Download Chapter 7

CHAPTER: 7 & 8
Measuring the Circular Flow
GDP, GNP, NNP, NI, PI, & DI
AP Macro Outline – 2005-2006
I.
A.
B.
C.
D.
E.
8 – 12 %
Basic economic concepts
Chapters 1, 2, 3, 4, 5 & parts of 20
Scarcity, choice and opportunity costs
Production possibilities curve
Comparative advantage, specialization and exchange
Demand, supply, and market equilibrium
Macroeconomic issues: business cycle, unemployment, inflation, growth
II. Measurement of economic performance
Chapters 4, 5, 7, 8
A. National Income Accounts (4-6%)
1. Circular flow
2. Gross Domestic Product
3. Components of GDP
4. Real versus Nominal GDP
B. Inflation measurement and adjustment (4-5%)
1. Price indices
2. Nominal versus real values
3. Costs of inflation
C. Unemployment (4-5%)
1. Definition and measurement
2. Types of unemployment
3. Natural rate of unemployment
12 – 16 %
20 – 30%
V. Inflation, Unemployment and Stabilization Policies
Chapters 16, 17, 18, 19
A. Fiscal and Monetary policies (15-20%)
1. Demand side effects
2. Supply side effects
3. Policy mix
4. Government deficits and debt
B. Inflation and unemployment (5-10%)
1. Types of inflation
a)
Demand-pull
b) Cost-push
2. The Phillips Curve: short run versus long run
3. Role of expectations
VI. Economic Growth and Productivity
Mix of all chapters
A.
Investment in Human capital
B.
Investment in physical capital
C.
Research and development and technological progress
D.
Growth policy
VII. Open economy: International Trade and Finance
Chapters 6, 37, 38
A. Balance of payment accounts
1. Balance of trade
2. Current account
3. Capital account
B. Foreign exchange market
1. Demand for and supply of foreign exchange
2. Exchange rate determination
3. Currency appreciation and depreciation
C. Net Exports and Capital flows
D. Links to financial and goods markets.
4 – 6%
10 – 12%
AP Macro Outline – 2005-2006
I.
A.
B.
C.
D.
E.
8 – 12 %
Basic economic concepts
Chapters 1, 2, 3, 4, 5 & parts of 20
Scarcity, choice and opportunity costs
Production possibilities curve
Comparative advantage, specialization and exchange
Demand, supply, and market equilibrium
Macroeconomic issues: business cycle, unemployment, inflation, growth
II. Measurement of economic performance
Chapters 4, 5, 7, 8
A. National Income Accounts (4-6%)
1. Circular flow
2. Gross Domestic Product
3. Components of GDP
4. Real versus Nominal GDP
B. Inflation measurement and adjustment (4-5%)
1. Price indices
2. Nominal versus real values
3. Costs of inflation
C. Unemployment (4-5%)
1. Definition and measurement
2. Types of unemployment
3. Natural rate of unemployment
12 – 16 %
NEXT!!!!
The Circular Flow Revisited
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
BUSINESSES
INPUTS
GOVERNMENT
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
Foreign Expenditures
U.S. Exports
U.S. Imports
U.S. Expenditures
REST OF
THE WORLD
I. The Importance of
Macroeconomic Measurement
A. National Income Accounting:
•1. Economic Pulse of the Nation
I. The Importance of
Macroeconomic Measurement
A. National Income Accounting:
•1. Economic Pulse of the Nation
•2. Comparisons Over Time
I. The Importance of
Macroeconomic Measurement
A. National Income Accounting:
•1. Economic Pulse of the Nation
•2. Comparisons Over Time
•3. Basis For Public Policy
The Importance of
Macroeconomic Measurement
National Income Accounting:
•Economic Pulse of the Nation
•Comparisons Over Time
•Basis For Public Policy
What Are These Accounting
Measures?
B. GROSS DOMESTIC PRODUCT...
the total market value of
all final goods and
services produced inside
the USA in one year no
matter who owns the
company!!!!
C. GROSS NATIONAL PRODUCT...
the total market value of all
final goods and services
produced in the economy in
one year...
INCLUDES: the value of US
owned production in
foreign countries, but
EXCLUDES: foreign owned
companies inside the USA.
GROSS DOMESTIC PRODUCT...
the total market value
NOTES:
of all final goods and
services
in
GNP produced
vs. GDP
AP Essay
the economy
in one
