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O’Sullivan • Sheffrin • Perez
Measuring a Nation’s
Production and Income
© 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan • Sheffrin • Perez
chapter
1 How can we use economic analysis to compare the size of a major corporation
to a country?
Using Value Added to Measure the True Size of Wal-Mart
2 How do we determine when a recession has occurred in the United States?
The NBER and the 2001 Recession
3 Do increases in gross domestic product necessarily translate into
improvements in the welfare of citizens?
The Links Between Self-Reported Happiness and GDP
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MEASURING A NATION’S PRODUCT AND INCOME
• macroeconomics
The study of the nation’s
economy as a whole;
focuses on the issues of
inflation, unemployment,
and economic growth.
• inflation
Sustained increases in the
average prices of all
goods and services.
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chapter
5.1
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
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
• gross domestic product (GDP)
The total market value of final
goods and services produced
within an economy in a given
year.
• intermediate goods
Goods used in the production
process that are not final goods
and services.
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5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
• real GDP
A measure of GDP that controls for
changes in prices.
• nominal GDP
The value of GDP in current dollars.
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Extra Application 4
THE ECONOMY HEATS UP
Reports indicate the economy is still going strong. Manufacturing and services are both
showing growth as is personal income. Retail sales growth is up 0.6 %for April and chain
store receipts grew by 3% for the month. In spite of the positive indicators some
economists are worried about the ultimate impact of higher gasoline prices on consumer
spending.
• One widely awaited economic indicator is the consumer sentiment index from the
University of Michigan which provides a useful forecasting tool about future growth.
• Optimistic consumers spend money and pessimistic consumers reduce spending.
• Analysts are also waiting for the Fed’s press release later this week.
• Strong economic numbers may spell
more rate increases in the near term.
Optimistic consumers fuel economic growth. As consumers
feel better about the economy they will open their wallets
and demand more goods and services. This increased
optimism pushes the aggregate demand curve out and
results in higher output as shown in the graph.
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
 FIGURE 5.2
U.S. Real GDP, 1930–2005
• economic growth
Sustained increases in
the real GDP of an
economy over a long
period of time.
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Extra Application 5
INDUSTRIAL PRODUCTION FALLS
January’s industrial production numbers indicate a slight decline of 0.2 percent from the
previous month. The drop follows November and December gains of 0.9 percent and 1.1
percent respectively. While the overall numbers do indeed indicate a drop in production,
the number is somewhat misleading.
• Manufacturing output was up 0.7 percent during January while utilities fell by a record
10.1 percent in one month.
• The precipitous utility decline was a result of the mild weather.
• Mining output was 1.7 percent higher than the previous month.
• Most analysts believe that last month’s drop does
not truly reflect the level of output.
Industrial production has been on an upward trend for the
past year. The one big exception during September 2005
can be traced to the production disruptions following the
Hurricane’s hitting the Gulf Coast. The remainder of that
time period it appears that industrial production has
remained strong and the growth trend may even be
escalating when you factor in the drag created by utilities
due to the mild January weather.
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
Economists divide GDP into four broad categories, each corresponding to different
types of purchases represented in GDP:
1 Consumption expenditures: purchases by consumers
2 Private investment expenditures: purchases by firms
3 Government purchases: purchases by federal, state, and local governments
4 Net exports: net purchases by the foreign sector (domestic exports minus domestic
imports)
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
CONSUMPTION EXPENDITURES
• consumption expenditures
Purchases of newly produced goods
and services by households.
PRIVATE INVESTMENT EXPENDITURES
• private investment expenditures
Purchases of newly produced goods
and services by firms.
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5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
PRIVATE INVESTMENT EXPENDITURES
Private investment expenditures in GDP consist of three components:
1 First, there is spending on new plants and equipment during the year.
2 Second, newly produced housing is included in investment spending.
3 Finally, if firms add to their stock of inventories the increase in inventories during
the current year is included in GDP.
• gross investment
Total new investment expenditures.
• depreciation
Reduction in the value of capital goods over a one-year period
due to physical wear and tear and also to obsolescence; also
called capital consumption allowance.
• net investment
Gross investment minus depreciation.
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5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
GOVERNMENT PURCHASES
• government purchases
Purchases of newly produced goods and
services by local, state, and federal
governments.
• transfer payments
Payments from governments to individuals
that do not correspond to the production of
goods and services.
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5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
NET EXPORTS
• import
A good produced in a foreign country
and purchased by residents of the
home country (for example, the United
States).
• export
A good produced in the home country
(for example, the United States) and
sold in another country.
• net exports
Exports minus imports.
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
The Components of GDP
NET EXPORTS
• trade deficit
The excess of imports
over exports.
• trade surplus
The excess of exports
over imports.
FIGURE 5.3
U.S. Trade Balance as a
Share of GDP,
1960–2005
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chapter
5.2
THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
GROSS DOMESTIC PRODUCT
Putting It All Together: The GDP Equation
Y = C + I + G + NX
Y = GDP
C = Consumption
I = Investment
G = Government purchases
NX = net exports
GDP = consumption + investment + government purchases + net exports
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5.3
THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY
USING NATIONAL INCOME
• national income
The total income earned by a nation’s
residents both domestically and abroad in
the production of goods and services.
Measuring National Income
• gross national product
GDP plus net income earned abroad.
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5.3
THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY
USING NATIONAL INCOME
Measuring National Income
• personal income
Income, including transfer
payments, received by
households.
