ECO 121 Macroeconomics Lecture Four Aisha Khan Section L & M Spring 2010 Aisha Khan Section L & M Lecture Four

Recap Introduction to Growth and Instability of an economy Distribution of income in the economy Households, businesses and the government Introduction to trade and exchange rate International trade agreements

Output and National Income M&B Chapter 6 Assessing the economy’s performance

National income accounting Measures the country’s entire output performance Compiling the accounts for the economy Assess the health of the economy by comparing levels of production at regular intervals Track the long run course of the economy Formulate policies that will safeguard and improve the economy’s health

GDP Gross Domestic Product Primary monetary measure Annual total output of goods and services Also known as Aggregate Output Total market value of all final goods and services produced in a given year (includes all g&s produced by either citizen-supplied or foreign-supplied resources employed in the country)

GDP To measure accurately Avoiding multiple counting Each g&s must be counted once and only once How can we ensure this? Total market value of all final goods and services produced in a given year Intermediate goods vs final goods

Sales Value of Materials or Product Value-added example Stage of production Sales Value of Materials or Product Value Added 0 $ Firm A (sheep ranch) 120 Firm B (wool processor) 180 60 ( = 180 – 120 ) Firm C (suit manufacturer) 220 40 ( = 220 – 180 ) Firm D (clothing wholesaler) 270 50 ( = 270 – 220 ) Firm E (retail clothier) 350 80 ( = 350 – 270 ) Total Sales values 1140

GDP Excludes non-production transactions Many monetary transactions don’t necessarily result in generation of final goods Financial transactions Public transfer payments Private transfer payments Stock market transactions Second hand sales

Two ways of looking at GDP Expenditure Approach (Output approach) How the final user paid for Income Approach (Earnings or Allocation approach) Add up the entire wage, rental, interest, profit incomes that were created while producing the good or service

Expenditure Approach Add up all the spending on final g&s that has taken place throughout the year

Expenditure Approach Personal consumption expenditures ( C ) Durable, Nondurable consumer goods, spending on services Gross Private Domestic Investment ( I ) Investment  creation of new capital assets All final purchases of machinery, equipment, construction Changes in inventories Increase in inventory (stock of unconsumed output) Decrease in inventory (counted in last years GDP therefore negative investment)

Gross Private Domestic Investment ( I ) Gross investment vs net investment Net investment = gross investment - depreciation Government Purchases ( G ) Expenditure in providing public services Expenditures for social capital (highways) Net Exports ( NX )

National Income Identity Y = C + I + G + NX

Income Approach Compensation of employees Rents Interest Proprietors income Corporate profits National Income

Balancing National Income Balance national income by adding the following Consumption of fixed capital Net foreign factor income Statistical Discrepancy

Other national accounts Additional useful information Through various adjustments to GDP

Net Domestic Product Depreciation is a cost to production GDP includes depreciation NDP = GDP – depreciation(consumption of fixed capital) NDP is adjusted for depreciation

National Income Includes all income earned through the use of American-owned resources (home or abroad) NI = NDP- net foreign factor income – statistical discrepancy

Why do economists include only final goods and services in measuring GDP? Why don’t they include the value of stocks and bonds bought and sold? Why don’t they include the value of the used furniture bought and sold? Calculate GDP using the expenditure & theincome method.

Personal consumption expenditures $245 Proprietors income 33 Net foreign factor income 4 Net exports 11 Transfer payments 12 Dividends 16 Rents 14 Compensation of employees 223 Statistical discrepancy 8 Taxes on production and imports 18 Consumption of fixed capital 27 Undistributed corporate profits 21 Social security contributions 20 Personal taxes 26 Interest 13 Corporate income taxes 19 Corporate profits 56 Government purchases 72 Net private domestic investment Personal saving