2001
GNP=
year...
GDP + net receipts
Of American
Companies
Abroad
GROSS Domestic &
National PRODUCT...
the total market value of all final
goods and services produced in the
economy in one year...
•D. Characteristics
• 1. Final Goods – to measure
accurately we want to take care
to ensure that goods and services
are only counted once.
GROSS DOMESTIC/NATIONAL PRODUCT
the total market value of all final
goods and services produced in an
economy in one year...
•Final Goods vs.
•2. Intermediate Goods
Goods and services that
are purchased for further
processing and
manufacturing.
GROSS DOMESTIC PRODUCT...
the total market value of
all final goods and
services produced in the
economy in one year...
•Final Goods - only
•Intermediate Goods - excluded
•3. Value Added - Approach
Calculating the GDP by this Method!
GROSS DOMESTIC & NATIONAL
PRODUCTS ...
the total market value of all final goods and
services produced in the economy in one
year…only in the USA for GDP or by US
companies abroad for GNP.
GDP and GNP are both:
•4. A Monetary Measure
•5. Avoid Double Counting
•6. Excludes Nonproduction
Transactions
GROSS DOMESTIC PRODUCT...
•A Monetary Measure
•To Avoid Double Counting: GDP
Excludes Nonproduction
Transactions
7. Examples of Nonproduction Transactions
- Financial Transactions are excluded:
- Public Transfer Payments
(welfare, social security, veteran’s benefits)
- Private Transfer Payments
($ money from parents or rich relative)
- Security Transactions
(Buying or selling existing stocks and bonds)
GROSS DOMESTIC
& NATIONAL PRODUCT...
the total market value of all final
goods and services produced in the
economy in one year...
Excludes:
Financial Transactions
- Secondhand Sales – they have
already been counted in
previous years.
GROSS DOMESTIC
& NATIONAL PRODUCT...
the total market value of all final
goods and services produced in the
economy in one year...
Excludes:
Financial Transactions
Secondhand Sales
Services for which no
compensation is given.
GROSS DOMESTIC PRODUCT...
the total market value of all
final goods and services
produced in the economy in
one year...
•A Monetary Measure, Avoids
Double Counting, & Excludes
Nonproduction Transactions
•II. Two Sides to GDP
GROSS DOMESTIC PRODUCT...
•Two Sides to GDP:
A. Spending & Income
More?
GROSS DOMESTIC PRODUCT...
B. Expenditures Approach
Amount spent to
purchase
this year’s total
output
GROSS DOMESTIC PRODUCT...
B. Expenditures Approach
Amount spent to purchase
this year’s total output
1. GDP = C + I + G + X - M
C. Income Approach
The money income derived
from production of this year’s
output 1. GDP = W + P + i + R + Inbt + Dep
Expenditures Approach
1. Back to Expenditures
2. C + I + G + X - M
- Personal Consumption Expenditure ( C )
Expenditures Approach
Personal Consumption Expenditure ( C )
• Durables
Expenditures Approach
Personal Consumption Expenditure ( C )
• Durables
• Nondurables
Expenditures Approach
Personal Consumption Expenditure ( C )
• Durables
• Nondurables
• Services
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
Gross – Total investment (added and replacement)
Private – Individual firms, not the government
Domestic – in the U.S. not overseas
Investment??? See next slide
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
• Machinery, Equipment, & Tools
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
• Machinery, Equipment, & Tools
• All Construction – residential
and commercial
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
• Machinery, Equipment, & Tools
• All Construction
• Changes in Inventories
- GDP measures this year’s total Output/production.
- Even though a good may sit in inventory
and not be sold it was still produced so it is counted.
- Increase in inventories is an addition to GDP
- Decrease in inventories is a subtraction to GDP
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
• Machinery, Equipment, & Tools
• All Construction
• Changes in Inventories
Gross vs. Net Investment
Gross Private Domestic Investment


