1. Measuring the Nation’s Income

2. National Income Accounting 0 Bureau of Economic Accounting (BEA) Bureau of Economic Accounting 0 Measures the Economy’s overall performance 0 Like a personal accountant….. But for the economy

3. The GDP 0 Gross Domestic Product 0 Total market value of all final goods and services in a given year Included or excluded?? 1. Fords produced by an American-owned factory in Detroit 2. Hondas produced by a Japanese-owned factory in Ohio Both Included! GDP includes all goods and services produced within the country

4. Gives a Monetary Measure Year 1: Produce 3 iPods and 2 Zunes Year 2: Produce 2 iPods and 3 Zunes Which year has a greater output? Need a price tag! GDP is based on a monetary measure to gain an accurate measure of economic output

5. 2 Rules of GDP 1. Avoid Multiple Counting: 0 Only accounts for Final Goods Final Goods/Services: example: Any retail good Intermediate G/S: example: Peanuts sold from Bob the farmer to Jiffy to make peanut butter If both transactions were counted in the GDP we would have multiple counting

6. 2 Rules of GDP Financial TransactionsSecond Hand Sales 0 Public Transfer Payments 0 Private Transfer Payments 0 Stocks/Bonds 0 In reality…. They are just slips of paper! 0 Sell your ‘03 Ford Focus to your best friend 2.Excluded Non-production Transactions

7. Two ‘Faces’ of GDP Expenditure Approach Income Approach 0 a.k.a. Output approach 0 Sum of all money spent 0 a.k.a. Allocations approach 0 Sum of income created during production In general, buying (spending money) and selling (receiving income) are two aspects of the same transactions

8. The Simple Circular Flow 0 Question 0 Why must total income be identical total output? 0 Answer 0 Every transaction involves an expenditure and a receipt Resource Markets

9. Two Main Methods of Measuring GDP Expenditure Approach

10. Figure 8-2 GDP and Its Components

11. Two Main Methods of Measuring GDP Income Approach Resource Markets

12. GDP is a flow concept Measuring GDP is similar to taking your blood pressure. Expenditure Arm Income Arm Just how your blood pressure is the same on both arms In Macroeconomics ExpendituresEqualsIncome

13. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports

14. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports Same

15. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports Same Value of what is produced Value of what is spent

16. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports Same Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17. How GDP Is Measured? Households Firms Income (wages, salary, rent, interest, profits) Expenditures by Consumers, Investors, Government, and Net Exports Same As Value of what is produced Value of what is spent Flow of Income Approach Expenditures Approach (GDP = C + I + G + Xn )

18. Expenditures Approach GDP= C + I g + G + X n

19. GDP= C+ ……… Personal Consumption 0 Durable consumer goods 0 Cars, appliances, electronics 0 Nondurable consumer goods 0 Bread, milk, pencils, toothpaste 0 Consumer Expenditures for Services 0 Lawyers, doctors, barbers

20. GDP=... I g +... Gross Private Domestic Investment 1. Final purchases of machinery, equipment, tools 2. All construction 0 Both residential and nonresidential construction Why is residential construction not counted in consumption? 0 Houses could be rented to bring in an income return 3. Changes in inventory 0 Including unsold goods… “unconsumed output”

21. ... More about Investment 0 Not counted in investment 0 Stocks/bonds 0 Resale of tangible goods (houses) So how does a Realtor’s Commission fit in? Is it included in GDP? 0 counted as CONSUMPTION (service) 0 Overall…. Investment deals with the creation of new capital

22. Quick Note 0 Gross Private Domestic Investment = Net Private Domestic Investment + Consumption of Fixed Capital/Depreciation

23. GDP=... G+... 0 Government purchases 0 “Government consumption expenditures” 0 All government expenditures on final goods 0 Service- costs for public goods 0 Social capital- highways, schools What is not counted in G? 0 Transfer payments

24. GDP=... X n 0 Net Exports (International Trade) 0 Net Exports (X n )= Exports (X) – Imports (M)

25. GDP Sept 26 th, 2014 Q22014Q22014 Measured in billions of dollars

27. Personal consumption expenditures$245 Net foreign factor income4 Transfer payments12 Rents14 Statistical discrepancy8 Consumption of fixed capital (depreciation)27 Social security contributions20 Interest13 Proprietors’ income33 Net exports11 Dividends16 Compensation of employees223 Taxes on production and imports18 Undistributed corporate profits21 Personal taxes26 Corporate income taxes19 Corporate profits56 Government purchases72 Net private domestic investment33 Personal saving20 Calculate GDP

28. What’s measured on the income side? Income received by Households What is included in this part? 0 Wages 0 Rent 0 Interest 0 Profit 0 Compensation of Employees 0 Rent 0 Interest 0 Proprietor’s income; corporate profits; taxes on production and expenditure 0 Remember! This is the income for the country, not individuals! spending income GDP measures spending and income Income = r + w + i + p = factor payments

