Measuring a Nations Production and Income: GDP

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Measuring a NationsProduction and IncomeGDP
GNP
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Macroeconomics

• Macroeconomics is the branch of economics that
  deals with a nations economy as a whole.
• Macroeconomics focuses on the economic
  issuesunemployment, inflation, growth, trade,
  and the gross domestic productthat are most
  often discussed in the media and in political
  debates.

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Macroeconomics

• Macroeconomics focuses on two basic issues
• Long-run economic growth, or the factors behind
  the rise in living standards in modern economies.
• Fluctuations in economic performance
• An economy is considered to be in a recession
  when it fails to grow for at least six
  consecutive months.
• At other times, unemployment may not be a
  problem, but we become concerned about sustained
  increases in prices, or inflation.

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The Flip Sides of Macroeconomic Activity
Production and Income

• The terms production and income are the
  flip sides of the macroeconomic coin.
• Production leads to income and income leads to
  production.

• These two measuresa countrys production (GDP)
  and income (GNP)are critical to a nations
  economic health.

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The Circular Flow ofProduction and Income

• The circular flow shows how production of goods
  and services generates income for households and
  how households purchased goods and services
  produced by firms.

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The Circular Flow ofProduction and Income
(Continued)

• In factor, or input markets, households supply
  labor to firms and also capital and land,
  buildings, machines, and equipment, are used to
  produce output.
• Product markets, or output markets, are markets
  in which goods and services are sold to consumers.

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The Production Approach to computing Gross
Domestic Product

• Gross domestic product (GDP) is the total market
  value of all the final goods and services
  produced within an economy in a given year.
• Total market value refers to the quantity of
  goods multiplied by their respective prices.

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The Production Approach to computing Gross
Domestic Product (Continued)

• An intermediate good is a good that is used in
  the production process. It is not considered a
  final good or service.
• Only newly produced goods are included in GDP.

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The Production Approach to computing Gross
Domestic Product (Continued)
Real-Nominal PRINCIPLE What matters to people is
the real value of money or incomeits purchasing
powernot the face value of money or income.

• Real GDP is a measure of GDP that takes into
  account price changes. This measure of total
  output does not increase just because prices
  increase.
• When we use current prices to measure GDP, that
  is what we call nominal GDP, which can increase
  as a result of higher production or higher prices.

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Per Capita GDP

• Per Capita GDP GDP divided by the population.
• GDP figures are useful for obtaining an estimate
  of the productive capabilities of an economy but
  they do not necessarily measure happiness or well
  being.

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U.S. Real GDP, 1930-2003

• The graph shows that real GDP has grown
  substantially over this period.
• This is what economists call economic growth.

• Economic Growth sustained increases in the real
  production of an economy over a long time.

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The Components of GDP

• Economists divide GDP into four broad expenditure
  categories
• Consumption expenditures purchases by consumers
• Private investment expenditures purchases by
  firms.
• Government purchases purchases by federal,
  state, and local governments.
• Net exports net purchases by the foreign sector
  (domestic exports minus domestic imports).

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The Expenditure Approach to Computing GDP
GDP C I G (X M)
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Consumption Expenditures

• Consumption expenditures are purchases of
  currently produced goods and services, either
  domestic or foreign.
• We can break down consumption into durable goods,
  or goods that last a long time, nondurable goods
  that last for a short time, and services, which
  reflect work done in which people play a
  prominent role in delivery.

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Private Investment Expenditures

• Private investment expenditures include
• Spending on new plants and equipment.
• Newly produced housing.
• Additions to inventories during the current year.

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Private Investment Expenditures (Continued)

• New investment expenditures are called gross
  investment.
• During the year, some of the existing plant,
  equipment, and housing will deteriorate. This
  wear and tear is called depreciation.
• The true addition to the stock of capital of the
  economy is net investment.

• Net investment equals gross investment minus
  depreciation.

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Government Purchases

• Government purchases refer to purchases of newly
  produced goods and services by all levels of
  government.
• Transfer payments are funds paid to individuals
  but not associated with the production of goods
  and services.
• A large part of the federal government budget is
  not part of GDP.

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Net Exports

• Imports (M) are goods we buy from other
  countries. Exports (X) are goods made here and
  sold to other countries.
• Net exports (X M) are total exports minus total
  imports
• When we buy more goods from abroad than we sell,
  we have a trade deficit (M gt X)
• A trade surplus occurs when our exports exceed
  our imports (X gt M)

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U.S. Trade Balanceas a Share of GDP 1960-2003

• Prior to the mid-1970s, the United States usually
  ran a trade surplus with other nations. However,
  in recent years, the trade deficits are now the
  norm for the United States.

