2. Four Factors of Production Labor Land Capital Payments to Factors of Production Interest Wage Rent Profit Entrepreneurship

3. Labor Land Capital Entrepreneurship Produce Goods and Services Sold Total Income Rent Wage Profit Interest Should be determined by the “free market” Capitalism Should be determined by the government Communism Should be determined by free market and the government Socialism Factors of Production How should be distributed?

4. Capitalism Economic system in which the means of production are privately owned and operated for private profit Decisions are made by private actors in a free market Not owned by Government

5. Laissez-faire: free market A market in which there is no economic intervention and regulation by the government, Except to enforce private contracts and the ownership of property.

6. Households to Goods and Services Buy U.S. goods Buy U.S. goods Interest Rent Wages Profits Firms Save Buy goods and services Borrow to buy goods Circular Flow Diagram Buys goods and services Foreign Goods Pay taxes $ $ $ $ $ $ Pay $ Pay $

7. Measuring Production Gross Domestic Product 6 Goods and Services 17T

8. Why is this number important? The more goods and services we produce, the more Income is generated and the better our ability to satisfy needs. 7 Goods and Services 17T Interest Rent Wages Profits

9. GDP Sum of expenditures on new, final goods and services produced in the U.S during the year. GDP includes ONLY NEW production GDP is NOT the sum of total sales! GDP is NOT the sum of total sales! Excludes used goods GDP = Total sales of new goods…

10. Car Manufacturer purchase new tires from tire manufacturer at $200 each Car Manufacturer purchase new windows from window manufacturer at $300 each Consumer buys new car for $16,000. GDP = Total sales of new goods…

11. 4 Windows : $1200 4 tires : $800 1 car: $16,000 $18,000 Total Sales of New Goods Include twice the value of the tires and the windows + + = Intermediate Goods GDP = Total sales of new goods… GDP excludes sales of intermediate goods to avoid double counting. Final Good

12. Intermediate Good A good (or service) that is used as an input or component in the production of another good. A good that will be further processed before sold as final good. Goods and services purchased by firms… 11 Excluded

13. Final Good A good (or service) purchased by the final user With no further transformation, use or as an input in the production of other goods. 12 Included

14. GDP Sum of expenditures on new, final goods and services produced in the U.S during the year. 13 GDP includes ONLY Final goods Excludes goods purchased by firms to produce final goods…

15. Firms purchase Capital Goods Capital good: A manufactured factor of production used to produce other goods… Examples: factories, buildings, trucks, tools, machinery, and equipment. 14 GDP excludes goods purchased by firms to produce final goods…

16. Intermediate vs. Capital Goods 15 Flour Sugar Flour Sugar Included Excluded Depreciation

17. Investment The purchase of capital goods 16 Included

18. GDP Sum of expenditures on new, final goods and services produced in the U.S during the year. 17 GDP includes goods purchased by consumsers and capital gods purchased by firms Excludes Intermediate goods purchased by firms

19. Households Firms Unsold goods are Investment Goods and Services Unsold Inventory + Consumer Purchases Purchases by other countries Investment Purchase of Capital Goods Government Purchases

20. Investment = Purchase of Equipment, tools, software. Non-residential construction: shopping malls, factories, airports. Inventories and New homes and Condominiums purchased by consumers 19

21. Households Goods and Services Save Buy goods and services Saving = purchase of paper goods Stocks, Funds Bonds, CD’s, Life Insurance Stocks, Funds Bonds, CD’s, Life Insurance

22. GDP Excludes Paper Goods GDP excludes purchases of Bonds, stocks, Certificates of Deposit.. 21

23. 22 Included

24. Excluded

25. Goods Produced by the Government are NOT sold All goods and services purchased by the government are FINAL goods. Government production is included when the government purchase the inputs necessary to produce: services of government employees, raw materials, tools, equipment. Government production is calculated at the value of the inputs used. 24 Government is the final user

