Chapter 10: Measuring a Nation’s Income
Chapter 10: Measuring a Nation’s IncomeAGEC 217
Patrick S. Ward
Purdue University
June 28, 2010
Chapter 10: Measuring a Nation’s Income
Overview
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Overview
Moving from Microeconomics to Macroeconomics
Up till now, our study of economics has focused onmicroeconomics
Studying how individual households and firms make decisionsand how they interact with one another in marketsThe focus is on individual decision-making units
We now move to study macroeconomicsStudying the economy as a wholeThe focus is on aggregated decision-making unitsStudying economy-wide phenomena including inflation,unemployment and economic growth
Macroeconomics is intimately linked with microeconomics:
Changes in the overall economy arise from the decisions ofindividual households and firms
Chapter 10: Measuring a Nation’s Income
Overview
Macroeconomics
Why study macroeconomics?
The health of the overall economy affects us all
We see reports of macroeconomic indicators and statistics allover the place Examples
We want to be able to interpret these reports and statisticsand understand how they will affect the economy
Chapter 10: Measuring a Nation’s Income
Overview
The Goal of Macroeconomics
We want to be able to explain changes that affect manyhouseholds, firms and market simultaneously
How does a tax change affect productivity?
How does productivity affect GDP?
How does GDP growth affect inflation?
How does inflation affect the exchange rate?
What effect do exchange rates have on GDP?
Chapter 10: Measuring a Nation’s Income
Income and Expenditure
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Income and Expenditure
National Income and Expenditure
When judging economic well-being, it is natural to look at theeconomy’s total income
Gross Domestic Product: the market value of all final goodsand services produced within the borders of a country in agiven period of time.
Measures the country’s total overall economic output
Chapter 10: Measuring a Nation’s Income
Income and Expenditure
Gross Domestic Product (GDP)
GDP measures two things at once
1 The total income of everyone in the economy
2 The total expenditure on the economy’s goods and services
These two values are really the same because for the economy as awhole, income must equal expenditure
Every dollar spent by consumers is income for the sellers
Chapter 10: Measuring a Nation’s Income
Income and Expenditure
Income and Expenditure
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“GDP is the market value...”
GDP adds together many different kinds of products
Uses market prices to determine the value of good and services
Allows us to add apples and oranges
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...of all...”
GDP is a very comprehensive measure
Includes all items produced in the economy and sold legally inmarkets
ApplesOrangesPearsGrapefruitBooksMoviesHealthcareetc.
Excludes items produced or sold illicitly
Excludes items produced and consumed at home (that neverenter the marketplace)
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...final...”
GDP only accounts for final goods—not intermediategoods
This eliminates the problem of double counting
Important exception:
If an intermediate good is held in inventory for use or sale at alater time, these goods are counted in GDPAdditions to inventory add to GDPWhen the goods in inventory are later used or sold, they aresubtracted from inventory and then subtracted from GDP
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...goods and services...”
GDP includes both tangible goods and intangible services
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...produced...”
GDP counts those goods and services that are currentlyproduced
Excludes anything produced in the past
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...within the borders of a country...”
The items that are counted in GDP are confined to limitedgeographic areas
Example: Foreign companies producing goods in the US
Subaru is a Japanese automobile manufacturing companySubaru has a large manufacturing facility in LafayetteThe value of all of the cars produced in Lafayette are countedin GDP
Example: US companies with overseas operations
IBM is a US companyHalf of IBM’s employees work outside the US producingvaluable outputsNone of the value of this output is counted in US GDP
It is instead counted in the GDP of the other countries wherethe goods are produced
Chapter 10: Measuring a Nation’s Income
The Measurement of GDP
“...in a given period of time.”
Just as GDP is limited by geographic confines (borders), it isalso limited by temporal constraints
Usually a year or quarter
Data are usually seasonally adjusted to remove any seasonalpatterns
Chapter 10: Measuring a Nation’s Income
Components of GDP
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Components of GDP
Components of GDP
Y = C + I + G + NX
Y = GDP
C = Consumption
G = Government purchases
I = Investment
NX = Net exports (exports - imports)
Memorize this!!!!
Chapter 10: Measuring a Nation’s Income
Components of GDP
Consumption
Spending by households on goods and services
Excludes purchases of new housing
Goods: tangible itemsDurable goods: goods that continue to be serviceable for atleast 3 years
Cars, refrigerators, washing machines, circular saw etc.
