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I, Pencil
"the key to understanding the world"
"the absence of a mastermind"
"if we can leave creative energies of humandkind uninhibited,
there's no limit to what we can accomplish"
"the market at work:
the spontaneous configuration
of the creative human energies of millions of people,
with their various skills and talents organizing voluntarily
in response to human necessity and desire“
http://www.youtube.com/watch?v=IYO3tOqDISE
MacroEconomics:
Ch.7
Measuring Domestic Output, National Income, and the Price Level
Microeconomics
Macroeconomics
Ch.7
Measuring Domestic Output,
National Income, and the Price Level
Macroeconomic Measurement and National Income Accounting:
• Provide a sense of the economy as a whole
• Allows for comparisons over time
• Vitally important to the formation of public policy
Gross Domestic Product (GDP)
The total
totalmarket
marketvalue
value
The
of all final goods and services produced within a country in a given year.
of all final goods and services produced
Valuation using money as a common denominator.
within •a country
• avoids
in a given
year “double counting”
(i.e. excludes intermediate goods used in production of final goods)
Gross Domestic Product
GDP is designed to measure what is produced
(or created) during the current period
Excluded transactions:
• sales of existing assets / secondhand sales
- used cars, existing houses
• purely financial transactions (“transfer payments”)
- welfare
- social security
- allowances
- alimony
- purchase of stock
GDP: Expenditures Approach
GDP = C + Ig + G + Xn
Categories of buyers:
• household consumers (C)
• businesses (Ig)
• government (G)
• foreign buyers (Xn)
Personal Consumption Expenditures (C)
• includes durable goods, nondurable goods and services.
Gross Private Domestic Investment—(Ig)
• Final purchases of machinery, equipment, and tools by businesses.
• All construction (including residential)
•
Changes in business inventory (may be a positive or negative number)
GDP: Expenditures Approach (cont)
Government Purchases (of consumption goods and capital goods) – (G)
• Spending by all levels of government (federal, state and local)
•
Direct purchases of resources (labor in particular)
• Excludes transfer payments (not associated with current production)
Net Exports—(Xn)
• Spending on goods produced in the U.S. is included in GDP,
(whether the purchase is made domestically or internationally).
•
Many goods purchased in the U.S. are produced elsewhere (i.e. imports).
Net exports (Xn) is the difference: exports minus imports
 positive or negative depending on which is the larger amount.
GDP = C + Ig + G + Xn
NOMINAL v. REAL GDP
Nominal GDP: calculated using the current prices at time of production
Real GDP: adjusted for price level changes (inflation/deflation)
 Over time, both prices and quantities are subject to change.
 Real GDP separates the effects of price changes and quantity changes.
A price index is used to adjust from nominal to real GDP.
GDP measurement: http://www.youtube.com/watch?v=yUiU_xRPwMc&feature=related
Nominal v. Real GDP:
http://www.youtube.com/watch?v=29S7FzI7s7g
The Consumer Price Index (CPI)
• measures the “cost of living” for a typical consumer.
• uses a “market basket” approach; tracks 300+ goods
and services commonly purchased, including:
 FOOD AND BEVERAGES
(supermarkets, restaurants)
 HOUSING
(rent, mortgage payments, heat, electricity, furniture)
 APPAREL (clothing, jewelry)
 TRANSPORTATION
(cost of cars, insurance, public trans., airfare, gas)
 MEDICAL CARE
(prescription drugs, doctors, hospitals, glasses/contacts)
 RECREATION (TVs, toys, pets, sports)
 EDUCATION AND COMMUNICATION (tuition, postage, phone, computer)
 OTHER GOODS AND SERVICES (tobacco, haircuts)
 GOVERNMENT CHARGES (tolls, taxes, license/registration fees)
Shortcomings of GDP
“Economic advance is not the same thing as human progress.”
- John Clapham
• does not measure unpaid output (parental care, volunteer work)
• does not measure improvements in product quality
• doesn’t directly measure living conditions
• does not measure or track the distribution of income (although “per capita GDP”
gives some – but not a perfect - indication regarding relative standard of living)
• Legal and Illegal activities of the “black market” are not counted in GDP
• Noneconomic sources of utility (crime reduction, divorce rates, etc.) are not covered
GDP = C + Ig + G + Xn
“[GDP] measures everything…
except that which makes life worthwhile.”