26. Households U.S. Goods and Services U.S. goods Firms U.S goods U.S goods U.S goods U.S goods Foreign Goods Foreign Goods U.S goods U.S goods Foreign Goods Imports Exports Purchase of Foreign Goods (IMPORTS) should not be added as U.S. production

28. GDP does not include Non- Market Production Goods or services produced but not paid for. Cleaning, cooking, home improvement projects, child care, volunteering 27 Non Market

29. GDP does not include unreported production Goods or services produced and paid for but not reported Illegal goods and services Legal unreported goods and services 28 Underground

30. Total Production is larger than GDP 29 Underground Non Market U.S. Goods and Services

31. GDP is NOT equal to total sales GDP excludes: Sales of intermediate goods Sales of paper goods Sales of used goods Sales of illegal goods Non- market goods and services. 30

32. Limitations of GDP Excludes non-market production of goods or services –Child care, elderly care, cooking, cleaning, gardening, home projects, farming. Excludes underground production of goods or services –Illegal and legal goods and services not reported to tax authority. 31

33. Limitations of GDP continued… GDP does not ”subtract”. Deforestation. Contamination. Destruction of animal and plant life. Destruction of assets. 32 China 9T Germany 3T China 9T China 9T China 9T

34. Limitations of GDP continued… Leisure is not accounted for. USA 17T EU 17T Worked 12 months Worked 11 months

35. 34 U.S #1

36. Does this mean that the U.S. grows faster than any other country?

37. 36 2012 U.S not in the top 10! 2014

38. Does this mean Americans are the richest in terms of income per person?

39. 2013 U.S Drops from #1 to #13

40. Does it mean all Americans earn $53,000/year?

41. 40 ~Half the population make less than $50,000/year

42. 0: Perfect Equality 100: Perfect Inequality

43. GDP alone is not a good measure of wellbeing We need to know how this income is distributed. 42 Can not be used for cross country comparisons unless we add both: income distribution and population size.

44. Germany Spain France England Italy Japan GDP excludes goods and services produced by Americans outside the U.S GDP includes goods and services produced by other countries inside the U.S. Foreign Production in the US

45. U.S. Production Includes goods and services produced by U.S. companies anywhere in the world Excludes goods and services produced by other countries inside the U.S.

46. Foreign Production in the US German y Spain France England Italy Japan Add Income earned abroad Subtract Income earned by foreign companies in the U.S. From Domestic to National

47. Investment Purchase of new capital goods. Net I = Gross I – Depreciation Purchase of new capital goods minus Depreciation. Gross Investment Gross Investment Net Investment Net Investment

48. Gross Domestic Product 47 Gross Investment Includes all purchases of new capital goods Gross Domestic Product GG II

49. NET DOMESTIC PRODUCT 48 Purchases of capital goods minus Depreciation NDPNDP Net Domestic Product Gross Investment – Depreciation

50. From Gross to Net 49 Gross Domestic Product Net Domestic Product Subtract Depreciation Gross Domestic Product Net Domestic Product Add Depreciation

51. GDP We want to know quantity produced We can not add quantities produced because We can not add apples and computers and web pages… One pear is not the same as one computer: there is more value embodied in the computer… 50

52. Prices provide the best “weight” to approximate value.

53. Prices allow us to add apples and computers.

54. Calculating GDP Nominal GDP Multiply quantities purchased by the price at which they sold on that year. Example: For 2009 GDP, we use prices paid in 2009. Because we use prices of 2009 to compute GDP for 2009, we say that we used “current” prices. 53 GDP at current prices

55. REAL VERSUS NOMINAL GDP 54

56. The Sum of expenditures on all goods produced over the year

57. If prices rise… Quantities produced are the same But GDP Increased! Prices distort our view of true quantity produced

58. We have to use prices We must eliminate the effect of changing prices. 57

59. Nominal GDP: use current prices 58 12 23 34

61. The Short vs. The Long Run Time Total Production Every year we produce more than the previous year Full Employment: zero unemployment, no excess capacity Above Full employment Below Full employment At Full employment Potential GDP GDP at Full Employment

