Gross Domestic Product (GDP) is the measure of the health of the economy. Is the primary measure of the annual output or total market value of final goods and services produced in a given year (McConnell-Brue, 2001, p.117). The word final is a qualifier, which is important. There is no double counting. The price of an airplane is sum of many components. Steel is counted once in the production, when the airplane is finished. There are two approaches to determine GDP: income or expenditures. Either approach yield the same GDP.
Income approach views GDP as sum of compensation to employees, rent, interest, proprietors’ income and corporate profit to obtain national income (McConnell-Brue, 2001, p. 124). Indirect business taxes, consumption of fixed capital (depreciation) and net foreign factor income are added to measure GDP.
From an expenditure approach, GDP is the sum of personal consumption expenditures (C), gross private domestic investment (Ig), government purchases (G) and net exports (Xn).
GDP = C+Ig+G-Xn
Ã¢Â?Â¢ Personal consumption: covers all expenditures by household on durable consumer goods (cars, refrigerator, CD player), non durable consumer goods (bread, milk, pens) and consumer expenditures for services (doctors, consultants).
Gross private domestic investment: includes the final purchases of machinery, equipment and tool by business enterprises, construction and changes in inventory.
Government purchases: includes expenditures for goods and services that government consumes in providing public services and expenditures for social capital such as schools and highways. Government transfers are not included because no production is generated. It is a transfer of government receipts to certain household. Examples of government transfers are unemployment compensation payments, welfare payments and subsidies to farmers.
Ã¢Â?Â¢ Net exports (Xn): equated to the value exports (X) less imports (M).
Xn= X – M
Exports must be counted in the GDP because they are part of US production. Imports are part of another country’s GDP. These expenditures (imports) must be subtracted. Xn can be negative. For example, if US exports $3B and imports $6B, the net exports are -$3B, a negative amount. When this happens, Americans must decrease their holding of foreign currency or investment abroad to offset this negative amount.
An increase in C, Ig and G spending will result in the growth of the economy. Keep in mind, the unemployment rate impacts GDP. As unemployment rate is on the rise, more applications for unemployment compensation are filed. The aggregate demand will shift leftward. Therefore, there will be less spending, realizing a decrease in C, Ig and G. To correct this rise in unemployment rates, the Federal Reserves would execute easy money policy to stimulate economic growth.
From the CBO forecast, during early to mid 1990’s, unemployment rates were on a downward trend while easy money policy was in place. To hedge against inflation, the Federal Reserves raised interest rates slowing the growth of borrowing and spending. It was a successful strategy – tight money policy. Tight money policy is evident because the Treasury note yield was on a decline while it’s price was increased.
The unemployment forecast for the upcoming years are projected at a steady rate of 5.2 %, which appears to be the acceptable rate. The Ã?Â¼ of a point increase in short term interest rates was the sixth increase since June 2004 – a tightening of money supply. As a result of this increase in interest rates, the price of 10 year Treasury rose slightly and bond yield decrease to 4.14 % (CNN Money 2/2/2005). The inflationary rate is expected to be low. Rather than taking a greater stance, these gradual steps are conservative and measured to ensure expansion growth is not impacted. In addition, claims for unemployment insurance aid had decrease for the second straight week, slipping 13,000 in the week ended February 5 from 316,000 in the previous week and to the lowest since 302,000 in October 2000 (CNN Money 2/10/2005). We anticipate a rise in GDP, but inflation is contained. Of importance, this job market increase is gradual. A major turn toward a strong job market would justify another interest rate hike.
CNN Money. (2005). Bonds Unfazed by Fed. Retrieved February 13, 2005 from https://cnnmoney.com Cnn-Money.Com. (2005). Bonds Extend Early Losses. Retrieved February 13, 2005 from https://cnnmoney.com McConnel-Brue. (2001). Principles, Problems and Policies. Fifteenth Edition, Chapter 7, p.117. Retrieved February 8, 2005 from University of Phoenix, Economics for Managerial Decision Making website: https://mycampus.phoenix.edu/secure/resource/resource.asp McConnel-Brue. (2001). Principles, Problems and Policies. Fifteenth Edition, Chapter 7, p.124. Retrieved February 8, 2005 from University of Phoenix, Economics for Managerial Decision Making website: https://mycampus.phoenix.edu/secure/resource/resource.asp