- Robert F. Kennedy
Shortcomings of GDP (cont.)
"Too much and too long, we seem to have surrendered community excellence and
community values in the mere accumulation of material things. Our gross national
product - if we should judge America by that - counts air pollution and cigarette
advertising, and ambulances to clear our highways of carnage. It counts special locks
for our doors and the jails for those who break them. It counts the destruction of our
redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and
the cost of a nuclear warhead, and armored cars for police who fight riots in our
streets. It counts Whitman's rifle and Speck's knife, and the television programs which
glorify violence in order to sell toys to our children.
Yet the gross national product does not allow for the health of our children, the quality
of their education, or the joy of their 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 wit nor our courage, neither our wisdom
nor our learning, neither our compassion nor our devotion to our country; it measures
everything, in short, except that which makes life worthwhile. And it tells us
everything about America except why we are proud that we are Americans."
Robert F. Kennedy, University of Kansas, Lawrence, Kansas, March 18, 1968
Why are changes in inventories included as part of
investment spending? Suppose inventories declined by
$1 billion during 2001. How would this affect the size of
gross private domestic investment and gross domestic
product in 2001? Explain.
7-5
If inventories declined by $1 billion in 2001,
$1 billion would be subtracted from both gross
private domestic investment and GDP.
A decline in inventories indicates that goods
produced in a previous year have been used up in
this year’s production.
If $1 billion is not subtracted, then $1 billion of
goods produced in a previous year would be
counted as having been produced in 2001, thereby
overstating 2001’s production.
7-13 Which of the following are actually included in this year’s GDP? Explain your answer in each case.
a. Interest on an AT&T bond
Included. Income earned for the service provided to AT&T (letting them use your money)
b. Social security payments received by a retired factory worker
Excluded. A gov’t transfer payment (for services rendered in other years).
c.
The services of a painter in painting the family home
Depends. A 3rd party painter is included; a son paid for painting his dad’s home is not.
d. The income of a dentist
Included. Payment for a final service.
e. The money received by Smith when she sells her economics textbook to a book buyer
Excluded. Secondhand sales are not counted.
f.
The monthly allowance a college student receives from home
Excluded. A private transfer payment.
g. Rent received on a two-bedroom apartment
Included. Payment for the final service of housing.
h. The $$ received by Mac when he resells his current-year model Plymouth Prowler to Stan
Excluded. Secondhand sale. The production of the car counted when initially sold.
7-13 Which of the following are actually included in this year’s GDP? Explain your answer in each case.
i.
Interest received on corporate bonds
Included; earned as a service of allowing the use of your money.
j.
A 2-hour decline in the length of the workweek
Excluded. The effect of the decline will be counted, but the change in the work week
itself is not the production of a final good or service or a payment for work done.
k. The purchase of an AT&T bond
Excluded. A non-productive transaction; just a transfer of ownership of financial
assets. (If AT&T uses the money from the sale of a new bond to carry out an
investment in real physical assets, that investment will be counted.)
l.
A $2 billion increase in business inventories
Included. An increase in inventories only occurs as a result of increased production.
m. The purchase of 100 shares of GM common stock
Excluded. Merely the transfer of ownership of existing financial assets.
n. The purchase of an insurance policy
Included. Insurance is a service.
7-6 Use the concepts of gross and net investment to distinguish between an economy that has
a rising stock of capital and one that has a falling stock of capital.
When gross investment exceeds depreciation, net investment is positive and production
capacity expands; the economy ends the year with more physical capital than it started with.
When gross investment equals depreciation, net investment is zero; the economy ends the year
with the same amount of physical capital.
When depreciation exceeds gross investment, net investment is negative and production
capacity declines; the economy ends the year with less physical capital.
“In 1933 net private domestic investment was minus $6 billion. This means in that particular
year the economy produced no capital goods at all.” Do you agree?
The statement is wrong.
Net investment of minus $6 billion does not mean that zero new capital goods were produced; it
simply means depreciation exceeded gross investment by $6 billion.
Explain: “Though net investment can be positive, negative, or zero, it is quite impossible for
gross investment to be less than zero.”
The statement is correct.
If only one $20 shovel is bought by a construction firm in the entire economy in a year and no
other physical capital is bought, then gross investment is $20—a positive amount.
This remains true even if net investment is highly negative because depreciation is well above
$20. Gross investment can never be less than zero.
7-8
SOLUTION