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Chapter 8. Measuring the Economy’s Performance. Learning Objectives. Describe the circular flow of income and output Define gross domestic product (GDP) Understand the limitations of using GDP as a measure of national welfare. Learning Objectives (cont'd).

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chapter 8

Chapter 8

Measuring the Economy’s

Performance

learning objectives
Learning Objectives

Describe the circular flow of income and output

Define gross domestic product (GDP)

Understand the limitations of using GDP as a measure of national welfare

learning objectives cont d
Learning Objectives (cont'd)

Explain the expenditure approach to tabulating GDP

Explain the income approach to computing GDP

Distinguish between nominal GDP and real GDP

the simple circular flow
The Simple Circular Flow

The concept of the circular flow of income involves two principles:

In every economic exchange, the seller receives exactly the same amount that the buyer spends.

Goods and services flow in one direction and money payments flow in the other.

the simple circular flow cont d
The Simple Circular Flow (cont'd)

Profits explained

Question

Why is profit a cost of production?

Answer

Profits are the return entrepreneurs receive for the risk they incur when organizing productive activities.

the simple circular flow cont d6
The Simple Circular Flow (cont'd)

Final Goods and Services

Goods and services that are at their final stage of production and will not be transformed into yet other goods or services

the simple circular flow cont d8
The Simple Circular Flow (cont'd)

Product Markets

Transactions in which households buy goods

the simple circular flow cont d9
The Simple Circular Flow (cont'd)

Factor Markets

Transactions in which businesses buy resources

the simple circular flow cont d10
The Simple Circular Flow (cont'd)

Total Income

Wages, rent, interest, profits

the simple circular flow cont d11
The Simple Circular Flow (cont'd)

Question

Why must total income be identical to the dollar value of total output?

Answer

Every transaction simultaneously involves an expenditure and a receipt.

national income accounting
National Income Accounting

National Income Accounting

A measurement system used to estimate national income and its components

Total Income

The yearly amount earned by the nation’s resources (factors of production)

national income accounting cont d
National Income Accounting (cont'd)

Gross Domestic Product (GDP)

The total market value of all final goods and services produced by factors of production located within a nation’s borders

national income accounting cont d14
National Income Accounting (cont'd)

Observations

GDP measures the dollar value of final output.

GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders.

national income accounting cont d15
National Income Accounting (cont'd)

Intermediate Goods

Goods used up entirely in the production of final goods

Value Added

The dollar value of an industry’s sales minus the value of intermediate goods (for example, raw materials and parts) used in production

national income accounting cont d17
National Income Accounting (cont'd)

Numerous transactions occur that have nothing to do with final goods and services being produced:

Financial transactions

Transfer Payments

Secondhand Goods

national income accounting cont d18
National Income Accounting (cont'd)

Exclusion of financial transactions

Securities

Stocks and bonds

Government transfer payments

Social Security

Unemployment compensation

Private transfer payments

Individual gifts

Corporate gifts

national income accounting cont d19
National Income Accounting (cont'd)

Transfer of secondhand goods excluded

Why not count the sale of a used computer, guitar, or snowboard as part of GDP?

Other excluded transactions

Household production

Legal and illegal underground transactions

national income accounting cont d20
National Income Accounting (cont'd)

GDP’s limitations

Excludes non-market production

It is not necessarily a good measure of the well-being of a nation.

national income accounting cont d21
National Income Accounting (cont'd)

GDP is a measure of the value of production in terms of market prices, and an indicator of economic activity.

