Macro Measurements Expenditure/Income Approach GDP

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Chapter 5

• Macro MeasurementsExpenditure/Income ApproachGDP

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• Now we study the branch of macroeconomics that
  examines aggregate performance of all markets in
  the market system.
• To measure the performance of the macro economy,
  economists rely on statistical measurements in
  three areas
• Gross Domestic Product (GDP)
• Rate of Inflation (discussed later)
• Unemployment (discussed later)

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• macroeconomicsThe study of the nations economy
  as a whole focuses on the issues of inflation,
  unemployment, and economic growth.

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THE FLIP SIDES OF MACROECONOMICACTIVITY
PRODUCTION AND INCOME

• The Circular Flow of Production and Income

• FIGURE 5.1The Circular Flow of Production and
  Income
• The circular flow shows how the production of
  goods and services generates income for
  households and how households purchase goods and
  services produced by firms.

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Gross Domestic Product (GDP)

• Gross domestic product (GDP) is the total dollar
  value of final output produced within a nations
  borders in a given time period.

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Gross Domestic Product (GDP)

• Each good and service produced and brought to
  market has a price.

• That price serves as a measure of value for
  calculating total output.

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The Measurement of Output
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Highlights

• Most comprehensive measure of output is GDP
• GDP value added at each state of production
  Total value of g s produced in a given year
  domestically
• Nominal and Real GDP are calculated
• Nominal current prices
• Real GDP expressed in terms of constant prices
  (sans inflation)
• People basically care about buying power.

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GDP Per CapitaTotal GDP divided by Total
Population

• This is the way to compare international output
  among different countries/economies.
• Divide the pie- how many pieces for each?
• In 2001 Americas total GDP of 10 trillion was
  shared by 280 million citizens. Average per
  capita GDP was around 36,000.
• 2004 it was 37,600 population 2004 was 292
  million
• 2005 41,800
• 2008 46,000
• 2009 45,787
• 2010 47,199

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1998 TO 2011 Per Capita U.S.
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Richest and Poorest countries 2010
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So What does per capita really tell us?

• It is a statistical comparison that indicates how
  well off people are in a country.
• Real per capital increases when REAL GDP rises
  faster than population
• It can indicate the differences in the ways
  people live. How many TVs they have. How many
  cell phones, Internet connections, cars,
  refrigerators, paved roads, schools, etc.
• All it does is state that if per capita is
  higher, the average amount of goods/person is
  higher than the base comparison.

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Highlights Continued

• Each year capital is worn out called
  depreciation..
• By subtracting depreciation from GDP we derive
  net domestic
• product (NDP)
• Difference between NDP and GDP is equal to the
  difference
• between gross investment expenditures and net
  investment

Expenditure Approach to GDP Measurement Income Approach to GDP Measurement
Consumption Investment Government Net Exports Total value of output Wages and salaries Corporate profits Proprietors income Farm Income Rents Interest Sales taxes Depreciation Total value of income
Value of total expenditure must equal value of
total income
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OUTPUT INCOME

• All the spending that establishes the value of
  output also determines the value of incomes.
• Generally speaking, the market value of incomes
  must equal the market value of output.
• Every dollar spent on output becomes a dollar of
  income for someone.

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Computing GDP

• The value of GDP can be computed by adding up
  expenditures of market participants(add up the
  market value of all domestic expenditures made on
  final goods and services in a single year.)
• GDP C I G (X IM)
• Where
• C Consumption expenditure X exports
• I investment expenditure IM imports
• G government expenditure

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Total Expenditure on final G S is broken down
in four categories

• Consumption expenditures-
• Comprises the largest share (2/3s) of total
  expenditure.
• Includes nondurable goods (food,clothing) and
  durable goods (appliances, autos)
• Includes consumption service expenditures such as
  barbers, doctors, lawyers, mechanics.