Nondurable goods: goods that are used up when used once, orthat have a lifespan of less than 3 years
Food, clothing, pencils, etc.
Services: Nontangible items
Economics classes, doctor visits, haircuts
Chapter 10: Measuring a Nation’s Income
Components of GDP
Investment
The purchase of good that will be used in the future toproduce more goods and services
Investment does not include things we normally think of asinvestments, like stocks and bonds
Capital equipment:
Machines, computers, bulldozers, printing presses, etc.
Structures:
Factories, houses, warehouses, etc.
Inventories of goods produced but not yet sold
Investment goods such as structures and vehicles used inproduction are not intermediate goods
Chapter 10: Measuring a Nation’s Income
Components of GDP
Government Purchases
Spending on goods and services by local, state, and federalgovernments
Salaries of government workers
Expenditures on public works
Does not include government transfers (like Social Securitypayments, welfare payments, or stimulus payments) becausethese are ultimately used either for consumption or investment
Chapter 10: Measuring a Nation’s Income
Components of GDP
Net Exports
Foreign purchases of domestically produced goods minusdomestic purchase of foreign-produced goods
Exports minus imports
Increasing exports adds to GDP
Increasing imports subtracts from GDP
Chapter 10: Measuring a Nation’s Income
Components of GDP
Test Your Understanding
In each of the following cases, determine how much GDP and eachof its components is affected (if at all)
1 Debbie spends $200 to buy her husband dinner at the finest restaurant inBoston.
2 Sarah spends $1,800 to purchase a new laptop to use in her publishingbusiness. The laptop was built in China.
3 Jane spends $1,200 on a computer to use in her editing business. She gotlast year’s model on sale for a great price from a local manufacturer.
4 General Motors builds $500 million worth of cars, but consumers only buy$470 million worth of them
Chapter 10: Measuring a Nation’s Income
Components of GDP
Components of GDP in 2009
Total Per Person Percent(in billions of dollars) (in dollars) of Total
Gross Domestic Product, Y $14,256.30 $46,226.59 100%Consumption, C 10,089.10 32,714.29 71%Investment, I 1,628.80 5,281.45 11%Government Purchases, G 2,930.70 9,502.91 21%Net Exports, NX -392.40 -1,272.37 -3%
Note: per person figures were derived by dividing the total dollaramount by the population (308.4 million at the end of 2009)
Chapter 10: Measuring a Nation’s Income
Components of GDP
Components of GDP in 2009
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Nominal vs. Real GDP
There are two possible reasons for total spending to rise from oneyear to the next:
1 The economy may be producing a larger output of goods andservices
2 Goods and services could be selling at higher prices
Economists want to separate these two effects
Economists want to know if output has changed—not prices
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Nominal GDP
Nominal GDP is simply a measure of the value of goods andservices produced in an economy during a period of time when thegoods and services are valued using current market prices
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Real GDP
Real GDP answers the hypothetical question: What would be thevalue of the goods and services produced in an economy during aperiod of time if the goods and services were valued using theprices that prevailed in some specific year in the past?
Real GDP adjusts the current value of output for inflation
Real GDP shows how the economy’s overall production ofgoods and services changes over time
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
GDP Deflator
GDP Deflator: a measure of the price level calculated as theratio of the nominal GDP to real GDP times 100
GDP Deflator =Nominal GDP
Real GDP× 100
The GDP deflator measures the current level of prices relativeto the level of the base year
The GDP deflator will be exactly 100 in the base year, sinceReal GDP and Nominal GDP will be the same in that year
With the GDP deflator, we can calculate the rate of inflationin the economy
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
GDP Deflator and Inflation
Inflation: the situation in which the economy’s overall pricelevel is rising
We can calculate a measure of inflation using the GDPdeflator
Inflation Rate =GDP Deflator in year 2 - GDP Deflator in year 1
GDP Deflator in year 1
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating Nominal and Real GDP
Consider an economy that produces only two goods, pizza andlattes. The table below shows the prices and quantities producedof the two goods in 2008, 2009, and 2010.
Pizza Latte
Year P Q P Q2008 $10.00 400 $2.00 1,0002009 $11.00 500 $2.50 1,1002010 $12.00 600 $3.00 1,200
What is the nominal GDP in each year?
