Download + = GDP

Chapter 5
Macro Measurements
Expenditure/Income Approach
GDP
macroeconomics
The study of the nation’s economy as a
whole; focuses on the issues of inflation,
unemployment, and economic growth.

THE “FLIP” SIDES OF MACROECONOMIC
ACTIVITY: PRODUCTION AND INCOME
The
Circular Flow of Production and Income
FIGURE 5.1
The Circular Flow of Production and Income
The circular flow shows how the production of goods and services
generates income for households and how households purchase goods
and services produced by firms.
Gross Domestic Product (GDP)

Gross domestic product (GDP) is the total
dollar value of final output produced within a
nation’s borders in a given time period.
Gross Domestic Product (GDP)


Each good and service produced and brought
to market has a price.
That price serves as a measure of value
for calculating total output.
The Measurement of Output
Output
Amount
Last Year’s Output
In physical terms
Oranges
Bicycles
Rock concerts
Total
In monetary terms
2 billion oranges @ $0.20 each
2 million bicycles @ $50 each
700 rock concerts @ $1 million each
Total
2 billion
2 million
700
?
$ 400
100
700
$1200
million
million
million
million
Highlights






Most comprehensive measure of output is
GDP
GDP = value added at each state of
production – Total value of g & s produced
in a given year domestically
Nominal and Real GDP are calculated
Nominal= current prices
Real = GDP expressed in terms of constant
prices (sans inflation)
People basically care about buying power.
GDP Per Capita
Total GDP divided by Total Population
This is the way to compare international output among different
countries/economies.
Divide the pie- how many pieces for each?
In 2001 America’s total GDP of $10 trillion was shared by 280
million citizens. Average per capita GDP was around
$36,000.
2004 it was $37,600 – population 2004 was 292 million+
2005 = $41,800
2008 = $46,000
2009 = $45,787
2010 = $47,199
1998 TO 2011 Per Capita U.S.
Richest and Poorest countries 2010
So… What does per capita really tell us?
It is a statistical comparison that indicates how well
off people are in a country.
Real per capital increases when REAL GDP rises
faster than population
It can indicate the differences in the ways people
live. How many TVs they have. How many cell
phones, Internet connections, cars, refrigerators,
paved roads, schools, etc.
All it does is state that if per capita is higher, the
average amount of goods/person is higher than
the base comparison.
Highlights Continued
Each year capital is worn out – called depreciation..
By subtracting depreciation from GDP we derive net domestic
product (NDP)
Difference between NDP and GDP is equal to the difference
between gross investment expenditures and net investment—
Expenditure Approach to Income Approach to
GDP Measurement
GDP Measurement
Consumption
+
Investment
+
Government
+
Net Exports
Total value of output
Wages and salaries +
Corporate profits +
Proprietors’ income +
Farm Income +
Rents +
Interest +
Sales taxes +
Depreciation =
Total value of income
Value of total expenditure must equal value of total income
OUTPUT = INCOME



All the spending that establishes the value of
output also determines the value of incomes.
Generally speaking, the market value of
incomes must equal the market value of
output.
Every dollar spent on output becomes a
dollar of income for someone.
Computing GDP

