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III THE DATA OF MACROECONOMICS. 5. Measuring a Nation’s Income . Microeconomics and Macroeconomics. Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets Macroeconomics is the study of the economy as a whole

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III

THE DATA OF MACROECONOMICS

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5

Measuring a Nation’s Income

microeconomics and macroeconomics
Microeconomics and Macroeconomics
  • Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets
  • Macroeconomics is the study of the economy as a whole
    • Its goal is to explain the economic changes that affect many households, firms, and markets at once

CHAPTER 5 MEASURING A NATION’S INCOME

macroeconomics
Macroeconomics
  • Macroeconomics answers questions like these:
    • Why is average income high in some countries and low in others?
    • Why do prices rise rapidly in some time periods while they are more stable in others?
    • Why do production and employment expand in some years and contract in others?

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the importance of data
The Importance of Data
  • In macroeconomics, data is crucial
  • Data helps policy makers see what problems, if any, need to be addressed
  • Data helps macroeconomists identify the theories that make correct predictions and the theories that make incorrect predictions
  • Data often reveals interesting puzzles that macroeconomic theories need to solve

CHAPTER 5 MEASURING A NATION’S INCOME

total income
Total Income
  • When judging whether an economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning

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total income1
Total Income
  • We can temporarily boost our standard of living by borrowing from others.
  • But in the long run we can’t keep borrowing indefinitely
  • This is why a nation’s standard of living depends heavily on its total income

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income expenditure
Income = Expenditure
  • We could measure either total income or total expenditure
    • We will get the same number either way
  • For an economy as a whole, income must equal expenditure because:
    • Every transaction has a buyer and a seller.
    • Every dollar of spending by some buyer is a dollar of income for some seller.

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but what about saving
But what about saving?
  • Q: People typically save part of what they earn. How then is income equal to expenditure for the economy as a whole?
  • A: What people save tends to be loaned to businesses who then spend what they borrowed.

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international trade
International Trade
  • We buy foreign-made goods and foreigners buy goods made by us
  • Q: In that case, how can our total income be equal to our total expenditure?
  • A: Very good point! It is better to say that total income equals the total expenditure on domestically produced goods (GDP)

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gross domestic product
Gross Domestic Product
  • Gross Domestic Product (GDP) is one measure of a country’s total income
    • There are other measures
  • GDP is the total market value of all final goods and services produced within a country in a given period of time.
    • For example, the GDP of the United States was nearly seventeen trillion dollars in 2013
      • $16,803.0 billion, according to the U.S. Department of Commerce

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gross domestic product1
Gross Domestic Product
  • We just saw that GDP is the total market value of all final goods and services produced
  • Therefore, GDP is also the total expenditure on all final goods and services produced
  • As expenditure is equal to income, GDP is also total income

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gdp is the market value
GDP is the Market Value …
  • In GDP, all output is valued at market prices.
  • The market value of all sandwiches produced is both the total expenditure of the buyers of those sandwiches and the total income of the makers of those sandwiches
  • As our goal is to measure total income, it therefore makes sense to measure the market values of the various produced goods and add them up

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of all final goods
… Of All Final Goods …
  • GDP records only the value of final goods, not intermediate goods
    • Intermediate goods are those goods that disappear inside other goods that are produced for sale
    • Final goods are goods that are not intermed iate goods
  • This way, the value of intermediate goods is counted only once, not twice or thrice.

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of all final goods1
… Of All Final Goods …
  • Intermediate goods are sold by their producers to producers of other goods
    • Examples: milk sold by a dairy to an ice-cream company, grapes sold by a vineyard to a winemaker, printer paper sold to Kinko’s
  • Final goods are goods that are sold to the final users of those goods
    • Examples: milk you buy at the supermarket, table grapes you buy at the farmer’s market, printer paper you buy for your computer printer
    • All goods made this year but not sold by year’s end are regarded as final goods (inventories)

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of all final goods2
… Of All Final Goods …
  • Suppose a dairy farmer sells milk worth $50,000 to an ice-cream company.
    • The farmer does not buy anything from any other firm.
  • The total income of the dairy farmer and her employees is, therefore, $50,000
  • The ice-cream company uses the milk to produce ice-cream which it sells for $75,000.
    • The ice-cream company does not buy anything from any firm other than the dairy.
  • Therefore, the total income of the owners and employees of the ice-cream firm is $25,000.
  • Therefore, the total income of this country is $75,000
  • This is accurately measured by the value of the ice-cream (the final good) alone
  • Had we also counted milk, the intermediate good, we would have calculated total income to be $125,000, which would have been an exaggeration.

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and services
… and Services …
  • GDP includes both
    • tangible goods (food, clothing, cars) and
    • intangible services (haircuts, housecleaning, doctor visits, legal consultations).
  • Trade in assets does not affect GDP.
    • Such trade does not require new productive activity, it is merely the transfer of ownership of an asset from one person to another

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produced within a country
… Produced Within a Country …
  • GDP measures the value of all production within the geographic boundaries of a country.
  • The citizenship of the owners of the resources used in production is not the key issue
  • Production by foreigners living in a country is counted in the country’s GDP
  • Production by a country’s citizens working in other countries is not counted

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in a given period of time
… In a given period of time
  • GDP measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).
  • GDP includes goods and services currently produced, not transactions involving goods produced in the past.
    • Transactions involving used cars or buildings that were constructed in the past are not counted

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what s not counted in gdp
What’s not counted in GDP?
  • GDP includes all items produced in the economy and sold legally in markets.
    • It excludes items produced and sold illicitly, such as illegal drugs.
  • GDP excludes most items that are produced and consumed at home and that never enter the marketplace.

