Download ECONOMICS

William A. McEachern Macro3
ECON
6
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1
The Product of a Nation
• 17th and 18th century
– Mercantilism
• Economic prosperity: stock of precious
metals
• 1758
– Circular flow of output and income
• National income accounting system
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2
National Income Accounts
• GDP
– Market value
– All final goods and services
– Produced during a year
– By resources located in US
• One person’s spending
– Another person’s income
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3
National Income Accounts
• Expenditure approach
– Spending on all final goods and services
• Produced in the nation
• Within the year
• Income approach
– Earnings by those who produce all output
• In the nation
• During the year
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4
National Income Accounts
• Final goods and services
– Sold to the final user
• Intermediate goods and services
– Purchased by firms
– For further processing and resale
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5
GDP: Expenditure Approach
• Consumption, C
– Household purchases of final goods and
services
• Except for new residences (investment)
– Personal consumption expenditures
– Households
• Services, nondurable goods, durable goods
– 70% of GDP
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6
GDP: Expenditure Approach
• Investment, I
– Gross private domestic investment
– New capital goods
• Physical capital
• New residential construction
– Net additions to inventories
– 16% of GDP
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7
GDP: Expenditure Approach
• Physical capital
– Manufactured items used to produce
goods and services
• New plants, new equipment
• Residential construction
– Building new homes or dwelling places
• Inventories
– Producers’ stocks of finished and inprocess goods
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8
GDP: Expenditure Approach
• Government purchases, G
– Spending for goods and services
• By all levels of government
– Government outlays minus transfer
payments
– 19% of GDP
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9
GDP: Expenditure Approach
• Net exports, X-M
– Exports (X) minus imports (M)
• Physical items
• Invisibles (intangibles)
– Negative
• Imports > Exports
– 5% of GDP for last decade
C+I+G+(X-M)=Aggregate expenditure=GDP
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10
GDP: Income Approach
• Aggregate income
– All earnings of resource suppliers in an
economy
– During a given period, usually a year
• Wages
• Interest
• Rent
• Profit
Aggregate expenditure = GDP = Aggregate income
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11
GDP: Income Approach
• Value added at each stage of production
– Selling price of a product
• Minus the cost of intermediate goods
purchased from other firms
– Income earned
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12
Exhibit 1
Computing Value Added for a New Desk
Stage of
Production
Logger
Miller
Manufacturer
Retailer
(1)
Sale Value
(2)
Cost of
Intermediate Goods
(3)
Value Added
(3)=(1)-(2)
$20
50
120
200
$20
50
120
$20
30
70
80
Market value of final good
$200
The value added at each stage of production is the sale price at that stage minus the
cost of intermediate goods, or column (1) minus column (2). The values added at each
stage sum to the market value of the final good, shown at the bottom of column (3).
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13
Circular Flow
• Circular flow
– Of income and spending in the economy
• Assumptions
– Capital – doesn’t wear out
– Firms – pay out all profits
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14
Exhibit 2
Circular Flow of Income and Expenditure
The circular-flow model captures important
relationships in the economy. The bottom half
depicts the income arising from production. At
juncture (1), GDP equals aggregate income.
Taxes leak from the flow at (2), but transfer
payments enter the flow at (3). Taxes minus
transfers equals net taxes, NT. Aggregate
income minus net taxes equals disposable
income, DI, which flows to households at
juncture (4). The top half of the model shows
the flow of expenditure. At (5), households
either spend disposable income or save it.
Consumption enters the spending flow
directly. Saving leaks from the spending flow
into financial markets, where it is channeled
to borrowers. At (6), investment enters the
spending flow. At (7), government purchases
enter the spending flow. At (8), imports leak
from the spending flow, and at (9), exports
enter the spending flow. Consumption plus
investment plus government purchases plus
net exports add up to the aggregate
expenditure on GDP received by firms at (10).
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15
Circular Flow
• Income flow
– Income arising from production
– GDP = Aggregate income
– Net taxes, NT = Taxes - Transfer
payments
– Disposable income, DI = GDP - NT
• GDP=DI+NT
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16
Circular Flow
• Disposable income (DI)
– Income households have available to
spend or to save
– After paying taxes and receiving transfer
payments
• Net taxes (NT)
– Taxes minus transfer payments
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Circular Flow
• Expenditure flow
– DI = C + S
• Consumption, C
• Savings, S, to financial markets
– Investments, I (borrowed)
• Firms – on capital
• Households – residential construction
– Government spending, G
– Net exports = X – M
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Circular Flow
C+I+G+(X-M) = Aggregate Expenditure = GDP
• Financial markets
– Banks and other financial institutions
– Facilitate the flow of funds from savers to
borrowers
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Leakages = Injections
•
•
•
•
C+I+G+(X-M)=DI+NT
C+I+G+(X-M)=C+S+NT
I+G+X=S+NT+M
Injections
– I, G, X
• Leakages
– S, NT, M
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20
Leakages = Injections
• Injection
– Any spending other than by households
– Any income other than from resource
earnings
– Investment, government purchases, exports,
and transfer payments
• Leakage
– Any diversion of income from the
domestic spending stream
– Saving, taxes, and imports
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Limitations
• Some production – not included in GDP
– Do-it-yourself production
– Underground economy
• Underground economy
– Market transactions that go unreported
• Illegal
• People involved want to evade taxes
– 10% of GDP
– $1.5 trillion
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22
Limitations
• Leisure, quality, and variety
– More leisure
– Better quality
– Greater variety
• Net domestic product
– GDP minus depreciation
• Net investment = I – depreciation
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23
Limitations
• Depreciation
– Value of capital stock used up to produce
GDP or that becomes obsolete during the
year
• GDP – doesn’t reflect all costs
– Negative externalities
• Air pollution, water pollution
– Depletion of natural resources
• Soil depletion, loss of other natural resources
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24
Accounting for Price Changes
• Nominal GDP
– GDP based on prices prevailing at the
time of production
• Price index
– Average price of products
– In base year = 100
– (Price in current year / Price in base
year)*100
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25
Accounting for Price Changes
• Changes in a price index over time
– Chow changes in the economy’s average
price level
• Consumer price index, or CPI
– Measure of inflation
– Based on the cost of a fixed market
basket of goods and services
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26
Exhibit 3
Hypothetical Example of a Price Index (base year 2009)
Year
(1)
Price of Bread
in Current Year
(2)
Price of Bread
in Base Year
(3)
Price index
(3)=[(1)/(2)]×100
2006
2007
2008
$1.25
1.30
1.40
$1.25
1.25
1.25
100
104
112
The price index equals the price in the current year divided by the price in the base
year, all multiplied by 100.
