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EdiTioN
Foundations of
Macroeconomics
For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools. This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization and adaptation from the North American version. SEVENTH EdiTioN
R
obin Bade • Michael Parkin
Bade • Parkin
This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the beneit of students outside the United States and Canada. If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author.
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Chapter 5 • GDP: A Measure of Total Production and Income
171
EYE on the GLOBAL ECONOMY
Which Country has the highest standard of living?
You’ve seen that as a measure of the
standard of living, GdP has limitations.
To compare the standard of living
across countries, we must consider
other factors in addition to GdP.
GdP measures only the market
value of all the final goods and services
produced and bought in markets. GdP
omits some goods and services (those
produced in the home and in the hidden economy). it omits the value of
leisure time, of good health and long
life expectancy, as well as of political
freedom and social justice. it also
omits the damage (negative value) that
pollution does to the environment.
These limitations of GdP as a measure of the standard of living apply in
every country. So to make international comparisons of the standard of
living, we must look at real GdP and
other indicators. Nonetheless, real
GdP per person is a major component of international comparisons.
Many alternatives to GdP have
been proposed. one, called Green
GdP, subtracts from GdP an estimate
of the cost of greenhouse gas emissions and other negative influences on
the environment. Another measure,
called the Happy Planet index, or HPi,
goes further and subtracts from GdP
an estimate of the cost of depleting
nonrenewable resources.
Neither the Green GdP nor the
HPi are reliable measures because
they rely on guesses about the costs
of pollution and resource depletion
that are subjective and unreliable.
Taking an approach that focuses on
the quality of life factors, the United
Nations (UN) has constructed a
Human development index (Hdi),
which combines real GdP, life
expectancy and health, and education.
The figure shows the relationship
between the Hdi and GdP in 2012.
(in the figure, each dot represents a
country.) These two measures of the
standard of living tell a similar but not
identical story.
The United States has the third
highest Hdi in the figure, lower than
Norway and Australia. Why does the
United States not have a higher Hdi?
The UN says that the people who
live in the two countries with higher
Hdis live longer, have access to universal health care, and have better schools
than do people in the United States.
The Hdi emphasized equality of access
to these services.
The Hdi doesn’t include political
freedom and social justice. if it did, the
United States would score highly on
that component of the index.
The bottom line is that we don’t
know which country has the highest
standard of living. But we do know that
GdP per person alone does not provide the complete answer.
Human Development Index
1.2
Australia
1.0
United
States
Norway
Germany
Singapore
0.8
Hong Kong
Kuwait
0.6
0.4
Liberia
Niger
0.2
0
Congo
0.2
0.4
0.6
0.8
1.0
1.2
1.4
Real GDP per person (PPP index)
Source of data: United Nations Human Development Report, 2011, http://hdr.undp.org/.
172
Part 2 • MONITORING THE MACROECONOMY
ChECKPoint 5.3
MyEconLab study Plan 5.3
Key terms Quiz
Describe the uses of real GDP and explain its limitations as a measure of the
standard of living.
solutions
Practice Problems
tAbLE 1
Country
China
Russia
United States
Canada
Real GDP per person
$4,833
$13,543
$48,666
$50,265
The United Nations Human Development Report gives the data for 2011 in
Table 1. Other information suggests that household production is similar in
Canada and the United States and smaller than in China and Russia. The underground economy is larger in Russia and China and a similar proportion of each
of these economies. Canadians and Americans enjoy more leisure hours than
do the Chinese and Russians. Canada and the United States spend significantly
more on the environment than do China and Russia. Use this information and
ignore any other influences to work Problems 1 and 2.
1. In which pair (or pairs) of countries is it easiest to compare the standard of
living? And in which pair (or pairs) is it most difficult? Explain why.
2. Do the differences in real GDP per person correctly rank the standard of living in these four countries? What additional information would we need to
be able to make an accurate assessment of the relative standard of living in
these four countries?
In the News
Economists look to expand GDP to include the quality of life
Robert Kennedy, when seeking the Democratic presidential nomination in
1968, remarked that GDP measures everything except that which makes life
worthwhile.
Source: The New York Times, September 1, 2008
Which items did Robert Kennedy probably think were missing?
solutions to Practice Problems
1.
2.
