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Frank & Bernanke 4th edition, 2009

Frank & Bernanke 4th edition, 2009. Ch. 4: Spending, Income, and GDP. Why Measure A Nation’s Income. To have a sense of an economy’s size. The well being of a citizen, on average, depends on the nation’s income per person. http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu

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Frank & Bernanke 4th edition, 2009

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  1. Frank & Bernanke4th edition, 2009 Ch. 4: Spending, Income, and GDP

  2. Why Measure A Nation’s Income • To have a sense of an economy’s size. • The well being of a citizen, on average, depends on the nation’s income per person. • http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu • As the income of the society increases, the average person will have a higher standard of living. • One can drown in a lake of 3-ft average depth. • Standard of living may not necessarily be the goods and services a household can consume.

  3. Definition of GDP • Gross Domestic Product is the market value of all the final goods and services produced within a country in a year. • How do you determine the value of child care? • How do you include the production of steel or plastics? • How do you include the sales of existing homes? • How do you account for $4 million paid at an auction for a Van Gogh painting? • How do you account for government services?

  4. Market Value • Suppose we live in an economy where only hamburgers, colas and fries are produced. • Prices are: hamburgers $2; colas $1; fries $0.50. • If this economy produces 100 hamburgers, 150 colas and 200 fries, what is the market value? • What is the market value if 200 hamburgers, 100 colas and 100 fries are produced?

  5. Percentages of American Men and Women over Age 16 Working Outside the Home “By 2010 women will be the majority.” Check at www.bls.gov http://www.economist.com/opinion/displayStory.cfm?story_id=15174489&source=hptextfeature • Increase in female labor force participation increases the demand for housekeeping and child care. • Unpaid household work is not counted in GDP. • Paid household work is counted in GDP. • The increase in female labor force participation has overstated GDP growth.

  6. Participation Rates Labor Force Participation Rate is total employed plus unemployed divided by the labor force. From 2000 to 2011 participation rates for men dropped from 75% to 70%. From 2000 to 2011 participation rates for women dropped from 60% to 58%.

  7. Why GDP Is Equal to Income? • How is my contribution to the US economy calculated? • The amount of educational service I create is equal to my gross income. • How is the income of a real estate agent calculated? • When she sells a 25-yr old house, she gets a percent of the price as a payment for her services.

  8. Why GDP Is Equal to Income? • How is the GDP contribution of the textbook company calculated? • After they pay the author, the paper company and the ink company, the amount of revenue they get from textbook sales plus the value of their book inventory (unsold books) is their contribution to the US GDP. • Their contribution is equal to wages, salaries, rent, interest and profits generated.

  9. Value Added • Calculate the contribution of the following activities to GDP. • Farmer sells cotton for $100. • Cotton is processed into thread and sold for $130. • Thread is made into cloth and sold for $200. • Cloth is made into shirts and sold for $300. Final value = Value added

  10. Circular Flow GDP from expenditure Consumption expenditures of households Households Firms Income (wages, salaries, rent, interest, profit) earned by households GDP from income

  11. Circular Flow • Upper flow is equal to GDP. • Lower flow is equal to income. • If GDP < Income, businesses will reduce production and create less income => unemployment. • If GDP > Income, businesses will want to expand production and create more income => boom.

  12. GDP HOUSEHOLDS FIRMS Y=wages+salaries+rent+profits+interest C FINANCIAL SYSTEM Spri I EX IM T TR+INT REST OF THE WORLD GOVERNMENT NX>0 -Sfor -Sgov NX<0 Sfor T>TR+INT+G :Sgov G

  13. How Can We Measure GDP? • Expenditure Approach: the upper flow. Y = C + I + G + NX • Income Approach: the lower flow. Y = Sum of factor incomes Y = Wages + Salaries + Rent + Interest + Profits

  14. Components of Expenditure • Consumptionincludes spending on food, entertainment, shelter, health care, transportation, clothing, household items, insurance, education.

