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“Foundations of Economics” Measuring the Overall Performance of Economic Systems 1 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Introduction • Microeconomic Analysis – supply and demand in a particular market or industry. • Macroeconomic Analysis – performance of the overall economy. • Gross Domestic Product – best indicator of overall economic performance. 2 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Some Figures • World GDP comparison • GDP per capita © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product • GDP – market value of final goods and services produced within a country in a particular time period. – Market values. – Final good – purchased by ultimate user. – Within a country. – Time period is usually a year. 4 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product Market Value – GDP is a market value—goods and services are valued at their market prices. – To add apples and oranges, computers and popcorn, we add the market values so we have a total value of output in dollars. 5 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product Final Goods – Intermediate goods doesn’t count – Intermediate Goods • Goods used up entirely in the production of final goods. • Not included in the calculation of GDP. 6 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product Final Goods – Add value-added at each stage of the production process. • Value Added – The dollar value of an industry’s sales minus the value of intermediate goods used in production – Example: farmer, miller, baker, consumer 7 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product Within a country – Output produced abroad by domestically owned factors of production doesn’t count. (e.g. Lululemon factory in China ) - Output produced domestically by foreign owned factors of production should be included. (e.g. General Motor Cars manufactured in Ontario) 8 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product In the course of a year – Used goods and second-hand sales do NOT count. (e.g. selling a used car ) - inventory should be included. inventories: goods that are produced but unsold count as firms’ own investment 9 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Gross Domestic Product Three ways of measuring GDP: – Product approach: the total of the value added by each producer in the course of contributing to the year’s total output of final goods; – Income approach: the total income received, in the form of wages and salaries, interest, rent, and profits, by those who contributed the resources used to produce the year’s total output; – Expenditure approach: the total purchases of final goods by households, business firms and government, plus the purchases by foreigners in excess of what the foreigners sold us in return. 10 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Calculating GDP • Expenditure approach – Consumption (C) – Investment (I) – Government purchases of Goods and Services (G) – Net Exports - net spending by the Rest of the World on domestic production (NX) 11 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Copyright © 2013 Pearson Canada Inc., Toronto, Ontario © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Copyright © 2013 Pearson Canada Inc., Toronto, Ontario © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Nominal and Real GDP • Nominal GDP – Product of prices and quantities (P x Q). – If prices increase and quantities remain unchanged nominal GDP increases. • Question – If prices increase and quantities remain the same, has the real output of the economy increased? 14 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Nominal and Real GDP • Adjusting GDP for Price Changes – Real GDP • The value of all final goods and services produced in a year stated in unchanging prices (base year’s price). 15 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Example: 2003 2004 Good Quantity Price Quantity Price Milk 500 $2 900 $3 Cheese 1000 $5 1000 $4 Butter 2000 $1 3000 $2 16 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Appendix: Limitations of National Income Accounting • GDP – Only attempts to measure economic performance. – Ignores all non-market forms of production. – Ignores illegal production. 17 © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko Limitations of GDP © 2006 Prentice Hall Business Publishing Copyright © 2014 by Nelson Education Ltd. The Economic Way of Thinking, 11/e 5-18 Heyne/Boettke/Prychitko Active Learning GDP and Its Components In each of the following cases, determine how much GDP and each of its components is affected (if at all). A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Toronto. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. C. Jane 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. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them. © 2006 Prentice Hall Business Publishing Copyright © 2014 by Nelson Education Ltd. The Economic Way of Thinking, 11/e 5-19 Heyne/Boettke/Prychitko Active Learning Answers A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Toronto. Consumption and GDP rise by $200. B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China. Investment rises by $1800, net exports fall by $1800, GDP is unchanged. © 2006 Prentice Hall Business Publishing Copyright © 2014 by Nelson Education Ltd. The Economic Way of Thinking, 11/e 5-20 Heyne/Boettke/Prychitko Active Learning Answers C. Jane 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. Current GDP and investment do not change because the computer was built last year. D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them. Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million. © 2006 Prentice Hall Business Publishing Copyright © 2014 by Nelson Education Ltd. The Economic Way of Thinking, 11/e 5-21 Heyne/Boettke/Prychitko