Preview Questions

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(No Transcript)
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Introduction
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Preview Questions

• What is gross domestic product (GDP), and what
  does it measure?
• Why are only final goods and services evaluated
  in deriving GDP?

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Chapter Outline

• The Simple Circular Flow
• National Income Accounting
• Two Main Methods of Measuring GDP
• Other Components of National Income Accounting

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Chapter Outline

• Distinguishing Between Nominal and Real Values
• Comparing GDP Throughout the World

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Did You Know That...

• Whenever a single person who is currently paying
  a housekeeper marries that housekeeper,
  government statistics show that the economys
  performance has declined?

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National Income Accounting

• National Income Accounting
• A measurement system used to estimate national
  income and its components

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The Simple Circular Flow

• Profits Explained
• Question
• Why is profit a cost of production?
• Answer
• Profits are the return entrepreneurs receive for
  the risk they incur when organizing productive
  activities.

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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 nations borders.

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National Income Accounting

• Observe
• GDP measures the dollar value of output
• GDP measures the dollar value of final goods and
  services

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National Income Accounting

• Stress of Final Output
• What is a final good?
• Wheat?
• Steel?
• Oil?
• Bread?
• Automobile?
• Gasoline?

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National Income Accounting

• Intermediate Goods
• Goods used up entirely in the production of final
  goods

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Sales Value and Value Added at Each Stage of
Donut Production
Stage of Production Dollar Value of Sales Value
Added
Stage 1 Fertilizer and Seed .01 Stage 2
Growing .02 Stage 3 Milling .04 Stage 4
Baking .10 Stage 5 Retailing .15 Total
dollar value of all sales .32
Total value added .15
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National Income Accounting

• Exclusion of Financial Transactions, Transfer
  Payments, and Secondhand Goods
• Numerous transactions occur that have nothing to
  do with final goods and services being produced.

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National Income Accounting

• Financial Transactions
• 1) Securities
• Stocks and bonds
• 2) Government Transfer Payments
• Social security
• Unemployment compensation
• 3) Private Transfer Payments
• Individual gifts
• Corporate gifts

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National Income Accounting

• Transfer of Secondhand Goods
• Why not count the sale of a used car, stereo, or
  snowboard as part of GDP?
• Other Excluded Transactions
• Household production
• Legal underground transactions
• Illegal underground transactions

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Two Main Methodsof Measuring GDP

• Expenditure Approach
• A way of computing national income by adding up
  the dollar value at current market prices of all
  final goods and services.

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Two Main Methodsof Measuring GDP
Businesses
Households
Expenditure Approach
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Two Main Methodsof Measuring GDP

• Income Approach
• A way of measuring national income by adding up
  income received by all factors of production

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Two Main Methodsof Measuring GDP
Income Approach
Businesses
Households
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Two Main Methodsof Measuring GDP

• Deriving GDP by the Expenditure Approach
• Consumption Expenditure (C)
• Durables
• Life span of more than three years
• Nondurables
• Life span of less than three years
• Services
• Intangible commodities

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Two Main Methodsof Measuring GDP

• Deriving GDP by the Expenditure Approach
• Gross Private Domestic Investment (I)
• The creation of capital goods, such as factories
  and machines, that can yield production and hence
  consumption in the future

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Two Main Methodsof Measuring GDP

• Deriving GDP by the Expenditure Approach
• Gross Private Domestic Investment (I)
• Fixed Investment
• Inventory Investment
• New Residential Structures

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Two Main Methodsof Measuring GDP

• Deriving GDP by the Expenditure Approach
• Government Expenditures (G)
• State, local, and federal
• Valued at cost

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Two Main Methodsof Measuring GDP

• Deriving GDP by the Expenditure Approach
• Net Exports (Foreign Expenditures)

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Two Main Methodsof Measuring GDP

• Mathematical Representation Using the Expenditure
  Approach

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Faults with GDP

• Doesnt reflect all production -

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GDP and Its Components
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Two Main Methodsof Measuring GDP

• Depreciation and Net Domestic Product
• Deducting 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 obsolescence

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Two Main Methodsof Measuring GDP

• GDP C I G X
• NDP C I G X - depreciation
• Net Investment I - depreciation
• Domestic investment minus an estimate of the wear
  and tear on the existing capital stock
• NDP C Net I G X

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Two Main Methodsof Measuring GDP

• Deriving GDP by the Income Approach

Businesses
Households
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Two Main Methodsof Measuring GDP

• Gross Domestic Income (GDI)
• The sum of all income--wages, interest, rent, and
  profits--paid to the four factors of production

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Two Main Methodsof Measuring GDP

