Formula Used and Calculation of Real GDP - Essay Example

Over the last few years, although there are quarterly fluctuations, there is a general downward GDP trend. Looking at annual real GDP, one can see a downward trend from 2.7% in 2006 to a slightly lower 2.1% in 2007 to the almost flat growth of .4% in 2008. Although 2009 is not yet over, the average of the first 3 quarters shows real GDP to have shrunk, with a rate of –1.4%. However, there is the suggestion that the GDP downward trend has recently reversed and is increasing somewhat since real quarterly GDP growth reached its minimum point of –6.4% during the first quarter of 2009 and went up both in the second and third quarters of 2009. The third quarter went into positive territory at 2.8% for the first time since the second quarter of 2008.

One event that has likely contributed to the general downward trend in real GDP is the decline in housing prices or the bursting of the housing bubble. According to the Case-Shiller housing index (Standard and Poor’s, 2009), housing prices peaked in the second quarter of 2006 and declined thereafter until the first quarter of 2009. One direct consequence of declining home values is a decline in household wealth, which will likely lead consumers to spend less since having less money will translate to spending less money. Furthermore, if declining home values lead to default and foreclosures, those consumers will have even less money available for spending. Given that according to the 2008 real GDP figures, consumption is 70% of GDP (U.S. Department of Commerce, 2009), lower consumption will mean lower GDP.
Another event that likely explains some of the GDP movement is the financial meltdown that occurred in September 2008, with the government bailouts of AIG, Freddie Mac, Fannie Mae, and the bankruptcy of Lehman Brothers. With the loss of confidence in the stability of financial markets, the stock market was at 11,544 at the end of August 2008 fell to 10,918 on September 15, 2008, and was at 8,451 by October 10, 2008 (Dow Jones, 2009). This decline in stock values not only reduces household wealth, which adversely affects consumer spending but also gives consumers less confidence in the economy. And consumers will tend to spend less if they are less optimistic about the economy (Ludvigson, 2004). The subsequent two quarters (fourth quarter 2008 and first quarter 2009) following the financial meltdown indeed had especially low GDP growth numbers (-5.4% and –6.4%). Read More