GDP is not a measure of a nation’s overall welfare.

two main methods of measuring gdp
Two Main Methods of Measuring GDP

Expenditure Approach

Computing GDP by adding up the dollar value at current market prices of all final goods and services

two main methods of measuring gdp cont d24
Two Main Methods of Measuring GDP (cont'd)

Income Approach

Measuring GDP by adding up all components of national income, including wages, interest, rent, and profits

two main methods of measuring gdp cont d26
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Expenditure Approach

Consumption Expenditure (C)

Durable Consumer Goods

Life span of more than three years

Nondurable Consumer Goods

Goods that are used up in three years

Services

Mental or physical help

two main methods of measuring gdp cont d27
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Expenditure Approach

Gross Private Domestic Investment (I)

The creation of capital goods, such as factories and machines, that can yield production and hence consumption in the future

Also included: changes in business inventories and repairs made to machines, buildings

two main methods of measuring gdp cont d28
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Expenditure Approach

Gross Private Domestic Investment (I)

Producer Durables or Capital Goods

Life span of more than three years

Fixed Investment

Purchases by business of newly produced producer durables or capital goods

Inventory Investment

Changes in stocks of finished goods and goods in process, as well as changes in raw materials

two main methods of measuring gdp cont d29
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Expenditure Approach

Government Expenditures (G)

State, local, and federal

Valued at cost

two main methods of measuring gdp cont d30
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Expenditure Approach

Net Exports (Foreign Expenditures)

Net exports (X) = Total exports – Total imports

two main methods of measuring gdp cont d31
Two Main Methods of Measuring GDP (cont'd)

Presenting the Expenditure Approach

Where

C = consumption expenditures

I = investment expenditures

G = government expenditures

X = net exports

GDP = C + I + G + X

two main methods of measuring gdp cont d33
Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Income Approach

slide34
Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2009 (in billions of 2009 dollars per year)

Sources: U.S. Department of Commerce and author’s estimates.

other components of national income accounting
Other Components of National Income Accounting

National Income (NI)

The total of all factor payments to resource owners

Personal Income (PI)

The amount of income that households actually receive before they pay personal income taxes

other components of national income accounting cont d
Other Components of National Income Accounting (cont'd)

Disposable Personal Income (DPI)

Personal income after personal income taxes have been paid

distinguishing between nominal and real values
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

distinguishing between nominal and real values cont d
Distinguishing Between Nominal and Real Values (cont'd)

Constant Dollars

Dollars expressed in terms of real purchasing power

This price-corrected GDP is the real GDP.

example correcting gdp for price index changes
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

distinguishing between nominal and real values cont d41
Distinguishing Between Nominal and Real Values (cont'd)

Per capita GDP

Adjusting for population growth

Real GDP

Population

Per capita real GDP =

figure 8 4 nominal and real gdp
Figure 8-4 Nominal and Real GDP

Source: U.S. Department of Commerce

comparing gdp throughout the world
Comparing GDP Throughout the World

Foreign Exchange Rate

The price of one currency in terms of another

comparing gdp throughout the world cont d
Comparing GDP Throughout the World (cont'd)

Foreign exchange rate

$1.50 = 1 euro, or $1 = .67 euros

French income per capita = 24,120 euros

French per capita income in terms of dollars equals 24,120 euros x $1.50 = $36,180

comparing gdp throughout the world cont d45
Comparing GDP Throughout the World (cont'd)

Purchasing Power Parity

Adjustments in exchange rate conversions that takes into account differences in the true cost of living across countries

summary discussion of learning objectives
Summary Discussion of Learning Objectives

The circular flow of income and output

In every economic transaction, receipts exactly equal expenditures

Goods and services flow in one direction and money payments flow in the other

Gross domestic product (GDP)

The total market value of a nation’s final output of goods and services produced in a year using factors of production located within its borders

summary discussion of learning objectives cont d
Summary Discussion of Learning Objectives (cont'd)

The limitations of using GDP as a measure of national welfare

Excludes non-market transactions

Does not measure national well-being

The expenditure approach to tabulating GDP

GDP = C + I + G + X

summary discussion of learning objectives cont d49
Summary Discussion of Learning Objectives (cont'd)

The income approach to computing GDP

The sum of wages, rent, interest, profits

Distinguishing between nominal GDP and real GDP

Nominal GDP is the value of newly produced final output measured in current market prices.

Real GDP adjusts nominal GDP into constant dollars by correcting for price level changes.