Download The Circular-Flow Diagram

Income and Expenditure
p
• What is Gross Domestic Product (GDP) GAYRİ SAFİ YURTİÇİ HASILA (GSYH)? SAFİ YURTİÇİ HASILA
(GSYH)?
• How is GDP related to a nation’s total income and spending? • What are the components of GDP? Wh t
th
t f GDP?
How is GDP corrected for inflation?
• How is GDP corrected for inflation?
• Does GDP measure society’s well‐being
The Circular‐Flow Diagram
g
• Gross Domestic Product (GDP), Gayri Safi Yurtiçi Hasıla (GSYH)
is the market value of all final goods & services produced within
the market value of all final goods & services produced within
a country in a given period of time. • GDP also measures total income of everyone in the economy, GDP also measures total income of everyone in the economy,
• GDP also measures the total expenditure on the economy’s ou pu o goods se ces
output of goods & services. For the economy
y as a whole,,
income equals expenditure,
expenditure because
every dollar of expenditure by a buyer
is a dollar of income for the seller.
The Circular‐Flow Diagram
Households:
ƒ own the factors of production,
sell/rent them to firms for income
ƒ buy and consume g&s
• is a simple depiction of the macroeconomy.
• illustrates GDP as spending, revenue, factor payments and income
factor payments, and income. • First, some preliminaries:
– Factors of production are inputs like labor, land, capital and natural resources
capital, and natural resources. – Factor payments are payments to the factors of production. (e.g., wages, rent) Firms
Households
The Circular‐Flow Diagram
The Circular‐Flow Diagram
Revenue (=GDP)
G&S
sold
Firms
Households
Firms:
ƒ buy/hire factors of production,
use them
th
to
t produce
d
g&s
&
ƒ sell g&s
What This Diagram Omits
• The government
– collects taxes
collects taxes
– purchases g&s
Markets for
Goods &
Services
Firms
Factors of
production
Wages, rent,
profit
fit ((=GDP)
GDP)
Spending (=GDP)
G&S
bought
Households
Markets for
Factors of
Production
Labor, land,
capital
Income (=GDP)
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
• The financial system
– matches savers
matches savers’ supply of funds with borrowers
supply of funds with borrowers’ demand for loans
• The foreign sector
– trades g&s, financial assets, and currencies with trades g&s, financial assets, and currencies with
the country’s residents
Goods are valued at their market prices
prices, so:
• GDP measures all goods using the same units
((e.g., d
dollars
ll
iin th
the U
U.S.),
S ) rather
th th
than ““adding
ddi
apples to oranges.”
• Things that don’t have a market value are
excluded, e.g., housework you do for yourself.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
Final goods are intended for the end user
user.
Intermediate goods are used as components
or ingredients in the production of other goods.
GDP only includes final goods, as they already
embody the value of the intermediate goods
used in their production
production.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
GDP includes currently produced goods
goods,
not goods produced in the past.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
GDP includes tangible goods
(like DVDs, mountain bikes, beer)
and intangible services
(dry cleaning, concerts, cell phone service).
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
GDP measures the value of production that occurs
within a country’s borders, whether done by its own
citizens or by foreigners located there
there.
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services produced within a country d d i hi
in a given period of time.
g
usually a year or a quarter (3 months)
months).
The Components of GDP
• Recall: GDP is total spending. • Four components:
F
t
– Consumption (C)
– Investment (I)
– Government Purchases (G)
Government Purchases (G)
– Net Exports (NX)
• These components add up to GDP (denoted Y):
h
dd
(d
d Y)
Y = C + I + G + NX
Consumption (C)
Consumption (C)
• is total spending by households on g&s. • Note on housing costs: – For renters, consumption includes rent payments. For renters, consumption includes rent payments.
– For homeowners, consumption includes the imp ted rental al e of the ho se
the imputed rental value of the house, but not the purchase price or mortgage payments. Investment (I)
Investment (I)
• is total spending on goods that will be used in the future to produce more goods
the future to produce more goods. • includes spending on
c udes spe d g o
– capital equipment (e.g., machines, tools)
– structures (factories, office buildings, houses)
structures (factories office buildings houses)
– inventories (goods produced but not yet sold)
Note: “Investment” does not
mean the
th purchase
h
off fi
financial
i l
assets like stocks and bonds.
Government Purchases (G)
Government Purchases (G)
• is all spending on the g&s purchased by the government at the central and local levels.
• G excludes transfer payments, such as excludes transfer payments such as
Social Security or unemployment insurance benefits. These payments represent transfers of
These payments represent transfers of income, not purchases of g&s.