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27
Accounting for Price Changes
• Consumer price index, CPI
– Market basket
– (Cost of basket in current year / Cost in
base year)*100
– Overstates inflation, 1% per year
• Quality bias
• Substitution
• Discount stores
• Widely used products
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28
Exhibit 4
Hypothetical Market Basket Used to Develop the Consumer
Price Index
Product
Twinkies
Fuel oil
Cable TV
(1)
Quantity in
market
basket
(2)
Prices in
base year
365 packages $0.89/package
500 gallons
1.00/gallon
12 months
30.00/month
(3)
(4)
Cost of
Prices in
basket in
current
base year
year
(3)=(1)×(2)
$324.85
500.00
360.00
$1,184.85
$0.79
1.50
30.00
(5)
Cost of
basket in
current year
(5)=(1)×(4)
$288.35
750.00
360.00
$1,398.35
The cost of a market basket in the current year, shown at the bottom of column (5),
sums the quantities of each item in the basket, shown in column (1), times the price
of each item in the current year, shown in column (4).
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29
Accounting for Price Changes
• GDP price index
– Comprehensive inflation measure
• Of all goods and services included in GDP
– (Nominal GDP/Real GDP)*100
– Before 1995
• Fixed-weighted system; base year 1987
– Chain-weighted system; base year 2000
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30
Exhibit 5
U.S. Gross Domestic Product in Nominal Dollars
and Chained (2005) Dollars
Real GDP, the red line, shows the value of output measured in chained (2005) dollars. The blue line
measures GDP in nominal dollars of each year shown. The two lines intersect in 2005, when real
GDP equaled nominal GDP. Year-to-year changes in nominal-dollar GDP reflect changes in both
real GDP and in the price level. Year-to-year changes in chained-dollar GDP reflect changes in real
GDP only. Nominal-dollar GDP grows faster than chained-dollar GDP. Prior to 2005, nominal-dollar
prices are less than chained-dollar prices, so nominal-dollar GDP is less than chained-dollar GDP.
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31
Appendix
National Income Accounts
• National income
– Earned by American-owned resources
– Net domestic product
– Plus net earnings from American
resources abroad
– Minus the statistical discrepancy
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32
Deriving Net Domestic Product and National
Income in 2009 (trillions)
Gross domestic product (GDP)
Minus depreciation
Net domestic product
Plus net earnings of American resources abroad
Statistical discrepancy
National income
$14.26
-1.86
12.40
+ 0.11
- 0.23
$12.28
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33
Appendix
National Income Accounts
• Personal income
– National income
– Plus income received but not earned
– Minus income earned but not received
• Income earned but not received
• Employer’s share of Social Security taxes
• Taxes on production
• Net of subsidies
• Corporate income taxes
• Undistributed corporate profits
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34
Appendix
National Income Accounts
• Income received but not earned
– Government transfer payments
– Receipts from private pension plans
– Interest paid by government and by
consumers
• Disposable income
– Personal income minus taxes
– Spend or save
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35
Exhibit 7 Deriving Personal Income and Disposable
Income in 2009 (trillions)
National income
Income received but not earned minus
income earned but not received
Personal income
Minus personal taxes and nontax
charges
Disposable income
$12.28
-0.26
12.02
-1.10
$10.92
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36
Appendix
National Income Accounts
• Summary income statement of the
economy
– Aggregate expenditure
• Consumption
• Gross investment
• Government purchases
• Net exports
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37
Appendix
National Income Accounts
• Summary income statement of the
economy
– Aggregate income
• Employee compensation
• Proprietors’ income
• Corporate profits
• Net interest
• Rental income of persons
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38
Appendix
National Income Accounts
• Employee compensation
– Money wages
– Employer contributions
• Social Security taxes, medical insurance,
and other fringe benefits
• Proprietors’ income
– Earnings of unincorporated businesses
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39
Appendix
National Income Accounts
• Corporate profits
– Net revenues received by incorporated
businesses
• Before subtracting corporate income taxes
• Net interest
– Interest received by individuals
– Excludes
• Interest paid by consumers to businesses
• Interest paid by government
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40
Appendix
National Income Accounts
• Rental income of persons
– Imputed rental value of owner-occupied
housing
– Minus the cost of owning that property
• Property taxes, insurance, depreciation
• Interest paid on the mortgage
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Exhibit 8 Expenditure and Income Statement for the US
Economy in 2009 (trillions)
Aggregate Expenditure
Consumption (C)
Gross investment (I)
Government purchases (G)
Net exports (X-M)
GDP
$10.09
1.63
2.93
-0.39
$14.26
Aggregate Income
Depreciation
Net taxes on production
Statistical discrepancy
Compensation of employees
Proprietors’ income
Corporate profits
Net interest
Rental income of persons
GDP
$1.86
1.10
0.23
7.77
1.04
1.31
0.68
0.27
$14.26
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42