Total investment in a
year.
Net Private
Investment:
Gross private domestic
investment – (minus)
depreciation!
Expenditures Approach
NOTES:
Personal Consumption Expenditure ( C )
Net Investment
& Economic Growth
Gross Private Domestic Investment ( Ig )
• Machinery, Equipment, & Tools
• All Construction
• Changes in Inventories
Gross vs. Net Investment
Expenditures Approach
NOTES:
Personal Consumption Expenditure ( C )
Net Investment
& Economic Growth
Gross Private Domestic Investment ( Ig )
Expanding Economy
• Machinery, Equipment, & Tools
• All Construction
• Changes in Inventories
Gross vs. Net Investment
Expenditures Approach
NOTES:
Personal Consumption Expenditure ( C )
Net Investment
& Economic Growth
Gross Private Domestic Investment ( Ig )
Expanding Economy
Machinery,
&
Static Equipment,
Economy
•
• All Construction
• Changes in Inventories
Tools
Gross vs. Net Investment
Expenditures Approach
NOTES:
Personal Consumption Expenditure ( C )
Net Investment
& Economic Growth
Gross Private Domestic Investment ( Ig )
Expanding Economy
• Machinery,
&
Static Equipment,
Economy
• All Construction
Declining Economy
Tools
• Changes in Inventories
Gross vs. Net Investment
Economies Grow as Investment
rises:
Investment
Shifts PPC’s to
the right!
American
Business
Economies grow in
The Long and
Short Run
Because of Investment!
Investment is Volatile!!!!



Keynes the father of
MACRO believed
business Investment to
be the most volatile of
the factors in GDP!
Can your family stop
paying its bills?
Can government not
pay social security?
Fear
9/11
Y-2K
Recession
2000-2001
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
Government Purchases ( G )
Expenditures Approach
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
Government Purchases ( G )
Net Exports ( Xn ) = (X – M)
GDP = W + P + i + R + InBT + Dep
The Circular Flow Revisited
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
BUSINESSES
INPUTS
GOVERNMENT
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
Foreign Expenditures
U.S. Exports
U.S. Imports
U.S. Expenditures
REST OF
THE WORLD
GDP = C + I + G + (X – M)
Expenditures Approach
Summary
C + Ig + G + Xn = GDP
Expenditures Approach
Summary
C + Ig + G + Xn = GDP
Next: The Income Approach
C. Incomes Approach
• 1. Compensation of Employees
Largest, includes not only wages but other compensation
costs such as social security, pensions, health funds etc…
Incomes Approach
• 1. Compensation of Employees
• 2. Rents
Payments to landlords, rent on office space.
It is net rental income – depreciation.
This will always be calculated for you as final rents.
Incomes Approach
• 1. Compensation of Employees
• 2. Rents
• 3. Interest
Payments to households on savings, CD’s, corporate bonds.
Incomes Approach
• 1.
• 2.
• 3.
• 4.
Compensation of Employees
Rents
Interest
Proprietors’ Income
Profits of the small business owner.
Incomes Approach
• 1.
• 2.
• 3.
• 4.
• 5.
Compensation of Employees
Rents
Interest
Proprietors’ Income
Corporate Profits
Corporate earnings can be distributed in three ways.
Incomes Approach
• Compensation of Employees
• Rents
• Interest
• Proprietors’ Income
• Corporate Profits
1- Corporate Income Taxes
Incomes Approach
• Compensation of Employees
• Rents
• Interest
• Proprietors’ Income
• Corporate Profits
1- Corporate Income Taxes
2- Dividends
Incomes Approach
• Compensation of Employees
• Rents
• Interest
• Proprietors’ Income
• Corporate Profits
1- Corporate Income Taxes
2- Dividends
3- Undistributed Corporate Profits
So far we have something called national income
Incomes Approach
• 1. Compensation of Employees
• 2. Rents
• 3. Interest
• 4. Proprietors’ Income
• 5. Corporate Profits
- Corporate Income Taxes
- Dividends
- Undistributed Corporate Profits
• 6. Indirect Business Taxes &
Depreciation
Depreciation....
Consumption of Fixed Capital
Depreciation is also....
Consumption of Fixed Capital
Net American Factor Income
Earned Abroad less foreign
Incomes in the US = GNP
Measuring the US economy
Sum of the Final Demands
Method:
GDP = C + I + G + (X – M)
Income Method:

