Measuring a Nation’s Income 10 Measuring a Nation’s Income

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

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

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

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

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

The Components of GDP Consumption Investment 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

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

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

The components of U.S. GDP 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

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

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

2 Real and Nominal GDP Prices and Quantities Year Price of hot dogs Quantity of hamburgers 2008 2009 2010 $1 $2 $3 100 150 200 $4 50 Calculating Nominal GDP ($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) ($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 ($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.

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

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)

Real GDP over recent history The GDP data Real GDP grows over time Growth is not steady Recession Real GDP declines Lower income Rising unemployment Falling profits Increased bankruptcies

GNP Growth is Not Steady

Real GDP in the United States 2 Real GDP in the United States 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.

The Business Cycle – Another Look

Business Cycle - Phases

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

International differences in GDP and the quality of life Rich countries - Higher GDP per person Better Life expectancy Literacy Internet usage Poor countries - Lower GDP per person Worse

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).

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/

Equality of Distribution of Income

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!)

GDP and the quality of life 3 GDP and the quality of life Country Real GDP per person (2005) Life expectancy Adult literacy (% of population) Internet usage 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 63 47 99% 99 92 89 91 90 61 50 69 63 % 67 45 15 18 19 9 7 3 0.3 4 The table shows GDP per person and three other measures of the quality of life for twelve major countries.