Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 8 Measuring the Economy’s Performance

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-2 Chapter Outline The Simple Circular Flow National Income Accounting Two Main Methods of Measuring GDP Other Components of National Income Accounting Distinguishing Between Nominal and Real Values Comparing GDP Throughout the World

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-3 Figure 8-1 The Circular Flow of Income and Product

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-4 The Simple Circular Flow (cont'd) Product Markets –Transactions in which households buy goods

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-5 The Simple Circular Flow (cont'd) Factor Markets –Transactions in which businesses buy resources

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-6 The Simple Circular Flow (cont'd) Question –Why must total income be identical to the dollar value of total output? Answer –Every transaction simultaneously involves an expenditure and a receipt.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-7 The Simple Circular Flow The concept of the circular flow of income involves two principles: 1.In every economic exchange, the seller receives exactly the same amount that the buyer spends. 2.Goods and services flow in one direction and money payments flow in the other.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-8 National Income Accounting –A measurement system used to estimate national income and its components Total Income –The yearly amount earned by the nation’s resources (factors of production) –Equals Total Spending (why?)

Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 8-9 National Income Accounting (cont'd) Gross Domestic Product (GDP) –The total market value of all final goods and services produced by factors of production located within a nation’s borders

Copyright © 2010 Pearson Addison-Wesley. All rights reserved National Income Accounting (cont'd) Stress on final output –What is a final good? Wheat? Steel? Oil? Bread? Automobile? Gasoline? –Hint: Some are intermediate goods.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved National Income Accounting (cont'd) Intermediate Goods –Goods used up entirely in the production of final goods Value Added –The dollar value of an industry’s sales minus the value of intermediate goods (for example, raw materials and parts) used in production –Value Added (not $ sales) is your contribution to the economy

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Table 8-1 Sales Value and Value Added at Each Stage of Donut Production

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Cost Breakdown for a pair of Nike shoes from Indonesia (1995) CostTotal Production labour Materials Rent, equipment Supplier's operating profit Duties Shipping Cost to Nike $2.75 $9.00 $3.00 $1.75 $3.00 $0.50 $20.00 Research and development Promotion and advertising Sales, distribution, admin. Nike's operating profit Cost to retailer $0.25 $4.00 $5.00 $6.23 $35.50 Retailer's rent Personnel Other Retailer's operating profit Cost to consumer $9.00 $9.50 $7.00 $9.00 $70.00 www-personal.umich.edu/~lormand/poli/nike/nike101-8.htm

Copyright © 2010 Pearson Addison-Wesley. All rights reserved National Income Accounting (cont'd) Transactions that have nothing to do with final goods and services being produced: Financial transactions (stocks, bonds, loans) Transfer Payments (social security tax/benefit, unemployment benefits) Secondhand Goods Pure gifts

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Two Main Methods of Measuring GDP (cont'd) Presenting the Expenditure Approach –Where C=consumption expenditures I=investment expenditures G=government expenditures X=net exports (exports – imports) GDP = C + I + G + X

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Two Main Methods of Measuring GDP (cont'd) Deriving GDP by the Income Approach Gross Domestic Income (GDI) –Wages: salaries and labor income –Rent: farms, houses, stores –Interest: savings accounts –Profits: sole proprietorships, partnerships, corporations

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2009 (in billions of 2009 dollars per year) Sources: U.S. Department of Commerce and author’s estimates.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Distinguishing Between Nominal and Real Values Nominal Values –Measurements in terms of the actual market prices at which goods are sold; expressed in current dollars, also called money values Real Values –Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars –This price-corrected GDP is the real GDP.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved *Price index: measured by the GDP deflator Real GDP =  x 100 Nominal GDP Price index* Example: Correcting GDP for Price Index Changes Correcting GDP for price index changes –Nominal (current) dollars GDP –Real (constant) dollars GDP

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Table 8-3 Correcting GDP for Price Index Changes

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Per capita real GDP = Real GDP Population Distinguishing Between Nominal and Real Values (cont'd) Per capita GDP –Adjusting for population growth

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Source: U.S. Department of Commerce Figure 8-4 Nominal and Real GDP

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Table 8-4 Comparing GDP Internationally

Copyright © 2010 Pearson Addison-Wesley. All rights reserved National Income Accounting (cont'd) GDP’s limitations –Excludes non-market production –It is not necessarily a good measure of the well-being of a nation. –Does money buy happiness? –OK, can you tell me which country do you want to live in?

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Myth #8: Money is everything Money is everything up to a point Get a real job and you are there