29. Personal consumption expenditures$245 Net foreign factor income4 Transfer payments12 Rents14 Statistical discrepancy8 Consumption of fixed capital (depreciation)27 Social security contributions20 Interest13 Proprietors’ income33 Net exports11 Dividends16 Compensation of employees223 Taxes on production and imports18 Undistributed corporate profits21 Personal taxes26 Corporate income taxes19 Corporate profits56 Government purchases72 Net private domestic investment33 Personal saving20 Calculate GDP, using the Income approach

30. Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2009 (in billions of 2009 dollars per year) Sources: U.S. Department of Commerce

31. Real versus Nominal GDP 0 Introductory Video 0 http://www.econedlink.org/interactives/index.php?iid =207 http://www.econedlink.org/interactives/index.php?iid =207

32. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 32 Real versus Nominal GDP  Inflation can distort economic variables like GDP, so we have two versions of GDP:  Nominal GDP  values output using current prices  not corrected for inflation  Real GDP  values output using the prices of a base year  is corrected for inflation

33. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33 EXAMPLE: Compute nominal GDP in each year: 2011:$10 x 400 + $2 x 1000 = $6,000 2012:$11 x 500 + $2.50 x 1100 = $8,250 2013:$12 x 600 + $3 x 1200 = $10,800 PizzaLatte yearPQPQ 2011$10400$2.001000 2012$11500$2.501100 2013$12600$3.001200 37.5% Increase: 30.9%

34. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 34 EXAMPLE: Compute real GDP in each year, using 2011 as the base year: PizzaLatte yearPQPQ 2011$10400$2.001000 2012$11500$2.501100 2013$12600$3.001200 20.0% Increase: 16.7% $10 $2.00 2011:$10 x 400 + $2 x 1000 = $6,000 2012:$10 x 500 + $2 x 1100 = $7,200 2013:$10 x 600 + $2 x 1200 = $8,400

35. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35 EXAMPLE: In each year,  nominal GDP is measured using the (then) current prices.  real GDP is measured using constant prices from the base year (2011 in this example). year Nominal GDP Real GDP 2011$6000 2012$8250$7200 2013$10,800$8400

36. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 36 EXAMPLE:  The change in nominal GDP reflects both prices and quantities. year Nominal GDP Real GDP 2011$6000 2012$8250$7200 2013$10,800$8400 20.0% 16.7% 37.5% 30.9%  The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation.

37. Nominal and Real GDP in the U.S., 1965–2010 Real GDP (base year 2005) Nominal GDP billions

38. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 38 Latte yearPQ 2000$2.001000 2001$3.001200 2002$4.001800 2003$5.001600 Try It!  Calculate Nominal GDP for each year.  Calculate Real GDP for each year.  Base year is 2000.

39. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 39  Nominal GDP:  2000= $2000  2001= 3600  2002= 7200  2003= 8000  Real GDP  2000=2000  2001=2400  2002=3600  2003=3200

40. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 40 The GDP Deflator (Also known as the price index)  The GDP deflator is a measure of the overall level of prices.  Definition:  One way to measure the economy’s inflation rate is to compute the percentage increase in the GDP deflator from one year to the next. GDP deflator = 100 x nominal GDP real GDP

41. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 41 EXAMPLE: Compute the GDP deflator in each year: year Nominal GDP Real GDP GDP Deflator 2011$6000 2012$8250$7200 2013$10,800$8400 2011:100 x (6000/6000) = 100.0 100.0 2012:100 x (8250/7200) = 114.6 114.6 2013:100 x (10,800/8400) = 128.6 128.6 14.6% 12.2%

42. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 42 NOTE:  If you were to go in the other direction (using 2013 as the base year in the previous example), you would get slightly different percentages  Why?  Economists use a process called Chain-linking to be more accurate  Calculating changes in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year  For our purposes, we won’t worry about this

43. ACTIVE LEARNING Computing GDP ACTIVE LEARNING 2 Computing GDP Use the above data to solve these problems: A. Compute nominal GDP in 2011. B. Compute real GDP in 2012. C. Compute the GDP deflator in 2013. 2011 (base yr)20122013 PQPQPQ Good A$30900$311000$361050 Good B$100192$102200$100205 GDP deflator = 100 x nominal GDP real GDP

44. ACTIVE LEARNING Answers ACTIVE LEARNING 2 Answers A. Compute nominal GDP in 2011. $30 x 900 + $100 x 192 = $46,200 B. Compute real GDP in 2012. $30 x 1000 + $100 x 200 = $50,000 2011 (base yr)20122013 PQPQPQ Good A$30900$311,000$361050 Good B$100192$102200$100205 GDP deflator = 100 x nominal GDP real GDP

