Chapter 7- National Income Accounting Distribution of GDP 1

Keeping Tabs on the Economy Recall: You must be able to measure and track the economy in order to understand what is going on and react appropriately. In the U.S. the Bureau of Economic Analysis compiles this data. 2

National Income Accounts The Bureau of Economic Analysis (BEA) compiles data in what we call the national income and product accounts. National Accounts: Keep track of the flow of money between different sectors of the economy. 3

National Income Accounting- a set of rules and definitions for measuring economic activity in the aggregate economy (economy as a whole) 4

GDP (Gross Domestic Product)- the total market value of all final goods/services produced in an economy in a one-year period Measures values, not quantities GDP measures only final goods- a good/service purchased by a final user Intermediate good- a good/service that is an input to another good/service GDP only includes current production 5

GNP (Gross National Product)- Aggregate final output of citizens and businesses of an economy in a one-year period. Citizens working over seas not counting in GDP Economic output produced by citizens 6

GDP: Measuring Total Production and Income Business cycle Alternating periods of economic expansion and economic recession. 7

GDP: Measuring Total Production and Income Recession The period of a business cycle during which total production and total employment are decreasing. Economic growth The ability of an economy to produce increasing quantities of goods and services. Expansion The period of a business cycle during which total production and total employment are increasing. 8

Production, Income, and the Circular Flow Diagram The Circular Flow and the Measurement of GDP 9

Gross Domestic Product Measures Total Production Transfer payments: Payments by the government to individuals for which the government does not receive a new good or service in return. Production, Income, and the Circular Flow Diagram 10

Four Components of GDP Consumption (C) Government Spending Investment International Spending 11

Households (C) Consumer Spending: Household spending on goods and services, not including spending on new houses. Most households receive the majority of their income from wages, but some receive investment income in the form of profits, interest, and rents. Consumer spending on services is greater than the sum of spending on durable and nondurable goods. 12

Households cont’d Government Transfers: Cash payments by the government to individuals. Disposable Income: Money available to spend on consumption and savings. DI = Income + Government Transfers - Taxes 13

Households cont’d Private Savings: What consumers have left of disposable income after consuming. S- private = Disposable Income - Spending The total flow of money out of households must equal the total flow of money in. 14

Government (G) Government purchases: Spending by federal, state, and local governments on goods and services. Governments, just like other institutions, purchases goods and services. Government Borrowing: If the government can’t afford it’s programs, it must turn to financial markets to borrow. Purchases made by state and local governments are greater than purchases made by the federal government. 15

Spending on Homeland Security Making the Connection Government spending on homeland security more than doubled between 2001 and 2006.

Business Investment (I) Investment: Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses. Business fixed investment is the largest component of investment Don’t Let This Happen to YOU! Remember What Economists Mean by Investment 17

International Sector (NX) Exports: Goods and services sold to residents of other countries. Imports: Goods and services purchased from other countries. Net Exports: The difference between the value of exports and the value of imports. – NX = Exports - Imports Imports are greater than exports, so net exports are negative. 18

GDP GDP=Y=C+I+G+NX GDP is used as a measure of the size of an economy and can be used to both track the economy and to compare with others. U.S. GDP 2007: $13,768.8 billion U.S. GDP 2009: $14,256 billion 19

Components of GDP in 2008 Gross Domestic Product Measures Total Production

2 Ways to Measure GDP 1. Measuring GDP by the Value-Added Method Value added : The market value a firm adds to a product. Calculating Value Added FIRMVALUE OF PRODUCTVALUE ADDED Cotton FarmerValue of raw cotton = $Value added by cotton farmer= 1 Textile Mill Value of raw cotton woven into cotton fabric = $3 Value added by cotton textile mill = ($3 – $1)= 2 Shirt Company Value of cotton fabric made into a shirt = $15 Value added by shirt manufacturer = ($15 –$3)= 12 L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35 Value added by L.L. Bean = ($35 – $15)= 20 Total Value Added= $35 21

Does GDP Measure What We Want It to Measure? Household production refers to goods and services people produce for themselves. GDP doesn’t count all forms of production. Household Production The Underground Economy Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. 22

The Underground Economy is Growing! 23

Does GDP Measure What We Want It to Measure? Shortcomings of GDP as a Measure of Well-Being The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up 24

Did World War II Bring Prosperity? Making the Connection

Real GDP versus Nominal GDP Real GDP The value of final goods and services evaluated at base-year prices. Calculating Real GDP Nominal GDP The value of final goods and services evaluated at current-year prices. 26

Real GDP versus Nominal GDP Price level A measure of the average prices of goods and services in the economy. The GDP Deflator GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by

Example 1 Nominal GDPReal GDPDeflator 1999 Level$9,274.3$8, Level$9,824.6$ % Change 28

Example 2 YearNominal GDPGDP Deflator 1998$8, $9, $9, $10, Find Real GDP in Find Real GDP in Find Real GDP in Find Real GDP in 2001 Note: (We could calculate the percentage change between each year to find how much production of goods/services change.) 29

Real GDP versus Nominal GDP Nominal GDP and Real GDP, 1990–2008

Other Measures of Total Production and Total Income Net National Product (NNP) National Income Personal Income 31