2 How Do You Measure an Economy? 2010 headline: “China Passes Japan as Second-Largest Economy.”How can you compare the sizes of two economies when they produce different things?By comparing the value of their production.GDP (gross domestic product) is the most important and common way to estimate an economy’s size.If someone asks you, “How is the economy doing?”, your answer should be based on GDP Growth. America has the largest GDP in the world, estimated at about $17 trillion. China passed Japan to become #2. Is China close to surpassing the United States to become the #1 biggest economy in the world? Not even close, China’s GDP is currently estimated to be approximately $9 trillion.Copyright 2013 Worth Publishers
3 National Income Accounting The national income and product accounts (NIPA)measure our nation’s economic performancecompare American income and output to that of other nationstrack the economy’s condition throughout the business cycleThe National Income and Product Accounts keeps track of the flows of money between different sectors of the economy.
4 An Expanded Circular-Flow Diagram Government purchases of goods and servicesGovernment borrowingTaxesGovernment transfersConsumer spendingPrivate savingsWages, profit,interest, rentMarkets for goods and servicesFinancial marketsFactor marketsWages, profit, interest, rentA circular flow of funds connects the four sectors of the economy—households, firms, government, and the rest of the world—via three types of markets: the factor markets, the markets for goods and services, and the financial markets. Funds flow from firms to households in the form of wages, profit, interest, and rent through the factor markets. After paying taxes to the government and receiving government transfers, households allocate the remaining income— disposable income—to private savings and consumer spending.Please point out that imports are a LEAKAGE to our Circular Flow Model. It is a leakage because US Dollars leave the Country.Borrowing and stock issues by firmsGDPInvestment spendingForeign borrowing and sales of stockExportsImportsForeign lending and purchases of stock
5 The National AccountsHouseholds earn income from various sources. Stock: a share in the ownership of a company held by a shareholder. These stocks can pay dividends (shares of profit). Bond: borrowing in the form of an IOU that pays interest. Government transfer: payment by the government to individuals for which no good or service is provided in return (Social Security). Disposable income: total household income minus taxes; available to spend on consumption or to save.Be sure to understand: A Stock represents ownership in a company. A Bond does not. Anyone can purchase a share of stock in a publicly traded company. You don’t even need a broker. Anyone 18 years or older can go online, open an account at any online brokerage, and begin buying stock by themselves! It is important to understand stocks are riskier than bonds. You can lose your investment in a stock, whereas, AAA bonds are more secure.
6 The National AccountsHouseholds don’t spend all of their disposable income. Some of it is saved in the financial markets. Private savings: disposable income minus consumer spending (disposable income that is not spent on consumption). Financial markets: the banking, stock, and bond markets, which channel private savings and foreign lending into investment spending, government borrowing, and foreign borrowing.
7 The National AccountsThe government spends and borrows for various reasons. Government borrowing: the total amount of funds borrowed by federal, state, and local governments in the financial markets. Government purchases of goods and services: total expenditures on goods and services by federal, state, and local governments.Many students were able to identify that the United States is currently running a budget deficit. It is important to understand that the government almost always operates with a budget deficit. Many economists point to our large National Debt, which is now about $17 trillion (Yes I said TRILLION). That equates to about 100% of our GDP, which is a sign that our debt is too large. Students should understand that the proper way to measure our debt is as a percentage of GDP. The highest our debt has ever been was in the early 1940’s, when it equaled 112% of GDP.
8 Copyright 2013 Worth Publishers The National AccountsExports: goods and services sold to other countries. Imports: goods and services purchased from other countries.The United States has almost always had a trade deficit, which means we import way more than we export. In 2012, our trade deficit was $539 billion. When we import more than we export, it actually causes a reduction to our total GDP.Copyright 2013 Worth Publishers
9 What Is GDP?Gross domestic product (GDP): the market value of all final goods and services produced within a country in a year.It is important to understand that GDP is the total of all goods and services PRODUCED in a year, not sold in the year. Whatever is produced, but not sold, goes into the inventories account, which still adds to GDP.
10 Copyright 2013 Worth Publishers The National AccountsFinal goods and services: goods and services sold to the final, or end, user. Intermediate goods and services: goods and services (bought from one firm by another firm) that are inputs for production of final goods and services.GDP is the total of all FINAL goods produced. We do not include intermediate goods sold to companies who then use those goods to make the final product. For example, if a glass company sells a windshield to a car manufacturer, it would not go into GDP. But once the final car is produced, the value of the windshield would be included in the total value of the car.Copyright 2013 Worth Publishers
11 What Is GDP? …Produced… GDP measures production. Sale of used goods: NOT included.The sale of financial assets, such as stocks and bonds, are not included.Also make the point that the sale of used goods does not go into the calculation of GDP. Also, the sale of Financial Assets are not included in GDP. All of Wall Streets gains are important to American Households, but are not part of GDP.This building’s value was counted when it was built.
