Copyright 2000 Addison-Wesley Longman CHAPTER 2 The Measurement of Income, Prices, and Unemployment It has been said that figures rule the world; maybe. I am quite sure that it is figures which show us whether it is being ruled well of badly -Johann Wolfgang Goethe, 1830

Flows and Stocks Investment and the Capital Stock: K = K -1 + I –Capital stock = capital stock last year + investment Saving and Wealth W = W -1 + S

Current Account and net International Investment Position –net international investment position (NIIP) measures the net stock of outstanding loans between a country and the rest of the world NIIP = NIIP -1 + CA Public Debt and the Deficit D g = D g -1 + DEF

Copyright 2000 Addison-Wesley Longman

National Income Accounting Purpose: measure the flow of output; it measures the performance of the economy for purposes of public policy Created in the aftermath of the Great Depression, during WWII to determine the capacity of US industry to help fight the war

Copyright 2000 Addison-Wesley Longman Gross Domestic Product GDP is the most important measure of economic output GDP is defined as the total value of all final goods and services produced by the domestic economy in one year Includes: –Currently produced goods and services –Goods sold on the market –Excludes goods that are resold in the current period Genuine Progress Indicator

GDP and GNP GNP=total value of all goods and services produced by the nation’s citizens GNP = GDP + NFP NFP (Net Foreign Product) = factor payments to domestic residents abroad minus factor payments to foreigners earned domestically

Measuring GDP Output Approach: GDP = C + I + G + NX Value-added Approach: GDP = Wages + Profits + Rents + Interest + Indirect Business Taxes

Copyright 2000 Addison-Wesley Longman Figure 2-2 The Contribution of One Loaf of Bread to Consumption Expenditures and Income Created

Types of Expenditures Consumption ( C ) –durable goods –nondurable goods –services Investment (I) –Inventory investment –Fixed investment producer goods new construction Government (G) –R = tax revenue –F = transfer payments –T = net taxes = R - F Net Exports (NX) –exports –Imports

Copyright 2000 Addison-Wesley Longman Flow in equations Y = C+S+T E= C+I+G+(NX) Y=E C+S+T= C+I+G+(NX) S+T= I+G+(NX) Saving and taxes (income not consumed equals that part of expenditures that is not consumed Leakages=withdrawals from expenditures (income not consumed) S,T, IM Injections=expenditure s not consumed) I,G, EX

Copyright 2000 Addison-Wesley Longman Figure 2-3 Introduction of Saving and Investment to the Circular Flow Diagram

Copyright 2000 Addison-Wesley Longman Figure 2-4 Introduction of Taxation, Government Spending, and the Foreign Sector to the Circular Flow Diagram

Consumption as a Percentage of GDP

Investment as a Percentage of GDP

Government Spending as a Percentage of GDP

Exports and Imports as a Percentage of GDP

Types of Income Compensation Corporate Profits Proprietor Profits Interest Rents

Employee Compensation as a Percentage of National Income

Corporate Profits, Proprietorships, and Interest as a Percentage of National Income

Other Measures of Economic Output Net national product (NNP) = GNP - depreciation National Income (NI) = NNP - indirect taxes + business transfer payments (gifts, etc)

Personal Income (PI) = NI –- contributions to social insurance (FICA) –- corporate profits minus dividends –+ personal interest income from the government and consumers –+ government transfer payments (e.g., unemployment insurance, relief, benefits to veterans) Disposable Income (Y d ) = NI - personal taxes

GDP over time

Copyright 2000 Addison-Wesley Longman Figure 2-5 Nominal GDP, Real GDP, and the Implicit GDP Deflactor,

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Figure 2-6 The U.S. Ratio of Actual to Natural Real GDP (Y/Y N ) and the Unemployment Rate,

Copyright 2000 Addison-Wesley Longman Relation Between Unemployment and the Business Cycle Okun’s law: for every 2 percent increase in GDP, unemployment falls by 1 percent

Copyright 2000 Addison-Wesley Longman Unemployment Rate

Copyright 2000 Addison-Wesley Longman