1. Chapter 21 Tracking the U.S. Economy © 2009 South-Western/ Cengage Learning

2. The Product of a Nation 17 th and 18 th century – Mercantilism Economic prosperity: stock of precious metals 1758 – Circular flow of output and income National income accounting system 2

3. National Income Accounts GDP – Market value – All final goods and services – Produced during a year – By resources located in US One person’s spending – Another person’s income 3

4. National Income Accounts Expenditure approach – Spending on all final goods and services Income approach – Earnings by those who produce all output Final goods and services Intermediate goods and services – Additional processing – Resale 4

5. GDP: Expenditure Approach Consumption, C – Personal consumption expenditures – Households Services Nondurable goods Durable goods – 2/3 rds of GDP 5

6. GDP: Expenditure Approach Investment, I – Gross private domestic investment New capital goods – Physical capital – New residential construction Net additions to inventories – Current production not used for current consumption – Inventories » Goods in process » Finished goods – 1/6 th of GDP 6

7. GDP: Expenditure Approach Government purchases, G – Government consumption and gross investment Goods and services Not included: – Transfer payments – 1/5 th of GDP 7

8. GDP: Expenditure Approach Net exports, X-M – Exports (X) minus imports (M) Physical items Invisibles (intangibles) – Negative Imports > Exports – 2% of GDP for last decade – 5-6% of GDP recently C+I+G+(X-M)=Aggregate expenditure=GDP 8

9. GDP: Income Approach Aggregate income – Sum of income from production Earned by resource suppliers – Wages – Interest – Rent – Profit Aggregate expenditure = GDP = Aggregate income 9

10. GDP: Income Approach Avoid double counting – Market value of final good, OR – Sum of value added Each stage of production Value added – Selling price minus payments for inputs – Income earned 10

11. Exhibit 1 Computation of value added for a new desk 11 Stage of Production (1) Sale Value (2) Cost of Intermediate Goods (3) Value Added Logger Miller Manufacturer Retailer $20 50 120 200 - $20 50 120 $20 30 70 80 Market value of final good$200 The value added at each stage of production is the sale price at that stage minus the cost of intermediate goods, or column (1) minus column (2). The value added at each stage sum to the market value of the final good.

12. Circular Flow: Income and Expenditure Assumptions Capital – doesn’t wear out Firms – pay out all profits Income flow – GDP = Aggregate income – Net taxes, NT Taxes - Transfer payments – Disposable income, DI DI = GDP - NT GDP=DI+NT 12

13. Exhibit 2 Circular flow of income and expenditure 13 1: GDP=aggregate income 2: Taxes leak 3: Transfer payments enter Net taxes: NT = taxes – transfers 4: Disposable income flows to households DI = aggregate income – NT 5: Households spend or save DI Consumption enters Savings leak 6: Investment enter 7: Government purchases enter 8: Imports leak 9: Exports enter 10: Consumption + Investment + Government purchases + Net export = Aggregate expenditure

14. Circular Flow: Income and Expenditure Expenditure flow – DI = C + S Consumption, C Savings, S – to financial markets – Investments, I (borrowed) Firms – on capital Households – residential construction – Government spending, G – Net exports = X-M C+I+G+(X-M) = GDP 14

15. Leakages = Injections C+I+G+(X-M)=DI+NT C+I+G+(X-M)=C+S+NT I+G+X=S+NT+M Injections – I, G, X Leakages – S, NT, M 15

16. Limitations: National Income Accounting Some production – not included in GDP Do-it-yourself production Underground economy Leisure, quality, and variety Net domestic product GDP minus depreciation Net investment = I - depreciation GDP – doesn’t reflect all costs Negative externalities Depletion of natural resources 16

17. Accounting for Price Changes Nominal GDP – Prices in same year Price index – In base year = 100 – (Price in current year / Price in base year)*100 17

18. Exhibit 3 Hypothetical example of a price index, base year 2006 18 Year (1) Price of Bread in Current Year (2) Price of Bread in Base Year (3) Price index =(1)/(2)×100 2006 2007 2008 $1.25 1.30 1.40 $1.25 1.25 100 104 112 The price index equals the price in the current year divided by the price in the base year, all multiplied by 100.

19. Accounting for Price Changes Consumer price index, CPI – Market basket – (Cost of basket in current year / Cost in base year)*100 – Overstates inflation, 1% per year Quality bias Substitution Discount stores Widely used products 19

20. Exhibit 4 Hypothetical market basket used to develop the consumer price index 20 Product (1) Quantity in market basket (2) Prices in base year (3) Cost of Basket in base year =(1)×(2) (4) Prices in current year (5) Cost of Basket in current year =(1)×(4) Twinkies Fuel oil Cable TV 365 packages 500 gallons 12 months $0.89/package 1.00/gallon 30.00/month $324.85 500.00 360.00 $0.79 1.50 30.00 $288.35 750.00 360.00 $1,184.85$1,398.35 The cost of a market basket in the current year, shown at the bottom of column (5), sums the quantities of each item in the basket, shown in column (1), times the price of each item in the current year, shown in column (4)

21. Accounting for Price Changes GDP price index – Production – (Nominal GDP/Real GDP)*100 – Before 1995 Fixed-weighted system; base year 1987 – Chain-weighted system; base year 2000 21

22. Exhibit 5 US gross domestic product in nominal dollars and chained (2000) dollars 22

23. National Income Accounts National income –Earned by American-owned resources Personal income –Received by individuals Disposable income –Personal income minus taxes –Spend or save 23

24. Exhibit 6 Deriving net domestic product and national income in 2006 (in trillions of dollars) 24 Gross domestic product (GDP) Minus depreciation Net domestic product Plus net earnings of American resources abroad National income $13.19 -1.61 11.58 + 0.08 $11.66

25. Exhibit 7 Deriving personal income and disposable income in 2006 (in trillions of dollars) 25 National income Income received but not earned minus income earned but not received Personal income Minus personal taxes and nontax charges Disposable income $11.66 -0.68 10.98 -1.35 $9.63

26. National Income Accounts Employee compensation Proprietors’ income Corporate profits Net interest Rental income of persons 26

27. Exhibit 8 Expenditure and income statement for the US economy in 2006 (in trillions of dollars) 27 Aggregate Expenditure Consumption (C) Gross investment (I) Government purchases (G) Net exports (X-M) GDP $9.22 2.21 2.52 -0.76 $13.19 cc Aggregate Income Depreciation Net taxes on production Compensation of employees Proprietors’ income Corporate profits Net interest Rental income of persons GDP $1.61 0.92 7.45 1.01 1.55 0.60 0.05 $13.19