Two pairs—Canada and the United States, and China and Russia—are easy
to compare because household production, the underground economy,
leisure hours, and the environment are similar in the countries in each pair.
The most difficult comparison is Canada and the United States with either
China or Russia. Household production and the underground economy narrow the differences but leisure hours and the environment widen them.
Differences in real GDP per person probably correctly rank the standard of
living because where the gap is small (Canada and the United States), other
factors are similar, and where other factors differ, the gaps are huge.
More information on the value of household production, the underground
economy, the value of leisure, and the value of environmental differences is
required to make an accurate assessment of relative living standards.
solution to In the News
GDP measures production that is traded in markets. GDP does not include
household production, leisure time, health and life expectancy, political freedom,
and social justice. These items are probably the ones that Kennedy believed were
missing from GDP as a measure of the quality of life.
Chapter 5 • GDP: A Measure of Total Production and Income
ChaPtER suMMaRy
key Points
1. Define GDP and explain why the value of production, income, and
expenditure are the same for an economy.
• GDP is the market value of all final goods and services produced within a
country in a given time period.
• We can value goods and services either by what they cost to produce
(incomes) or by what people are willing to pay (expenditures).
• The value of production equals income equals expenditure.
2. Describe how economic statisticians measure GDP and distinguish between
nominal GDP and real GDP.
• BEA measures GDP by summing expenditures and by summing incomes.
With no errors of measurement the two totals are the same, but in practice,
a small statistical discrepancy arises.
• A country’s GNP is similar to its GDP, but GNP is the value of production
by factors of production supplied by the residents of a country.
• Nominal GDP is the value of production using the prices of the current
year and the quantities produced in the current year.
• Real GDP is the value of production using the prices of a base year and the
quantities produced in the current year.
3. Describe the uses of real GDP and explain its limitations as a measure of the
standard of living.
• We use real GDP per person to compare the standard of living over time.
• We use real GDP to determine when the economy has reached a business
cycle peak or trough.
• We use real GDP per person expressed in purchasing power parity dollars
to compare the standard of living among countries.
• Real GDP omits some goods and services and ignores some factors that
influence the standard of living.
• The Human Development Index takes some other factors into account.
key Terms
Business cycle, 166
Consumption expenditure, 153
depreciation, 160
Exports of goods and services, 154
Final good or service, 152
Government expenditure on goods
and services, 154
MyEconLab Key terms Quiz
Gross domestic product (GdP), 152
imports of goods and services, 154
intermediate good or service, 152
investment, 153
Net exports of goods
and services, 154
Net taxes, 154
Nominal GdP, 162
Potential GdP, 165
Real GdP, 162
Recession, 166
Saving, 154
173
174
Part 2 • MONITORING THE MACROECONOMY
ChaPtER ChECKPoint
MyEconLab Chapter 5 study Plan
study Plan Problems and applications
HOUSEHOLDS
V
R
U
FIGURE 1
Q
FACTOR
MARKETS
GOVERNMENTS
FIRMS
1. Figure 1 shows the flows of income and expenditure in an economy. In 2013,
U was $2 trillion, V was $1.5 trillion, W was
$7 trillion, X was $1.5 trillion, and Z was zero.
FINANCIAL
MARKETS
Calculate total income, net taxes, and GDP.
Use the following data to work Problems 2 and 3.
W
The national accounts of Parchment Paradise are
Z
X
kept on (you guessed it) parchment. A fire in the
statistics office destroys some accounts, leaving
only the following data:
GOODS
MARKETS
REST
OF
WORLD
•
•
•
•
•
•
•
•
•
GDP (income approach) $2,900
Consumption expenditure $2,000
Indirect taxes less subsidies $100
Interest, rent, and profit $500
Investment $800
Government expenditure $400
Wages $2,000
Net factor income from abroad $50
Net exports −$200
2. Calculate GDP (expenditure approach) and depreciation.
3. Calculate net domestic product at factor cost, the statistical discrepancy, and
GNP.
tAbLE 1
(a) In 2013:
Item
Quantity
Price
Fun
Food
40
60
$2
$3
Quantity
Price
35
65
$3
$2
(b) In 2014:
Item
Fun
Food
Use the following information to work Problems 4 to 6.
An economy produces only fun and food. Table 1 shows the prices and the
quantities of fun and food produced in 2013 and 2014. The base year is 2013.
