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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