1. Chapter Measuring a Nation’s Income 10

2. The Economy’s Income and Expenditure Gross Domestic Product (GDP) – Measures the total income of everyone in the economy – Measures the total expenditure on the economy’s 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 2

3. Figure The circular-flow diagram 1 3 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.

4. 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 4

5. Measurement of Gross Domestic Product “… of all…” – All items produced in the economy And sold legally in markets – Excludes items that are: Produced and sold illicitly, or Produced and consumed at home “… final…” – Value of intermediate goods is already included in the prices of the final goods 5

6. Measurement of Gross Domestic Product “… 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 6

7. The Components of GDP Y = C + I + G + NX – Identity – Y = GDP – C = consumption – I = investment – G = government purchases – NX = net exports 7

8. The Components of GDP Consumption – Spending by households – On goods and services – Exception: purchases of new housing Investment – Spending on capital equipment, inventories, and structures – Including household purchases of new housing – Inventory accumulation 8

9. The Components of GDP Government purchases – Government consumption expenditure and gross investment – Spending on goods and services – By local, state, and federal governments – Does not include transfer payments 9

10. The Components of GDP Net exports = Exports - Imports – Exports Spending on domestically produced goods by foreigners – Imports Spending on foreign goods by domestic residents 10

11. 2007, 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 11

12. 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 12

13. Real Versus Nominal GDP Real GDP – Production of goods and services – Valued at constant (or base year) prices – Designate one year as base year – Not affected by changes in prices For the base year – Nominal GDP = Real GDP 13

14. Table Real and Nominal GDP 2 14 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.

15. Real Versus Nominal GDP The GDP deflator (all goods and services) – Measure of the price level for all goods and services – inflation at the national 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 – Economy’s overall price level is rising 15

16. 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) 16

17. 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 17

18. GNP Growth is Not Steady 18

19. Figure Real GDP in the United States 2 19 This figure shows quarterly data on real GDP for the U.S. economy since 1965. Recessions—periods of falling real GDP—are marked with the shaded vertical bars.

20. The Business Cycle – Another Look 20

21. Business Cycle - Phases 21

22. GDP - Good Measure of Economic Well-being? GDP – “single measure of the economic well- being of a society”? – Measures both economy’s total income and total expenditure – Larger GDP correlated with Good life Better healthcare Better educational systems 22

23. 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 23

24. GDP - Good Measure of Economic Well-being? Does not consider how income is distributed (GINI coefficient) A low Gini coefficient indicates a more equal distribution, – 0 corresponding to complete equality, – higher Gini coefficients => more unequal » 1 corresponding to complete inequality. When used as a measure of income inequality, » most unequal society will be one in which a single person receives 100% of the total income and the remaining people receive none (G = 1−1/N); » and the most equal society will be one in which every person receives the same income (G = 0). 24

25. Relative Income Distribution Rankings U.S., Gini coefficient of 0.450, ranks near the extreme end of the inequality scale – comparable income inequality: Cameroon, Madagascar, Rwanda, Uganda, Ecuador. China, significantly more equal than the U.S. with a Gini coefficient of 0.415 http://www.theatlantic.com/international/archive/2011/09/map-us-ranks-near-bottom-on-income-inequality/245315/ 25

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29. Equality of Distribution of Income 29

30. GDP - Good Measure of Economic Well-being? GDP – not a perfect measure of well-being – Besides equality/inequality of distribution of income – Also doesn’t include value of Leisure Quality of the environment Almost all activity that takes place outside markets (some legal, some not!) 30

31. 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 70 64 65 63 47 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.