Chapter 8- Measuring Total Production & Income

Distribution of GDP

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Keeping Tabs on the Economy

• You must be able to measure and track the economy in order to understand what is going on and react appropriately.

• In the U.S. the Bureau of Economic Analysis compiles this data.

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National Income Accounts

• The Bureau of Economic Analysis (BEA) compiles data in what we call the national income and product accounts.

• National Accounts: Keep track of the flow of money between different sectors of the economy.

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National Income Accounting- a set of rules and definitions for measuring economic activity in the

aggregate economy (economy as a whole)

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• GDP (Gross Domestic Product)- the total market value of all final goods/services produced in an economy in a one-year period • Measures values, not quantities

• GDP measures only final goods- a good/service purchased by a final user

• Intermediate good- a good/service that is an input to another good/service

• GDP only includes current production

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• GNP (Gross National Product)- Aggregate final output of citizens and businesses of an economy in a one-year period.

• Citizens working over seas not counting in GDP

• Economic output produced by citizens

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GDP: Measuring Total Production and Income

Recession: The period of a business cycle during which total production and total employment are decreasing.

Economic growth: The ability of an economy to produce increasing quantities of goods and services.

Expansion: The period of a business cycle during which total production and total employment are increasing.

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GDP: Measuring Total Production and Income

Business cycle Alternating periods of economic expansion and economic recession.

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Production, Income, and the Circular Flow Diagram

The Circular Flow and the Measurement of GDP

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Four Components of GDP

• Consumption (C)

• Government Spending (G)

• Investment (I)

• International Spending (NX)

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Households (C)

• Consumer Spending: Household spending on goods and services, not including spending on new houses.

• Consumer spending on services is greater than the sum of spending on durable and nondurable goods.

• Most households receive the majority of their income from wages, but some receive investment income in the form of profits, interest, and rents.

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Gross Domestic Product Measures Total Production

Transfer payments: Payments by the government to individuals for which the government does not receive a new good or service in return.

Production, Income, and the Circular Flow Diagram

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Households cont’d

• Government Transfers: Cash payments by the government to individuals.

• Disposable Income: Money available to spend on consumption and savings. DI = Income + Government Transfers - Taxes

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Households cont’d

• Private Savings: What consumers have left of disposable income after consuming. S-private = Disposable Income - Spending

• The total flow of money out of households must

equal the total flow of money in.

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Government (G)

• Government purchases: Spending by federal, state, and local governments on goods and services.

• Governments, just like other institutions, purchases goods and services.

• Government Borrowing: If the government can’t afford it’s programs, it must turn to financial markets to borrow.

• Purchases made by state and local governments are greater than purchases made by the federal government.

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•Spending on Homeland Security Making

the

Connection

Government spending on homeland security more than doubled between 2001 and 2006.

Business Investment (I)

• Investment: Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses.

• Business fixed investment is the largest component of investment

Don’t Let This Happen to YOU! Remember What Economists Mean by Investment 17

International Sector (NX)

• Exports: Goods and services sold to residents of other countries.

• Imports: Goods and services purchased from other countries.

• Net Exports: The difference between the value of exports and the value of imports. – NX = Exports - Imports

• Imports are greater than exports, so net exports are negative.

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GDP

• GDP=Y=C+I+G+NX

• GDP is used as a measure of the size of an economy and can be used to both track the economy and to compare with others.

• U.S. GDP 2007: $13,768.8 billion U.S. GDP 2009: $14,256 billion

U.S. GDP 2011: $15,094 billion

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Components of GDP in 2010

Gross Domestic Product Measures Total Production

2 Ways to Measure GDP 1. Measuring GDP by the Value-Added Method

Value added : The market value a firm adds to a product.

Calculating Value Added

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $ Value added by cotton farmer = 1

Textile Mill Value of raw cotton woven

into cotton fabric = $3

Value added by cotton textile

mill = ($3 – $1) = 2

Shirt Company Value of cotton fabric made

into a shirt = $15

Value added by shirt

manufacturer = ($15 –$3) = 12

L.L. Bean Value of shirt for sale on

L.L. Bean’s Web site = $35

Value added by L.L. Bean

= ($35 – $15) = 20

Total Value Added = $35

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Does GDP Measure What We Want It to Measure?

Household production refers to goods and services people produce for themselves.

GDP doesn’t count all forms of production.

Household Production

The Underground Economy

Underground economy: Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

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The Underground Economy is Growing!

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Does GDP Measure What We Want It to Measure?

Shortcomings of GDP as a Measure of Well-Being

The Value of Leisure Is Not Included in GDP

GDP Is Not Adjusted for Pollution or Other Negative Effects of Production

GDP Is Not Adjusted for Changes in Crime and Other Social Problems

GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

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•Did World War II Bring Prosperity? Making

the

Connection

Real GDP versus Nominal GDP

Real GDP The value of final goods and services evaluated at base-year prices.

Calculating Real GDP

Nominal GDP The value of final goods and services evaluated at current-year prices.

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Example 1 Year Nominal GDP GDP Deflator

1998 $8,782 103.2

1999 $9,274 104.7

2000 $9,825 106.9

2001 $10,082 109.4

1. Find Real GDP in 1998 2. Find Real GDP in 1999 3. Find Real GDP in 2000 4. Find Real GDP in 2001

Note: (We could calculate the percentage change between each year to find how

much production of goods/services change.)

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Real GDP versus Nominal GDP Nominal GDP and Real GDP, 1990–2010

Real GDP versus Nominal GDP

Price level A measure of the average prices of goods and services in the economy.

The GDP Deflator

GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.

100Nominal GDP

GDP deflatorReal GDP

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Example 2 Nominal GDP Real GDP Deflator

1999 Level $9,274.3 $8,859.0

2000 Level $9,824.6 $9191.4

% Change

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Other Measures of Total Production and Total Income

Net National Product (NNP)

National Income

Personal Income

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