4. Calculate nominal GDP in 2013 and 2014.
5. Calculate the percentage increase in production in 2014.
6. If potential GDP was $270 in 2013 and it grew by 1 percent in 2014, in which
phase of the business cycle is the economy? Explain.
Use the following information to work Problems 7 to 9.
Expansion remains slow
The Commerce Department reported that retail sales increased 1.3 percent in
June. Net exports were up 0.8 percent in the first quarter and inventories held by
businesses rose by 0.3 percent in June. Total sales by businesses rose 0.3 percent.
Source: Commerce Department, 2013
7. Which component of GDP changed because retail sales increased? Which
component of GDP changed because inventories held by businesses fell?
8. Explain the effect of the rise in net exports on GDP.
9. Does the statement that total sales by businesses were up 0.3 percent mean
that GDP increased by 0.3 percent? Explain your answer.
10. Read Eye on the Booms and Busts on p. 168 and explain why the NBER
reported that the 2008 recession began before real GDP had fallen for two
successive quarters.
175
Chapter 5 • GDP: A Measure of Total Production and Income
Instructor assignable Problems and applications
1. In France, real GDP was the same in 2012 as it had been in 2011, but in the
last quarter of 2012 and the first quarter of 2013, France’s real GDP decreased.
In the United States, real GDP increased in 2012, and in the first quarter of
2013, it was higher than in the last quarter of 2012.
Based on this information, which country was in a recession at the beginning of 2013? What features of the information provided led you to your
conclusion?
2. Classify each of the items in List 1 as a final good or service or an intermediate
good or service and identify it as a component of consumption expenditure,
investment, or government expenditure on goods and services.
Use the following information to work Problems 3 and 4.
Mitsubishi Heavy Industries makes the wings of the new Boeing 787 Dreamliner
in Japan. Toyota assembles cars for the U.S. market in Kentucky.
3. Explain where these activities appear in the National Income and Product
Accounts of the United States.
4. Explain where these activities appear in the National Income and Product
Accounts of Japan.
Use the data on the economy of Iberia in Table 1 to work Problems 5 and 6.
5. Calculate Iberia’s GDP.
6. Calculate Iberia’s imports of goods and services.
Use Table 2, which shows an economy’s total production and the prices of the
final goods it produced in 2013 and 2014, to work Problems 7 to 9.
7. Calculate nominal GDP in 2013 and 2014.
8. The base year is 2013. Calculate real GDP in 2013 and 2014.
9. Calculate the percentage increase in production in 2014.
Use the following information to work Problems 10 and 11.
Cash-paying vultures pick bones of U.S. housing market as mortgages dry up
New-home sales fell to an annual pace of 250,000 in February, an all-time low in
records dating to 1963, the Commerce Department reported March 23. Existinghome sales dropped to a 4.88 million annualized pace in February, down 2.8 percent from a year earlier, the National Association of Realtors said, while the
median price of existing homes fell to $156,100, the lowest since February 2002.
Source: Bloomberg, March 29, 2011
10. Where do new-home sales appear in the circular flow of expenditure and
income? Explain how a fall in new home sales affects real GDP.
11. Where do sales of previously owned homes appear in the circular flow of
expenditure and income? Explain how a fall in sales of previously owned
homes affects real GDP.
12. The road less traveled
If we are right, this year is different and global growth will rise to an abovetrend pace during the second half of 2013.
Source: J.P. Morgan Global Data Watch, May, 2013
Does this news mean that the 2008–2009 recession was expected to end in
the second half of 2013? Does recession end only when real GDP growth
rises above trend??
MyEconLab homework, Quiz, or
test if assigned by instructor
LISt 1
• Banking services bought by Target
• Security system bought by the
White House
• Coffee beans bought by Starbucks
• New coffee machines bought by
Starbucks
• Starbucks grande mocha frappuccino bought by a student
• New battle ship bought by the
U.S. navy
tAbLE 1
Item
Amount
Net taxes
Government
expenditure
Saving
Consumption
expenditure
Investment
Exports
$18 billion
$20 billion
$15 billion
$67 billion
$21 billion
$30 billion.
tAbLE 2
(a) In 2013:
Item
Quantity
Price
100
50
$2
$6
(b) In 2014:
Item
Quantity
Price
75
65
$5
$10
Fish
Berries
Fish
Berries