Presentation on theme: "Measuring the Economy’s Performance"— Presentation transcript:
1 Measuring the Economy’s Performance Chapter 8Measuring the Economy’s Performance
2 IntroductionDoes a general increase in the level of a nation’s economic activity and the resulting rise in the capability of a person to buy more goods and services tend to make that person happier?To answer this question, economists have to measure not only the level of “happiness” but also the level of the country’s economic activityThis chapter will help you understand the measurement of a nation’s overall economic performance.
3 Learning Objectives Describe the circular flow of income and output Define gross domestic product (GDP)Understand the limitations of using GDP as a measure of national welfare
4 Learning Objectives (cont'd) Explain the expenditure approach to tabulating GDPExplain the income approach to computing GDPDistinguish between nominal GDP and real GDP
5 Chapter Outline The Simple Circular Flow National Income Accounting Two Main Methods of Measuring GDPOther Components of National Income AccountingDistinguishing Between Nominal and Real ValuesComparing GDP Throughout the World
6 Did You Know That ...U.S. economic activity declined by a greater percentage during the first 18 months of the Great Recession of the late 2000s than during any other 18-month period since World War II?To measure the nation’s overall economic performance, the government utilizes the concept of national income accounting.
7 The Simple Circular Flow The concept of the circular flow of income involves two principles:In every economic exchange, the seller receives exactly the same amount that the buyer spendsGoods and services flow in one direction and money payments flow in the other
8 The Simple Circular Flow (cont'd) Profits explainedQuestionWhy is profit a cost of production?AnswerProfits are the return entrepreneurs receive for the risk they incur when organizing productive activities
9 Figure 8-1 The Circular Flow of Income and Product
10 The Simple Circular Flow (cont'd) Product MarketsTransactions in which households buy goodsFactor MarketsTransactions in which businesses buy resources
11 The Simple Circular Flow (cont'd) Total IncomeThe yearly amount earned by the nation’s resources (factors of production)Includes wages, rent, interest payments, and profits received by workers, landowners, capital owners, and entrepreneurs, respectively
12 The Simple Circular Flow (cont'd) Final Goods and ServicesGoods and services that are at their final stage of production and will not be transformed into yet other goods or services
13 The Simple Circular Flow (cont'd) QuestionWhy must the dollar value of total output equal total income?AnswerEvery transaction simultaneously involves an expenditure and a business receipt
14 National Income Accounting A measurement system used to estimate national income and its componentsGross Domestic Product (GDP)The total market value of all final goods and services produced by factors of production located within a nation’s borders
15 National Income Accounting (cont'd) ObservationsGDP measures the dollar value of final outputGDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders
16 National Income Accounting (cont'd) Stress on final outputWhat is a final good?Wheat?Steel?Crude oil?Bread?Automobile?Gasoline?
17 National Income Accounting (cont'd) Intermediate GoodsGoods used up entirely in the production of final goodsValue AddedThe dollar value of an industry’s sales minus the value of intermediate goods (for example, raw materials and parts) used in production
18 Table 8-1 Sales Value and Value Added at Each Stage of Donut Production
19 National Income Accounting (cont'd) Numerous transactions occur that have nothing to do with final goods and services being produced:Financial transactionsTransfer of secondhand goodsOthers excluded transactions
20 National Income Accounting (cont'd) Financial transactionsSecuritiesStocks and bondsGovernment transfer paymentsSocial SecurityUnemployment compensationPrivate transfer paymentsIndividual giftsCorporate gifts
21 National Income Accounting (cont'd) Transfer of secondhand goodsWhy not count the sale of a used computer, guitar, or snowboard as part of GDP?Other excluded transactionsHousehold productionLegal and illegal underground transactions
22 National Income Accounting (cont'd) GDP’s limitationsExcludes non-market productionIt is not necessarily a good measure of the well-being of a nation
23 National Income Accounting (cont'd) GDP:Is a measure of the value of production in terms of market prices, and an indicator of economic activityIs not a measure of a nation’s overall welfare
24 International Example: The French Government Seeks to De-emphasize GDP The president of France, Nicolas Sarkozy, endorsed a report that proposes the development of an alternative measure of economic performance.Similar to the United Nation’s Human Development Index, that alternative measure considers GDP per person along with measures of health and knowledge.