62. Three Ways of Calculating GDP The Expenditures Approach 61 C + I + G + X - M Interest + Rent + Wages + Profits The Incomes Approach

63. Value Added Approach ProducedSold it for: Value Added: Indian community owns forest tree$2 2-0=$2 Logging Company buys tree transforms into log log$10 10-2=$8 Wood Company buys logs transforms into plywood plywood$15 15-10=$5 Furniture Manufacturer buys plywood makes table table$30 30-15=$15 Macy's buys table places on showroom for display table in showroom$35 35-30=$5 Sum of Value Added $35 Sum of Value Added = Price paid by final user = $35

64. Growth Increases in GDP come from: Increases in the number of workers and/or Increases in the number of factories and/or Improvements in technology 63 Growth in GDP come from: Growth in the labor force and/or Growth in the country’s stock of capital and/or Improvements in technology Growth in GDP come from: Growth in the labor force and/or Growth in the country’s stock of capital and/or Improvements in technology

65. 64 Real GDP = Hours of work X Output per hour Real GDP = Hours of work x Labor productivity Growth rate of potential GDP = Growth rate of labor force x Growth rate of labor productivity Real GDP ~$ 14T Hours of work per year ~250 B Labor productivity ~$14T/250 B = $ 56 per hour.

66. Personal Consumption Expenditures 9,734 C Depreciation 1,687 Wages 7,874 Domestic and foreign wages Indirect Business Taxes 1,041 Rental Income 65 Domestic and foreign Rent Gross Private Domestic Investment 2,125 I Profits 2,638 Domestic and foreign Profits Exports 1,643 X Government Purchases 2,690 G Interest 603 Domestic and foreign Interest Imports 2,351 M Income received from other countries 818 Income paid to other countries 722 GDP = C + I + G + X -M 13,841 National Income = Wages + Interest+Rents+Profits+Indirect Business Taxes 12,221 Domestic and foreign Income GNP = GDP - income paid to other countries + income received from other countries 13,937 Income received by U.S. Nationals NNP = GNP - Depreciation 12,250 Should be equal Statistical Discrepancy = NNP – NI =29

67. 66 Personal Consumption Expenditures 9,734 Depreciation 1,687 Wages 8,031 Indirect Business Taxes 1,062 Rental Income 66.3 Gross Private Domestic Investment 2,168 Profits 2,691 Exports 1,676 Government Purchases 2,744 Interest 615.06 Imports 2,398 Income received from other countries 834.36 Income paid to other countries 736.44 GDP = C + I + G + X -M National Income = Wages + Interest+Rents+Profits+Indirect Business Taxes GNP = GDP - income paid to other countries + income received from other countries

68. 67 Personal Consumption Expenditures 9,734 Depreciation 1,687 Wages 8,031 Indirect Business Taxes 1,062 Rental Income 66.3 Gross Private Domestic Investment 2,168 Profits 2,691 Exports 1,676 Government Purchases 2,744 Interest 615.06 Imports 2,398 Income received from other countries 834.36 Income paid to other countries 736.44 GDP = C + I + G + X -M 14,118 National Income = Wages + Interest+Rents+Profits+Indirect Business Taxes 12,465 GNP = GDP - income paid to other countries + income received from other countries 14,216

69. A bakery’s purchases 68 Did you use it entirely into the pie? No: Capital Good Include this purchase in GDP Yes: Intermediate Good. Do not include this purchase in GDP Sugar Flour Apples Coffee Water Scotch tape Pens Notepads Scissors Shredder Phone Computer Oven

70. 1.Bullet proof vests purchased by military. 2.Bullet proof vest purchased by Security Company. 3.Leather 4.Bicycle purchased by Gym. 5.Computer 6.Newly produced goods no one purchased 7.House 8.Tools 9.Cash for clunkers 10. Computer purchased by the City of Santa Monica. 11. Coffee and pastries purchased LAPD. 12. Coffee and pastries purchased by Ford for their offices. 13. Goods manufactured in other countries. 14. The State of Florida purchase oil from Venezuela 15. Venezuela purchase corn from Iowa farmers. 69 new