GDP =
W+P+i+R+
Indirect Business
Taxes +
Depreciation
Value Added Approach

Sum of the value
added in each step
of the
production….with
round about
production this
may include
many, many
steps!
Gross Domestic Product’s 3
methods of calculation:




GDP = C + I + G + (X – M)
GDP = W + i + R + P + Inbt + Dep
Value Added
GNP = GDP + (US production in
foreign countries – Foreign
production in the US)
Most Famous and Largest of the
National Income Accounts!!!!!
Gross National Product
GNP = GDP – Foreign
production in the US + US
production in foreign
countries
 Net Foreign Factors (NFF)
 GNP = GDP + NFF
Significance – shows how much foreign production takes place

in the U.S compared to U.S. production overseas.
Not an indicator relied on by economists as much today.
Economists are concerned with output with in each respective
Country no matter who owns the company.
Net National Product
Net Domestic Product
NNP = GNP – Depreciation
Depreciation: the loss in
value from use of a capital
good.
NDP = GDP – Depreciation
Depreciation: the loss in
value from use of a capital
good.
Many Economist Consider these the best measures of the national economy!!!!
Why????
Investment in capital is what pushes us beyond that PPC!!!!
National Income

NI = W + P + i + R

NI = GDP – (Dep + Inbt)

NI = NDP - Inbt
This shows us what Households and
Businesses made as income.
It takes out depreciation ($ spent to
replace worn out capital) and
Sales and Excise taxes that go to
the government.
Remember, Weasel Puss is Red!!!
Personal Income

PI = NI – (RE + CPT + FICA) + TP
• RE: Retained Earnings/ Corporate Earnings
• CPT: Corporate Profit Taxes
• FICA: Federal Insurance Corporation of
America ( Social Security )
• TP: Transfer Payments
This shows what Households earned as income!!!
Disposable Income


DI = PI – PT
DI = C + S
This shows what households
have to spend.
Remember what isn’t taken away
in taxes we either spend or save.
Spending is a big indicator of
economic growth!!!!
Do you get it??????








Use the following information to calculate GDP,
GNP and NNP, NDP and NI.
Profits 1150, consumer consumption 8000, net
exports (-150), wages 7250, depreciation 359,
Investment 635, interest 311, indirect business
taxes 200, rent 101, net foreign factors 40,
government expenditures 886.
GDP – expenditure approach??
GDP – income approach??
GNP??
NNP?? NDP??
NI – income approach??
Congratulations you just completed question 7 of your
homework for 10 points.
Marginal Propensity to Consume
& Marginal Propensity to Save



