Chapter

Measuring a Nations Income

23
Microeconomics vs. Macroeconomics
Microeconomics
Study of how households and firms
Make decisions
Interact in markets
Macroeconomics
Study of economy-wide phenomena
Including inflation, unemployment, and economic
growth
2
What Macroeconomics Is About
Macroeconomics:
The study of structure and performance of national economies
and government policies that affect economic performance.
Issues addressed by macroeconomists:
Long-run economic growth
Business cycles
Unemployment
Inflation
The international economy
Macroeconomic policy
Gross Domestic Product
GDP (gross domestic product) is the market value
of final goods and services newlyproduced within
a nationduring a fixed period of time
The Economys Income and Expenditure
Gross Domestic Product (GDP)
Measures the total income of everyone in the economy
Measures the total expenditure on the economys output of
goods and services
For an economy as a whole
Income must equal expenditure
Circular-flow diagram assumptions:
All goods and services bought by households
Households - -spend all of their income
5
Figure
The circular-flow diagram
1
6
Households buy goods and services from firms, and firms use their revenue from
sales to pay wages to workers, rent to landowners, and profit to firm owners. GDP
equals the total amount spent by households in the market for goods and services.
It also equals the total wages, rent, and profit paid by firms in the markets for the
factors of production.
Measurement of Gross Domestic Product
Gross domestic product (GDP)
Market value of all final goods and services
Produced within a country
In a given period of time
GDP is the market value
Market prices - reflect the value of the goods
7
Measurement of Gross Domestic Product
of all
All items produced in the economy
And sold legally in markets
Excludes most items
Produced and sold illicitly
Produced and consumed at home
final
Value of intermediate goods is already included in
the prices of the final goods
8
Measurement of Gross Domestic Product
goods and services
Tangible goods & intangible services
produced
Goods and services currently produced
within a country
Goods and services produced domestically,
regardless of the nationality of the producer
in a given period of time
A year or a quarter
9
The Components of GDP
Y =C +I +G +NX
This is a iIdentity, Y =GDP
Where:
C =consumption
I =investment
G =government purchases
NX =net exports
10
The Components of GDP
Consumption (C):
Spending by domestic households on final goods
and services (including those produced abroad)
Three categories
Consumer durables (examples: cars, TV sets, furniture, major
appliances)
Nondurable goods (examples: food, clothing, fuel)
Services (examples: education, health care, financial services,
transportation)
11
The Components of GDP
Investment (I):
Spending for new capital goods (fixed ivestment) plus
inventory investment
Three categories
Business (or nonresidential) fixed investment:
Spending by businesses on structures and equipment and software
Residential fixed investment:
Spending on the construction of houses and apartment buildings
Inventory investment: (increases in firms inventory holdings)
12
The Components of GDP
Government purchases of goods and services (G):
Spending by the government on goods or services
Not all government expenditures are purchases of goods and
services
Some are payments that are not made in exchange for current goods
and services:
Social Security payments
Welfare
unemployment benefits
interest payments on the government debt
Some government spending is for capital goods that add to
the nations capital stock, such as highways, airports, bridges,
and water and sewer systems
13
The Components of GDP
Net exports (NX):exports minus imports
Exports: goods produced in the country that are
purchased by foreigners
Imports: goods produced abroad that are purchased by
residents in the country
Imports are subtracted from GDP, as they represent
goods produced abroad, and were included in
consumption, investment, and government
purchases
14
GDP of the United States =$14 trillion
GDP per person =$45,838
Consumption =$32,225 per person
Investment =$7,061 per person
Government purchases =$8,912 per person
Net exports =$2,360 per person
The components of U.S. GDP, 2007
15
Table
U. S GDP and its components, 2007
1
16
Total
(in billions of dollars)
Per person
(in dollars)
Percent
of total
Gross domestic product, Y
Consumption, C
Investment, I
Government purchases, G
Net exports, NX
$13,843
9,732
2,132
2,691
712
$45,838
32,225
7,061
8,912
2,360
100%
70
15
19
-5
This table shows total GDP for the U.S. economy in 2007 and the breakdown of GDP
among its four components.
When reading this table, recall the identity Y =C +I +G +NX.
