Economic Well Being Agec 217, Summer 2007

Economic Well Being Macroeconomics The study of the economy as a whole

Circular Flow Diagram (Mankiw) Firms sell Households buy MARKETS FOR GOODS AND SERVICES Revenue Spending Goods and services sold Goods and services bought FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Factors of production Labor, land, and capital Wages, rent, and profit Income = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western

Economic Well Being Macroeconomic Indicators Employment and Unemployment Income Wealth Inflation Stock market indices Interest rates Retirement solvency Output (GDP)

Economic Well Being

Economic Well Being Gross Domestic Product (GDP) The market value of all final goods and services produced within a country in a given period of time Final goods (intermediate goods not included) Produced within borders, by citizens or foreigners Time period: typically one year

GDP Gross Domestic Product = C + I + G + NX C  Consumption I  Investment G  Government Spending NX  Net Exports Net Exports = Exports - Imports

GDP Per capita GDP Nominal GDP Real GDP Gross Domestic Product per person in a country Nominal GDP Uses prices in the year of the measurement Real GDP Uses prices for a “base” year to enable year to year comparisons

Total in Trillions of Dollars GDP Values (US, 2001) Total in Trillions of Dollars Percent of Total Consumption (C) $7.0 69% Investment (I) $1.6 16% Government Purchases (G) $1.9 18% Net Exports (NX) -$0.3 -3% Total $10.1 100%

Historical GDP

GDP Measured Assume a diet of Pizza and Soda 2005: 500 pizza slices and 300 sodas Prices: pizza = $1.00 and soda = $0.50 2006: 550 pizza slices and 330 sodas Prices: pizza = $1.10 and soda = $1.00

GDP Measured Nominal GDP’s 2005 2006 Percent change = 44% growth 500 * $1.00 + 300 * $0.50 = $650 2006 550 * $1.10 + 330 * $1.00 = $935 Percent change = 44% growth

GDP Measured Real GDP’s (Base year = 2005) 2005 2006 500 * $1.00 + 300 * $0.50 = $650 2006 550 * $1.00 + 330 * $0.50 = $715 Percent change = 10% growth

GDP Measured GDP Deflator (measure of inflation) for base year (Inflation: the percent increase in price level) Calculation Nominal GDP / Real GDP * 100 2005 (2005 base) GDP Deflator = ($650 / $650) * 100 = 100 2006 (2005 base) GDP Deflator = ($935 / $715) * 100 = 131

GDP Measured Using the deflator Calulation 2006 Nominal GDP / GDP Deflator * 100 = Real GDP 2006 ($935 /131) * 100= $715

GDP Recession: Two quarters of declining real GDP Depression: A severe or long recession

GDP Recession: Negative % change in real GDP for two consecutive quarters % Change GDP = (Current Period GDP – Previous Period GDP) *100 -------------------------------------------------------- Previous Previous GDP

GDP rationale Real GDP per capita is a measure of income and buying power in an economy. It measures our ability to produce the items we need and desire. Recessions as measured by GDP often arrive with stock market drops beforehand and higher unemployment afterwards.

Critiques of GDP Household Income and GDP

Critiques of GDP Consumer Confidence Index (Conference Board): Is it predictive of actual conditions? 1. Current business conditions. 2. Business conditions for the next six months. 3. Current employment conditions. 4. Employment conditions for the next six months. 5. Total family income for the next six months. Frogs in water

Critiques of GDP Human Development Index Life Expectancy Education (literacy and enrollment) GDP http://en.wikipedia.org/wiki/Human_Development_Index

Critiques of GDP Human Development Index

Critiques of GDP What we spend money on is not always positive (car accident). GDP does not include how much time we spend on labor Some of production has environmental impacts, for which the costs are not always measured

Summary GDP is comparatively easy to measure and consistently used to determine a country’s overall economic health as it has links to many measures of well being. However, GDP may not capture all aspects of well being that are important to a nation’s citizens.