econ 202 dr. ugur aker 1 why measure a nation’s income to have a sense of an economy’s size. the...

Econ 202 Dr. Ugur Aker

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Why Measure A Nation’s Why Measure A Nation’s IncomeIncome

To have a sense of an economy’s size.The well being of a citizen, on average,

depends on the nation’s income and its population.

As the income of the society increases, the average person will have a higher standard of living.– One can drown in a lake of 3-ft average depth.– Standard of living may not necessarily be the

goods and services a household can consume.


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Source: http://hdr.undp.org/reports/global/2002/en/indicator/indicator.cfm?File=indic_290_1_1.html

http://hdr.undp.org/statistics/highlights/


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Definition of GDPDefinition of GDP Gross Domestic Product is the market value of all

the final goods and services produced within a country in a year.– How do you determine the value of child care?– How do you include the production of steel or plastics?– How do you include the sales of existing homes?– How do you account for $4 million paid at an auction

for a Van Gogh painting?– How do you account for government services?


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Market ValueMarket ValueSuppose we live in an economy where only

hamburgers, colas and cookies are produced.Prices are: hamburgers $2; colas $1; cookies

$0.50.If this economy produces 100 hamburgers, 150

colas and 200 cookies, what is the market value?

What is the market value if 200 hamburgers, 100 colas and 100 cookies are produced?


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Why GDP Is Equal to Income?Why GDP Is Equal to Income?

How is my contribution to the US economy calculated?– The amount of educational service I create is equal

to my gross income.

How is the income of a real estate agent calculated?– When she sells a 25-yr old house, she gets a

percent of the price as a payment for her services.


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Why GDP Is Equal to Income?Why GDP Is Equal to Income?How is the GDP contribution of the textbook

company calculated?– After they pay the author, the paper company and

the ink company, the amount of revenue they get from textbook sales plus the value of their book inventory (unsold books) is their contribution to the US GDP.

– Their contribution is equal to wages, salaries, rent, interest and profits they pay.


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Value AddedValue AddedCalculate the contribution of the following

activities to GDP.Farmer sells cotton for $100.Cotton is processed into thread and sold for

$130.Thread is made into cloth and sold for $200.Cloth is made into shirts and sold for $300.


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Circular FlowCircular Flow

HouseholdsFirms

Consumption expenditures of households

Income (wages, salaries, rent, interest, profit) earned by households


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Circular FlowCircular Flow

Upper flow is equal to GDP.Lower flow is equal to income.If GDP < Income, businesses will reduce

production and create less income.If GDP > Income, businesses will want to

expand production and create more income.


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How Can We Measure GDP?How Can We Measure GDP?

Expenditure Approach: the upper flow.

Y = C + I + G + NXIncome Approach: the lower flow.

Y = Sum of factor incomes

Y = Wages + Salaries + Rent + Interest + Profits


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Components of Expenditure Components of Expenditure ApproachApproach

Consumption includes spending on food, entertainment, shelter, health care, transportation, clothing, household items, insurance, education.


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Investment includes purchases made by firms to generate future income. Machinery, tools, buildings, trucks and cars are part of investment if they are bought to generate future income. By convention, newly built houses and inventory are included under investment.


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Government purchases are expenditures of federal, state and local governments on goods and services plus their payrolls.


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Net exports is exports minus imports.Dell Computer sales in China are part of US

exports.Dell Computer purchases of plastic molds

for their computers from China are part of US imports.


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GDPGDP

http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid


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Labor and Capital Income

Source: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=05de01.txt


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A GDP Increase Always Increases A GDP Increase Always Increases The Size of the EconomyThe Size of the Economy

WRONG!What if GDP in 1998 were 1000, in 1999

were 1500 but inflation was 50%?In this case, the increase in GDP is solely

attributable to price increases, not improving the well being (standard of living) of the average citizen.


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Nominal vs. Real MeasuresNominal vs. Real MeasuresIn macroeconomics, most variables are

measured in real terms, not nominal terms.Real variable eliminates the effect of inflation.Nominal variable includes the effect of

inflation.GDP comparisons are always made with real

GDP.Nominal GDP uses current prices.Real GDP uses base year prices.


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Real and Nominal GDPReal and Nominal GDP

The Economy Produces 2 Goods: Pizza and Soda

Year Pp Qp Ps Qs Nominal GDP Real GDP GDP Deflator

1997 10 1000 2 5000 $20,000.00 $20,000.00 100.01998 11 1000 3 6000 $29,000.00 $22,000.00 131.81999 13 1200 4 7000 $43,600.00 $26,000.00 167.7

Nominal GDP is calculated by adding the amounts spent on eachProduct. Real GDP is calculated by using the prices of pizza and Soda from 1997 o calculate the amounts spent in future years.GDP Deflator is Nominal GDP/Real GDP.


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Real and Nominal GDP


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What Is Wrong With Real GDP?What Is Wrong With Real GDP?

Real GDP increases if you sell your services rather than provide them free.

If you build a house through Habitat for Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it counts.

If you pollute during production and someone pays to clean the environment, the GDP will be higher than if the producer tried to reduce pollution during production so no clean-up was necessary.


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Underground EconomyUnderground Economy

If market transactions cannot be tracked by data collectors, they may be ignored.

Transactions with high cash usage and no paper trail can remain hidden from the government.

GDP may actually be much higher than government statistics if there is a large underground economy.


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How Does the Government Measure Unemployment?

• Bureau of Labor Statistics (Department of Labor) collects information every month.

• The first Friday of every month at 8:30 AM eastern time, the unemployment rate for the previous month is announced.

• People of age 16 and older are classified as either EMPLOYED or UNEMPLOYED or NOT IN THE LABOR FORCE.


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How Does the Government Measure Unemployment?

• Employed– Any one working for pay.– It may be full-time or part-time.

• Unemployed– Temporary lay-off.– Waiting to start a job.– Looking for a job.

• Not in the labor force– Retirees– Students– Homemakers– Inmates


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http://stats.bls.gov/news.release/empsit.nr0.htm

econ 202 dr. ugur aker 1 why measure a nation’s income to have a sense of an economy’s size. the...

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