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10
National Accounting,
GDP, Growth
Introduction to Economics
ETH Zürich, Prof. Dr. Jan-Egbert Sturm
Winter Term 2006/07
General Information
24.10.
Introduction; Transformation Curve, Opportunity Cost
Mankiw ch.1,2
31.10.
Markets: Demand and Supply
Ch. 4
7.11.
Elasticities
Ch. 5
14.11.
Costs, Production Function
Ch. 13
21.11.
Markets with perfect competiton
Ch. 7, 14
28.11.
Taxation
Ch. 8
5.12.
International Trade
Ch. 9
12.12.
Imperfect competition: Monopoly, and Oligoploy
Ch. 15, 16
19.12.
Public Goods, Externalities
Ch. 10,11
9.1.
National Accounting, Gross Domestic Product, Growth
Ch. 23, 25
16.1.
Money and Inflation
Ch. 24, 29, 30
23.1.
Business Cycles
Ch. 33, 34
30.1.
Open Economy Macro
Ch. 31
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Economics
• 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.
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Macroeconomics
• Macroeconomics answers questions like the following:
• 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 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.
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THE ECONOMY’S INCOME AND EXPENDITURE
• 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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THE MEASUREMENT OF GROSS DOMESTIC
PRODUCT
• Gross domestic product (GDP) is a measure of the income and
expenditures of an economy.
• It is the total market value of all final goods and services
produced within a country in a given period of time.
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THE MEASUREMENT OF GROSS DOMESTIC
PRODUCT
• The equality of income and expenditure can be illustrated with
the circular-flow diagram.
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Figure 1 The Circular-Flow Diagram
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
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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.
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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 (haircuts, housecleaning, doctor visits).
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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.
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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).
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THE COMPONENTS OF GDP
• What Is Not Counted in GDP?
• GDP excludes most items that are produced and consumed at home
and that never enter the marketplace.
• It excludes items produced and sold illicitly, such as illegal drugs.
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THE COMPONENTS OF GDP
• GDP (Y) is the sum of the following:
•
•
•
•
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
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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 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.
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Table 1 GDP and Its Components (USA, 2001)
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Copyright©2004 South-Western
GDP and Its Components (USA, 2001)
Investment
16%
Government Purchases
18%
Consumption
69%
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Net Exports
-3 %
GDP and Its Components (CH, 2006)
Investment
21%
Net Exports
7%
Government
consumption
12%
• Estimated GDP in 2006 (in prices of 2005):
456 billion CHF
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Private
consumption
60%
Total Demand and Its Components (CH, 2006)
Exports
34%
Investment
15%
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Private
consumption
43%
Government
consumption
8%
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 VERSUS NOMINAL GDP
• An accurate view of the economy requires adjusting nominal to
real GDP by using the GDP deflator.
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Table 2 Real and Nominal GDP
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Copyright©2004 South-Western
Table 2 Real and Nominal GDP
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Copyright©2004 South-Western
Table 2 Real and Nominal GDP
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Copyright©2004 South-Western
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 tells us the rise in nominal GDP that is attributable to a rise in
prices rather than a rise in the quantities produced.
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The GDP Deflator
• The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =
 100
Real GDP
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Table 2 Real and Nominal GDP
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Copyright©2004 South-Western
Chain-weighted Real GDP
• Over time, relative prices change, so the base year should be
updated periodically.
• In essence, “chain-weighted Real GDP” updates the base year
every year.
• This makes chain-weighted GDP more accurate than constantprice GDP.
• But the two measures are highly correlated, and constant-price
real GDP is easier to compute…
• …so we’ll usually use constant-price real GDP.
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Figure 2 GDP in Switzerland
Nom inal and Real GDP in Sw itzerland
500000
Nominal GDP
Millions of CHF
450000
Real GDP (2000 prices)
400000
350000
300000
250000
1990
1992
1994
1996
1998
Year
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2000
2002
2004
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GDP in Switzerland:
Some slowdown expected for 2007
Billions CHF
Q-to-Q in %
4
BFS: SNA 09/2006,
Quartalization by seco
KOF-Forecast 10/2006
(quarter)
120
3
118
2
116
1
114
0
2.6%
2.1%
1.5%
112
-1
110
-2
108
2003
2004
2005
2006
Prof. Dr. Jan-Egbert Sturm / [email protected]
2007
2008
GDP AND ECONOMIC WELL-BEING
• GDP is the best single measure of the economic well-being of a
society.
• GDP per person tells us the income and expenditure of the
average person in the economy.
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GDP AND ECONOMIC WELL-BEING
• Higher GDP per person indicates a higher standard of living.
• GDP is not a perfect measure of the happiness or quality of life,
however.