The value of GDP can be computed by adding
up expenditures of market participants:(add up
the market value of all domestic expenditures made
on final goods and services in a single year.)
GDP = C + I + G + (X – IM)
Where:
C = Consumption expenditure
I = investment expenditure
G = government expenditure
X = exports
IM = imports
Total Expenditure on final G & S is broken
down in four categories:
Consumption expenditures Comprises the largest share (2/3’s) of
total expenditure.
 Includes nondurable goods (food,clothing)
and durable goods (appliances, autos)
 Includes consumption service expenditures
such as barbers, doctors, lawyers,
mechanics.
Expenditures Continued
Investment Expenditures
Includes expenditures on fixed investment goods
and inventory investment.
Fixed investments goods are those that are useful
over a long period of time- includes purchases
of new equipment, factories, other nonresidential
housing as well as new residential housing. Also
includes cost of replacing existing investment
goods that have become worn out or obsolete.
The market value of all investment goods that must
be replaced in a single year is referred to as
depreciation for that year.
Investment Continued
Inventory Goods are final goods waiting to be
sold that firms have on hand at the end of the
year.
The year-to-year change in the market value of
firms’ inventory goods is considered an
investment expenditure because these
inventory goods will eventually yield a flow
of consumption or production services.
Total Expenditures Continued
Government Expenditures
Includes hiring of civil servants and military
personnel, construction of roads and public
buildings.Supplies for the war, contracts for
many products/services… Boeing…etc.
Social Security, welfare, and other transfer
payments are not included.(because
government expenditures on transfer payments do
not involve the purchase of any new goods or
services and are therefore excluded from the
calculation.
Total Expenditures Continued
Net Exports
Exports are g & s produced domestically but sold to
foreigners.
Imports are g & s produced by foreigners, but sold
domestically.
Expenditures on exports are added to total
expenditures while expenditures on imports
are subtracted.
X-M = value of net exports to nation’s total
expenditures.
What’s Not Included in GDP

Certain nonmarket goods and
services such as
chores performed
at home by family
members.
What’s Not
Included in GDP
Underground
activities, both legal
and illegal
What’s Not Included in GDP

Sales of used
goods

Financial
transactions such
as trading of
stocks and bonds
What’s Not Included in GDP

Government transfer
payments such as
social security

Leisure time
Measures of Income

GDP accounts have two sides.


One side focuses on expenditure – the
demand side.
The other side focuses on income – the
supply side.
Income Approach
Income Approach:
 Add up all the income earned by households and
firms in a single year.
 By adding together rent, wages, profit, interest
income, one should obtain the same value of
GDP as is obtained using the expenditure
approach…BUT…
 2 types of expenditures that are included in
expenditure, but do not provide households or
firms any income (depreciation expenditures and
indirect business taxes)
Income Approach Continued
Depreciation expenditures (replacing existing,
but worn out investment goods, do increase the
incomes of those providing the replacement
goods, but they also decrease the profit incomes
of those purchasing the replacement goods.)
Result= aggregate income remains unchanged.
Indirect business taxes consist of sales taxes and
other excise taxes that firms collect but not
regarded as part of firms’ incomes. (Hence,
included in expenditures approach but not
income)
Measures of Income

The total value of market incomes
must equal the total value of final
output, or GDP.
Two Ways of Measuring GDP
Expenditure Approach
Resource Cost-Income Approach
Personal Consumption
Expenditures
Aggregate Income:
Compensation of employees
(Wages and salaries)
Income of self-employed
Proprietors
Rents
Profits
Interest
+
Gross Private Domestic
Investment
+
Government Consumption and
Gross Investment
+
Net exports of goods and
Services
=
GDP
+
Non-Income Cost Items:
Indirect business taxes
Depreciation
+
Net Income of Foreigners
=
GDP

There are two methods of calculating GDP:


It can be calculated either by summing the expenditures on
the “final user” goods and services purchased by consumers,
investors, governments, and foreigners (net exports), or,
by summing the income payments and direct cost items that
accompany the production of goods and services.
Output = Income
VALUE OF OUTPUT
VALUE OF INCOME
Consumer spending
Wages
Investment spending
Government spending
Product
market
Factor
market
Profits
Interest
Rent
Net exports
Sales taxes
Depreciation
Measuring GDP





GDP is the scoreboard for economic performance
GDP is the most widely used measure of economic performance.
GDP is measured quarterly.
GDP = total value of goods and services produced in the United
States in a given year.
Many transactions have to be excluded from GDP
Counts only the g & s purchased by their final users

Counts only the g & s produced during the specified period

Excludes all financial transactions and income transfers.
(because financial transactions do not count for current production- examples
purchase and sale of stocks, bonds, securities= merely transfer of
ownership)
Transfer payments are unproductive money into economy (both from
GDP standpoint and growth standpoint.

