National Income Accounting Lecture 8 Dr. Jennifer P. Wissink ©2018 Jennifer P. Wissink, all rights reserved. February 21, 2018 1

Announcements-MACRO Spring 2018 MEL Quiz due TONIGHT. Make sure to hit Submit Quiz before 11pm! Seems to be that if you already submitted your 1st attempt, then if you fail to submit your 2nd attempt, the system will not allow me to submit it for you. CES Event!

GDP: Gross Domestic Product Gross Domestic Product (GDP) is the total “dollar” market value of all final goods and services currently produced within a given period by factors of production located within a country. About how big was it in the U.S. in 2017? Current GDP: Billions of Dollars, Not Seasonally Adjusted Real GDP: Billions of Chained 2009 Dollars, Not Seasonally Adjusted A = $19,386.8 billion (current or nominal) B = $17,092.7 billion (real, chained 2009 $) C = BOTH! https://www.bea.gov/national/index.htm

The Circular Flow & National Income Accounting

Important GDP Notes Gross Domestic Product (GDP) is the total “dollar” market value of all final goods & services currently produced within a given period by factors of production located within a country. Market value... Final goods and services... The term final goods and services in GDP refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing (i.e., transformation) by another. Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales. Currently produced stuff... Done this period Something created Located within, i.e., stuff produced HERE... Output produced by a country’s citizens, regardless of where the output is produced, is measured by Gross National Product (GNP). It’s gross... Refers to investment purchases of newly produced capital like housing, plants, equipment, and inventory.

i>clicker questions A piano is produced in 2014 and valued at $8,000. It does not sell until 2015. So the $8,000 gets recorded in GDP for 2015 since that is when it sells. A. True B. False On Feb 18, 2015 Joe buys some IBM stock from Fred and pays Fred $10,000 for it. There are no transaction fees or broker fees. It’s just a transaction between these two guys. When calculating GDP for 2015 you include this $10,000. A. True B. False In 2015 Mikko, A Finnish citizen residing in Ithaca, NY sells $5,000 worth of financial advice to clients. Half of these clients also reside in the U.S. The other half do not. Therefore, only $2,500 of Mikko’s financial advice gets counted in 2015 U.S. GDP. A. True B. False

GDP Observations & Limitations Population matters... Leisure matters... Quality matters... Home production matters... Illegal markets matter... Distribution matters... Social Benefits/Costs matter... What’s produced matters... Depreciation matters... So what do we do? Try the best we can. Look at various indicators and scale them or compare them in meaningful ways. How Happy Is America? http://www.npr.org/blogs/money/2013/02/08/171414674/how-happy-is-america

Interesting Reads How Society Pays When Women’s Work Is Unpaid http://www.nytimes.com/2016/02/23/upshot/how-society-pays-when-womens-work-is-unpaid.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=photo-spot-region&region=top-news&WT.nav=top-news&_r=0 How Should Inventory Investment be Measured in National Accounts? http://www.bea.gov/papers/pdf/wp_how_should_inventory_investment_be_measured_in_national_accounts.pdf

Interesting Numbers United States 2015 GDP per capita, PPP (current international $) 56,116 GDP, PPP (current international $) 18.037 trillion Source: World Development Indicators database Pop in US: 321,418,820 China 2015 GDP per capita, PPP (current international $) 8,029 GDP, PPP (current international $) 11.008 trillion Source: World Development Indicators database Pop in China: 1,371,000,000

http://data.worldbank.org/indicator/NY.GDP.PCAP.CD

Calculating GDP The expenditure approach: A method of computing GDP that measures the total amount spent on all currently produced final goods during a given period. The income approach: A method of computing GDP that measures the income – that is, wages/salaries, rents, interest, and profits - received by all factors of production in producing final goods.

Coal Mine Car Plant Car Dealer Steel Mill Iron Works Key $ amount for upstream inputs Key wages: 20 rents: 10 interest: 30 profits: 10 $ amount of value added Car Plant Steel Mill Car Dealer wages: 18 rents: 2 interest: 0 profits: 0 wages: 10 rents: 0 interest: 0 profits: 20 wages: 50 rents: 0 interest: 0 profits: -20 wages: 90 rents: 100 interest: 0 profits: 0 Iron Works

Billions of Dollars ($) TABLE 6.2 Components of U.S. GDP, 2014: The Expenditure Approach, GDP = C + I + G + (EX – IM) Billions of Dollars ($) Percentage of GDP (%) Personal consumption expenditures (C) 11,930.3 68.5 Durable goods 1,302.5 7.5 Nondurable goods 2,666.2 15.3 Services 7,961.7 45.7 Gross private domestic investment (l) 2,851.6 16.4 Nonresidential 2,210.5 12.7 Residential 559.1 3.2 Change in business inventories 82.0 0.5 Government consumption & gross investment (G) 3,175.2 18.2 Federal 1,219.2 7.0 State and local 1,956.1 11.2 Net exports (EX – IM) −538.2 −3.1 Exports (EX) 2,337.0 13.4 Imports (IM) 2,875.2 16.5 Gross domestic product 17,418.9 100.0 Source: U.S. Bureau of Economic Analysis, March 27, 2015.

The Expenditure Approach to GDP Personal consumption expenditures (C) are expenditures by consumers on the following: Durable goods: Goods that last a relatively long time, such as cars and appliances. Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

The Expenditure Approach to GDP Gross private domestic investment (I) Total investment by the private sector (stuff taken off the shelf but not for consumption). It includes the purchase of new housing, plants, equipment, and inventory by the private sector. Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

The Expenditure Approach to GDP Government consumption and gross investment (G) Counts expenditures by federal, state, and local governments for final goods and services. Does not include transfer payments. Net exports (EX – IM) The difference between exports and imports. Exports (EX) are sales to foreigners of U.S. produced goods and services. Imports (IM) are U.S. purchases of goods and services from abroad.

The Income Approach to GDP

Touchstones For GDP Questions Did it go through a legal market? Omit “under the table” illegal stuff. Omit “home” production. Omit “unmarketed” externalities. Was it currently produced? Omit transactions in which money or goods changes hands but in which no new goods and services are produced. Omit capital gains on resale of assets (but include the value of currently rendered services or currently produced items that were a part of the transaction). Omit transfer payments – nothing produced. Are we making sure we’re only calculating “final” values? Omit double counting intermediate goods (but you can use these IF you are using value added summed up all along the way, rather than final good sales). Include gross investment. Include currently produced inventory. Was it produced within the borders of the country? Omit output produced by citizens working abroad.

i>clicker question This economy produced more in year 2 than it did in year 1. A. True False Hard to say A Three-Good Economy PRODUCTION YEAR 1 YEAR 2 Q1 Q2 Good A 6 11 Good B 7 4 Good C 10 12 20

Nominal GDP vs Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. When any variable is measured in current dollars, it is described in nominal terms. Real GDP is GDP measured in reference to some base year so we can control for overall price changes. Simple Old Method (used prior to 1996) Picked a base year as the year chosen to be the reference year. Used the set of prices in the base year to evaluate quantities produced in the base years and in other years. A more complicated procedure is now used to perform these calculations. We will only learn how to perform the old procedure.

Calculating Nominal GDP and Real GDP A Three-Good Economy (1) (2) (3) (4) (5) (6) (7) (8) GDP IN YEAR 1 YEAR 2 IN PRODUCTION PRICE PER UNIT PRICES Q1 Q2 P1 P2 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2 Good A 6 11 $.50 $ .40 Good B 7 4 .30 1.00 Good C 10 12 .70 .90 Total 22