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Expenditures Continued

• Investment Expenditures
• Includes expenditures on fixed investment goods
  and inventory investment.
• Fixed investments goods are those that are useful
  over a long period of time- includes purchases of
  new equipment, factories, other nonresidential
  housing as well as new residential housing. Also
  includes cost of replacing existing investment
  goods that have become worn out or obsolete.
• The market value of all investment goods that
  must be replaced in a single year is referred to
  as depreciation for that year.

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Investment Continued

• Inventory Goods are final goods waiting to be
  sold that firms have on hand at the end of the
  year.
• The year-to-year change in the market value of
  firms inventory goods is considered an
  investment expenditure because these inventory
  goods will eventually yield a flow of consumption
  or production services.

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Total Expenditures Continued

• Government Expenditures
• Includes hiring of civil servants and military
  personnel, construction of roads and public
  buildings.Supplies for the war, contracts for
  many products/services Boeingetc.
• Social Security, welfare, and other transfer
  payments are not included.(because government
  expenditures on transfer payments do not involve
  the purchase of any new goods or services and are
  therefore excluded from the calculation.

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Total Expenditures Continued

• Net Exports
• Exports are g s produced domestically but sold
  to foreigners.
• Imports are g s produced by foreigners, but
  sold domestically.
• Expenditures on exports are added to total
  expenditures while expenditures on imports are
  subtracted.
• X-M value of net exports to nations total
  expenditures.

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Whats Not Included in GDP

• Certain non-market goods and services such as
  chores performed at home by family members.

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Whats Not Included in GDP

• Underground activities, both legal and illegal

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Whats Not Included in GDP

• Sales of used goods
• Financial transactions such as trading of stocks
  and bonds

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Whats Not Included in GDP

• Government transfer payments such as social
  security
• Leisure time

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Measures of Income

• GDP accounts have two sides.
• One side focuses on expenditure the demand
  side.
• The other side focuses on income the supply
  side.

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Income Approach

• Income Approach
• Add up all the income earned by households and
  firms in a single year.
• By adding together rent, wages, profit, interest
  income, one should obtain the same value of GDP
  as is obtained using the expenditure
  approachBUT
• 2 types of expenditures that are included in
  expenditure, but do not provide households or
  firms any income (depreciation expenditures and
  indirect business taxes)

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Income Approach Continued

• Depreciation expenditures (replacing existing,
  but worn out investment goods, do increase the
  incomes of those providing the replacement goods,
  but they also decrease the profit incomes of
  those purchasing the replacement goods.) Result
  aggregate income remains unchanged.
• Indirect business taxes consist of sales taxes
  and other excise taxes that firms collect but not
  regarded as part of firms incomes. (Hence,
  included in expenditures approach but not income)

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Measures of Income

• The total value of market incomes must equal the
  total value of final output, or GDP.

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Two Ways of Measuring GDP
Aggregate Income
Rents
Profits
Interest
Indirect business taxes
Depreciation

• There are two methods of calculating GDP

• It can be calculated either by summing the
  expenditures on the final user goods and
  services purchased by consumers, investors,
  governments, and foreigners (net exports), or,

• by summing the income payments and direct cost
  items that accompany the production of goods and
  services.

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Output Income
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Measuring GDP

• GDP is the scoreboard for economic performance
• GDP is the most widely used measure of economic
  performance.
• GDP is measured quarterly.
• GDP total value of goods and services produced
  in the United States in a given year.
• Many transactions have to be excluded from GDP
• Counts only the g s purchased by their final
  users
• Counts only the g s produced during the
  specified period
• Excludes all financial transactions and income
  transfers.
• (because financial transactions do not count for
  current production- examples purchase and sale of
  stocks, bonds, securities merely transfer of
  ownership)
• Transfer payments are unproductive money into
  economy (both from GDP standpoint and growth
  standpoint.