71. 5. Determine if the following items are included in GDP and under what component C, I, G, X or M? a. Jane buys newly issued shares of stock in Macro.com. Inc. b. Ross buys a new pair of jeans at a local department store. c. Joey has his mustache trimmed at his hair salon. d. Rachel buys an antique chest at a resale shop. e. Phoebe grows her own herbs on her apartment balcony. f. Michael travels to France and buys French wine. g. John, a stay-at-home dad, takes care of his 4 year old twins. h. Mary sends her 3 year old to pre-school. i. Rose volunteers at a homeless shelter. j. Government pays farmers a 10 cent/pound subsidy. k. Amazon. COM buys books from a publisher. l. Mark buys a book from a publisher. m. Mitsubishi Co. builds a car in Illinois and ships it to Japan for sale. n. Mike bets $500 on a basketball game. o. You buy land to build a home.

72. Good AGood B YearQuantityPrice per unitQuantityPrice per unit 12,0000.1751 22,4000.15601.1 32,6000.25751.2 6. Calculate: Nominal GDP for year 2, Real GDP for year 2 (use year 1 as base), GDP growth rate in Real GDP for year 2.

73. ItemBillions $ Personal Consumption Expenditures9,734 Depreciation1,687 Wages7,874 Indirect Business Taxes1,041 Rental Income65 Gross Private Domestic Investment2,125 Profits2,638 Exports1,643 Government Purchases2,690 Interest603 Imports2,351 Income received from other countries818 Income paid to other countries722 GNP = National Income (NNP) = GDP =

74. Label A-M GA B E C D H I J K L M F

75. Practice 74 1. What is GDP? What is included? What is excluded? What are its limitations? 2. Explain the difference between GDP & GNP, NDP & GDP, between real GDP and nominal GDP. Provide an example to illustrate your answer. 3. Explain how a loaf of bread can be considered both a final good and an intermediate good. Provide an example to illustrate your answer. 4. Is the purchase of a home included in the calculation of GDP? If yes how and why? If not, why not?

76. 5.What would happen in a country in which the value of depreciation is larger than the value of gross investment? 6.Why do we calculate GDP in dollars instead of computing GDP in pounds or units produced? 7.When would NX be a negative number and what implication does this have for the computation of GDP? 8.Why do we have to subtract imports in the calculation of GDP? Hint: We could simply not add M into GDP = C+I +G +X. But why do we have to subtract them from the above calculation GDP = C + I + G + X – M? 9.What would be the effect on GDP with legalization of marijuana, cocaine, prostitution and gambling?

77. 76 10.Are there key differences between an increase in the capital stock and an improvement in the level of technology? 11.Describe how the labor force, the nation's capital stock, and the rate of technical progress contribute to potential GDP growth and labor productivity. 12.During the course of the twentieth century, the average workweek in the United States has gotten shorter and Americans have enjoyed greater amounts of leisure time. How has this development affected potential GDP and labor productivity?

78. Why NNP and income are not the same? They are constructed using different sources of information which produce different results due to: –Sampling errors –Coverage differences –Timing differences when expenditures and incomes are recorded. The overall difference between GDP and GDI is known as the statistical discrepancy 77

79. 78 1.Net Investment includes all business’ purchases of new equipment, buildings, software. ______ 2.Gross Investment includes only business’ purchases of new equipment which add to the stock of capital. ______ 3.Gross Domestic product includes all business’ purchases of new equipment, buildings and software as part of the Investment component______ 4.Net Domestic Product includes only production inside U.S. borders regardless of national ownership. ______ 5.Gross National Product includes production of goods and services by U.S. nationals regardless of where in the world production takes place. ______ 6.If the value of depreciation is greater than the value of gross investment, then the stock of capital will decrease. ______ 7.If the value of depreciation is greater than the value of gross investment, then Net Investment is negative. ______