1. Chapter 8 Measuring the Economy’s Performance Chapter 8:
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 8:
Measuring the Economy’s Performance
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2. The Simple Circular Flow
Two observations
In every economic exchange, the seller receives exactly the same amount that the buyer spends.
Goods and services flow in one direction and money payments flow in the other.

3. The Simple Circular Flow (cont'd)
Profits explained
Question
Why is profit a cost of production?
Answer
Profits are the return entrepreneurs receive for the risk they incur when organizing productive activities.

4. The Simple Circular Flow (cont'd)
Final Goods and Services
Goods and services that are at their final stage of production and will not be transformed into yet other goods or services

5. The Simple Circular Flow (cont'd)
Product Markets
Transactions in which households buy goods

6. The Simple Circular Flow (cont'd)
Total Income
Wages, rent, interest, profits

7. The Simple Circular Flow (cont'd)
Factor Markets
Transactions in which businesses buy resources

8. Figure 8-1 The Circular Flow of Income and Product

9. 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.

10. 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)

11. National Income Accounting
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
GDP measures the dollar value of final output.
GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders.

12. National Income Accounting (cont'd)
Stress on final output
What is a final good?
Wheat?
Steel?
Oil?
Bread?
Automobile?
Gasoline?

13. 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

14. Table 8-1 Sales Value and Value Added of Donut Production

15. National Income Accounting
Numerous transactions occur that have nothing to do with final goods and services being produced.
Exclusion of financial transactions
Securities
Stocks and bonds
Government transfer payments
Social Security
Unemployment compensation
Private transfer payments
Individual gifts
Corporate gifts

16. National Income Accounting
Transfer of secondhand goods excluded
Why not count the sale of a used computer, guitar, or snowboard as part of GDP?
Other excluded transactions
Household production
Legal and illegal underground transactions

17. National Income Accounting
GDP’s limitations
Excludes non-market production
It is not necessarily a good measure of the well-being of a nation.
GDP is not a measure of a nation’s overall welfare.
GDP is a measure of the value of production in terms of market prices, and an indicator of economic activity.

18. Two Main Methods of Measuring GDP
Expenditure Approach
Computing GDP by adding up the dollar value at current market prices of all final goods and services

19. Two Main Methods of Measuring GDP (cont'd)
Expenditure Approach

20. Two Main Methods of Measuring GDP (cont'd)
Income Approach
Measuring GDP by adding up all components of national income, including wages, interest, rent, and profits

21. Two Main Methods of Measuring GDP (cont'd)
Income Approach

22. Two Main Methods of Measuring GDP (cont'd)
Deriving GDP by the expenditure approach
Consumption Expenditure (C)
Durable Consumer Goods
Life span of more than three years
Nondurable Consumer Goods
Goods that are used up in three years
Services
Mental or physical help

23. Two Main Methods of Measuring GDP (cont'd)
Deriving GDP by the expenditure approach
Gross Private Domestic Investment (I)
The creation of capital goods, such as factories and machines, that can yield production and hence consumption in the future
Also included: changes in business inventories and repairs made to machines, buildings

24. Two Main Methods of Measuring GDP (cont'd)
Deriving GDP by the expenditure approach
Gross Private Domestic Investment (I)
Producer Durables or Capital Goods
Life span of more than three years
Fixed Investment
Purchases by business of newly produced producer durables or capital goods
Inventory Investment
Changes in stocks of finished goods and goods in process, as well as changes in raw materials

25. Two Main Methods of Measuring GDP (cont'd)
Deriving GDP by the expenditure approach
Government Expenditures (G)
State, local, and federal
Valued at cost
Net Exports (Foreign Expenditures)
Net exports (X) = Total exports – Total imports

26. 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
GDP = C + I + G + X

27. Figure 8-2 GDP and Its Components
Note unique scale on vertical axis.

28. Two Main Methods of Measuring GDP (cont'd)
Depreciation and net domestic product
Deducting for depreciation (capital consumption allowance)
Reduction in the value of capital goods over a one-year period due to physical wear and tear, and also to obsolescence
NDP = GDP – Depreciation

29. Two Main Methods of Measuring GDP (cont'd)
NDP = GDP – Depreciation
GDP = C + I + G + X
NDP = C + I + G + X – Depreciation
Net Investment = I – Depreciation
Domestic investment minus an estimate of the wear and tear on the existing capital stock
NDP = C + Net I + G + X

30. Two Main Methods of Measuring GDP (cont'd)
Deriving GDP by the income approach

31. Deriving GDP by the Income Approach
Gross Domestic Income (GDI)
The sum of all income—wages, interest, rent, and profits—paid to the four factors of production
Wages: salaries and labor income
Rent: farms, houses, stores
Interest: savings accounts
Profits: sole proprietorships, partnerships, corporations

32. Two Main Methods of Measuring GDP
Gross domestic product equals gross domestic income plus indirect business taxes and depreciation
These last items are called non-income expense items
Indirect business taxes
All business taxes except the tax on corporate profits
Include sales and business property taxes

33. Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2007 (in billions of 2007 dollars per year)
Source: U.S. Department of Commerce. First quarter preliminary data annualized.

34. Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2007 (in billions of 2007 dollars per year)

35. Other Components of National Income Accounting
National Income (NI)
The total of all factor payments to resource owners
Personal Income (PI)
The amount of income that households actually receive before they pay personal income taxes
Disposable Personal Income (DPI)
Personal income after personal income taxes have been paid

36. Table 8-2 Going from GDP to Disposable Income, 2007

37. 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

38. 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
Constant Dollars
Dollars expressed in terms of real purchasing power

39. Example: Correcting GDP for Price Index Changes
Nominal (current) dollars GDP
Real (constant) dollars GDP
Nominal GDP
Price level*
Real GDP =
x 100
*Price level: measured by the GDP deflator

40. Table 8-3 Correcting GDP for Price Index Changes

41. Distinguishing Between Nominal and Real Values (cont'd)
Per capita GDP
Adjusting for population growth
Per capita real GDP =
Real GDP
Population

42. Figure 8-4 Nominal and Real GDP
Source: U.S. Department of Commerce

43. Comparing GDP Throughout the World
Foreign Exchange Rate
The price of one currency in terms of another
Foreign exchange rate & comparing GDP
$1.25 = 1 euro, or $1 = 0.80 euros
French per capita income = 23, euros
French per capita income in terms of dollars equals 23, euros x $1.25 = $28,961

44. Comparing GDP Throughout the World (cont'd)
Purchasing Power Parity
Adjustments in exchange rate conversions that takes into account differences in the true cost of living across countries

45. Table 8-4 Comparing GDP Internationally

46. Chapter 8 Measuring the Economy’s Performance Chapter 8:
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 8:
Measuring the Economy’s Performance
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.