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Tracking the U.S. Economy

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1 Tracking the U.S. Economy
National Income Accounting Expenditure approach to GDP Income approach to GDP Circular flow of income and expenditure Leakages and injections Limitations of GDP

2 National income accounting (NIA) is the measurement of aggregate or total economic activity.
NIA is useful for assessing the performance of the macroeconomy. NIA is also helpful in evaluating the effectiveness of policy initiatives such as the Bush tax cuts.

3 “One person’s spending is another person’s income”
Every dime I spend for new goods and services must be received as income (wages, salaries, rent, interest, or profit) by resource owners.

4 Aggregate spending for new, final goods and services = GDP = Aggregate income received by resource owners (national Income) Expenditure approach to GDP: Add together all spending on new, final goods and services produced within the nation’s borders in a year. Income approach: Add all earnings from all resources used to produce output within the nation’s borders in a year.

5 Expenditure approach GDP = C + I + G + (X – M) Where,
C is personal consumption expenditure; I is gross private domestic investment; G is government expenditure (local, state, and federal) X is exports, and; M is imports

6 Gross Domestic Product (GDP)
The market value of all final goods and services and services produced during a year by resources located within the country, regardless of who owns the resources. Final goods and services are sold to final, or end, users. For example, tires purchased by a consumer are final goods. Tires purchased by Ford Motor are intermediate goods. Production in a Toyota Plant in Kentucky is counted in U.S. GDP. Production in a Ford Plant in Mexico is counted in Mexican GDP.

7 Consumption Household spending for newly-produced goods and services is defined as consumption. We distinguish between 3 categories or types: Spending for consumer durables Spending for consumer nondurables Spending for consumer services.

8 Consumer Spending by Type, 2007 (in billions)
Total spending by U.S. households in 2007 was a $9.9 trillion Source: Bureau of Economic Analysis


10 Gross private domestic investment (I)
Business spending for newly built equipment, software , and structures. Net additions to business inventories of raw materials , semifinished goods, and finished goods. New residential housing construction.

11 Investment does NOT include
The purchase of stocks, bonds, or other financial assets. Secondhand sales Remember that investment only happens when there is production of new tangible capital goods




15 Government Expenditures
All expenditures for newly produced, final goods and services by all levels of government. For purposes of computing GDP, G DOES NOT include transfer payments such as social security or food stamps.

16 Net Exports (X – M) We subtract imports from GDP since we do not want to count foreign output in domestic GDP

17 Net Exports (NX) of the U.S. (Monthly)

18 MEASURING U.S. GDP The Expenditure Approach
You might like to tell your students that measuring real GDP is actually very cheap. The BEA (in the Department of Commerce) employs fewer than 500 economists, accountants, statisticians, and IT specialists at an annual cost of less that $70 million. It costs each American less than 0.25¢ (a quarter of a cent) to measure the value of the nation’s production. For some further perspective, the National Oceanic and Atmospheric Administration (also in the Department of Commerce), whose mission is to “describe and predict changes in the Earth’s environment, and conserve and manage wisely the nation’s coastal and marine resources so as to ensure sustainable economic opportunities,” employs more than 11,000 scientists and support personnel at an annual cost of $3.2 billion!

19 Value-added At each stage of production, the selling price of a product minus the cost of intermediate goods purchased from other firms. Value-added is equivalent to the factor income earned by resource owners at a particular stage of production (like oil drilling).

20 Computation of value added for a new desk
Stage of Production (1) Sale Value (2) Cost of Intermediate Goods (3) Added Logger Miller Manufacturer Retailer $20 50 120 200 - 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.

21 The Income Approach The NIA divides earned income into 2 categories:
Wages or compensation of employees: Includes wages and salaries plus fringe benefits—such as health insurance, pension, and social security contributions. Interest, Rent, and Profit or the net operating surplus: the sum of the incomes earned by capital, land, and entrepreneurship.

22 Interest, Rent, and Profit
Interest is the income households receive on loans they make minus the interest they pay on their borrowing. Rent includes payments for the use of land and other rented inputs. Profit includes the profits of corporations and small businesses.

23 Net Domestic Product at Factor Cost: The sum of factor payments—wages, interest, rent and profits.
We must make two adjustments to get from net domestic product at factor cost to GDP From factor cost to market price; From gross to net.

24 From Factor Cost to Market Price
The expenditure approach values goods at market prices; the income approach values them at factor cost. Indirect taxes (such as sales taxes) make market prices exceed factor cost. Subsidies (payments by government to firms) make factor cost exceed market prices. To convert the value at factor cost to the value at market prices, we must: Add indirect taxes and subtract subsidies

25 From Gross to Net The expenditure approach measures gross product; the income approach measures net product. Gross profit is a firm’s profit before subtracting the depreciation of capital. Net profit is a firm’s profit after subtracting the depreciation of capital. Depreciation is the decrease in the value of capital that results from its use and from obsolescence.

26 MEASURING U.S. GDP: The Income Approach


28 Disposable Income (DI) and Net Taxes (NT)
Disposable income (DI) is the income households have available to spend or save after paying taxes and receiving transfer payments. Net taxes (NT) are tax payments minus transfer payments received Note that: GDP = DI + NT and: DI = C + S

29 Leakages and Injections
Leakages are any diversion from the domestic spending stream; includes saving, taxes, and imports. Injections are expenditure in domestic goods markets by spending agents other than domestic households; includes investment, government expenditure, and exports.

30 Leakages Equal Injections
National Income accounting identities: C + I + G + (X – M) = DI + NT (1) DI = C + S (2) Substitute (2) into (1) to obtain: C + I + G + (X – M) = C + S + NT (3) Canceling out C’s and adding M to both sides: I + G + X = C + S + M (4)

31 Circular flow of income and expenditure
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

32 Expenditure and income statement for the US economy in 2006 (in trillions of dollars)
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 $1.61 0.92 7.45 1.01 1.55 0.60 0.05

33 Deriving net domestic product and national income in 2006 (in trillions of dollars)
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

34 Deriving personal income and disposable income in 2006 (in trillions of dollars)
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

35 Limitations of (real) GDP as a measure of the standard of living
Household (non-market) production The underground economy Leisure time Environment quality

36 Economist Quality of Life Index
The Economist Index weighs the following factors Income Health Freedom Unemployment Family life Climate, Political stability and security Gender equality Family and community life

37 Country/Rank1 Index Ireland/1 8.33 Norway/3 8.05 Australia/6 7.93
Index ranges from 1 to 10. Source: The Economist Country/Rank1 Index Ireland/1 8.33 Norway/3 8.05 Australia/6 7.93 Italy/8 7.81 Spain/10 7.73 USA/13 7.62 Japan/17 7.39 France/25 7.08 Mexico/32 6.77 China/60 6.08 Indonesia/71 5.81 Russia/105 4.80 1 Out of 111 countries rated

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