Measuring a Nation’s Income

1. 10 Measuring a Nation’s Income

2. Measuring a Nation’s Income • Microeconomics • Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets. • 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.

3. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • GDP is the market value of all final goods and services produced within a country in a given period of time.

4. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “GDP is the Market Value . . .” • Output is valued at market prices. • “. . . Of All Final . . .” • It records only the value of final goods, not intermediate goods (the value is counted only once). • “. . . Goods and Services . . . “ • It includes both tangible goods (food, clothing, cars) and intangible services (medical, legal, retail sales).

5. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . Produced . . .” • It includes goods and services currently produced, not transactions involving goods produced in the past. • “ . . . Within a Country . . .” • It measures the value of production within the geographic confines of a country.

6. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . In a Given Period of Time.” • It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

7. GDP vs GNP • Domestic Product – within a country • National Product – owned by country’s citizens • Example – Subaru plant – US GDP, Japan’s GNP • GNP - the market value of all final goods and services produced by factors owned by a country’s citizens in a given period of time.

8. MARKETS FOR GOODS AND SERVICES • Firms sell Goods and Goods • Households buy services and services bought sold HOUSEHOLDS FIRMS • Buy and consume • Produce and sell goods and services goods and services • Own and sell factors • Hire and use factors of production of production MARKETS Labor, land, Factors of FOR and capital production FACTORS OF PRODUCTION • Households sell Wages, rent, • Firms buy and profit Figure 1 The Circular-Flow Diagram Spending Revenue Income = Flow of inputs and outputs = Flow of dollars

9. Calculating GDP • Expenditure Approach • Income Approach

10. THE COMPONENTS OF GDP • GDP (Y) is the sum of the following: • Consumption (C) • Durable goods • Non-durable Goods • Investment (I) • Non-residential • Residential (Housing) • Inventories • Government Purchases (G) • Net Exports (NX) = Exports - Imports Y = C + I + G + NX

11. Table 1 GDP and Its Components (2010)

12. Government Purchases 18% Net Exports -3 % Investment 16% Consumption 69% GDP and Its Components

13. Income Approach • National Income • Compensation of employees 57% • Proprietor’s income 7% • Corporate profits 9% • Interest and rental income 7% • Depreciation 13% • Indirect Taxes and Subsidies 7% • Net Factor Payments to rest of the world

14. 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.

15. Table 2 Real and Nominal GDP

16. The GDP Deflator • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. • It measures the changes in the price level.

17. The GDP Deflator • The GDP deflator is calculated as follows:

18. The GDP Deflator • Converting Nominal GDP to Real GDP • Nominal GDP is converted to real GDP as follows:

19. Figure 2 Real GDP in the United States Billions of 1996 Dollars $10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 1970 1975 1980 1985 1990 1995 2000

20. 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.

21. Limitations of GDP • Measures only income – ignores quality of education, medical care, environment • Excludes non-market production • Excludes underground economy

22. Table 3 GDP, Life Expectancy, and Literacy

23. 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.

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

25. 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.