Chapter 7 Measuring A Nation's Income

• Microeconomics


  The study of how individual households and firms make decisions, interact with one another in markets
• Macroeconomics


  The study of the economy as a whole.We begin our study of macroeconomics with the country’s total income and expenditure.
• Gross Domestic Product (GDP) 


  measures total income of everyone in the economy.

  also measures total expenditure on the economy’s output of goods & services.
• For the economy as a whole, income equals expenditure because every dollar a buyer spends is a dollar of income for the seller.
• Circular-Flow Diagram


  a simple depiction of the macroeconomyillustrates GDP as spending, revenue, factor payments, and income
• Circular-Flow Diagram

  Preliminaries:

  Factors of production are inputs like labor, land, capital, and natural resources.

  Factor payments are payments to the factors of production (e.g., wages, rent).
• Circular-Flow Diagram

  Households

  own the factors of production, sell/rent them to firms for income.

  buy and consume goods & services.

  Firms

  buy/hire factors of production, use them to produce goods and services

  sell goods & services

  
• Circular-Flow Diagram Omits

  The government

  collects taxes, buys goods and services

  
  

  The financial system

  matches savers’ supply of funds with borrowers’ demand for loans

  
  

  The foreign sector

  trades goods & services, financial assets, and currencies with the country’s residents
• Gross Domestic Product 


  "the market value of all final goods & services produced within a country in a given period of time"
• Market Value

  Goods are valued at their market prices, so:

  All goods measured in the same units. (e.g. PHP)

  Things that don’t have a market value are excluded. (e.g. housework you do yourself)
• Final Market Value of Goodsand Services

  Final goods: intended for the end user.

  Intermediate goods: used as components or ingredients in the production of other goods

  GDP only includes final goods – they already embody the value of the intermediate goods used in their production.
• Goods and Services

  GDP includes tangible goods

  (like DVDs, mountain bikes, beer)

  and intangible services

  (dry cleaning, concerts, cell phone service).
• Production


  GDP includes currently produced goods, not goods produced in the past.
• Production done within a country

  GDP measures the value of production that occurs within a country’s borders, whether done by its own citizens or by foreigners located there.
• "given period of time"

  GDP is usually measured yearly or a quarterly (3 months).
• Components of GDP

  GDP (Y) is total spending.

  Consumption (C)

  Investment (I)

  Government Purchases (G)

  Net Exports (NX)

  Equation:

  Y = C + I +G + NX
• Consumption (C)


  is total spending by households on g&s.
• Investment (I)

  is total spending on goods that will be used in the future to produce more goods.

  includes spending on:

  ✦ capital equipment (e.g., machines, tools)

  ✦ structures (factories, office buildings, houses)

  ✦ inventories (goods produced but not yet sold)
• "Investment” does not mean the purchase of financial assets like stocks and bonds.
• Government Purchases (G)


  is all spending on the g&s purchased by govt at the federal, state, and local levels.

  G excludes transfer payments, such as Social Security or unemployment insurance benefits. They are not purchases of g&s.
• Net Exports (NX)

  ✦ Exports represent foreign spending on the economy’s g&s.

  ✦ Imports are the portions of C, I, and G that are spent on g&s produced abroad.

  NX = exports – imports
• GDP Does Not Value

  ✦ the quality of the environment✦ leisure time✦ non-market activity, such as the child care a parent provides his or her child at home✦ an equitable distribution of income
• Importance of GDP

  ✦ Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc.

  ✦ Many indicators of the quality of life are positively correlated with GDP (e.g. Life expectancy, Literacy, Internet usage)
• CHAPTER SUMMARY

  ❀ Gross Domestic Product (GDP) measures a country’s total income and expenditure.

  ❀ The four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports.

  ❀ Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year and is corrected for inflation.

  ❀ GDP is the main indicator of a country’s economic well-being, even though it is not perfect. 43
• GDP Problems

  Debbie spends $200 to buy her husband dinnerat the finest restaurant in Boston.

  Consumption and GDP rise by $200.
• GDP Problems

  Sarah spends $1800 on a new laptop to use inher publishing business. The laptop was built inChina.

  Investment rises by $1800, net exports fall by $1800, GDP is unchanged.
• GDP Problems


  Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

  Current GDP and investment do not change, because the computer was built last year.
• GDP Problems

  General Motors builds $500 million worth of cars, but consumers only buy $470 million of them.

  Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million.
• Nominal GDP


  values output using current prices. It is not corrected for inflation.
• Real GDP


  values output using the prices of a base year. Real GDP is corrected for inflation.
• Base Year


  ✦ is the year in which an index is set to 100

  ✦ Each time inflation is measured, the prices of the chosen goods are taken, and the current index value is computed and compared to the base value.
• GDP Deflator


  a measure of the overall level of prices.

  One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next.

  GDP Deflator = (Nominal GDP/Real GDP) * 100
• GDP and Economic Well-Being

  ✦ Real GDP per capita is the main indicator of the average person’s standard of living.✦ But GDP is not a perfect measure of well-being.