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating Nominal GDP
Nominal GDP is the value of the economy’s output valued atcurrent prices
2008: $10.00 × 400 + $2.00 × 1, 000 = $6, 000
2009: $11.00 × 500 + $2.50 × 1, 100 = $8, 250
2010: $12.00 × 600 + $3.00 × 1, 200 = $10, 800
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating Nominal GDP Growth
By what percent did the economy grow from 2008 to 2009? From2009 to 2010?
%∆Y =Y2 − Y1
Y1× 100%
GDP Growth from 2008 to 2009:%∆Y = Y2009−Y2008
Y2008× 100% = 8,250−6,000
6,000 × 100% =0.375 × 100% = 37.5%
GDP Growth from 2009 to 2010:%∆Y = Y2010−Y2009
Y2009× 100% = 10,800−8,250
8,250 × 100% =0.309 × 100% = 30.9%
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating Real GDP
To calculate Real GDP, we first have to choose the base year. Wethen use the prices from this base year to value the output of allyears.
The prices in the base year provide the basis for comparingquantities in different years
Let’s use 2008 as the base year
Real GDP is the value of output measured at constant prices (inthis case, 2008 prices)
2008: $10.00 × 400 + $2.00 × 1, 000 = $6, 000
2009: $10.00 × 500 + $2.00 × 1, 100 = $7, 200
2010: $10.00 × 600 + $2.00 × 1, 200 = $8, 400
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating Real GDP Growth
By what percent did the economy grow from 2008 to 2009 in realterms? From 2009 to 2010?
Real GDP Growth from 2008 to 2009:%∆Y = Y2009−Y2008
Y2008× 100% = 7,200−6,000
6,000 × 100% =0.200 × 100% = 20.0%
Real GDP Growth from 2009 to 2010:%∆Y = Y2010−Y2009
Y2009× 100% = 8,400−7,200
7,200 × 100% =0.167 × 100% = 16.7%
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Calculating the GDP Deflator and Rates of Inflation
Recall the formula for calculating the GDP deflator is:
GDP Deflator =Nominal GDP
Real GDP× 100
GDP Deflator for 2008 = 6,0006,000 × 100 = 100
GDP Deflator for 2009 = 8,2507,200 × 100 = 114.58
GDP Deflator for 2010 = 10,8008,400 × 100 = 128.57
Chapter 10: Measuring a Nation’s Income
Real vs. Nominal GDP
Nominal vs. Real GDP
Figure: Nominal GDP and Real GDP (2005 Dollars)
Chapter 10: Measuring a Nation’s Income
Is GDP a Good Measure of Economic Well-Being?
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Is GDP a Good Measure of Economic Well-Being?
GDP and Well-Being
GDP is considered the best single measure of the economicwell-being of a society
...but there are a lot of things that are left out of GDP that maybe more indicative of quality of life.
Health
Education
Leisure
So how can GDP be a good measure of well-being if it omits theseimportant factors?
Chapter 10: Measuring a Nation’s Income
Is GDP a Good Measure of Economic Well-Being?
GDP and Well-Being
Countries with large GDP can afford
Better healthcare
Better education
More leisure time
GDP also says nothing about the distribution of income
GDP per capita is the income of the average person
Nor does it say anything about the degradation of the environment
Chapter 10: Measuring a Nation’s Income
Conclusion
1 Overview
2 Income and Expenditure
3 The Measurement of GDP
4 Components of GDP
5 Real vs. Nominal GDP
6 Is GDP a Good Measure of Economic Well-Being?
7 Conclusion
Chapter 10: Measuring a Nation’s Income
Conclusion
Conclusion I
GDP is the best single measure we have for the well-being ofa society
...but it is not a perfect measure
GDP measures an economy’s total expenditures on newlyproduced goods and services and the total income earnedfrom the production of these goods and services
GDP is the market value of all final goods and servicesproduced within the borders of a country in a givenperiod of time
GDP = C + I + G + NX
Chapter 10: Measuring a Nation’s Income
Conclusion
Conclusion II
Because every transaction has a buyer and a seller, the totalexpenditure in the economy must equal the total income inthe economy
Nominal GDP uses current prices to value economic output
Real GDP uses constant prices or the prices from apre-determined base year to value economic output
Chapter 10: Measuring a Nation’s Income
Conclusion
Examples
Examples of macroeconomic indicators in the news
“U.S. Jobless Claims Drop but Remain at Elevated Levels”(New York Times)
“U.S. economy’s growth revised lower” (CNN)
“Housing Market: Falling again” (The Economist)
“Fed Grows More Wary on Economy” (Wall Street Journal)
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