25 Two Main Methods of Measuring GDP Expenditure ApproachComputing GDP by adding up the dollar value at current market prices of all final goods and services
26 Two Main Methods of Measuring GDP (cont'd) Income ApproachMeasuring GDP by adding up all components of national income, including wages, interest, rent, and profits
27 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the expenditure approachConsumption Expenditure (C)Durable Consumer GoodsItems that last more than three years (automobiles, furniture)Nondurable Consumer GoodsGoods that are used up in three years (gasoline, food)ServicesMental or physical help
28 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the expenditure approachGross Private Domestic Investment (I)The creation of capital goods, such as factories and machines, that can yield production and hence consumption in the futureAlso includes changes in business inventories and repairs made to machines, buildings
29 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the expenditure approachGross Private Domestic Investment (I)Producer Durables or Capital GoodsLife span of more than three yearsFixed InvestmentPurchases by business of newly produced producer durables or capital goodsInventory InvestmentChanges in stocks of finished goods and goods in process, as well as changes in raw materials
30 Example: Is Failing to Include Intangibles Depressing Measured Business Fixed Investment? Some economists suggest that because investment is broadly defined as the use of current resources to expand productive capabilities, business fixed investment should also include intangible investment, such as research and employee education.Economist Leonard Nakamura has estimated that if intangible investment had been counted as part of business fixed investment, business fixed investment as a percentage of GDP would have been nearly doubled in recent years.30
31 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Expenditure ApproachGovernment Expenditures (G)State, local, and federalValued at cost
32 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Expenditure ApproachNet Exports (Foreign Expenditures)Net exports (X) = Total exports – Total imports
33 Two Main Methods of Measuring GDP (cont'd) Presenting the expenditure approachwhereC = consumption expendituresI = investment expendituresG = government expendituresX = net exportsGDP = C + I + G + X
35 Two Main Methods of Measuring GDP (cont'd) Net Domestic Product (NDP)Allowing for depreciation (capital consumption allowance)The amount that businesses would have to save in order to take care of deteriorating machines and other equipmentNDP = GDP – Depreciation
36 Two Main Methods of Measuring GDP (cont'd) Because NDP = GDP – Depreciation, andGDP = C + I + G + XNDP = C + I + G + X – DepreciationNDP = C + net I + G + Xwhere net I (net investment ) = I – DepreciationDomestic investment minus an estimate of the wear and tear on the existing capital stockThe change in the capital stock over a one-year period
37 Two Main Methods of Measuring GDP (cont’d) Deriving GDP by the Income ApproachGross Domestic Income (GDI)The sum of all income (wages, interest, rent, and profits) paid to the four factors of production
38 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Income ApproachGross Domestic Income (GDI)Wages: salaries and labor incomeRent: farms, houses, storesInterest: savings accountsProfits: sole proprietorships, partnerships, corporations
39 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Income ApproachGross domestic product equals gross domestic income plus indirect business taxes and depreciationThese last items are called non-income expense items
40 Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Income ApproachIndirect business taxesAll business taxes except the tax on corporate profitsInclude sales and business property taxes
41 Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2011 (in billions of 2005 dollars per year)
42 Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2011 (in billions of 2005 dollars per year) (cont’d)
43 Other Components of National Income Accounting National Income (NI)The total of all factor payments to resource ownersPersonal Income (PI)The amount of income that households actually receive before they pay personal income taxes
44 Other Components of National Income Accounting (cont'd) Disposable Personal Income (DPI)Personal income after personal income taxes have been paid
45 Table 8-2 Going from GDP to Disposable Income, 2011
46 Distinguishing Between Nominal and Real Values Nominal ValuesMeasurements in terms of the actual market prices at which goods are sold; expressed in current dollars, also called money valuesReal ValuesMeasurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars
47 Distinguishing Between Nominal and Real Values (cont'd) Constant DollarsDollars expressed in terms of real purchasing powerThis price-corrected GDP is the real GDP
48 Example: Correcting GDP for Price Index Changes, 2001-2011 Nominal (current) dollars GDPReal (constant) dollars GDPNominal GDPPrice index*Real GDP =x 100*Price index: measured by the GDP deflator
49 Table 8-3 Correcting GDP for Price Index Changes
51 Why Not … always use the most recent completed calendar year as the base year for computing real GDP?In principle, the government could update its base year every year.However, the government’s national income accountants typically revise the real GDP figure a number of times before settling on a final amount.Thus, the government usually waits until those accountants feel certain about the GDP measurement for a given year before establishing that year as the base year.
52 Distinguishing Between Nominal and Real Values (cont'd) Per capita real GDPReal GDP divided by total populationPer capita real GDP =Real GDPPopulation
53 Comparing GDP Throughout the World Foreign Exchange RateThe price of one currency in terms of anotherExample:$1.25 = 1 euro, or $1 = .80 eurosFrench income per capita = 28,944 eurosFrench per capita income in terms of dollars equals 28,944 euros x $1.25 = $36,180
54 Comparing GDP Throughout the World (cont'd) Purchasing Power ParityAdjustment in exchange rate conversions that takes into account differences in the true cost of living across countries
55 International Example: Purchasing Power Parity Comparisons of World Incomes The International Monetary Fund accepted the purchasing power parity approach a few years agoIt started presenting the statistics on each country’s GDP relative to others and based on the purchasing power parity relative to the dollarWhy is China’s per capita GDP higher based on purchasing power parity?
57 You Are There: Questioning China’s Official Real GDP Statistics Some economists argue that China’s government has overstated its real GDP growth rate since as electricity production has indeed declined.Paul Cavey of Macquarie Securities notes, however, that the decline in aluminum and steel production accounted for the lower electricity usage, while production of other items might have contributed to a net increase in real GDP.
58 Issues & Applications: Can More Per Capita Real GDP Buy Additional Happiness? A 1974 study by economist Richard Easterlin suggests that above a relatively low level of real GDP, further increases in real GDP do not make people happier.A recent study by Betsey Stevenson and Justin Wolfers, however, found that an increase in a person’s purchasing power by itself does not necessarily make people happier, but it enables the person to pay for activities that lead to greater satisfaction.
59 Summary Discussion of Learning Objectives The circular flow of income and outputIn every economic transaction, receipts exactly equal expendituresGoods and services flow in one direction and money payments flow in the otherGross domestic product (GDP)The total market value of a nation’s final output of goods and services produced in a year using factors of production located within its borders
60 Summary Discussion of Learning Objectives (cont'd) The limitations of using GDP as a measure of national welfareExcludes non-market transactionsDoes not measure national well-beingThe expenditure approach to tabulating GDPGDP = C + I + G + X
61 Summary Discussion of Learning Objectives (cont'd) The income approach to computing GDPThe sum of wages, rent, interest, profitsDistinguishing between nominal GDP and real GDPNominal GDP is the value of newly produced final output measured in current market prices.Real GDP adjusts nominal GDP into constant dollars by correcting for price level changes