$1.00 = MPC + MPS
MPC = ^C/^DI
MPS = ^S/^DI
A measurement that attempts to ask the
question, to what extent does consumption
spur economic growth?
II. Comparing GDP’s
A. NOMINAL vs. REAL GDP
Current priced GDP’s or Nominal GDP’s cannot be compared!
GDP’s corrected for inflation or Real GDP’s can be compared!
Measuring the Price Level
B. The GDP Deflator/Index....
NOMINAL & REAL GDP
Measuring the Price Level
The GDP Deflator/Index....
NOMINAL & REAL GDP
...inflating for falling prices
Measuring the Price Level
The GDP Deflator/Index....
NOMINAL & REAL GDP
...inflating for falling prices
...deflating for rising prices
Inflating & Deflating GDP
Converting a Nominal to a Real
=
RGDP2005
or
GDP Deflator/
GDP index
Nominal
GDP 2005
x 100
PI of year
you want to compare
Top 10 Economic Powers in the World By GDP
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
United States
Japan
Germany
Britain
France
China
Italy
Canada
Brazil
Mexico
$10,910,000,000,000
$4,765,000,000,000
$1,866,000,000,000
$1,427,000,000,000
$1,294,000,000,000
$1,080,000,000,000
$1,074,000,000,000
$704,000,000,000
$701,000,000,000
$575,000,000,000
Per capita RGDP or RGDP/Person



RGDP/Population
If RGDP is rising
slower than
population, standard
of living is falling!
If RGDP is rising
faster than population
standard of living is
rising!
Top Countries in GDP Per Capita
1.
2.
3.
4.
5.
6.
7.
8.
Norway
USA
Switzerland
Denmark
Iceland
Finland
Britain
Germany
$38,500
$37,500
$31,000
$30,500
$30,000
$27,500
$27,300
$27,200
Source – The Economist
9.
10.
11.
12.
13.
Sweden
France
Italy
Japan
Spain
$27,100
$27,000
$26,900
$26,800
$23,000
Bottom 10 Countries
GDP Per Capita
1.
2.
3.
4.
5.
6.
7.
8.
9.
Source – United Nations
10.
Sierra Leone
$480
Tanzania
$501
Burundi
$578
Malawi
$586
Ethiopia
$628
Sudan
$664
Guinea-Bissau
$678
Congo
$727
Mali
$753
Niger
$753
C. Measuring the Price Level
INFLATION:
A sustained increase in the
average/general level of prices
Rate of inflation (CPI and PPI)
calculated using index
numbers based on a fixed/weighted
Market Baskets
CPI – PPI – GDP Deflator




The big 3 measures of inflation!
CPI – consumer prices
PPI – producer prices
GDP deflator – all prices
Inflationary Measures



Consumer Price Index: 250 – 400 item
weighted market basket of goods and
services purchased by urban/suburban
families of moderate income.
Producer Price Index: a similar weighted
market basket purchased by businesses
GDP Index: all items purchased in the
American economy
Measuring the Price Level
Consumer Price Index
Price of 2005
market basket
CPI =
Price of same market
basket in base year
x 100
Measuring the Price Level
Consumer Price Index is a
Base year average of 1982-4
CPI =
Price of 1982-1984
market basket in
specific year (2005)
Price of same market
basket in base period
(1982-1984)
CPI82-84 = 100
x 100
Measuring the Price Level
Producer Price Index
Price of the 2005
market basket
PPI =
Price of same market
basket in base period
(1982-1984)
x 100
CPI




Calculated using
the same method
but different market
baskets!!!
See Excel Spread
Sheets on CPI.
My family was a
CPI family and
you’re not!
http://minneapolisfe
d.org/research/data/
us/calc/index.cfm
Speed of Inflation