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Putting It All TogetherThe GDP Equation

• Letting the symbol Y stand for GDP and the
  symbols C, I, G, NX stand for consumption,
  investment, government purchases, and net
  exports, respectively, we can write
• Or in words

GDP consumption investment government
purchases net exports
Where NX X - M
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GNP? GDP? Whats different?

• Gross National Product (GNP) the total market
  value of all final goods and services provided
  annually by the citizens of a country.
• Gross Domestic Product (GDP) the final market
  value of all goods produced in a country, whether
  by citizens or not.

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The Income Approach to Computing GDP

• The income that flows to the private sector is
  called national income. It is the total income
  earned by U.S. citizens and businesses, no matter
  where they reside or are located.
• Gross national product (GNP) is the total income
  earned worldwide by U.S. firms and residents.
• Domestic Income total income earned by the
  people and businesses within a countrys borders.
• When we subtract depreciation from GNP, we reach
  net national product (NNP), where net means
  after depreciation.

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Computing National Income

• Compensation of Employees Wages, salaries,
  employers contribution to social security and
  employee benefit plans, plus the monetary value
  of fringe benefits, tips, and paid vacations
  plus
• Proprietors Income all forms of income earned
  by self-employed individuals and the owners of
  unincorporated business, including unincorporated
  farmers plus
• Corporate Profits include all income earned by
  the stockholders of corporations plus
• Rental Income of Persons income received by
  individuals for the use of their non-monetary
  assets plus

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Computing National Income (Continued)

• Net Interest the interest income received by
  U.S. households and government minus the interest
  they paid out.
• In other words

• National Income Compensation of employees
  Proprietors Income Corporate Profits Rental
  Income Net Interest

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The Income Approach to Computing GDP
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Computing National Income

• The third and last adjustment we make to reach
  national income is to subtract indirect taxes,
  which are sales taxes or excise taxes on products.

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From National Income to GDP Making Some
Adjustments

• GDP National Income
• - income earned from the rest of the world
• income earned by the rest of the world
• indirect business taxes
• capital consumption allowance
• statistical discrepancy

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Composition of U.S. National Income,Third
Quarter of 2003 (billions of dollars)

• The chart shows that compensation of employees is
  the largest component of national income.

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The Circular Flow Total Purchases
(Expenditures) Equal Total Income in a Simple
Economy
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Other National Income Accounting Measurements

• In addition to national income, we are sometimes
  interested in determining the total payments that
  flow directly into households, a concept known as
  personal income.
• Personal Income National income undistributed
  corporate profits social insurance taxes
  corporate profits taxes transfer payments
• Personal Disposable income Personal Income
  personal taxes

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Measuring National Income Through Value Added

• The value added of a firm is the sum of all the
  incomewages, profits, rents, and interestthat
  it generates.
• In calculating national income, it is important
  to include all the firms in the economy, even the
  firms that produce intermediate goods.

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The Circular Flow With Government and the Foreign
Sector
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Measuring Real Versus Nominal GDP

• To calculate real GDP we use constant prices.

Growth of real GDP
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Real GDP Versus Nominal GDP

• We can measure the change in prices over time
  using an index number called the GDP deflator.
• This means that prices rose by 15 between the
  two years2006 2007.
• A chain index is a method for calculating price
  changes based on taking an average of price
  changes using base years from neighboring years.

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Economic Growth, Real GDP, and Business Cycles

• Economic Growth increases in Real GDP.

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Computing Real GDP

• Real GDP
• GDP x 100
• Chain Weighted Price Index

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Ups and downs of the Business Cycle

• Peak at the peak of the business cycle, Real GDP
  is at a temporary high.
• Contraction A decline in the real GDP. If it
  falls for two consecutive quarters, it is said
  the economy to be in a recession.
• Trough The Low Point of the GDP, just before it
  begins to turn up.
• Recovery When the GDP is rising from the trough.
• Expansion when the real GDP expands beyond the
  recovery.

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The Phases of the Business Cycle
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Recession

• Standard Definition two consecutive quarter
  declines in Real GDP.
• NBER Definition a significant decline in
  activity spread across the economy, lasting more
  than a few months, visible in industrial
  production, employment, real income, and
  wholesale-retail trade.

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GDP as a Measure of Welfare

• GDP is our best measure of the value of output
  produced by an economy, but as a measure of
  welfare, it has several recognized flaws that you
  need to be wary of.
• It ignores transactions that do not take place in
  organized markets.
• Leisure time is not included in GDP.
• It ignores the underground economy.
• It does not value changes in the environment that
  occur in the production of output.
• 5. It does not include sales of used goods

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Coming Up (Ch. 7) Aggregate Demand and
Aggregate Supply