Presentation on theme: "Measuring the Economy’s Performance"— Presentation transcript:
1 Measuring the Economy’s Performance ECON 151 – PRINCIPLES OF MACROECONOMICSChapter 8:Measuring the Economy’s PerformanceMaterials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
2 Learning Objectives Describe the circular flow of income and output Define gross domestic product (GDP)Understand the limitations of using GDP as a measure of national welfare
3 Learning Objectives Explain the expenditure approach to tabulating GDP Explain the income approach to computing GDPDistinguish between nominal GDP and real GDP
4 National Income Accounting A measurement system used to estimate national income and its components
9 The Simple Circular Flow Two observationsIn every economic exchange, the seller receives exactly the same amount that the buyer spends.Goods and services flow in one direction and money payments flow in the other.
10 The Simple Circular Flow Profits explainedQuestionWhy is profit a cost of production?AnswerProfits are the return entrepreneurs receive for the risk they incur when organizing productive activities
11 The Simple Circular Flow Product MarketsTransactions in which households buy goods
12 The Simple Circular Flow Final Goods and ServicesGoods and services that are at their final stage of production and will not be transformed into yet other goods or services
13 The Simple Circular Flow Factor MarketsTransactions in which businesses buy resources
14 The Simple Circular Flow Total IncomeThe yearly amount earned by the nation’s factors of production
15 The Simple Circular Flow QuestionWhy must total income be identical to the dollar value of total output?AnswerEvery transaction simultaneously involves an expenditure and a receipt
16 National Income Accounting Gross Domestic Product (GDP)The total market value of all final goods and services produced by factors of production located within a nation’s borders
17 National Income Accounting ObservationsGDP measures the dollar value of final outputGDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders
18 National Income Accounting Intermediate GoodsGoods used up entirely in the production of final goods
19 Sales Value and Value Added at Each Stage of Donut Production Stage of Production Dollar Value of Sales Value Added$.03Stage 1: Fertilizer and Seed $.03Stage 2: Growing .06Stage 3: Milling .12Stage 4: Baking .30Stage 5: Retailing .45$.03$.06$.18$.15Total dollar value of all sales $.96Total value added $.45
20 National Income Accounting Exclusion of financial transactions, transfer payments, and secondhand goodsNumerous transactions occur that have nothing to do with final goods and services being produced.
21 National Income Accounting Financial transactionsSecuritiesStocks and bondsGovernment transfer paymentsSocial SecurityUnemployment compensationPrivate transfer paymentsIndividual giftsCorporate gifts
22 National Income Accounting Transfer of secondhand goodsWhy not count the sale of a used car, stereo, or snowboard as part of GDP?Other excluded transactionsHousehold productionLegal underground transactionsIllegal underground transactions
23 Recognizing GDP Limitations GDP’s limitationsExcludes non-market productionDifferent countries have different legal versus illegal activitiesQuality of life is not measuredGDP poorly measures a nation’s well-being
24 Two Main Methods of Measuring GDP Expenditure ApproachA way of computing national income by adding up the dollar value at current market prices of all final goods and services
25 Two Main Methods of Measuring GDP Expenditure Approach
26 Two Main Methods of Measuring GDP Income ApproachA way of measuring national income by adding up income received by all factors of production
27 Two Main Methods of Measuring GDP Income Approach
28 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approachConsumption Expenditure (C)DurablesLife span of more than three yearsNondurablesLife span of less than three yearsServicesIntangible commodities
29 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approachGross Private Domestic Investment (I)The creation of capital goods, such as factories and machines, that can yield production and hence consumption in the future
30 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approachGovernment Expenditures (G)State, local, and federalValued at cost
31 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approachNet Exports (Foreign Expenditures)Net exports (X) = total exports - total imports
32 Two Main Methods of Measuring GDP Mathematical representation using the expenditure approachGDP = C + I + G + X
34 Two Main Methods of Measuring GDP Depreciation and net domestic productDeducting for depreciation (capital consumption allowance)Reduction in the value of capital goods over a one-year period due to physical wear and tear, and also to obsolescenceNDP = GDP - depreciation
35 Two Main Methods of Measuring GDP GDP = C + I + G + XNDP = C + I + G + X - depreciationNet Investment = I - depreciationDomestic investment minus an estimate of the wear and tear on the existing capital stockNDP = C + net I + G + X
36 Two Main Methods of Measuring GDP Deriving GDP by the income approach
37 Deriving GDP by the Income Approach Gross Domestic Income (GDI)The sum of all income—wages, interest, rent, and profits—paid to the four factors of production
38 Two Main Methods of Measuring GDP Gross Domestic Income (GDI)WagesInterestRentProfits
39 Two Main Methods of Measuring GDP Gross domestic product equals gross domestic income plus indirect business taxes and depreciation.These last items are called nonincome expense items.