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real versus nominal gdp
Real Versus Nominal GDP
  • Nominal GDP values the production of goods and services at current prices.
  • Real GDP values the production of goods and services at constant prices.

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real and nominal gdp of usa
Real and Nominal GDP of USA

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the gdp deflator
The GDP Deflator
  • The GDP deflator is a measure of the overall level of the prices of the final goods and services produced within a country during a given period of time

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the gdp deflator1
The GDP Deflator
  • It tells us what part of the rise in nominal GDP over a period of time is attributable to a rise in prices rather than a rise in the quantities produced.

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the gdp deflator2
The GDP Deflator
  • The GDP Deflator is calculated as follows:

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example 2013
Example: 2013
  • US Nominal GDP was $16,803.0billion
  • US Real GDP was $15,767.1billion (chained 2009 dollars)
  • US GDP Deflator = (16,803.0/15,767.1) × 100 = 106.57
    • This means that, roughly, final goods and services were on average 6.57% pricier in 2013 compared with 2009

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the gdp deflator3
The GDP Deflator
  • Why call it a deflator?
  • Nominal GDP changes from one year to the next partly because of inflation
  • Real GDP, on the other hand, changes because of changes in production alone
  • The GDP Deflator can convert Nominal GDP to Real GDP by deflating the effect of inflation in Nominal GDP

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converting nominal gdp to real gdp
Converting Nominal GDP to Real GDP
  • We just saw that
  • Therefore,
  • Therefore, if you know the Nominal GDP and the GDP Deflator, you can calculate the Real GDP

CHAPTER 5 MEASURING A NATION’S INCOME

the components of gdp
The Components of GDP

CHAPTER 5 MEASURING A NATION’S INCOME

the components of gdp1
The Components of GDP
  • We have seen that GDP is the total expenditure on domestically-produced final goods and services
  • Knowing the total expenditure is not enough, however
  • We also need to know the components of the total expenditure

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the components of gdp2
The Components of GDP
  • If total expenditure falls, total income will fall too …
  • … which is not good!
  • To figure out why total expenditure is falling, policy makers need to find out whether some particular component of expenditure is chiefly responsible for the fall in total spending
  • If the chief culprit is identified, policy makers would have a better chance of fixing the problem
components of gdp
Components of GDP
  • GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports
  • Macroeconomists look not only at total spending (GDP), they also look at the above components of total spending

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the components of gdp3
The Components Of GDP
  • Consumption (C):
    • The spending by households on goods and services, with the exception of purchases of new housing.
  • Investment (I):
    • The spending on capital equipment, inventories, and structures, including new housing.

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the components of gdp4
The Components Of GDP
  • Government Purchases (G):
    • The spending on goods and services by local, state, and federal governments.
    • Does not include transfer payments because they are not made in exchange for currently produced goods or services.
  • Net Exports (NX):
    • Exports minus imports.

CHAPTER 5 MEASURING A NATION’S INCOME

the components of real gdp 2013
The Components Of Real GDP: 2013

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the components of nominal gdp 2013
The Components Of Nominal GDP: 2013

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components of gdp1
Components of GDP
  • GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports
  • Q: Why do we subtract imports?

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components of gdp why do we subtract imports
Components of GDP: Why do we subtract imports?
  • GDP is the total spending on all final “Made in USA” goods.
  • But consumption, investment, and government spending all include spending on foreign goods.
  • Therefore, to make the two sides of the equation the same, we must take out all spending on imported goods lurking inside consumption, investment, and government spending

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slide44

U.S. Exports and Imports, as a percentage of real GDP

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growth rates
Growth Rates
  • To calculate the growth rate of some variable (such as GDP), use the following formula:
slide47
http://research.stlouisfed.org/fred2/series/GDPCA

CHAPTER 5 MEASURING A NATION’S INCOME

where to find us data
Where to find US data
  • Bureau of Economic Analysis, U.S. Department of Commerce: http://bea.gov
  • Federal Reserve Bank of St. Louis: http://research.stlouisfed.org/fred2/categories/18

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international comparisons
International Comparisons
  • When the GDP numbers for various countries’ are being compared, the same currency units must be used for all countries
  • There are two ways of converting from national countries to the US dollar (or some othercommon currency)
    • Use market exchange rates
    • Use a common set of prices (PPP)

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gdp per capita in us dollars
GDP per capita, in US dollars

Source: World Economic Outlook 2008 database, IMF

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gdp and economic well being
GDP And Economic Well-being
  • GDP is the best single measure of the economic well-being of a society.
  • GDP per persontells us the income and expenditure of the average person in the economy.

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table 3 gdp life expectancy and literacy
Table 3 GDP, Life Expectancy, and Literacy

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gdp and economic well being1
GDP And Economic Well-being
  • Some things that contribute to well-being are not included in GDP.
    • The value of leisure.
    • The value of a clean environment.
    • The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

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robert kennedy on gdp
Robert Kennedy on GDP
  • [Gross Domestic Product] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.

CHAPTER 5 MEASURING A NATION’S INCOME

any questions
Any questions?

CHAPTER 5 MEASURING A NATION’S INCOME

summary
Summary
  • Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy.
  • Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services.

CHAPTER 5 MEASURING A NATION’S INCOME

summary1
Summary
  • GDP is the market value of all final goods and services produced within a country in a given period of time.
  • GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports.

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summary2
Summary
  • Nominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services.
  • The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy.

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summary3
Summary
  • GDP is a good measure of economic well-being because people prefer higher to lower incomes.
  • It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, aren’t measured by GDP.

CHAPTER 5 MEASURING A NATION’S INCOME