Creeping
• 3-5 %

Galloping
• 8-15%

Hyper
• 100+%
In the American Economy Inflation at Greater Than 5% is considered
A problem that the Federal Government or the Fed should Fix!
Hyperinflation was rare before the 20th century; older
economies would revert to either specie metals or barter once inflation
reached a certain level. The widespread use of fiat money created the
possibility of hyperinflation as governments often tended to print larger
amounts of money to finance their expenses. Inflation results where
such an increase in money supply occurs without regard for
the actual market demand. Rates of inflation of several hundred
percent per month are often seen.
Extreme examples include Germany in the early 1920s when
the rate of inflation hit 3.25 million percent per month;
Greece in the mid-1940s with 8.55 billion percent per month; and Hungary
during the same approximate time period at 4.19 quintillion percent per
month. Other more moderate examples include Eastern European
countries in the period of economic transition in the early 1990s and in
Bolivia and Peru in 1985 and 1988, respectively.
Nations such as Ghana in North Western Africa continue to
this day to have inflation in the order of 30% per annum.
Value of money
Dramatically
Declines in
HyperInflation!
4 years tuition
Saved in 1922,
Buys a postage
Stamp in 1923!
Money was
Cheaper than
Coal!
Inflation 1923/24: a woman feeds her tiled stove with money.
The Democratic Weimer Republic created by Versailles is blamed.
Money was printed to pay Versailles’s imposed reparations!
Hyperinflation!
Various workers also had to be paid by the
Weimar Government, additional currency
was printed, which fueled a period of
hyperinflation. The value of the Mark
declined from 4.2 per US dollar to
1,000,000 per dollar by August 1923 and
4,200,000,000,000 per dollar on November
20. On December 1, a new currency was
established at the rate of 1,000,000,000,000
old marks for 1 new mark, the Rentenmark.
Measuring the Price Level
1 - Measuring Inflation &
Deflation
Measuring the Price Level
1 - Measuring Inflation &
Deflation
2 - Comparing GDPs
Measuring the Price Level
Consumer Price Index
Question 11 – Randy’s Year!
Year #1 Market Basket
$150
100 = Year #1 Market Basket x 100
$150
CPI base year = 100
Measuring the Price Level
Price Index: CPI, PPI, GDPD
Price Index
in a given
year
102
=
=
Price of market
basket
in a specific year2005
x 100
Price of the same market
basket in the base year 1982-1984
Price of Randy’s market
basket year 2 = $153
Price of Randy’s market
basket year 1 = $150
x 100
Measuring the Price Level
Price Index
Price Index
in a given
year
=
Price of market
basket
in a specific year
Price of the same market
basket in the base year
x 100
Measuring the Price Level
Consumer Price Index
CPI =
Price of 2005
weighted
market basket
Price of same weighted
market basket
in base period
(1982-1984)
x 100
Measuring the Price Level
Producer Price Index
PPI =
Price of some market
basket in specific year 2005
Price of same market
basket in 1982-84
x 100
GDP, Social Welfare, Flaws
 Nonmarket Transactions
Leisure
Improved Product Quality
Composition and Distribution of
Output
Per Capita Output
GDP and the Environment
The Underground Economy
GLOBAL PERSPECTIVE
THE UNDERGROUND ECONOMY AS A PERCENT OF GDP
0
Greece
Spain
Italy
Portugal
Belgium
Sweden
Germany
France
Holland
Britain
United States
Japan
Switzerland
5
10
15
20
25
30
GLOBAL PERSPECTIVE
THE UNDERGROUND ECONOMY AS A PERCENT OF GDP
0
Greece
Spain
Italy
Portugal
Belgium
Sweden
Germany
France
Holland
Britain
United States
Japan
Switzerland
5
10
15
20
25
30
Chapter
Conclusions
Copyright McGraw-Hill, Inc.
national income accounting
net exports
gross domestic product
national income
final goods
indirect business taxes
intermediate goods
consumption of fixed capital
multiple counting
net domestic product
value added
personal income
expenditures approach
disposable income
income approach
nominal GDP
personal consumption expenditures
real GDP
gross private domestic investment
price index
net private domestic investment
consumer price index
government purchases Copyright McGraw-Hill, Inc.
Quiz – Thursday, December 1






8- points multiple choice from chapter
23- points GDP, GNP, NDP, NI, PI, DI –
formulas.
4 points – Calculating RGDP and CPI’s –
formulas.
35 points total
Happy December
No notes for quiz!
Next...
MACROECONOMIC INSTABILITY:
UNEMPLOYMENT & INFLATION
Chapter 8