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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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Table 3 GDP, Life Expectancy, and Literacy
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Copyright©2004 South-Western
Production and Growth
• A country’s standard of living depends on its ability to produce
goods and services.
• Within a country there are large changes in the standard of
living over time.
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Production and Growth
• Productivity refers to the amount of goods and services
produced for each hour of a worker’s time.
• A nation’s standard of living is determined by the productivity
of its workers.
• Living standards, as measured by real GDP per person, vary
significantly among nations.
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Table 1 The Variety of Growth Experiences
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Copyright©2004 South-Western
ECONOMIC GROWTH AROUND THE WORLD
• Annual growth rates that seem small become large when
compounded for many years.
• Compounding refers to the accumulation of a growth rate over
a period of time.
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Huge effects from tiny differences
percentage increase in
standard of living after…
annual growth
rate of income
per capita
…25 years
…50 years
…100 years
2.0%
64.0%
169.2%
624.5%
2.5%
85.4%
243.7%
1,081.4%
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Huge effects from tiny differences
If the annual growth rate of
German real GDP per capita
had been just
one-tenth of one percent higher
during the 1990s,
Germany would have generated
an additional € 112 billion of income
during that decade
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Why Productivity Is So Important
• To understand the large differences in living standards across
countries, we must focus on the production of goods and
services.
• Productivity refers to the amount of goods and services that a
worker can produce from each hour of work.
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How Productivity Is Determined
• The inputs used to produce goods and services are called the
factors of production.
• The factors of production directly determine productivity.
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How Productivity Is Determined
• The Factors of Production
•
•
•
•
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Physical capital
Human capital
Natural resources
Technological knowledge
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How Productivity Is Determined
• Physical Capital
• is a produced factor of production.
• It is an input into the production process that in the past was an output
from the production process.
• is the stock of equipment and structures that are used to produce
goods and services.
• Tools used to build or repair automobiles.
• Tools used to build furniture.
• Office buildings, schools, etc.
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How Productivity Is Determined
• Human Capital
• the economist’s term for the knowledge and skills that workers
acquire through education, training, and experience
• Like physical capital, human capital raises a nation’s ability to produce
goods and services.
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How Productivity Is Determined
• Natural Resources
• inputs used in production that are provided by nature, such as land,
rivers, and mineral deposits.
• Renewable resources include trees and forests.
• Nonrenewable resources include petroleum and coal.
• can be important but are not necessary for an economy to be highly
productive in producing goods and services.
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How Productivity Is Determined
• Technological Knowledge
• society’s understanding of the best ways to produce goods and
services.
• Human capital refers to the resources expended transmitting this
understanding to the labor force.
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The Production Function
• Economists often use a production function to describe the
relationship between the quantity of inputs used in production
and the quantity of output from production.
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The Production Function
• Y = A F(L, K, H, N)
•
•
•
•
•
•
•
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Y = quantity of output
A = available production technology
L = quantity of labor
K = quantity of physical capital
H = quantity of human capital
N = quantity of natural resources
F( ) is a function that shows how the inputs are combined.
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The Production Function
• A production function has constant returns to scale if, for any
positive number x,
xY = A F(xL, xK, xH, xN)
• That is, a doubling of all inputs causes the amount of output to
double as well.
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The Production Function
• Production functions with constant returns to scale have an
interesting implication.
• Setting x = 1/L,
• Y/ L = A F(1, K/ L, H/ L, N/ L)
Where:
Y/L = output per worker
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker
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The Production Function
• The preceding equation says that productivity (Y/L) depends
on physical capital per worker (K/L), human capital per worker
(H/L), and natural resources per worker (N/L), as well as the
state of technology, (A).
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ECONOMIC GROWTH AND PUBLIC POLICY
• Government Policies That Raise Productivity and Living
Standards
•
•
•
•
•
•
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Encourage saving and investment.
Encourage investment from abroad
Encourage education and training.
Establish secure property rights and maintain political stability.
Promote free trade.
Promote research and development.
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The Importance of Saving and Investment
• One way to raise future productivity is to invest more current
resources in the production of capital.
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Figure 1 Growth and Investment
(b) Investment 1960–1991
(a) Growth Rate 1960–1991
South Korea
Singapore
Japan
Israel
Canada
Brazil
West Germany
Mexico
United Kingdom
Nigeria
United States
India
Bangladesh
Chile
Rwanda
0
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South Korea
Singapore
Japan
Israel
Canada
Brazil
West Germany
Mexico
United Kingdom
Nigeria
United States
India
Bangladesh
Chile
Rwanda
1
KOF
2
3
4
5
6 7
Growth Rate (percent)
0
10
20
30
40
Investment (percent of GDP)
Copyright©2003 Southwestern/Thomson Learning
International Evidence on Investment Rates and Income
per Person
Income per
person in 1992
(logarithmic scale)
1 00 ,00 0
Canada
Denmark Germ any
U.S.