The components of U.S. GDP 2008
Real Versus Nominal GDP
Real GDP
Production of goods and services
Valued at constant prices
Designate one year as base year
Not affected by changes in prices
For the base year
Nominal GDP =Real GDP
18
Real Versus Nominal GDP
Total spending rises from one year to the next
Economy - producing a larger output of goods and
services
And/or goods and services are being sold at higher
prices
Nominal GDP
Production of goods and services
Valued at current prices
19
Table
Real and Nominal GDP
2
20
Prices and Quantities
Year
Price of
hot dogs
Quantity of
hot dogs
Price of
hamburgers
Quantity of
hamburgers
2008
2009
2010
$1
$2
$3
100
150
200
$2
$3
$4
50
100
150
Calculating Nominal GDP
2008
2009
2010
($1 per hot dog 100 hot dogs) +($2 per hamburger 50 hamburgers) =$200
($2 per hot dog 150 hot dogs) +($3 per hamburger 100 hamburgers) =$600
($3 per hot dog 200 hot dogs) +($4 per hamburger 150 hamburgers) =$1,200
Calculating Real GDP (base year 2008)
2008
2009
2010
($1 per hot dog 100 hot dogs) +($2 per hamburger 50 hamburgers) =$200
($1 per hot dog 150 hot dogs) +($2 per hamburger 100 hamburgers) =$350
($1 per hot dog 200 hot dogs) +($2 per hamburger 150 hamburgers) =$500
Calculating the GDP Deflator
2008
2009
2010
($200 / $200) 100 =100
($600 / $350) 100 =171
($1,200 / $500) 100 =240
This table shows how to calculate real GDP, nominal GDP,
and the GDP deflator for a hypothetical economy that
produces only hot dogs and hamburgers.
Real Versus Nominal GDP
The GDP deflator
Measure of the price level
Ratio of nominal GDP to real GDP times 100
=100 for the base year
Measures the current level of prices relative to the
level of prices in the base year
Inflation
Economys overall price level is rising
21
Real Versus Nominal GDP
Inflation rate
Percentage change in some measure of the price level
from one period to the next
The GDP deflator
Can be used to take inflation out of nominal GDP
(deflate nominal GDP)
22
Real Versus Nominal GDP in Vietnam
The GDP data
Real GDP grows over time
Growth is not steady
Recession
Real GDP declines
Lower income
Rising unemployment
Falling profits
Increased bankruptcies
Real GDP over recent history
24
Figure
Real GDP in the United States
2
25
This figure shows quarterly data on real GDP for the U.S. economy since 1965.
Recessionsperiods of falling real GDPare marked with the shaded vertical bars.
Figure
Economic growth rate of Vietnam
(1986- 2010)
Source: ADB
GDP - Good Measure of Economic Well-being?
GDP single measure of the economic well-being
of a society
Economys total income
Economys total expenditure
Larger GDP
Good life
Better healthcare
Better educational systems
Measure - ability to obtain many of the inputs into a
worthwhile life
27
GDP - Good Measure of Economic Well-being?
GDP not a perfect measure of well-being
Doesnt include
Leisure
Value of almost all activity that takes place outside
markets
Quality of the environment
No distribution of income
28
Rich countries - Higher GDP per person
Better
Life expectancy
Literacy
Internet usage
Poor countries - Lower GDP per person
Worse
Life expectancy
Literacy
Internet usage
International differences in GDP
and the quality of life
29
Low GDP per person
More infants with low birth weight
Higher rates of infant mortality
Higher rates of maternal mortality
Higher rates of child malnutrition
Less common access to safe drinking water
Fewer school-age children are actually in school
Fewer teachers per student
Fewer televisions; Fewer telephones
Fewer paved roads
Fewer households with electricity
International differences in GDP
and the quality of life
30
Table
GDP and the quality of life
3
31
Country
Real GDP per
person (2005)
Life
expectancy
Adult literacy
(% of population)
Internet usage
(% of population)
United States
Japan
Germany
Russia
Mexico
Brazil
China
Indonesia
India
Pakistan
Bangladesh
Nigeria
$41,890
31,267
29,461
10,845
10,751
8,402
6,757
3,843
3,452
2,370
2,053
1,128
78 years
82
79
65
76
72
72
70
64
65
63
47
99%
99
99
99
92
89
91
90
61
50
47
69
63 %
67
45
15
18
19
9
7
3
7
0.3
4
The table shows GDP per person and three other measures of the quality of life for
twelve major countries.
Table
GNP vs. GDP
GNP (gross national product) =output produced by
domestically owned factors of production
GDP =output produced withina nation
GDP =GNP NFP (2.2)
NFP =net factor payments from abroad
=payments to domesticallyowned factors located abroad minus
payments to foreign factors located domestically
Table
GNP vs. GDP
Example: Engineering revenues for a road built by a U.S.
company in Vietnam:
part of U.S. GNP (built by a U.S. factor of production), not U.S. GDP
part of Vietnam GDP (built in Vietnam), not Vietnam GNP
Difference between GNP and GDP is small for the United
States, about 0.2%, but higher for countries that have
many citizens working abroad
Other Measures of Income
Gross National Product (GNP) is the total income earned by a
nations permanent residents.