12 What is GDP? …Within a Country… Only production that takes place within the borders of a country is included in GDP.Examples:Cars produced in Mexico by American firms: NOT included in the U.S. GDP.Cars produced in the U.S. by Japanese firms ARE included in the U.S. GDP.
13 Both are included in U.S. GDP. Neither is included in U.S. GDP. Are the following included in U.S. GDP? (1) The price paid by a German tourist when staying at a New York hotel. (2) The price paid by an American tourist when staying at a Berlin hotel.Both are included in U.S. GDP.Neither is included in U.S. GDP.Only the price paid by a German tourist when staying at a New York hotel is included in U.S. GDP.Only the price paid by an American tourist when staying at a Berlin hotel is included U.S. GDP.The answer is C.To NextActive Learning
14 What Is GDP? …in a year. GDP is like annual income: it measures a rate of production during a given period.For the current quarter’s GDP data, visit the U.S. Bureau of Economic Analysis here.GDP is the same thing As National Income.
15 Copyright 2013 Worth Publishers GDP: WHAT’S IN AND WHAT’S OUTIncludedDomestically produced final goods and services, including capital goods, new construction of structures, and changes to inventoriesNot IncludedIntermediate goods and servicesInputsUsed goodsFinancial assets, such as stocks and bondsGoods and services produced outside this countryCopyright 2013 Worth Publishers
16 Calculating Gross Domestic Product GDP can be calculated in an equation:Add up all spending on domestically produced final goods and services. This results in the equation GDP = C + I + G + X – IMwhere C = consumer spending, I = investment spending, G = government purchases of goods and services, X = sales to foreigners, and IM = imports (purchases here of foreign goods… or income that has leaked across national borders).This equation is absolutely paramount for the students to memorize. GDP = C + I + G+ (X-M). C is consumer spending and equates to about 70% of GDP. I is investment spending by companies, (Not Investment in Stocks and Bonds, investment in machinery and trucks and the resources used to make things) and makes up about 15% of GDP. G is government spending and equates to about 17% of GDP. Notice we are already at 102%, but when you factor in the effects of our trade deficit, (Exports minus Imports = negative 2%) we are able to arrive at 100%.
17 Copyright 2013 Worth Publishers Suppose country A sells $100 million worth of goods and services to country B. Country B sells $50 million worth of goods and services to country A. These are the only two countries in macro world. Net exports in country:B equal −$50 million.A equal $150 million.A equal -$150 million.B equal $50 million.The answer is A.To NextActive LearningCopyright 2013 Worth Publishers
18 Copyright 2013 Worth Publishers Income spent on imported goods:represents income that has leaked across national borders.must be subtracted from spending data to calculate an accurate value for domestic production.is income that is not spent on domestically produced goods and services.Answers (a), (b), and (c) are all correct.The answer is D.To NextActive LearningCopyright 2013 Worth Publishers
19 Spending = IncomeIt doesn’t matter HOW we measure the production, since one person’s spending is another’s income.$10 for a shave? Barber’s income of $10 = customer’s spending of $10.
20 Real GDP: A Measure of Aggregate Output We need to be able track the quantity of total output over time. Real GDP: the total value of the final goods and services produced in the economy during a given year, calculated using the prices of a selected base year. Nominal GDP: the value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced.Nominal GDP means the dollar value of goods using today’s prices. Real GDP means that Nominal GDP has been multiplied by a price index, so that you can compare the prices of goods today with the prices of goods historically. For example: A soda pop used to cost about 5 cents in the 1950’s, but costs about $1 today. Those are nominal dollars, to make a better comparison of prices, you would need to convert the nominal prices to real prices. Economists always prefer to talk about GDP in terms of Real GDP.
21 Copyright 2013 Worth Publishers Real-Life Real GDPNominal versus real GDP in 1995, 2005, and 2010Using Nominal GDP, it looks like GDP has been growing extremely well (95%). But if you use Real GDP, it has only grown 44%, which is still good. Please make sure students can calculate growth rates. The formula is [(X1 – X0) / X0 ] * 100. The 2010 value would be (X1) and the 1995 value would be(X0). So, [( )/7415] * 100 = 95% .Copyright 2013 Worth Publishers
22 GDP and the Meaning of Life Rich is better. Money matters less as you grow richer. Money isn’t everything.People’s quality of life increases dramatically as GDP grows. But after a certain point, money doesn’t improve a populations well being that much.Source: Gallup; World Bank.
23 Price Indexes and the Aggregate Price Level Aggregate price level: a measure of the overall level of prices in the economy. To measure the aggregate price level, economists calculate the cost of purchasing a market basket. Market basket: a hypothetical set of consumer purchases of goods and services.A market basket of goods includes the items that most American’s need to survive. Each year, economists go out and buy everything in that market basket. They then compare how much it cost to buy everything in the basket to last years cost. The difference in price would be how we construct the Consumer Price Index which is the best measure of inflation.