• personal disposable income
Personal income that households
retain after paying taxes.
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5.3
THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY
USING NATIONAL INCOME
Measuring National Income Through Value Added
• value added
The sum of all the income—wages, interest, profits,
and rent—generated by an organization. For a firm,
we can measure value added by the dollar value of
the firm’s sales minus the dollar value of the goods
and services purchased from other firms.
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chapter
5.3
THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY
USING NATIONAL INCOME
An Expanded Circular Flow
FIGURE 5.4
The Circular Flow with Government
and the Foreign Sector
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USING VALUE ADDED TO MEASURE THE TRUE SIZE
OF WAL-MART
APPLYING THE CONCEPTS #1: How can we use economic
analysis to compare the size of a major corporation
to a country?
During 2004, Wal-Mart’s sales were approximately $285 billion, nearly
2.4 percent of U.S. GDP. Some social commentators might want to measure
the impact of Wal-Mart just through its sales. But to produce those
sales, Wal-Mart had to buy goods from many other companies.
• Based on Wal-Mart’s annual reports, its cost of sales was $219 billion,
leaving approximately $66 billion in value added.
• If we used Wal-Mart’s sales to compare it to a country, it would have a
GDP similar to Indonesia, which is ranked 23rd in the world.
• However, using the more appropriate measure of value added, WalMart’s size is closer to the Ukraine, which is ranked 53rd in the world.
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chapter
5.4
A CLOSER EXAMINATION OF NOMINAL
AND REAL GDP
Measuring Real Versus Nominal GDP
FIGURE 5.5
U.S. Nominal and Real GDP,
1950–2005
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chapter
5.4
A CLOSER EXAMINATION OF NOMINAL
AND REAL GDP
How to Use the GDP Deflator
• GDP deflator
An index that measures how the prices of
goods and services included in GDP change
over time.
• chain-weighted index
A method for calculating changes in prices
that uses an average of base years from
neighboring years.
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5.5
FLUCTUATIONS IN GDP
FIGURE 5.6
The 1990 Recession
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5.5
FLUCTUATIONS IN GDP
• recession
Commonly defined as six consecutive
months of declining real GDP.
• peak
The date at which a recession starts.
• trough
The date at which output stops falling
in a recession.
• expansion
The period after a trough in the
business cycle during which the
economy recovers.
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Extra Application 6
THE U.S. ECONOMY SLOWS BUT DOESN'T SHRINK
The primary components of GDP are consumption, government spending, business
investment, and net exports. Consumer spending is critical to continued growth hence
the reason that consumer confidence is such a closely watched statistic.
• The most recent numbers indicate that the U.S. economy has slowed to an annual
growth rate of 1.6%.
• While that rate is the slowest rate in the past three years it still does not spell
economic doom.
• Slowing growth is not all bad since it tends to dampen upward price movements
or inflation.
• While slowing growth as measured by the change in gross domestic product (GDP)
can be good, it also positions the economy to be susceptive to negative shocks such
as additional weakness in consumer spending.
• Consumer spending typically accounts for about 70% of the total economy so
slowing growth could make consumers more cautious and cause them to slow
down on spending.
• The reduction in consumer spending could make negative growth (a recession) a
self-fulfilling prophecy.
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5.5
FLUCTUATIONS IN GDP
• depression
The common name for a severe recession.
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THE NBER AND THE 2001 RECESSION
APPLYING THE CONCEPTS #2: How do we
determine when a recession has occurred in the
United States?
Although the level of GDP is an extremely important indicator,
the NBER committee also examines a full range of other data.
This examination takes time, which is why the NBER often
announces the beginning and end of a recession many
months later.
• Example: On November 26, 2001, the NBER announced
that the peak of the 2001 recession occurred in March
2001.
• Nearly two years later, on July 17, 2003, they dated the
trough as occurring in November 2001.
• Although the common definition of a recession is a six-month consecutive period of
negative economic growth, the NBER defines a recession as a “significant decline in
activity spread across the economy, lasting more than a few months, visible in industrial
production, employment, real income, and wholesale-retail trade.”
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5.6
GDP AS A MEASURE OF WELFARE
Shortcomings of GDP as a Measure of Welfare
HOUSEWORK AND CHILDCARE
LEISURE
UNDERGROUND ECONOMY
POLLUTION
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THE LINKS BETWEEN SELF-REPORTED HAPPINESS AND GDP
APPLYING THE CONCEPTS #3: Do increases in gross domestic
product necessarily translate into improvements in the welfare
of citizens?
Both the US and the UK have experienced very large increases in
per capita income over the last 30 years. But, reported levels of happiness have actually
declined in the United States and remained relatively flat in the United Kingdom.
Could it be the increased stress of everyday life has taken its toll on our happiness
despite the increase in income?
Trends in the relative happiness of different groups in our society:
• Whites report higher levels of happiness than African Americans, but the
gap between African Americans and whites has decreased over the last
30 years.
• Men’s happiness has risen relative to that of women.
• Reported happiness appears to peak at age 40.
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chain-weighted index
consumption expenditures
depreciation
depression
economic growth
expansion
export
GDP deflator
government purchases
gross domestic product
(GDP)
gross investment
gross national product
(GNP)
personal disposable income
import
private investment
expenditures
inflation
real GDP
intermediate goods
recession
macroeconomics
trade deficit
national income
trade surplus
net exports
transfer payments
net investment
trough
nominal GDP
value added
peak
personal income
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