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When Goods are measured as output- units of
each good are weighted according to their
PURCHASE PRICEexample new car adds more than
NIKE shorts

• The total spending on ALL g s produced during
  the year is then summed (in dollar terms) to
  obtain the annual GDP
• GDP differs from GNP
• GDP g s produced within the borders of the
  US whether produced by foreigners or Americans
• GNP measures the output of all Americans,
  whether the g s are produced here or abroad.
• (The Nissan produced in Tennessee is included in
  U.S. GDP)

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Income Flow Chart
Searching for total income earned by factors of
production. The figure below how much income
flows into hands of Consumers.
Gross Domestic product (GDP) less
depreciation Net domestic product (NDP) less
direct business taxes National income (NI) less
corporate taxes less retained earnings less
Social Security taxes Plus net interest Plus
transfer payments Personal Income less personal
taxes Disposable Income
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Net Domestic Product

• NDP measures the total value of new goods
  available in the economy in a given year after
  worn-out capital goods have been replaced.
• Net domestic product (NDP)
• GDP Capital consumption allowance
• The estimated amount of capital goods used
  up in production through natural wear,
  obsolescence, and accidental destruction.

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Income Approach Continued
Personal Income total income received by all
person in the nation before personal taxes are
paid. To get from NI to PI- must subtract that
portion of NI that does not go to
households (social security contributions,
undistributed corporate profits Corporate income
taxes) goes to government Disposable Income-
Subtract personal income taxes Amount left over
is what we can spend or save.
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• If GDP grows too rapidly, it may cause increased
  inflation.
• If GDP grows too slowly, or declines, there will
  be an increase in the number of people
  unemployed.
• What determines the level of GDP?
• Ans(level of spending)
• What determines the level of spending?
• Ans. (add up the level of C I G (X-M)

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Business Cycle

• Recurrent swings (up and down) in
• Real GDP.

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Equilibrium GDP

• The level of GDP will depend on the total
  spending for consumption, investment, and
  government
• Anytime there is a change in the LEVEL
• of spending the GDP will begin to move toward
  the new level of spending.

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• When GDP is exactly equal to the level of total
  spending, the economy is in equilibrium.
• Achieving equilibrium is not necessarily the
  goal. The goal is to have growth towards full
  employment without excessive inflation

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Sohow do you calculate growth?

• Value of GDP by itself is not very interesting.
• What is interesting is the year-to-year
  percentage change in the value of GDP.
• How to calculate percentage change
• Need to know the value of the statistic at two
  dates in time. Growth rate last year is Yl and
  the value of the current year is Yc

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Formula

• Yc Yl x100
• Yl
• This formula is valid for calculating the
  percentage change in any statistic, not just the
  percentage change in GDP.
• change _change___
• original number
• If we move from 150 to 200 what is the change?

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Answer

• 33 l/3
• 150 200 50
• 50 5 1
• 150 15 3

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Calculate this

• In 1999 Real GDP was 9,299
• In 2000 Real GDP was 9,767
• What was the growth from 1999 to 2000
• 5
• 9,767-9,299 468
• 468/9,299 5

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Distinguishing Between Nominal and Real Values

• Nominal Values
• Measurements in terms of the actual market prices
  at which goods are sold expressed in current
  dollars, also called money values
• Real Values
• Measurements after adjustments have been made for
  changes in the average of prices between years
  expressed in constant dollars

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Example Correcting GDP for Price Index Changes

• Correcting GDP for price index changes
• Nominal (current) dollars GDP
• Real (constant) dollars GDP

Nominal GDP Price index
?x 100
Real GDP
Price index measured by the GDP deflator
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Terminology to be aware of

• Nominal GDP output at current prices
• Real GDP output at constant base-year prices
  (inflation has been deducted)
• GDP Price Index (market basket prices value) of
  g s in given year compared to base year.
• CPI currently base year 1983

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What is the bottom line?

• The amount left after evaluating the income
  approach is
• Disposable Income
• (this is what we have to spend or save)

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Would this change GDP?