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MEASURING NATIONAL INCOME Unit 2.1: The Level of Overall Economic Activity Section 2 – Measuring National Income 2.1 Circular Flow Model Quick Review: In the circular flow of income model, what is the… •Flow of goods & services, and FoP’s: ___Real Flow____ •Flow of revenues, income, & household expenditures: _Money__ •Total gained from the sale of all Factors of Production: _Income__ •Total amount spent by all households: ___Expenditure_____ •Total of the value of of all goods and services: _Output____ And… •What is the relationship among, Income, Expenditure, and Value? They equal each other 2.1 Leakages and Injections Quick Review: Complete the diagram Households (Consumers) Factor Incomes Consumer Expenditure Firms (Businesses) Summarize • As we see in our first model: •E=O=Y • (Expenditure = Output = Income) • And from the second (more realistic) model: • Leakages must = Injections, but… • T ≠ G, S ≠ I, M ≠ X • Transfer Payments (unemployment benefits, disability payments, welfare payments) are not counted in GDP! Measuring National Income (IB Syllabus) • Distinguish between GDP and GNP/GNI • Distinguish between nominal/real values of GDP, GNP/GNI • Distinguish between total and per capita measures • Examine the output approach, the income approach and the expenditure approach when measuring national income • Evaluate the use of national income statistics: • Their use for making comparisons over time, and • Their use for making comparisons between countries, and • Their use for making conclusions about standards of living All of which… • Will help us devise policies to enable us to meet economic objectives • Explain the meaning and significance of “green GDP”, a measure of GDP that accounts for environmental destruction. Measuring National Income Income from the sale of all F’s of P = Expenditures by households on goods & services AND Value of Goods and Services or Total Output • Expenditure Method: Spending on Final Goods and Services • Income Method: All Income Earned by Factors of Production • Output Method: Value of all Final Goods and Services Income Method => N.I. • All Income earned by the Factors of Production of a country in a given time period (typically a year) • Labor/Wages • Land/Rent • Capital/Interest • Entrepreneurship/Profits • Total = National Income • Not as common a measure of overall economic activity as GDP (which is expenditure-based) Output Method => N.O. • Value of all final Goods and Services produced in a • • • • country in a specified period (typically a year) Measures the value-added from each step of the production process Allows for measuring each sector of the economy (banking, agriculture, transportation, etc) by looking at the value added from each step of a multi-step production process. Total = National Output Not as common a measure of overall economic activity as GDP (which is expenditure-based) Expenditure Method => NE => GDP • Total amount of spending on final goods and services in a country in a specified period (typically a year) • Four components: • Consumption Spending (C; consumer durables, consumer nondurables, services) • Investment Spending (I; capital goods, new construction) • Includes inventories (built but unsold goods) • I = Gross investment (includes depreciation) • Government Purchases (G; all spending by all governments— excludes transfer payments) • Net Exports (X-M; value of Exports less value of Imports) And now, a “Top Ten Moment in Economics”…wait for it… Gross Domestic Product (GDP) = C + I + G + (X-M) Test Your Understanding • With a partner… • Answer the TYU questions 7.2 on Page 187 (notes below) 1.Why is it useful to know the value of aggregate output? ____________________________________________ ____________________________________________ ____________________________________________ 2.Explain why: 1. We measure aggregate output in terms of value __________________________________________ 2. We only count final goods and services __________________________________________ 3.What are the four expenditure components of GDP? ____________________________________________ 4.Three ways GDP can be measured: _______________ ____________________________________________ Definitions and Concepts • Nominal vs. Real: Think about Inflation • Nominal Value is “money value,” based on prevailing prices • Real Value takes into account changing prices • Calculating Real Value requires reference to a Base Year • Nominal GDP vs. Real GDP • See example on Page 189 of text Definitions and Concepts • Gross vs. Net: One word – Depreciation • Gross Investment = Depreciation + Net Investment (discarded capital goods) (additions of new capital) OR • Gross Investment – Depreciation = Net Investment • Total vs. Per Capita – Important to note: • Comparing different countries • Comparing changes in a country over time National Income measures are either expressed in aggregate (did our economy grow?) or per capita (did the standard of living change on an individual level?)