Presentation on theme: "Measuring the Economy’s Performance"— Presentation transcript:
1Measuring the Economy’s Performance Chapter 8Measuring the Economy’sPerformance
2Learning 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
3Learning Objectives (cont'd) Explain the expenditure approach to tabulating GDPExplain the income approach to computing GDPDistinguish between nominal GDP and real GDP
4The 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 spends.Goods and services flow in one direction and money payments flow in the other.
5The 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.
6The 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
7Figure 8-1 The Circular Flow of Income and Product
8The Simple Circular Flow (cont'd) Product MarketsTransactions in which households buy goods
9The Simple Circular Flow (cont'd) Factor MarketsTransactions in which businesses buy resources
10The Simple Circular Flow (cont'd) Total IncomeWages, rent, interest, profits
11The Simple Circular Flow (cont'd) QuestionWhy must total income be identical to the dollar value of total output?AnswerEvery transaction simultaneously involves an expenditure and a receipt.
12National Income Accounting A measurement system used to estimate national income and its componentsTotal IncomeThe yearly amount earned by the nation’s resources (factors of production)
13National Income Accounting (cont'd) Gross Domestic Product (GDP)The total market value of all final goods and services produced by factors of production located within a nation’s borders
14National Income Accounting (cont'd) ObservationsGDP measures the dollar value of final output.GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders.
15National 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
16Table 8-1 Sales Value and Value Added at Each Stage of Donut Production
17National Income Accounting (cont'd) Numerous transactions occur that have nothing to do with final goods and services being produced:Financial transactionsTransfer PaymentsSecondhand Goods
18National Income Accounting (cont'd) Exclusion of financial transactionsSecuritiesStocks and bondsGovernment transfer paymentsSocial SecurityUnemployment compensationPrivate transfer paymentsIndividual giftsCorporate gifts
19National Income Accounting (cont'd) Transfer of secondhand goods excludedWhy not count the sale of a used computer, guitar, or snowboard as part of GDP?Other excluded transactionsHousehold productionLegal and illegal underground transactions
20National Income Accounting (cont'd) GDP’s limitationsExcludes non-market productionIt is not necessarily a good measure of the well- being of a nation.
21National Income Accounting (cont'd) GDP is a measure of the value of production in terms of market prices, and an indicator of economic activity.GDP is not a measure of a nation’s overall welfare.
22Two Main Methods of Measuring GDP Expenditure ApproachComputing GDP by adding up the dollar value at current market prices of all final goods and services
23Two Main Methods of Measuring GDP (cont'd) Expenditure Approach
24Two Main Methods of Measuring GDP (cont'd) Income ApproachMeasuring GDP by adding up all components of national income, including wages, interest, rent, and profits
25Two Main Methods of Measuring GDP (cont'd) Income Approach
26Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Expenditure ApproachConsumption Expenditure (C)Durable Consumer GoodsLife span of more than three yearsNondurable Consumer GoodsGoods that are used up in three yearsServicesMental or physical help
27Two 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 included: changes in business inventories and repairs made to machines, buildings
28Two 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
29Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Expenditure ApproachGovernment Expenditures (G)State, local, and federalValued at cost
30Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Expenditure ApproachNet Exports (Foreign Expenditures)Net exports (X) = Total exports – Total imports
31Two Main Methods of Measuring GDP (cont'd) Presenting the Expenditure ApproachWhereC = consumption expendituresI = investment expendituresG = government expendituresX = net exportsGDP = C + I + G + X
33Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Income Approach
34Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2009 (in billions of 2009 dollars per year)Sources: U.S. Department of Commerce and author’s estimates.
35Other 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
36Other Components of National Income Accounting (cont'd) Disposable Personal Income (DPI)Personal income after personal income taxes have been paid
37Distinguishing 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
38Distinguishing Between Nominal and Real Values (cont'd) Constant DollarsDollars expressed in terms of real purchasing powerThis price-corrected GDP is the real GDP.
39Example: Correcting GDP for Price Index Changes Nominal (current) dollars GDPReal (constant) dollars GDPNominal GDPPrice index*Real GDP =x 100*Price index: measured by the GDP deflator
40Table 8-3 Correcting GDP for Price Index Changes
41Distinguishing Between Nominal and Real Values (cont'd) Per capita GDPAdjusting for population growthPer capita real GDP =Real GDPPopulation
42Figure 8-4 Nominal and Real GDP Source: U.S. Department of Commerce
43Comparing GDP Throughout the World Foreign Exchange RateThe price of one currency in terms of another
44Comparing GDP Throughout the World (cont'd) Foreign exchange rate$1.50 = 1 euro, or $1 = .67 eurosFrench income per capita = 24,120 eurosFrench per capita income in terms of dollars equals 24,120 euros x $1.50 = $36,180
45Comparing GDP Throughout the World (cont'd) Purchasing Power ParityAdjustments in exchange rate conversions that takes into account differences in the true cost of living across countries
47Summary 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
48Summary 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
49Summary 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.