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Chapter
Measuring a Nations Income
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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 economicgrowth
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What Macroeconomics Is About
Macroeconomics:
The study of structure and performance of national economiesand government policies that affect economic performance.
Issues addressed by macroeconomists: Long-run economic growth Business cycles Unemployment
Inflation
The international economy Macroeconomic policy
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Gross Domestic Product
GDP (gross domestic product) is the market valueof final goods and services newly produced withina nation during a fixed period of time
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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
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Figure
The circular-flow diagram
1
6
Households buy goods and services from firms, and firms use their revenue fromsales to pay wages to workers, rent to landowners, and profit to firm owners. GDPequals 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.
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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
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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 inthe prices of the final goods
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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
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The Components of GDP
Consumption (C):Spending by domestic households on final goodsand 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)
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The Components of GDP
Investment (I):Spending for new capital goods (fixed ivestment) plusinventory 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)
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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 tothe nations capital stock, such as highways, airports, bridges,and water and sewer systems
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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 representgoods produced abroad, and were included inconsumption, investment, and governmentpurchases
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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
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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
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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
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Table
Real and Nominal GDP
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20
Prices and Quantities
YearPrice ofhot dogs
Quantity of hot dogs
Price ofhamburgers
Quantity ofhamburgers
200820092010
$1$2$3
100150200
$2$3$4
50100150
Calculating Nominal GDP
200820092010
($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)
200820092010
($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
200820092010
($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 thatproduces only hot dogs and hamburgers.
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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
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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)
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Real Versus Nominal GDP in Vietnam
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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
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Figure
Economic growth rate of Vietnam
(1986- 2010)
Source: ADB
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GDP - Good Measure of Economic Well-being?
GDP single measure of the economic well-beingof 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 aworthwhile life
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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
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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 GDPand the quality of life
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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 GDPand the quality of life
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Table
GDP and the quality of life
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CountryReal GDP perperson (2005)
Lifeexpectancy
Adult literacy(% of population)
Internet usage(% of population)
United StatesJapanGermanyRussiaMexicoBrazilChinaIndonesiaIndiaPakistan
BangladeshNigeria
$41,89031,26729,46110,84510,7518,4026,7573,8433,4522,370
2,0531,128
78 years827965767272706465
6347
99%999999928991906150
4769
63 %67451518199737
0.34
The table shows GDP per person and three other measures of the quality of life fortwelve major countries.
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TableGNP vs. GDP
GNP (gross national product) = output produced bydomestically owned factors of production
GDP = output produced within a nationGDP = GNP NFP (2.2)
NFP = net factor payments from abroad= payments to domestically owned factors located abroad minuspayments to foreign factors located domestically
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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 UnitedStates, about 0.2%, but higher for countries that havemany citizens working abroad
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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 (Dp)
National Income (NI) is the total income earned by a nationsresidents in the production of goods and services
NI= NNP- Indirect business taxes+ Business subsidies+ statistical discrepancy
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Other measures of income Personal Income (PI): is the income that households and
noncorporate business receive.PI= NI retained earning
corporate income taxescontributions for social insurance
+interest income +government transfers Disposable Personal Income (Pi d) is the income thatshouseholds and noncorporate business have left aftersatisfying all their obligations to the government.
PId = PI- Personal taxes- Nontax payments
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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 calculated1.Fix the basket2.Find the prices3.Compute the baskets cost
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The Consumer Price Index
5. Compute the inflation rate Percentage change in the price index from the
preceding period
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Table
Calculating the CPI and the inflation rate: an example
1
5
Step 1: Survey consumers to determine a fixed basket of goodsBasket = 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
20092010
$1
23
$2
34
Step 3: Compute the cost of the basket of goods in each year
200820092010
($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 year200820092010
($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%
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Figure
The typical basket of goods and services
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This figure shows how thetypical consumer dividesspending among variouscategories of goods andservices. The Bureau ofLabor Statistics calls eachpercentage the relativeimportance of the category.
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FigureThe basket of goods and services in
calculating CPI in Vietnam (2010)
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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
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Figure
Two measures of inflation
2
11
This figure shows the inflation ratethe percentage change in the level of pricesas 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.
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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 ofinflation
r= i Inflation rate
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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
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Figure
Real and nominal interest rates
3
15
This figure shows nominal and real interest rates using annual data since 1965. The nominalinterest rate is the rate on a 3-month Treasury bill. The real interest rate is the nominalinterest rate minus the inflation rate as measured by the consumer price index. Notice that
nominal and real interest rates often do not move together