1. Chapter 7: Measuring Domestic Output and National Income

2. Assessing the Economy’s Performance Compares levels of production (every 3 months) Track fluctuations in growth Used to create policies to address issues

3. Gross Domestic Product Annual total value of output of goods and services (aggregate output)

4. A Monetary Measure Compares relative values of goods and services in different years GDP = C + I + G + (X-M)

5. Counting Goods Intermediate Goods In need of further processing Final Goods Ready for consumption

6. Avoid Multiple Counting GDP ignores intermediate goods

7. Value Added Value of firm’s output less value of inputs the firms have bought

8. GDP Exclusions Financial Transactions Soc. Sec., Welfare Private Transfer Payments Funds transferred from one person to another Stock Market Transactions Buying and selling stocks (just paper; no production) Second Hand Sales “Ebay”

9. Aggregate Spending Spending on output comes from 4 sectors Consumer Spending (C) Investment Spending (I) Government Spending (G) Net Exports (X-M) GDP = C + I + G + (X-M)

10. Consumer Spending (C) Personal Consumption Expenditures Covers all consumer goods and services Largest source of spending GDP = C + I + G + (X-M)

11. Investment Spending (I) Expenditures to increase output later New capital machinery purchased New construction for firms or consumers Market value of the change in unsold inventories GDP = C + I + G + (X-M)

12. Government Spending (G) Expenditures on goods, services, infrastructure, etc. Does not include spending on benefits GDP = C + I + G + (X-M)

13. Net Exports (X-M) Foreign bought US goods (X) Subtract total imports (M) GDP = C + I + G + (X-M)

14. GDP Practice The following list shows the total expenditures in the private, public and foreign sectors in the United States in 2009 (in billions of dollars). Household Consumption (C) = 10,001 Private Investment (I) = 1,590 Government Expenditures (G) = 2,914 Net Exports (X-M) = -386. Calculate total US GDP for 2010. GDP = C + I + G + (X-M) Total GDP = 10,001 + 1,590 + 2,914 +(-386) = $14,119 billion

15. The Income Approach to GDP The sum of all income sources is approximately equal to the sum of all spending sources (GDP) RESOURCE SUPPLIEDINCOME RECEIVED LaborWages LandRent CapitalInterest Entrepreneurial TalentProfits GDP = C + I + G + (X-M) = Aggregate Spending

16. Comparing GDP over time by accounting for different prices over time

17. Nominal GDP (“Current Dollar”, “Money” GDP) Value of current production at current prices

18. Real GDP (“Constant Dollar” GDP) Value of current production, but using prices from a point of time to evaluate inflations impact Example: Valuing 2003 production at 2002 prices creates 2003 Real GDP

19. Nominal to Real GDP Example Suppose GDP is made up of just one product, cups of latte. The table shows how many lattes have been made in a four-year period, the prices, and a price index. We need a price index in order to calculate real GDP. This index is a measure of the price of a good in a given year, when compared to the price of that good in a reference (or base) year. Using 2000 as the base year, the index is used to adjust nominal GDP to real GDP for this one good. First the latte price index, or LPI. YEAR# OF LATTES PRICE PER CUP NOMINAL GDP PRICE INDEX REAL GDP 20001,000$2$2,000= 100 x $2/$2 = 100 = $2,000 20011,200$3$3,600150$2,400 20021,800$4$7,200200$3,600 20031,600$5$8,000250$3,200 LPI in year t = 100 x (Price of a latte in year t) / (Price of a latte in base year)

20. The GDP Price Deflator Used to calculate the rate of price inflation for all goods produced in a nation Used for signs of growth and recession Nominal GDP Real GDP GDP Deflator =X 100

21. GDP Price Deflator Practice 1. If nominal GDP is $100 billion and real GDP is $80 billion, what is the deflator? 2. If Real GDP is $200 billion and deflator is 120 what is the nominal GDP? 3. If nominal GDP is $300 billion and the deflator is 150 what is the real GDP? Nominal GDP Real GDP GDP Deflator =X 100 1. Deflator is 1252. Nominal GDP is $240 billion 3. Real GDP is $200 billion

22. Is inflation bad?

23. Consumer Price Index (CPI) Measures average price level of consumers goods actually bought EXAMPLE using “Market basket of goods” Items in the “Market Basket” Quantity Purchased PriceSpendingPriceSpending on 2000 Quantities Chocolate Bars12$1.50$18$1.75$21 Concert Tickets4$45$180$60$240 Compact Discs18$16$288$15$270 Total Spending=$486=$531 2000 (Base Period) 2001 (Current Period)

24. CPI So, 2001 price index = 100 x (531) / (486) = Price Index current year = 100 x (Spending current year) / (Spending base year) Items in the basket Quantity Purchased PriceSpendingPriceSpending on 2000 Quantities Chocolate Bars12$1.50$18$1.75$21 Concert Tickets4$45$180$60$240 Compact Discs18$16$288$15$270 Total Spending=$486=$531 2000 (Base Period) 2001 (Current Period) 109.26

26. Inflation Annual rate of inflation is the percentage change in CPI from one year to another Consumers can see a “cost of living adjustment” to income to keep up with inflation

27. Nominal and Real Income Nominal = Income in actual currency terms unadjusted for inflation Real = Inflation-adjusted income Real income = (nominal income this year) / CPI (in hundredths)

28. Real Income Example Real income = (nominal income this year) / CPI (in hundredths) Real income 2002 = $40,000 / 1.816 = $22,026 Real income 2003 = $41,000 / 1.850 = $22,162 Real income increased by $136 What if the wages did not increase from 2002 to 2003? What would happen to this persons purchasing power? Real income 2003 = $40,000 / 1.85 = $21,622 (decrease of $404)

29. Real Income Activity

31. Expected Inflation Banks factor expected inflation through nominal interest rates Nominal Interest Rate = Real interest rate + Expected inflation

32. Unexpected Inflation and Examples Effects of unpredictable inflation Employers and employees Due to rapid inflation workers nominal income rise by 8%, but prices of goods rise by 10%, the employer has the advantage Fixed income earners If inflation rises but minimum/transfer payments do not their purchasing power greatly diminishes Savers and borrowers Savers put money into accounts but inflation rises higher than expected hurts the saver Borrowers take out a loan then inflation rises unexpectedly it hurts the lenders

33. Unemployment Frictional Fired employees, newly entered workers Seasonal Periodic and predicted job loss Structural Changes to a field that causes loss of job Cyclical Job loss pending the health of the economy

34. Full Employment No cyclical unemployment = full employment Natural Rate of Unemployment in US is 4-6%