Economics: Class 9 9/23/2014

GDP vs. National Welfare  GDP should not be confused with national well-being, although it is closes related  Limitations of GDP  GDP ignore many nonmarket transactions  The value of a person who works in the home but is not paid by his or her spouse. Also, unreported income earned in the “underground economy”  E.g. some waiters may not fully report their tip income, and some plumbers may not report their cash sales  GDP ignores the value of leisure  Leisure includes activities we would be willing to pay to do because they bring direct enjoyment to us. Some people feel that Americans are overworked, both in the workplace and at home.  GDP ignores the ecological costs of producing output (including the costs of pollution  GDP focuses on output, but it is consumption that affects our nation’s welfare  I.e. – if other nationals sell us more goods than we sell them, our nation will likely be better off because it can then consume more. But this will reduce GDP since net exports will then be negative. Focusing only on output thus gives a distorted view of national welfare  Government spending is valued at a cost, not at its value.  Worthwhile projects are thus undervalued and worthless projects overvalued.

National Income Accounting Formulas  Gross Domestic Product (GDP) = C + I + G + NX  GNP = GDP + Income Receipts from Rest of World – Income Payments to Rest of World  Net National Product (NNP) = GNP – Depreciation  Net Investment = Gross Investment (I) – Depreciation  National Income = GNP – Depreciation – Indirect Business Tax  = NNP – Indirect Business Tax  = Sum Of Factor Payments  Personal Income (PI) = Household Income  PI = NI – Social Security Contributions – Corporate Income Taxes – Undistributed Corporate Profits + Transfer Payments  Disposable Income = PI – Personal Taxes  = After-tax Household Income  = NI – Corporate Profits – Taxes + Personal Dividend Receipts + Interest Paid By Government = Transfer Payments by government and Business to households

Applying National Income Premises  National Income equals total income. This is because each dollar spent is received as income, national income also equals total spending.  National Income = C + I + G + NX  National Income in terms of how it is allocated by private households  National Income = C + Private Savings + Net Taxes  Net Taxes = (Taxes – Transfer payments)  Households earn income, and the government takes away taxes but gives back transfer payments. Households then either consume or save the remainder (the savings by households is called private savings)  Private Savings = Y – (Taxes – Transfer Payments) – C  Public Savings = Taxes – G – Transfer Payments  When taxes exceed (Government Spending Plus Transfer Payments) the government has a budget surplus  When government spends more than it collects in taxes, the government runs a deficit and public savings are negative  Total Savings (S) is the sum of private and public savings  S = Y – C – G or Y = C + G + S

Things to Remember from Chapter 5  GDP measures national output and not necessarily national welfare  Total Spending is on Consumption (C), Investment (I), Government Spending (G), or Net Exports (NX). Total income is allocated either to Consumption, Savings, or Taxes  Since Total Income = Total Spending, it is also true that National Savings = I + NX  I + Government Deficit = Private Savings + Trade Deficit and I + G + NX = Private Savings + (Taxes – Transfer Payments)

Practical Application  Which of the following are counted in GDP? A.Purchase of $5,000 of Walt Disney Company Stock B.A $5,000 payment to a lawyer to defend yourself in a court case C.A consumer spends $5,000 to buy a used Cadillac D.Another consumer spends $5,000 to purchase a state-of-the-art television system made in Japan E.$5,000 is earned by an American in Paris F.$5,000 in Social Security is paid to a retired school teacher G.A $5,000 computer is produced by a small firm but cannot sell

Practical Application