ECO 121 MACROECONOMICS Lecture Five Aisha Khan Section L & M Spring 2010

Recap  GDP (primary monetary measure)  Chapter 6 continued

Personal Income  All income received whether earned or unearned  Different from NI because some income earned paid out as social security taxes (payroll taxes), corporate income taxes and undistributed taxes, corporate profits (not received by households)  Transfer payments not earned  PI = NI – income earned but not received + income received but not earned

Disposable income  Disposable income = PI – personal taxes  DI = consumption + saving

Nominal GDP vs. Real GDP  GDP  Total market value of all final goods and services produced in a given year  Measured in money value  Money values may change from year to year  then how do we compare GDP values from year to year?  Must correct for changes due to inflation/deflation

 Nominal GDP is calculated at current prices prevailing when output was produced  Real GDP is a figure which is adjusted for price changes

Adjusting Nominal GDP  Two methods 1. Determine a price index  adjust Nominal GDP by dividing by the price index  Price index = (price of mkt basket /price of mkt basket in base year) * 100  Real GDP = nominal GDP / price index (hundreths)

2. Gather separate data on physical output  determine what it would sell for in base year  Next we can identify the price index  Price index = Nominal GDP/ Real GDP

Real GDP  Allows a better and direct comparison of physical output from year to year  Constant “dollar” measuring device  Purchasing power has been standardized

Consumer Price Index  Designed to measure the changes in the cost of a constant standard of living for a typical consumer  Fixed weight approach  Items in the basket remain the same  Less broad and doesn’t change its basket each year

GDP shortfalls  Doesn’t measure some useful output such as  Homemakers’ services  Parental child care  Volunteer efforts  Doesn’t measure improvements in quality or increased leisure time  Doesn’t measure improved living conditions

 No value adjustments in the composition of output or income distribution  Underground economy  Illegal activities aren’t counted  Legal activities may also be part of underground activities such as to avoid taxation  Harmful effects of production on the environment aren’t adjusted in GDP

 GDP per capita  Better measure of standard of living  Non economic sources of well being (courtesy, crime reduction) not covered in GDP

Reminders  Quiz 1  Chapters 7, 4, 5, (chapter 6 till Income approach)

Use the following to calculate a) GDP, b) NDP, c) NI d) PI e) DI Compensation of employees $ billion US imports of goods and services 16.5 US exports of g&s17.8Personal taxes40.5 Depreciation11.8Net foreign factor income2.2 Government purchases59.4Personal consumption expenditures Taxes on production and imports 14.4Statistical discrepancy0 Net private domestic investment 52.1 Transfer payments13.9