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Chapter 10. Measuring a Nation’s Income. Macroeconomics. 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.

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Chapter 10 l.jpg

Chapter 10

Measuring a Nation’s Income


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Macroeconomics

  • 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.

  • Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.


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Understanding the Economy

  • Identify the important areas:

    • Total output (and income)

    • The average of prices

    • Resource employment

  • Measure the important areas using:

    • Real Gross Domestic Product

    • Consumer Price Index

    • Monthly unemployment rate


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The Circular-Flow Diagram

Product Market

$

$

Businesses

Households

$

$

Market for Factors of Production


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Two Methods of Computing An Economy’s Income

  • Expenditure Approach:

    • Sum the total expenditures by households (from the top portion of the circular flow).

  • Resource Cost or Income Approach:

    • Sum the total wages and profit paid by firms for resources (from the bottom portion of the circular flow).


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The Economy’s Income and Expenditure

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

  • For an economy as a whole, income must equal expenditure.

  • The forces of supply and demand determine the market equilibrium price and quantity that is produced and exchanged.


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The Economy’s Income and Expenditure

  • A measure of the income and expenditures of an economy is Gross Domestic Product (GDP).

  • Gross Domestic Product 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


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Gross Domestic Product

The total market value of all final goods and services produced during a given period of time within a country, region, or state.


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Important Features of GDP

  • Output is valued at market determined prices.

  • Output is measured in dollar terms.

  • GDP records only the output of final goods. We want to “count” production only once.

  • Represents the amount of money one would need to purchase a year’s worth of the economy’s production of all final goods ($7,000,000,000,000).


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What Is and What Is Not Counted in GDP?

  • GDP includes all items produced in the economy and sold legally in markets.

  • GDP does not include items produced and consumed at home and never enter the marketplace. It does not include items produced and sold illicitly, such as illegal drugs.


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Gross National Product

The total market value of all final goods and services produced during a given period of time by the nation’s residents, regardless of the place produced.


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Quick Quiz!

  • Which contributes more to GDP: the production of a pound of hamburger or the production of a pound of caviar? Why?


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Three Other Measures of Income

  • Net National Product (NNP):

    • Total income of residents of a nation after subtracting capital consumption allowances.

  • Personal Income:

    • The income that households and non-corporate businesses receive.

  • Disposable Personal Income:

    • The income that household and non-corporate businesses have left after taxes.


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The Components of GDP

  • GDP (Y) is the sum of:

    • Consumption (C)

    • Investment (I)

    • Government Purchases (G)

    • Net Exports (NX)

      Y = C + I + G + NX


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The Four Components of GDP

  • Consumption (C):

    • Is the spending by households on goods and services

      • e.g. buying clothing, food, movie tickets

  • Investment (I):

    • Is the purchases of capital equipment and structures

      • e.g. factory, houses, etc.


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The Four Components of GDP

  • Government Purchases (G):

    • Includes spending on goods and services by local, state and federal governments (e.g. roads, police, etc.).

    • Does not include transfer payments, because it is not made in exchange for currently produced goods or services.

  • Net Exports (NX):

    • Exports minus imports.


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GDPComponents of Measurement


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GDPComponents of Measurement

Consumption

69 %


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GDPComponents of Measurement

Investment

13%

Consumption

69 %


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GDPComponents of Measurement

Government

Spending

19%

Investment

13%

Consumption

69 %


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GDPComponents of Measurement

Government

Spending

19%

Investment

13%

Net Exports

-1 %

Consumption

69 %


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The Income Approach

  • Components:

    • Wages (73.0%)

    • Interest (9.5%)

    • Rents (.5%)

    • Profits (17.0%)

  • We must also include taxes and depreciation for accurate accounting


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Quick Quiz!

  • List the four components of expenditure.

  • Which is the largest?


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Real versus Nominal GDP

  • GDP is the market value of the economy’s current production, referred to as Nominal GDP.

  • Real GDP measures any given year’s total output in “constant” prices.

  • An accurate view of the economy requires adjusting nominal to real GDP, using the GDP Price Deflator.



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Nominal GDP

  • Calculated as the sum of Prices in a year times quantities in a year

  • 1999: $1x10+$2x5=$20

  • 2000: $2X10+$4x5=$40

  • 2001: $3x5+$6x10=&75

  • Question: Is this an accurate measure of how much we produce?

  • Compare 1999 and 2000 to see!


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Real GDP

  • Calculated as sum of base year prices times quantities each year

  • Let’s make 1999 the base year

  • 1999: $1x10+$2x5=$20

  • 2000: $1x10+$2x5=$20

  • 2001:$1x5+$2x10=$25

  • Is this a more accurate measure of output?


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GDP Deflator

  • Just the ratio of nomimal GDP to real GDP times 100

  • 1999:$20/$20 x 100 = 100

  • This is an index, always 100 for the base year

  • 2000:$40/$20 x 100 = 200

  • 2001:$75/$25 x 100 = 300

  • What does it mean?


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GDP Price Deflator

  • The GDP Price Deflator is a price index that uses a bundle of all final goods and services.

    • It tells us the rise in nominal GDP that is attributable to a rise in prices.

  • Converting Nominal GDP to Real GDP:

    Real GDP19xx =

    (Nominal GDP19xx ) ÷ (GDP deflator19xx)X100


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Quick Quiz!

  • Define Real and Nominal GDP.

  • Which is a better measure of economic well-being? Why?


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GDP and Economic Well-Being

  • GDP Per Person tells us the income and expenditure of the average person in the economy.

    • It is a good measure of the material well-being of the economy as a whole.

    • More Real GDP means we have a higher material standard of living by being able to consume more goods and services.

    • It is NOT intended to be a measure of happiness or quality of life.


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GDP and Economic Well-Being

  • Some factors and issues not in GDP that lead to the “well-being” of the economy:

    • Factors that contribute to a good life such as leisure.

    • Factors that lead to a quality environment.

    • The value of almost all activity that takes place outside of the markets, e.g. volunteer work and child-rearing.