so that the remaining movements in the series better reflect cyclical patterns in economic activity.

What do we know about the accuracy of GDP?

The quarterly GDP estimates are made three times - what the BEA calls "vintages." The BEA web page "frequently Asked Questions" section explains. "Early vintages of the GDP estimates are based on partial and incomplete source data. Subsequent GDP estimates incorporate increasingly comprehensive and improved source data. Periodically, BEA conducts studies of reliability. In these studies, reliability is defined as whether the successive vintages of GDP estimates present a consistent, general picture of the economy.

The most recent reliability study found (as have previous studies) that the early estimates of GDP present a useful picture of economic activity. They consistently indicate whether growth is positive or negative, whether growth is accelerating or decelerating, whether growth is high or low relative to the trend, and where the economy is in relation to the business cycle. In addition, the latest study found that the average revisions to GDP are small and positive, indicated a tendency toward upward revisions, and found that the GDP estimates have not contained information that would have improved the prediction of future revisions to GDP growth." The BEA feels that the GDP estimates are reasonably accurate.

When asked if the GDP revisions tend to revise the estimates upward, the BEA replies, "Average revisions from the current quarterly estimates—advance, preliminary, and final—to the latest available estimates are not significantly different from zero. That is, even though GDP revisions are non-zero, they are “unbiased.”  In other words, on average they neither raise nor lower GDP growth." 

"Most GDP revisions result from the incorporation of new or revised source data that were not available at the time of the earlier estimates. In addition, annual revisions to quarterly estimates include the effects of periodic improvements in estimation methods that are necessary to keep the GDP attuned to the changing economy. Methodological improvements typically are put in place as part of once-every-five-year “comprehensive” GDP revisions. The most recent such revision, in 2003, yielded long-run growth rates of current-dollar and real GDP, measured from 1930-2002, that were virtually the same as the pre-revision growth rates." 

Measuring the size of the economy is a monumental task with many variables.  The BEA takes three months to provide what they feel is an accurate estimate, and then allows for future revision based on additional or more accurate data.  Measuring the "health" of the economy is even more difficult.  What is the best measurement of a healthy economy?  Output?  Jobs?  Growth?  Stability?
 

CONCLUSION

The bottom line - U.S. real gross domestic product increased at an annual rate of 1.7 percent in the second quarter of 2010.  In the first quarter, real GDP had increased by 3.7 percent. 

The 2008-2009 recession is "officially" over - ending in June of 2009 according to the Bureau of Economic Analysis.   There has been slow growth over the past year, but the unemployent rate is stil hovering just below 10 percent.  Saying that the recession is over is small comfort to the millions of workers who are still unemployed.

This lesson raised several questions about the real meaning of GDP growth to students and others.  If the economy is growing but few jobs are being created, is GDP growth a real indicator of the health of the economy?

ASSESSMENT ACTIVITY

Next, answer the essay question below on the 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 $123,100 2007 est.
2 Qatar $119,500 2008 est.
3 Luxembourg $79,600 2009 est.
4 Bermuda $69,900 2004 est.
5 Norway $57,400 2009 est.
6 Jersey $57,000 2005 est.
7 Kuwait $52,800 2009 est.
8 Brunei $53,100 2008 est.

9

10

Singapore

Faroe Islands

$52,200

$48,200

2009 est.

2008 est.

11 United States $46,000 2009 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 $14,430,000,000,000 2009 est.
2 United States $14,140,000,000,000 2009 est.
3 China $8,748,000,000,000 2009 est.
4 Japan $4,150,000,000,000 2009 est.
5 India $3,570,000,000,000 2009 est.
6 Germany $2,810,000,000,000 2009 est.
7 Russia $2,266,000,000,000 2009 est.
8 United Kingdom $2,128,000,000,000 2009 est.
9 France $2,097,000,000,000 2009 est.
10 Brazil $2,130,000,000,000 2009 est.


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