Net National Product (NNP)
NNP =GNP- Depreciation(D
p)
National Income (NI) is the total income earned by a nations
residents in the production of goods and services
NI= NNP- Indirect business taxes
+Business subsidies
+statistical discrepancy
Other measures of income
Personal Income (PI): is the income that households and
noncorporate business receive.
PI=NI retained earning
corporate income taxes
contributions for social insurance
+interest income +government transfers
Disposable Personal Income (Pi
d
) is the income thats
households and noncorporate business have left after
satisfying all their obligations to the government.
PI
d
=PI- Personal taxes- Nontax payments
Chapter
Measuring the Cost of Living
24
The Consumer Price Index
Consumer price index (CPI)
Measure of the overall cost of goods & services
bought by a typical consumer
How the consumer price index is calculated
1.Fix the basket
2.Find the prices
3.Compute the baskets cost
2
The Consumer Price Index
How the consumer price index is calculated
4. Chose a base year and compute the CPI
Price of basket of goods & services in current year
Divided by price of basket in base year
Times 100
3
The Consumer Price Index
5. Compute the inflation rate
Percentage change in the price index from the
preceding period
Table
Calculating the CPI and the inflation rate: an example
1
5
Step 1: Survey consumers to determine a fixed basket of goods
Basket =4 hot dogs, 2 hamburgers
Step 2: Find the price of each good in each year
Year Price of hot dogs Price of hamburgers
2008
2009
2010
$1
2
3
$2
3
4
Step 3: Compute the cost of the basket of goods in each year
2008
2009
2010
($1 per hot dog 4 hot dogs) +($2 per hamburger 2 hamburgers) =$8 per basket
($2 per hot dog 4 hot dogs) +($3 per hamburger 2 hamburgers) =$14 per basket
($3 per hot dog 4 hot dogs) +($4 per hamburger 2 hamburgers) =$20 per basket
Step 4: Choose one year as a base year (2008) and compute the CPI in each year
2008
2009
2010
($8 / $8) 100 =100
($14 / $8) 100 =175
($20 / $8) 100 =250
Step 5: Use the consumer price index to compute the inflation rate from previous year
2009
2010
(175 100) / 100 100 =75%
(250 175) / 175 100 =43%
Figure
The typical basket of goods and services
1
6
This figure shows how the
typical consumer divides
spending among various
categories of goods and
services. The Bureau of
Labor Statistics calls each
percentage the relative
importance of the category.
Figure
The basket of goods and services in
calculating CPI in Vietnam (2010)
The Consumer Price Index
Producer price index (PPI)
Measure of the cost of a basket of goods and
services bought by firms
Problems in measuring the cost of living
Substitution bias
Introduction of new goods
Unmeasured quality change
8
The Consumer Price Index
The GDP deflator vs. consumer price index
GDP deflator
Ratio of nominal GDP to real GDP
Reflects prices of all goods & services produced
domestically
CPI
Reflects prices of goods & services bought by
consumers
9
The Consumer Price Index
The GDP deflator vs. consumer price index
GDP deflator
Compares the price of currently producedgoods and
services to the price of the same goods and services
in the base year
CPI
Compares price of a fixed basket of goods and
services to the price of the basket in the base year
10
Figure
Two measures of inflation
2
11
This figure shows the inflation ratethe percentage change in the level of prices
as measured by the GDP deflator and the consumer price index using annual data
since 1965. Notice that the two measures of inflation generally move together.
Correcting Economic Variables for Effects of Inflation
Dollar figures from different times
Indexation
Automatic correction by law or contract of a dollar
amount for the effects of inflation.
A cost of living allowance- COLA
A COLA automatically raises the wage when the CPI rises
12
The Consumer Price Index
Real and nominal interest rates
Nominal interest rate (i)
Interest rate as usually reported without a
correction for the effects of inflation
Real interest rate (r)
Interest rate corrected for the effects of
inflation
r=i Inflation rate
13
Nominal interest rate
Always exceeds the real interest rate
U.S. economy has experienced rising consumer
prices in every year
Inflation is variable
Real and nominal interest rates do not always move
together
Periods of deflation
Real interest rate exceeds the nominal interest rate
Interest rates in the U.S. Economy
14
Figure
Real and nominal interest rates
3
15
This figure shows nominal and real interest rates using annual data since 1965. The nominal
interest rate is the rate on a 3-month Treasury bill. The real interest rate is the nominal
interest rate minus the inflation rate as measured by the consumer price index. Notice that
nominal and real interest rates often do not move together.