When Goods are measured as output- units of each good are weighted
according to their PURCHASE PRICE
example: new car adds more than NIKE shorts
The total spending on ALL g & s produced during the year is
then summed (in dollar terms) to obtain the annual GDP
 GDP differs from GNP
GDP – g & s produced within the borders of the US whether
produced by foreigners or Americans
GNP – measures the output of all Americans, whether the g & s
are produced here or abroad.
(The Nissan produced in Tennessee is included in U.S. GDP)

Income Flow Chart
Searching for total income earned by factors of production.
The figure below = how much income flows into hands of
Consumers.
Gross Domestic product
(GDP)
less depreciation
Net domestic product (NDP)
less direct business taxes
National income (NI)
less corporate taxes
less retained earnings
less Social Security taxes
Plus net interest
Plus transfer payments
Personal Income
less personal taxes
Disposable Income
Net Domestic Product




NDP measures the total value of new goods
available in the economy in a given year after wornout capital goods have been replaced.
Net domestic product (NDP) =
GDP – Capital consumption allowance*
*The estimated amount of capital goods used up
in production through natural wear, obsolescence,
and accidental destruction.
Income Approach Continued
Personal Income – total income received by all person in the
nation before personal taxes are paid.
To get from NI to PI- must subtract that portion of NI that does
not go to households
(*social security contributions, undistributed corporate profits
*Corporate income taxes) * goes to government
Disposable Income- Subtract personal income taxes
Amount left over is what we can spend or save.



If GDP grows too rapidly, it may cause
increased inflation.
If GDP grows too slowly, or declines, there will
be an increase in the number of people
unemployed.
***What determines the level of GDP?
Ans…(level of spending)
 ***What determines the level of spending?
Ans…. (add up the level of C + I + G + (X-M)
Business Cycle


Recurrent swings (up and down) in
Real GDP.
Equilibrium GDP

The level of GDP will depend on the total
spending for consumption, investment, and
government
Anytime there is a change in the LEVEL
of spending the GDP will begin to move
toward the new level of spending.

When GDP is exactly equal to the level of total
spending, the economy is in equilibrium.
Achieving equilibrium is not necessarily the
goal. The goal is to have growth towards
full employment without excessive inflation
So…how do you calculate growth?
Value of GDP by itself is not very
interesting.
 What is interesting is the year-to-year
percentage change in the value of GDP.
 How to calculate percentage change:
Need to know the value of the statistic at
two dates in time. Growth rate last year
is Yl and the value of the current year is
Yc

Formula
Yc – Yl
Yl
x100
This formula is valid for calculating the percentage
change in any statistic, not just the percentage
change in GDP.
% change = _change___
original number
If we move from 150 to 200 what is the % change?
Answer
33 l/3 %
150 – 200 = 50
50 = 5
150 15
=
1
3
Calculate this:::::::
In 1999 – Real GDP was 9,299
In 2000 – Real GDP was 9,767
What was the % growth from 1999 to 2000
5%
9,767-9,299 = 468
468/9,299 = 5
Distinguishing Between Nominal
and Real Values

Nominal Values


Measurements in terms of the actual market
prices at which goods are sold; expressed in
current dollars, also called money values
Real Values

Measurements after adjustments have been made
for changes in the average of prices between
years; expressed in constant dollars
Example: Correcting GDP for Price
Index Changes

Correcting GDP for price index changes

Nominal (current) dollars GDP

Real (constant) dollars GDP
Nominal GDP
x 100
Real GDP =
Price index*
*Price index: measured by the GDP deflator
Terminology to be aware of
Nominal GDP= output at current prices
Real GDP= output at constant base-year
prices (inflation has been deducted)
GDP Price Index (market basket prices…
value) of g & s in given year compared to
base year.
CPI currently base year 1983
What is the bottom line?
The amount left after
evaluating the income
approach is:
Disposable Income
(this is what we have to
spend or save)

Would this change GDP?