Question

During an intcrvicw with a reportcr, formcr Microsoft CEO Stcvc Ballmer discussed the data compiled on the usafacts.org Web site. Ballmer asked if the reporter knew how many people the government employed and provided the answer: "Almost 24 million. Would you have guessed that?" a. Is local, state, and federal governments spending on salaries and benefits for these employees considered production as measured by GDP? Briefly explain. b. According to data on the usafacts.org site, in 2014 the federal government spent $\mathrm{\$}57.3$ billion on Social Security payments to retired and disabled people. Is this federal government spending considered production as measured by GDP? Briefly explain.

Short answer

Yes, government spending on salaries and benefits is considered in GDP. However, the government spending on Social Security payments is not included in GDP calculations as it does not receive a good or service in return.

Step-by-step solution

Defining GDP

Gross Domestic Product (GDP) is the total monetary value of all finished goods and services produced within a country's borders in a specific time period. It serves as a comprehensive measure of a nation’s overall economic activity.

Part A: Salaries and Benefits

Yes, the salaries and benefits paid to local, state, and federal government employees are considered production as measured by GDP. When the government employs workers, it includes their wages and benefits in the compensation of employees component of GDP. This is because when the government pays its employees, it receives a service in return, which contributes to the overall economic production of the country.

Part B: Social Security Payments

Contrary to salaries and benefits, Social Security payments are not included in GDP calculations. The economic production as measured by GDP includes the value of goods and services produced by those who are employed. When the government provides Social Security payments, however, it does not receive a good or service in return, and thus, this federal government spending is considered a transfer payment and is not included in GDP calculations.

Key concepts

Government Expenditure

When we talk about government expenditure, it often refers to the spending by local, state, and federal governments on goods and services. One significant component of this is the salaries and benefits paid to government employees. This is included in the Gross Domestic Product (GDP) because these payments are made in exchange for services provided by workers. In GDP calculations, any payment that results in goods or services being produced is considered part of economic production.
A government employs various people to run essential services like schools, hospitals, and public safety. Because these services directly contribute to the economy, the compensation for these services is added to the GDP.
Other forms of government spending, like infrastructural investments or spending on public goods, also count towards GDP because they involve actual production or the provision of services.

Transfer Payments

Transfer payments, such as Social Security payments, are a different aspect of government spending. Unlike salaries and benefits, they are not included in GDP calculations. This is because transfer payments do not correspond to the production of goods or services. These payments represent a redistribution of income rather than actual economic activity.
Think of transfer payments like gifts; they are transfers of money from the government to individuals without anything being received in return. Since GDP is focused on measuring economic production, anything that doesn't involve the creation of goods or services is excluded from its calculation.

• Examples include unemployment benefits, pensions, and welfare payments.
• These are designed to help individuals financially but do not count as productive economic activities.

Economic Activity

Economic activity refers to the actions that involve the production, distribution, and consumption of goods and services. GDP is a vital measure of this because it looks at all completed selling prices for goods and services produced within a country.
Economic activity can be seen in things like manufacturing goods, providing services, and retail trade. In terms of GDP, this activity is crucial because it shows the health and growth of an economy.
Governments, households, businesses, and foreign entities all contribute to economic activity. While the government participates in this through things like infrastructure spending and employing workers, its role in providing transfer payments doesn't directly increase GDP.

• This is because those payments do not represent production or consumption that adds to the economy's overall output.
• Instead, they affect disposable income and can indirectly influence how much individuals spend, potentially stimulating economic activity in other ways.