1 0,0 00
Mexico
E gypt
F inland
B razi l
P aki stan
Ivory
Coast
U.K.
Israel
It
al
F rance y
Singapore
P eru
Indonesi a
1 ,00 0
Zimbabwe
India
Chad
1 00
Japan
0
Uganda
5
Kenya
Cam eroon
10
15
20
25
30
35
40
Investment as percentage of output
(average 1960 –1992)
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Diminishing Returns and the Catch-Up Effect
• As the stock of capital rises, the extra output produced from an
additional unit of capital falls; this property is called
diminishing returns.
• Because of diminishing returns, an increase in the saving rate
leads to higher growth only for a while.
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Diminishing Returns and the Catch-Up Effect
• In the long run, the higher saving rate leads to a higher level of
productivity and income, but not to higher growth in these
areas.
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Diminishing Returns and the Catch-Up Effect
• The catch-up effect refers to the property whereby countries
that start off poor tend to grow more rapidly than countries
that start off rich.
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Conditional convergence:
21 OECD countries
Per capita output growth: 1960-92
0.03
y = -0.0141x - 9E-17
2
R = 0.7422
0.02
0.02
0.01
0.01
-1.20
-1.00
-0.80
-0.60
-0.40
-0.20
0.00
0.00
0.20
-0.01
-0.01
-0.02
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Log output per capita: 1960
0.40
0.60
0.80
1.00
Investment from Abroad
• Governments can increase capital accumulation and long-term
economic growth by encouraging investment from foreign
sources.
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Investment from Abroad
• Investment from abroad takes several forms:
• Foreign Direct Investment
• Capital investment owned and operated by a foreign entity.
• Foreign Portfolio Investment
• Investments financed with foreign money but operated by domestic
residents.
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Education
• For a country’s long-run growth, education is at least as
important as investment in physical capital.
• In the United States, each year of schooling raises a person’s wage,
on average, by about 10 percent.
• Thus, one way the government can enhance the standard of living is
to provide schools and encourage the population to take advantage
of them.
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Education
• An educated person might generate new ideas about how best
to produce goods and services, which in turn, might enter
society’s pool of knowledge and provide an external benefit to
others.
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Education
• One problem facing some poor countries is the brain drain—
the emigration of many of the most highly educated workers to
rich countries.
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Property Rights and Political Stability
• Property rights refer to the ability of people to exercise
authority over the resources they own.
• An economy-wide respect for property rights is an important
prerequisite for the price system to work.
• It is necessary for investors to feel that their investments are secure.
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Free Trade
• Trade is, in some ways, a type of technology.
• A country that eliminates trade restrictions will experience the
same kind of economic growth that would occur after a major
technological advance.
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Free Trade
• Some countries engage in . . .
• . . . inward-orientated trade policies, avoiding interaction with other
countries.
• . . . outward-orientated trade policies, encouraging interaction with
other countries.
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Research and Development
• The advance of technological knowledge has led to higher
standards of living.
• Most technological advance comes from private research by firms
and individual inventors.
• Government can encourage the development of new technologies
through research grants, tax breaks, and the patent system.
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Population Growth
• Economists and other social scientists have long debated how
population growth affects a society
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Population Growth
• Population growth interacts with other factors of production:
• Stretching natural resources
• Diluting the capital stock
• Promoting technological progress
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International Evidence on Population Growth and
Income per Person
Income per
person in 1992
(logarithmic scale)
100,000
Germ any
U.S.
Denmark
Canada
Israel
10,000
U.K.
It al y
Japan
F inland F rance
Mexico
Singapore
E gypt
B razi l
P aki stan
P eru
Indonesi a
1,000
Cam eroon
Ivory
Coast
Kenya
India
Zimbabwe
Chad
100
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0
KOF
1
2
Uganda
3
4
Population growth (percent per y ear)
(average 1960 –1992)
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.
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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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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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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.
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Summary
• Economic prosperity, as measured by real GDP per person,
varies substantially around the world.
• The average income of the world’s richest countries is more
than ten times that in the world’s poorest countries.
• The standard of living in an economy depends on the
economy’s ability to produce goods and services.
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Summary
• Productivity depends on the amounts of physical capital,
human capital, natural resources, and technological knowledge
available to workers.
• Government policies can influence the economy’s growth rate
in many different ways.
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Summary
• The accumulation of capital is subject to diminishing returns.
• Because of diminishing returns, higher saving leads to a higher
growth for a period of time, but growth will eventually slow
down.
• Also because of diminishing returns, the return to capital is
especially high in poor countries.
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