45. ACTIVE LEARNING Answers ACTIVE LEARNING 2 Answers C. Compute the GDP deflator in 2013. Nom GDP = $36 x 1050 + $100 x 205 = $58,300 Real GDP = $30 x 1050 + $100 x 205 = $52,000 GDP deflator = 100 x (Nom GDP)/(Real GDP) = 100 x ($58,300)/($52,000) = 112.1 2011 (base yr)20122013 PQPQPQ Good A$30900$311,000$361050 Good B$100192$102200$100205 GDP deflator = 100 x nominal GDP real GDP

46. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 46 GDP and Economic Well-Being  Real GDP per capita is the main indicator of the average person’s standard of living.  But GDP is not a perfect measure of well-being.  Robert Kennedy issued a very eloquent yet harsh criticism of GDP:

47. Gross Domestic Product… “… does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.” - Senator Robert Kennedy, 1968

48. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 48 Then Why Do We Care About GDP?  Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc.  GDP does not measure the health of our children, but nations with larger GDP can afford better health care for their children.  GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and enjoy poetry.  GDP does not take account of our intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable attributes are easier to foster when people are less concerned about being able to afford the material necessities of life.  In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life  Many indicators of the quality of life are positively correlated with GDP. For example…

49. GDP and Life Expectancy in 12 countries 49 Life expectancy (years) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Pakistan Bangladesh Nigeria

50. GDP and Literacy in 12 countries 50 Adult Literacy (% of population) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Nigeria Pakistan Bangladesh

51. GDP and Internet Usage in 12 countries 51 Internet Usage (% of population) Real GDP per capita U.S. Germany Japan Mexico Russia Brazil China India Indonesia Nigeria Bangladesh Pakistan

52. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 52 GDP Does Not Value:  the quality of the environment  leisure time  non-market activity, such as the child care a parent provides his or her child at home  an equitable distribution of income  the underground economy  Non-economic sources of well-being

53. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 53 U nderground Economy Source: Open Assessment, E-Journal As a percentage of GDP, Selected Nations, 2007 Mexico South Korea India Italy Spain China Sweden Germany France United Kingdom Japan Switzerland United States 0 5 10 15 20 25 30 Percentage of GDP

54. SUMMARY Gross Domestic Product (GDP) measures a country’s total income and expenditure. The four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports. Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year and is corrected for inflation. GDP is the main indicator of a country’s economic well-being, even though it is not perfect.

55. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 55 Review  Robert works as a lawyer. A.GDP computations should be made using his income from providing legal services, not his production of legal services. B.GDP computations should be made using his production, not his income from providing legal services. C.GDP computations should include both his income and his production. D.GDP computations should include either his income or his production, but not both.

56. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 56 Review  Ralph pays someone to mow his lawn. Norton mows his own lawn. A.Only what Ralph pays to have his lawn mowed is included in GDP. B.What Ralph pays to have his lawn mowed and the estimated value to Norton of mowing his own lawn are both included in GDP. C.Neither what Ralph pays nor the estimated value of Norton's mowing is included in GDP. D.The answer depends on what Norton reports to survey takers.

57. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 57 Review  A professional gambler moves from a state where gambling is illegal to a state where gambling is legal. This move A.necessarily raises GDP. B.necessarily decreases GDP. C.doesn't change GDP because gambling is never included in GDP. D.doesn't change GDP because in either case his income is included.

58. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 58 Review  George buys and lives in a newly constructed home he paid $200,000 for in 2003. He sells the house in 2004 for $225,0000. A.The 2004 sale increases 2004 GDP by $225,000 and does nothing to 2003 GDP. B.The 2004 sale increases 2004 GDP by $25,000 and does nothing to 2003 GDP. C.The 2004 sale does not increase 2004 GDP and does nothing to 2003 GDP. D.The 2004 sale increases 2004 GDP by $225,000 and 2003 GDP is revised upward by $25,000.

59. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 59 Review  If in a given year an economy has consumption of $3000, investment of $2000, government purchases of $1500, exports of $500, imports of $600, taxes of $1200, transfer payments of $400, and depreciation of $300, then GDP will equal A.$6400. B.$7000. C.$7600. D.$8900. E.$9500.

60. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 60 Review  Suppose that twenty-five years ago a country had nominal GDP of 1,000, a GDP deflator of 200, and a population of 100. Today they have nominal GDP of 3,000, a deflator of 400, and population of 150? What happened to the real GDP per person? A.It more than doubled. B.It rose, but less than doubled. C.It was unchanged. D.It fell.

61. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 61 Review  Suppose that Wisconsin produces cheese and fish. In 2002, 20 units of cheese are sold at $5 each, and 8 units of fish are sold at $50 each. In 2001, the base year, the price of cheese was $10 per unit, and the price of fish was $75 per unit. A.Nominal 2002 GDP is $800, real 2002 GDP is $500, and the GDP deflator is 160. B.Nominal 2002 GDP is $500, real 2002 GDP is $800, and the GDP deflator is 160. C.Nominal 2002 GDP is $500, real 2002 GDP is $800, and the GDP deflator is 62.5. D.Nominal 2002 GDP is $800, real 2002 GDP is $500, and the GDP deflator is 62.5.