Net Exports (NX)
• NX = exports – imports
• Exports represent foreign spending on the y g
economy’s g&s. • Imports are the portions of C, I, and G
that are spent on g&s produced abroad
that are spent on g&s produced abroad. • Adding up all the components of GDP gives:
Y = C + I + G + NX
U.S. vs TURKEY
GDP and Its Components, 2010
U.S. GDP and Its Components, 2005
billions
% of GDP
per capita
Y
$12,480
$
,
100.0
$42,035
$
,
C
8,746
70.1
29,460
US
TURKEY
2010 (US$ billions)
2010 (TL billions)
2009 (TL billions)
GDP
14.460,4 100%
1.105,1 100%
951.988 100%
C
10 349 1
10.349,1 71 6%
71,6%
786 1
786,1 71 1%
71,1%
681 438
681.438 71 6%
71,6%
I
2,100
16.8
7,072
I
1.827,5 12,6%
180,0 16,3%
107.396 11,3%
G
2,360
18.9
7,950
X
1.837,5 12,7%
233,1 21,1%
221.422 23,3%
NX
–726
726
–5.8
58
–2,444
2 444
M
2.353,9 16,3%
294,0 26,6%
232.627 24,4%
G
3.000,2 20,7%
200,0 18,1%
174.359 18,3%
In each of the following cases, determine how much GDP and each of its components is affected (if at all)
GDP and each of its components is affected (if at all).
Answers
A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.
A. Debbie
Debbie spends $200 to buy her husband dinner spends $200 to buy her husband dinner
at the finest restaurant in Boston.
B. Sarah spends $1800 on a new laptop to use in her p
$
p p
publishing business. The laptop was built in China. Cons mption and GDP rise b $200
Consumption and GDP rise by $200. C Jane
C.
Jane spends $1200 on a computer to use in her editing spends $1200 on a computer to use in her editing
business. She got last year’s model on sale for a great price from a local manufacturer.
price from a local manufacturer. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them
but consumers only buy $470 million worth of them.
B. Sarah
Sarah spends $1800 on a new laptop to use in her spends $1800 on a new laptop to use in her
publishing business. The laptop was built in China. I
Investment rises by $1800, net exports fall t
t i b $1800 t
t f ll
by $1800, GDP is unchanged.
20
Answers
21
Real versus Nominal GDP
Real versus Nominal GDP
C. Jane spends $1200 on a computer to use in her editing p
p
g
business. She got last year’s model on sale for a great price from a local manufacturer. Current GDP and investment do not change, because the computer was built last year.
the computer was built last year.
D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them.
p
y$
,
Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million. 22
• Inflation can distort economic variables like GDP, so we have two versions of GDP: One is corrected for inflation the other is not
One is corrected for inflation, the other is not. • Nominal GDP values output using current p
g
prices. It is not corrected for inflation. • Real GDP values output using the prices of y
a base year. Real GDP is corrected for inflation. EXAMPLE:
EXAMPLE:
Pizza
Latte
Pizza
Latte
year
P
Q
P
Q
year
P
Q
P
Q
2002
$10
400
$2.00
1000
2002
400
$11
500
$2 50
$2.50
1100
2003
500
$2.00
$2 50
$2.50
1000
2003
$10
$11
2004
$12
600
$3.00
1200
2004
$12
600
$3.00
1200
Compute nominal GDP in each year:
2002:
2003
2003:
2004:
$10 x 400 + $2 x 1000 $11 500 $2 50 1100
$11 x 500 + $2.50 x 1100 $12 x 600 + $3 x 1200 $
$
Increase:
= $6,000
= $8,250
$8 250
= $10,800
$ ,
37.5%
30.9%
EXAMPLE:
year
Nominal
GDP
Compute real GDP in each year, using 2002 as the base year:
g
y
1100
Increase:
2002: $10 x 400 + $2 x 1000 = $6,000
20 0%
20.0%
2003: $10 x 500 + $2 x 1100 = $7,200
2004: $10 x 600 + $2 x 1200 = $8,400
$8 400
16.7%
EXAMPLE:
Real
GDP
year
Nominal
GDP
2002
$6000
$6000
2002
$6000
2003
$8250
$7200
2003
$8250
2004
$10,800
$8400
2004
$10,800
In each year,
• nominal
nominal GDP is measured using the (then) GDP is measured using the (then)
current prices. • real GDP is measured using constant prices from the base year (2002 in this example).
Real
GDP
37.5%
30.9%
$6000
$7200
$8400
20.0%
16.7%
• The change in nominal GDP reflects both prices and quantities. ƒ The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
Hence real GDP is corrected for inflation
Hence,
inflation.