  15. Components of Expenditure • Investment includes purchases made by firms to generate future income. Machinery, tools, buildings, trucks and cars are part of investment if they are bought to generate future income. By convention, newly built houses and inventory are included under investment.

  16. Components of Expenditure • Government purchases are expenditures of federal, state and local governments on goods and services plus their payrolls.

  17. Components of Expenditure Approach • Net exportsis exports minus imports. • Dell Computer sales in China are part of US exports. • Dell Computer purchases of plastic molds for their computers from China are part of US imports.

  18. GDP http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2004&LastYear=2008&3Place=N&Update=Update&JavaBox=no#Mid

  19. Production Expenditure Income Consumption Market value of final goods and services Labor Income = = Investment Government purchases Capital Income Net exports The Three Faces of GDP = =

  20. A GDP Increase Always Increases The Size of the Economy • WRONG! • What if GDP in 2009 were 1000, in 2010 were 1500 but inflation was 50%? • In this case, the increase in GDP is solely attributable to price increases, not improving the well being (standard of living) of the average citizen.

  21. Nominal vs. Real Measures • In macroeconomics, most variables are measured in real terms, not nominal terms. • Real variable eliminates the effect of inflation. • Nominal variable includes the effect of inflation. • GDP comparisons are always made with real GDP. • Nominal GDP uses current prices. • Real GDP uses base year prices.

  22. Real and Nominal GDP Nominal GDP is calculated by adding the amounts spent on each Product. Real GDP is calculated by using the 2007 prices of pizza andsoda to calculate the amounts spent in future years. GDP Deflator is Nominal GDP/Real GDP.

  23. Real and Nominal GDP

  24. What Is Wrong With Real GDP? • Real GDP increases if you sell your services rather than provide them free. • If you build a house through Habitat for Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it counts. • If you pollute during production and someone pays to clean the environment, the GDP will be higher than if the producer tried to reduce pollution during production so no clean-up was necessary.

  25. Underground Economy • If market transactions cannot be tracked by data collectors, they may be ignored. • Transactions with high cash usage and no paper trail can remain hidden from the government. • GDP may actually be much higher than government statistics if there is a large underground economy.

  26. Real GDP is not the Same as Economic Well-Being • Leisure Time • Shorter work week • Start working later • Retire earlier • Check the debate on leisure in EU conducted by The Economist. http://www.economist.com/debate/days/view/438&sa_campaign=debateseries/debate38/events/hp/panel/?source=hpevents

  27. Real GDP is not the Same as Economic Well-Being • Nonmarket Economic Activities • Household production • Volunteer services • Nonmarket activities are more important in poor countries • Underground economy

  28. Real GDP is not the Same as Economic Well-Being • Environmental Quality and Resource Depletion • Benefits of environment quality are not measured. • GDP is not adjusted for resource depletion.

  29. Real GDP is not the Same as Economic Well-Being • Quality of Life • Crime rates • Traffic congestion • Civic organizations • Open space

  30. Real GDP is not the Same as Economic Well-Being • Poverty and Economic Inequality • GDP does not capture the effects of income inequality

  31. GDP & Basic Indicators of Well-Being All developing countries Least developed countries Industrialized countries Indicator GDP per person 3,530 1,170 25,860 (U.S. dollars) Life expectancy at 64.5 51.7 78.0 birth (years) Infant mortality rate 61 100 6 (per 1,000 live births) Under-5 mortality rate 89 159 6 (per 1,000 live births) Doctors 78 30 252 (per 100,000 people) Incidence of HIV/Aids 1.3 4.3 0.3 (% in 15-49 age group) Undernourished 18 38 Negligible people (%) Primary enrollment 85.7 60.4 99.9 rate (as % of age group) Secondary enrollment 60.4 31.2 96.2 rate (as % of age group) Adult literacy rate (%) 72.9 51.7 98.6

  32. http://hdr.undp.org/en/media/HDR_2009_EN_Indicators.pdf http://hdr.undp.org/en/data/map/

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