Principles Of Macroeconomics

National Income Accounting

• GDP

• The Expenditure Approach

• The Income Approach

An Economic Barometer

What exactly is GDP?

How do we use it to tell us whether our economy is in a recession or how rapidly our economy is expanding?

How do we take the effects of inflation out of GDP to compare economic well-being over time?

And how do we compare economic well-being across countries?

Gross Domestic Product

Gross Domestic Product (GDP) Is…

….the market value of all final goods and services produced in a country in a given time period.

This definition has four parts: Market value Final goods and services Produced within a country In a given time period

Gross Domestic Product

Gross Domestic Product (GDP) Is…….the market value of all final goods and services

produced in a country in a given time period.

Market value GDP is a market value—goods and services are valued at

their market prices. “You can’t compare apples to oranges.”

Market prices measure the amount people are willing to pay for different goods, they reflect the value of goods. If apples are double the price of oranges, apples

contributes twice as much to GDP. Things that don’t have a market value are excluded,

e.g., housework you do for yourself.

Gross Domestic Product

Gross Domestic Product (GDP) Is…….the market value of all final goods and services

produced in a country in a given time period.

Final goods and services GDP is the value of the final goods and services produced. A final good (or service) is an item bought by its final user during a

specified time period. A final good contrasts with an intermediate good, which is an item

that is produced by one firm, bought by another firm, and used as a component of a final good or service.

GDP only includes final goods, as they already embody the value of intermediate goods used in their production.

Excluding intermediate goods and services avoids double counting.

Calculating GDP

American Ore Inc American Steel American Motors

Total factor income

Value of Sales 4,200 (ore) 9,000 (steel) 21,500 (Car)

Intermediate goods 4,200 (iron ore) 9,000 (steel)

Wages 2,000 3,700 10,000 15,700

Interest Payment 1,000 600 1,000 2,600

Rent 200 300 500 1,000

Profit 1,000 200 1,000 2,200

Total Expenditure by firm

4,200 9,000 21,500

Value Added 4,200 4,800 12,500

Aggregate Expenditure

Total Payment to Factors - 21,500Sum of Value Added - 21,500

Gross Domestic Product

Gross Domestic Product (GDP) Is…….the market value of all final goods and services produced in

a country in a given time period.

Produced 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.

Gross Domestic Product

GDP and the Circular Flow of Expenditure and Income

• GDP measures the value of production, which also equals total expenditure on final goods and total income.

• We can determine how much a consumer pays for it; that will tell us the value of the final product. Or we can add up all the income created in producing it.

• What is spent on a product is received as income by those who helped produce it.

Gross Domestic Product Firms hire factors of production from households. The blue flow, Y,

shows total income paid by firms to households.

Gross Domestic Product Households buy consumer goods and services. The red flow, C,

shows consumption expenditures.

Gross Domestic Product Households save, S, and pay taxes, T. Firms borrow some of what

households save to finance their investment.

Gross Domestic Product Firms buy capital goods from other firms. The red flow represents

this investment expenditure by firms.

Gross Domestic Product Governments buy goods and services, G, and borrow or repay debt

if spending exceeds or is less than taxes.

Gross Domestic Product The rest of the world buys goods and services from us, X, and sells

us goods and services, M—net exports are X - M

Gross Domestic Product And the rest of the world borrows from us or lends to us depending

on whether net exports are positive or negative.

Gross Domestic Product The blue and red flows are the circular flow of expenditure and

income. The green flows are borrowing and lending.

Gross Domestic Product The sum of the red flows equals the blue flow.

Gross Domestic Product That is: Y = C + I + G + X - M

The Components of GDP

Recall: GDP is total spending. Four components:

Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

These components add up to GDP (denoted Y):

Y = C + I + G + NX

Y = C + I + G + NX

Consumption (C)

Total spending by households on good and services. Note on housing costs:

For renters, consumption includes rent payments.

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)

Note: “Investment”“Investment” does not mean the purchase of financial assets like

stocks and bonds.

Note: “Investment”“Investment” does not mean the purchase of financial assets like

stocks and bonds.

Government Purchases (G)

is all spending on the good and services purchased by government at the federal, state, and local levels.

G excludes transfer payments, such as Social Security or unemployment insurance benefits. These payments represent transfers of income, not purchases of good and services.

Net Exports (NX)

NX = exports – imports Exports represent foreign spending on the economy’s good

and services. Imports are the portions of C, I, and G

that are spent on good and services produced abroad. Adding up all the components of GDP gives:

Y = C + I + G + NX

Y = C + I + G + NX

Expenditure

Name Symbol Billions of dollars Percentage of GDP

Consumption C 8,668 70.0

Investment I 2,054 16.6

Government G 2,338 18.9

Net Exports NX -687 -5.5

GDP Y 12,373 100.0

Measures GDP by using data on consumption, investment, government expenditure and net exports .

Amount in 2005

GDP, Income, Expenditure

Expenditure Equals Income• Because firms pay out everything they receive

as incomes to the factors of production, total expenditure equals total income.

• That is:Y = C + I + G + NX

• The value of production equals income equals expenditure

Aggregate Income

Aggregate income earned from production of final goods, Y, equals the total paid out for the use of resources, wages, interest, rent, and profit.

Firms pay out all their receipts from the sale of final goods, so income equals expenditure Y = C + I + G + (X – M).

Income Approach

Wages• Compensation of employees in the national accounts, is the

payment for labor services. • It includes salaries plus fringe benefits paid by employers

such as health care insurance, social security contributions, and pension contributions

Interest• Is the income households receive on loans

Rent• Includes payments for the use of land

Profit• Includes the profits of corporations (Corp Income tax,

dividends and undistributed Corp. profit) and small businesses.

Income Approach Adjustments

Indirect Business Tax firms treat this as cost of the production process and therefore add to the

prices of the products they sell (sale and excise taxes, license fees, and duties) Production of widgets adds 1.00 of wages, rent interest, and profit income. But government adds .05 to the price of a product. The value of the output is 1.05 but only 1.00 if this value is paid to the household.

Net to Gross Expenditure includes investment. Because some new capital is

purchased to replace depreciated capital ( annual charge which estimates the amount of capital equipment used in each years production)

To get gross domestic product from the income approach, we must add depreciation to total income.

Net foreign Factor National Income is the total income of American, whether earned in the

United States or abroad

Gross Domestic Product

Gross investment is the total amount spent on purchases of new capital and on replacing depreciated capital.

Net investment is the change in the stock of capital and equals gross investment minus depreciation.

Gross Domestic Product

This figure illustrates the relationships among capital, gross investment, depreciation, and net investment.