• Gross Domestic Income (GDI)
• 1) Wages
• 2) Interest
• 3) Rent
• 4) Profits

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Gross Domestic Product andGross Domestic Income,
1998(in billions of 1998 dollars per year)
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Gross Domestic Product andGross Domestic Income,
1998(in billions of 1998 dollars per year)
Expenditure Point of View--Product
Flow Expenditures by Different Sectors
Household sector Personal consumption
expenses 5,659.4 Government sector Purchase
of goods and services 1,466.4 Business sector
Gross private domestic investment (including
depreciation) 1,329.8 Foreign sector Net
exports of goods and services -123.4 Gross
Domestic Product 8,332.2
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Gross Domestic Product andGross Domestic Income,
1998(in billions of 1998 dollars per year)
Income Point of View--Cost Flow Domestic Income
(at Factor Cost)
Wages All wages, salaries, and supplemental
employee compensation 4,901.4 Rent All rental
income of individuals plus implicit rent on
owner-occupied dwellings 142.8 Interest Net
interest paid by business 464.7 Profit
Proprietorial income 519.7 Corporate profits
before taxes deducted 701.3 Nonincome expense
items Indirect business taxes and other
adjustments 730.8 Depreciation 951.3
Statistical discrepancy -79.8 Gross Domestic
Product 8,332.2
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Other Components ofNational Income Accounting

• National Income (NI)
• The total of all factor payments to resource
  owners.
• Personal Income (PI)
• The amount of income that households actually
  receive before they pay personal income taxes.

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Other Components ofNational Income Accounting

• Disposable Personal Income (DPI)
• Personal income after personal income taxes have
  been paid

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Going from GDP toDisposable Income, 1998
Billions of Dollars
Gross domestic product (GDP) 7,566.9 Minus
depreciation -891.8 Net domestic product
(NDP) 6,675.1 Minus indirect business taxes
and other adjustments -674.3 National Income
(NI) 6,000.8 Minus corporate taxes, Social
Security contributions, corporate retained
earnings -1,032.5 Plus government and business
transfer payments 1,311.1 Personal Income
(PI) 6,279.4 Minus personal income tax and
nontax payments -798.7 Disposable personal
income (DPI) 5,480.7
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Distinguishing between Real and Nominal Values

• Price Index
• The cost of todays market basket of goods
  expressed as a percentage of the cost of the same
  market basket during a base year

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Distinguishing Between Nominal and Real Values

• Nominal Values
• Measurements in terms of the actual market prices
  at which goods are sold expressed in current
  dollars

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Distinguishing Between Nominal and Real Values

• Real Values
• Measurements after adjustments have been made for
  changes in the average of prices between years
  expressed in constant dollars

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Distinguishing Between Nominal and Real Values

• Example
• 1960
• 2,800 nominal income/person per year
• 1996
• 28,000 nominal income/person per year
• 1960 income expressed in 1996 dollars
• 10,000 real income/person per year

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Distinguishing Between Nominal and Real Values

• Correcting GDP for Price Changes
• Nominal (current) dollars GDP
• Real (constant) dollars GDP

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Price Index Example

• Price of a soda in 1999 is 50 cents and price is
  75 cents in 2000. 50 percent increase
• Index 75cents / 50cents 1.5. Multiply by 100
  to get the index. The index is 150. This tells us
  that the price of soda has increased by 50 cents.

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Correcting GDPfor Price Changes
(1) (2) (3) (4) (2)/(3) x 100 Nominal
GDP Real GDP (billions of (billions of
dollars dollars Price Level Index per
year Year per year) (base year 1992 100) in
constant 1992 dollars)
1987 4,539.9 82.7 5,489.6 1988 4,900.4 85.9 5,70
4.8 1989 5,250.8 89.7 5,853.7 1990 5,546.1 93.7
5,919.0 1991 5,724.8 97.3 5,883.6 1992 6,020.2 1
00.0 6,020.2 1993 6,343.3 102.2 6,206.8 1994 6,7
38.4 104.3 6,460.6 1995 7,007.9 106.3 6,592.6 19
96 7,636.0 110.6 6,928.4 1997 8,079.9 112.4 7,188
.8
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Distinguishing Between Nominal and Real Values

• An Example
• Base Year 1992
• Price Index 100

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Distinguishing Between Nominal and Real Values

• Real GDP Nominal GDP in the base year

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Distinguishing Between Nominal and Real Values

• 1993
• Price Index 102.2

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Distinguishing Between Nominal and Real Values

• 1987
• Price Index 82.7

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Distinguishing Between Nominal and Real Values

• Questions
• Why is the price index greater than 100 for 1993?
• Why is the price index less than 100 for 1987?
• Why is Real GDP greater than Nominal GDP for 1987
  and less than Nominal GDP for 1993?

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Nominal and Real GDP
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Internet Activity

• For more information on GDP and its components
  click FRED to access Federal Reserve Economic
  Data.

FRED
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Distinguishing Between Nominal and Real Values

• Question
• Is Real Per Capita GDP a good indicator of social
  well-being?

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Distinguishing Between Nominal and Real Values

• Some Issues
• The distribution of output
• Changes in leisure time
• Increased traffic congestion
• Air pollution
• Crime
• Housework

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Internet sites to access

• Www.whitehouse.gov
• www.bea.doc.gov