MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT The Language of Macroeconomics: The National Income Accounts Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. PowerPoint by Beth Ingram University of Iowa

2-2 Key Concepts Gross Domestic Product (GDP) Gross National Income Real and Nominal Measures National Income Accounts GDP and Human Welfare

2-3 Gross Domestic Product Total market value of final goods and services produced in a country during a given period Need to know How much was produced (quantity) What the production was worth (price) Why do we need to know the price? Price provides a common unit in which to value quantities Important when you have more than one type of good

2-4 Example -- Company X Production in washers at $ dryers at $400 Production in washers at $ dryers at $450 Nominal Production = 200 x $ x $400 = $140,000 Nominal Production = 200 x $ x $450 = $165,000 Problem: dollar value of output higher, but real output the same

2-5 Nominal GDP vs. Real GDP Important Distinction Nominal GDP: measure output in current prices = py Real GDP (y): accounts for price change --- measure output in constant prices ---use prices from a base year ---is an index Difference between Nominal GDP and Real GDP is the change in prices Nominal GDP/Real GDP = GDP Deflator => tells change in prices => price index (py)/p = y

2-6 By how much has production increased between 2002 and 2005? (using 2002 as base year for prices) Production in washers at $ dryers at $400 Production in washers at $ dryers at $450 Real Production (2005) = 300 x $ x $400 = $190,000 Real Production (2002) = 200 x $ x $400 = $140,000 Growth Rate = ($190,000-$140,000)/$140,000 = 35.71%

2-7 By how much has production increased between 2002 and 2005? (using 2005 as base year for prices) Production in washers at $ dryers at $400 Production in washers at $ dryers at $450 Real Production (2005) = 300 x $ x $450 = $225,000 Real Production (2002) = 200 x $ x $450 = $165,000 Growth Rate = ($225,000-$165,000)/$165,000 = 36.36%

2-8 Chain Weighted Prices Problems with fixed prices Different growth rates dependent on which base year for price is used Fixed price assumes fixed fundamental value society places on good Chain weighting as “averaging” of prices Chain-weighted growth of 36.03%

2-9 GDP Annual Percent Growth

2-10 A Closer Look at GDP GDP = (1) total market value of (2) final goods and services produced in a (3) country during a (4) given period (1) Total market value Prices reflect value placed on good/service by society Ignores non-market economic activity (2) Final goods & services No intermediate goods…avoid double counting (3) In a country/region…domestically produced (4) Given period No used sales counted Services rendered on used sales is counted

2-11 GDP as Value-Added Measure (Bread Example) CompanyRevenues – Cost of purchased inputs = Value added ABC Grain$0.50$0.00$0.50 General Flour$1.20$0.50$0.70 Hot’n’Fresh$2.00$1.20 $0.80 Total$2.00 GDP equals final goods sold = $2.00 Or GDP equals valued added = $ $ $0.80 = $2.00

2-12 Measures of Output product (output) approach: The market value of the final goods and services produced in a country during a given period expenditure approach: how much households, firms, government, and foreigners spend on GDP Income approach: the income generated from making GDP Payments to labor and capital

2-13 Three Measures GDP are Equal ProductExpenditure Income ==

2-14 Product Approach: Sectors as a % of GDP (2001)

2-15 Income Approach Global Rule of Thumb: 70% of income goes to labor, 30% of income goes to capital U.S. example

2-16 Expenditure (Demand) Approach Consumption by individuals (C) Consumption and investment by government (G) Does not include transfer payments Investment by the private sector (I) Generally presented in two subcategories (1) Gross Capital Formation (2) Change in Inventories Net Exports (NX)…exports-imports Y = C + G + I + NX

2-17 Expenditure (Demand) Approach Expenditure approach often used to see what forms of spending are driving economic growth Calculate contributions to growth

2-18 Expenditure (Demand) Approach

2-19 Expenditure (Demand) Approach

2-20 World GDP

2-21 World GDP

2-22 GDP Per Capita

2-23 GDP and GNI GDP Output produced within a geographic location (US, Italy, etc.) GNI (Gross National Income) Also called GNP (Gross National Product) Output produced by citizens of a geographic region Value must be remitted back to country GNI = GDP + NFP (Net Factor Payments) NFP = payments to domestically owned factors (labor and capital) located abroad minus payments to foreign factors located domestically Payments: (1) net dividends, interest, rent flows abroad (2) net wage flows abroad

2-24 Example Joe Canadien, citizen of Canada, works in US and sends wages back to Canada US GDP includes Joe’s wagesCanadian GNI includes Joe’s wages

2-25 GDP: Two Questions Does GDP correctly measure production? Is GDP a good proxy for welfare?

2-26 GDP Measurement Problems Underground economic activity Illegal activities Tax avoidance Non-market transactions Homemaking Leisure Negative consequences of production pollution

2-27 Does Increased GDP = Improved Human Welfare? Indicator All developing countries GDP per person 3,5301,17025,860 (U.S. dollars) Life expectancy at birth (years) Infant mortality rate (per 1,000 live births) Under-5 mortality rate (per 1,000 live births) Doctors (per 100,000 people) Incidence of HIV/Aids (% in age group) Undernourished1838Negligible people (%) Primary enrollment rate (as % of age group) Secondary enrollment rate (as % of age group) Adult literacy rate (%) Least developed countries Industrialized countries

2-28 Does Increased GDP = Improved Human Welfare? Is more output better? Human Development Index Table from UNDP website Table Animated comparisons Animated HDI calculator HDI Note that as countries get richer, income per capita plays smaller role

2-29 Summary Need for consistent set of data Real and Nominal Variables GDP and GNI Value added = Income = Total Expenditure GDP a rough proxy for human welfare Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained therein.