Macroeconomics - ECO 2013 Fall 2005 – 1 Term August 24 – December 16, 2005

Chapter 7: Measuring Domestic Output, National Income, and Price Level National Income Accounting measures the economy’s OVERALL performance Bureau of Economic Analysis Assess health of the economy by comparing levels of production Track the long-run course of the economy Formulate policies

Gross Domestic Product (GDP) Aggregate Output: primary measure of the economy’s performance is its annual total output of G & S Gross Domestic Product (GDP) = Aggregate Output GDP = total market value of all FINAL G & S produced in a given year G & S produced by citizen-supplied or foreign-supplied resourced employed WITHIN a country

Gross Domestic Product (GDP) GDP is a monetary measure Avoids multiple counting: Includes ONLY FINAL goods & excludes intermediates Intermediates: G & S purchased for resale or further processing/manufacturing Final: G & S purchased for final use by consumer

GDP Excludes Nonproduction Transactions Nonproduction transactions must be excluded from GDP b/c they have nothing to do w/ the general of final goods Two types: Financial Transactions  Public Transfer Payments  Private Transfer Payments  Stock Market Transactions Secondhand Sales

Two ways to Calculate GDP Expenditures Approach Output Approach: Sum of all the money spent in buying good Income Approach Earnings / Allocations Approach: Income derived or created from producing good

Expenditures Approach Add up all spending on final G & S that has taken place throughout the year GDP = C + Ig + G + Xn where C = Personal Consumption Ig = Private Domestic Investment G = Government purchases of G & S Xn = Net exports

Personal Consumption Expenditures (C) Durable Consumer Goods Nondurable Consumer Goods Consumer Expenditures for Services

Gross Private Domestic Investment (Ig) Final purchases of machinery, equipment, & tools by business enterprises Construction Changes in inventories Net Investment = Gross Investment – Depreciation (amount of capital used up over the course of a year)

Government Purchases (G) Government Consumption Expenditures & Gross Investment Two components: Expenditures for G & S that government consumes in providing public services Expenditures for Social Capital (e.g., schools & highways) Does not include Transfer payments

Net Exports (Xn) Net Exports (Xn) = Exports (X) – Imports (M) When Imports (M) > Exports (X), Net Exports (Xn) is NEGATIVE  Trade Deficit!

Global Perspective of GDP United States Japan Germany France United Kingdom Italy China Brazil Canada Spain India Mexico Korea Netherlands Australia

Income Approach National Income + Adjustments GDP = Wages + Rent + Interest + Profit + Adjustments where Wages includes salary supplements (insurance, benefits) NET Rents received from property resources (less depreciation) Interest paid by private businesses to suppliers of capital Proprietor’s Income sole proprietorships, partnerships, & corporate profits Corporate Profits Corporate Income Taxes Dividends Undistributed Corporate Profits (aka Retained Earnings)

National Income All income that flows to American-supplied resources, here or abroard Add: 1. Indirect Business Taxes  Sales, Excise, Business Property, License Fees, Custom Duties 2. Consumption of Fixed Capital  Depreciation Allowance: Cost of Production 3. Net Foreign Factor Income  Total income of Americans, whether earned in US or abroad

Other National Accounts Net Domestic Product (NDP) NDP = GDP – Consumption of Fixed Capital (Depreciation) National Income (NI) NI = NDP – Net Foreign Factor Income – Indirect Business Taxes Personal Income (PI) PI = NI – Social Security Contributions – Corporate Income Taxes – Undistributed Corporate Profits – Transfer Payments Disposable Income (DI) DI = PI – Personal Taxes DI = Consumption (C) + Savings (S)

Nominal GDP v. Real GDP Compare market values of GDP from year to year, despite any changes due to inflation Deflate GDP when prices rise Inflate GDP when prices fall From a REFERENCE year Nominal GDP: GDP based on prices that prevailed when output was produced (aka unadjusted GDP) Real GDP: GDP that has been deflated or inflated to reflect changes in price level (aka adjusted GDP)

GDP Price Index Price Index: Measure of price of specified collection of G & S (market basket) in a given year as compared to price of an identical collection of G & S in a reference year Price Index in Given Year = (Price of Market Basket in Specific Year / Price of Market Basket in Base Year) * 100 Real GDP = Nominal GDP / Price Index (in hundredths)

Consumer Price Index (CPI) Compiled by Bureau of Labor Statistic (BLS) Reports price of a market basket of ~300 G & S that are presumably purchased by a “typical urban consumer”

Shortcomings of GDP Nonmarket Transactions (e.g., Homemakers) Understates GDP Leisure Understates well-being Improved Product Quality GDP is Quantitative v. Qualitative measure Underground Economy Business that conceal income Factors: 1. Extent & Complexity of Regulation 2. Type & Degree of Taxation 3. Effectiveness of Law Enforcement

Shortcomings of GDP Environment Social costs of negative by-products reduce economic well-being Overstates GDP Composition & Distribution of Output Per Capita Output Divide GDP by population Noneconomic Sources of Well-Being

Chapter 7 Study Questions 7: Net Exports 8 & 9: GDP, NDP, NI, PI 12: Real GDP 13: GDP