Sustained Growth of Real GDP: Aiming for sustainable economic expansion.
Rising Employment: Increasing job opportunities.
A More Equitable Income Distribution: Reducing income inequality.
Move Global Competitiveness/Export: Aiming to improve competiveness for exports.
Gross Domestic Product (GDP)
Definition: The market value of all final goods and services produced in an economy within a specific time period, usually one year.
Only final goods and services are included, which are products purchased as final products.
Example: Tires purchased by consumers are final goods. Tires purchased by car manufacturers are intermediate goods, not directly counted in GDP to avoid double-counting.
All goods counted in GDP must be produced during the specified year.
GDP is defined in value terms, typically in dollars in the United States.
Nominal vs. Real GDP
Nominal GDP: GDP calculated at current prices.
Useful for understanding economic data for a single year.
Not adjusted for inflation.
Real GDP: GDP calculated at constant prices.
Used for comparing economic data across different time periods.
Adjusted for inflation to reflect actual changes in output.
Meaning and Significance of GDP
GDP serves as an indicator of economic activity and is often used to measure standards of living (GDP per capita).
GDP per capita is calculated by dividing the GDP by the population.
High GDP per capita is generally correlated with high standards of living.
Increasing GDP and GDP per capita over time suggests growth in economic activity and improvements in living standards.
Flaws and Limitations of GDP
Non-marketed Goods and Services: Excluded from GDP.
Underground Economy: Economic activities not reported to the government are not included.
Value of Leisure: GDP does not account for the value of leisure time.
Improved Product Quality: GDP may not fully capture improvements in product quality.
Example: Computers
Environmental Impacts: Negative environmental effects of production are not deducted from GDP.
Non-economic Sources of Well-being: Factors like job stress are not considered.
Distribution of National Income: GDP does not reflect how income is distributed within the population.
Nonmarket Activities
The exclusion of non-marketed goods and services understates the total value of productive activities in the economy.
Example: Painting your parents’ house.
This exclusion also distorts comparisons over time and across nations.
Historical Context: In the 1950s, when most women were full-time homemakers, their services were not included in GDP. As more women entered the formal labor market and paid for services they previously provided themselves, GDP calculations changed.
In many Third World countries, families often grow their own food, build their own homes, and gather their own water and fuel, which are typically not reflected in GDP.
Underground Activities
The underground economy includes economic activities not reported to the government.
Reasons: Illegal activities or tax evasion.
Examples: Gambling, prostitution, drug trade.
Since these activities are not recorded, they are not included in GDP statistics.
Composition and Distribution
Composition of GDP: The types of goods and services included in GDP.
Distribution of Income: How national income is distributed within the economy.
Quality of Life Issues: Other factors influencing quality of life.
Value of leisure (e.g., comparing the U.S. to Western Europe).
Improved product quality (e.g., computers).
Environmental impacts.
Non-economic sources of well-being (e.g., job stress).
Government Revenue
Taxes: Collected from individuals, property owners, businesses, and consumers.
Government Borrowing: Issuing government securities, such as bonds and treasury bills.
These securities are IOUs, promising to repay the borrowed money plus interest at a future date.
Sold to banks, corporations, and individuals, both domestically and internationally.
Federal Taxes
Personal Income Tax: Placed on most forms of individual income.
Capital Gains Tax: Tax on net income received when an asset is bought at a lower price and sold at a higher price.
Payroll Taxes: Based on earnings from work, primarily for social insurance programs like Social Security and Medicare.
State and Local Taxes
State Taxes
Sales and excise taxes
Personal income taxes
Corporate (net) income taxes
Licenses
Property taxes
Local Taxes
Property taxes, primarily levied by local governments
Types of Government Taxes
Progressive Tax: Takes a higher percentage of income from high-income earners than from low-income earners.
Example: Federal personal income tax.
Proportional Tax: Takes the same percentage of income from all income levels.
Example: State personal income tax.
Regressive Tax: Takes a higher percentage of income from low-income earners than from high-income earners.
Examples: Sales tax, property taxes, excise taxes, Social Security tax.
Government Borrowing and its Effects
Government Issues Securities (Bonds): Anyone can purchase these.
Government Spending Financed by Borrowing: Expands the economy more than government spending financed through increased taxes.
Reason: Borrowing does not reduce individual spending as taxes do.
Budget Deficit and Surplus
Budget Deficit: When federal government spending exceeds federal government tax revenue in a given year.
Budget Surplus: When federal government tax revenue exceeds federal government spending in a given year.
The National Debt
Definition: The total amount of money owed by the federal government.
It is an accumulation of all funds borrowed by the federal government that have not been repaid.
No Limits: The government can theoretically borrow indefinitely.
Roll Over: Borrowing new money to pay off old debts.
Size and Benchmarking of the National Debt
Size: Over 30 trillion.
Inflation Adjustment: Necessary for comparing debt levels across different years.
Benchmark: Gross Domestic Product (GDP).
Debt-to-GDP Ratio: A useful metric for assessing the scale of the national debt.
53% in 1940.
122% in 1946 (World War II).
Impacts of the National Debt
Positive Consequences
Enables the government to expand the economy as needed.
Supports expenditures that can benefit society.
Present: Social Security and poverty reduction.
Future: Investments in health and education.
Negative Effects
Inequitable income redistribution (burden on future taxpayers).
Rising interest rates.
Reduces private investment.
Interest payments made to foreign entities, leading to real transfer of income out of the U.S.
Crowding-out effect (government borrowing can increase interest rates).
Burden on future generations.
Offset by public investment.
Subprime Mortgage Loans and the Great Recession
Background: Prior to the Great Recession (2007), subprime lenders provided higher-rate mortgages to borrowers who did not qualify for loans from mainstream lenders, typically due to low credit scores.
These borrowers were often financially stretched.
Loans were frequently underwritten with high debt-to-income ratios (50-55%), exceeding traditional ratios (30-33%).
In half of the cases, lenders used stated income rather than documented income, with stated income often exaggerated (90% of the time).
Effect on Minorities and the Poor: A disproportionate number of subprime loans were issued to minority families.
Over half of the home loans made in 2005 to African American families were subprime loans.
40% of loans to Latin American families were subprime loans.
By contrast, about 20% of loans made to white families were subprime loans.
The Financial Crisis of 2007 and 2008
Mortgage Default Crisis: A key factor in the financial crisis.
Many Causes: Government programs encouraging home ownership, bad incentives provided by mortgage-backed bonds, and declining real estate values.
The Great Recession: Impact and Recovery
Impact: Loss of more than eight million jobs, loss of half the value of the Dow and the S&P 500, loss of trillions of dollars in retirement accounts and household wealth.
Recovery: Full-time employment did not regain its pre-crisis level until August 2015.