Nominal and Real GDP in the U.S.,
The GDP Deflator
1965--2005
1965
• The GDP deflator is a measure of the overall l l f i
level of prices. • Definition:
Billions
$12 000
$12,000
$10,000
Real GDP
$8,000
(base year
2000)
$6,000
GDP deflator = 100 x
$4 000
$4,000
Nominal
GDP
$2,000
$0
1965 1970 1975 1980 1985 1990 1995 2000 2005
EXAMPLE:
yyear
Nominal
GDP
Real
GDP
GDP
Deflator
2002
$6000
$6000
100.0
2003
$8250
$7200
114 6
114.6
2004
$10,800
$8400
128.6
Compute the GDP deflator in each year:
nominal GDP
real GDP
ƒ One way to measure the economy’s inflation
rate is to compute the percentage increase in
the GDP deflator from one year to the next.
Computing GDP
Computing GDP
2004 (base yr)
P
14.6%
12.2%
good
dA
good B
$30
$100
Q
2005
P
2006
Q
900
$31 1,000
1 000
192 $102
200
P
Q
$36
$100
1050
10
0
205
Use the above data to solve these problems:
2002:
100 x (6000/6000) =
100.0
A. Compute nominal GDP in 2004.
2003:
100 x (8250/7200) =
114 6
114.6
B Compute real GDP in 2005. B. Compute real GDP in 2005
2004:
100 x (10,800/8400) =
128.6
C. Compute the GDP deflator in 2006. Answers
Answers
2004 (base yr)
P
good
dA
good B
A.
B.
$30
$100
Q
2005
P
2006
Q
900
$31 1,000
1 000
192 $102
200
2004 (base yr)
P
Q
P
$36
$100
1050
10
0
205
Compute nominal GDP in 2004.
good
dA
good B
$30
$100
Q
2005
P
2006
Q
900
$31 1,000
1 000
192 $102
200
P
Q
$36
$100
1050
10
0
205
C. Compute the GDP deflator in 2006. Nom GDP N
GDP = Real GDP = GDP deflator = C
Compute real GDP in 2005. t
l GDP i 2005
32
GDP and Economic Well Being
GDP and Economic Well‐Being
• Real
Real GDP per capita is the main indicator of GDP per capita is the main indicator of
the average person’s standard of living.
• But GDP is not a perfect measure of well being. well‐being
• Robert Kennedy issued a very eloquent yet harsh criticism of GDP: 33
Gross Domestic Product…
““… does
d
nott allow
ll for
f the
th health
h lth off our
children, the quality of their education,
or the joy of their play.
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,
p that which makes life worthwhile,, and it
in short,, except
can tell us everything about America except why we are
proud that we are Americans.”
Americans.
- Senator Robert Kennedy, 1968
GDP Does Not Value:
GDP Does Not Value:
Then Why Do We Care About GDP?
Then Why Do We Care About GDP?
• the quality of the environment
the quality of the environment
• Having
Having a large GDP enables a country to afford a large GDP enables a country to afford
better schools, a cleaner environment, h lth
health care, etc. t
• leisure time
• non‐market activity, such as the child care a parent provides his or her child at home
• Many
Many indicators of the quality of life are indicators of the quality of life are
positively correlated with GDP. For example…
• an equitable distribution of income
it bl di t ib ti
fi
GDP and Life Expectancy in 12 Countries
90
Life
expectancy 85
(in years)
Japan
80
U.S.
75
Indonesia
China
70
Germany
M i
Mexico
Brazil
65
India
60
Russia
Adult 100
Literacy
(% of 90
population) 80
Russia
China
M i
Mexico
70
Nigeria
60
India
U.S.
Japan
Germany
Brazil
Indonesia
50
Pakistan
Bangladesh
Nigeria
g
55
GDP and Adult Literacy in 12 Countries
P ki t
Pakistan
40
Bangladesh
30
50
$0
$10,000
$20,000
$30,000
Real GDP per capita, 2002
$40,000
$0
$10,000
$20,000
$30,000
Real GDP per capita, 2002
$40,000
GDP and Internet Usage in 12 Countries
Internet
Usage
(% of
population)
BRIEF SUMMARY
60
U.S.
• Gross Domestic Product (GDP) measures a country’s total income and expenditure.
50
Japan
40
Germany
y
The four spending components of GDP include: four spending components of GDP include:
• The
Consumption, Investment, Government Purchases, and Net Exports.
Net Exports.
30
• Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base
GDP is measured using the prices of a constant base year, and is corrected for inflation. 20
China
10
Mexico
Brazil
Russia
0
$0
$10,000
$20,000
$30,000
Real GDP per capita, 2002
$40,000
• GDP is the main indicator of a country’s economic well‐
h
d
f
’
ll
being, even though it is not perfect.