40 Gross Domestic Product and Gross Domestic Income, 2005 (in billions of 2005 dollars per year) Figure 8-5Source: U.S. Department of Commerce. First quarter preliminary data annualized.
41 Other Components of National Income Accounting National Income (NI)The total of all factor payments to resource ownersPersonal Income (PI)The amount of income that households actually receive before they pay personal income taxes
42 Other Components of National Income Accounting Disposable Personal Income (DPI)Personal income after personal income taxes have been paid
43 Going from GDP to Disposable Income, 2005 Source: U.S. Department of Commerce, and author’s estimatesTable 8-2
44 Distinguishing Between Nominal and Real Values Nominal ValuesMeasurements in terms of the actual market prices at which goods are sold; expressed in current dollars
45 Distinguishing Between Nominal and Real Values Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars
46 Example: Correcting GDP for Price Index Changes Nominal (current) dollars GDPReal (constant) dollars GDP*Price level: measured by the GDP deflatorReal GDP =x 100nominal GDPprice level*
47 Example: Correcting GDP for Price Index Changes Source: U.S. Department of Commerce, Bureau of Economic Analysis, and author’s estimatesTable 8-3
48 Source: U.S. Department of Commerce Nominal and Real GDPFigure 8-6Source: U.S. Department of Commerce
49 Distinguishing Between Nominal and Real Values Per capita GDPAdjusting for population growthPer capita real GDP =real GDPpopulation
50 Nominal and Real GDPThe Bureau of Economic Analysis now uses a chain-weighted measure of real GDP.This means that changes in the prices and output levels of a certain good will contribute to overall changes in GDP to the extent that the good accounts for a significant share of overall economic activity.
51 Distinguishing Between Nominal and Real Values Some issuesThe distribution of outputChanges in leisure timeIncreased traffic congestionAir pollutionCrimeHousework
52 Comparing GDP Throughout the World ExampleFrance$1.25 = 1 euroPer capita income = 23, eurosFrance per capita income in terms of dollars equals 23, x 1.25 = $28,961.
53 Comparing GDP Throughout the World True purchasing powerAccounting for goods and services that are not traded in the world marketPurchasing Power ParityAdjustments in exchange rate conversions that takes into account differences in the true cost of living across countries
54 International Example: Purchasing Power Parity Comparisons of Incomes Table 8-4Source: World Bank
55 Summary Discussion of Learning Objectives The circular flow of income and outputIn every economic transaction, receipts exactly equal expendituresGoods and services flow in one direction and money payments flow in the otherGross Domestic Product (GDP)The total market value of a nation’s final output of goods and services produced in a year using factors of production located within its borders
56 Summary Discussion of Learning Objectives The limitations of using GDP as a measure of national welfareExcludes non-market transactionsDoes not measure national well-beingThe expenditure approach to tabulating GDPGDP = C + I + G + X
57 Summary Discussion of Learning Objectives The income approach to computing GDPThe sum of wages, rent, interest, profit, depreciation, and indirect business taxesDistinguishing between nominal GDP and real GDPNominal GDP is the value of newly produced final output in the current year measured in current market prices.Real GDP adjusts nominal GDP into constant dollars by correcting for price level changes.
58 Measuring the Economy’s Performance ECON 151 – PRINCIPLES OF MACROECONOMICSChapter 8:Measuring the Economy’s PerformanceMaterials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.