1. Measuring the Economy’s Performance
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. Learning Objectives Describe the circular flow of income and output
Define gross domestic product (GDP)
Understand the limitations of using GDP as a measure of national welfare

3. Learning Objectives Explain the expenditure approach to tabulating GDP
Explain the income approach to computing GDP
Distinguish between nominal GDP and real GDP

4. National Income Accounting
A measurement system used to estimate national income and its components

5. The Simple Circular Flow
Figure 8-1

6. The Simple Circular Flow
Figure 8-1

7. The Simple Circular Flow
Figure 8-1

8. The Simple Circular Flow
Figure 8-1

9. 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.

10. The Simple Circular Flow
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

11. The Simple Circular Flow
Product Markets
Transactions in which households buy goods

12. The Simple Circular Flow
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

13. The Simple Circular Flow
Factor Markets
Transactions in which businesses buy resources

14. The Simple Circular Flow
Total Income
The yearly amount earned by the nation’s factors of production

15. The Simple Circular Flow
Question
Why must total income be identical to the dollar value of total output?
Answer
Every transaction simultaneously involves an expenditure and a receipt

16. 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

17. National Income Accounting
Observations
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

18. National Income Accounting
Intermediate Goods
Goods used up entirely in the production of final goods

19. Sales Value and Value Added at Each Stage of Donut Production
Stage of Production Dollar Value of Sales Value Added
$.03
Stage 1: Fertilizer and Seed $.03
Stage 2: Growing .06
Stage 3: Milling .12
Stage 4: Baking .30
Stage 5: Retailing .45
$.03
$.06
$.18
$.15
Total dollar value of all sales $.96
Total value added $.45

20. National Income Accounting
Exclusion of financial transactions, transfer payments, and secondhand goods
Numerous transactions occur that have nothing to do with final goods and services being produced.

21. National Income Accounting
Financial transactions
Securities
Stocks and bonds
Government transfer payments
Social Security
Unemployment compensation
Private transfer payments
Individual gifts
Corporate gifts

22. National Income Accounting
Transfer of secondhand goods
Why not count the sale of a used car, stereo, or snowboard as part of GDP?
Other excluded transactions
Household production
Legal underground transactions
Illegal underground transactions

23. Recognizing GDP Limitations
GDP’s limitations
Excludes non-market production
Different countries have different legal versus illegal activities
Quality of life is not measured
GDP poorly measures a nation’s well-being

24. Two Main Methods of Measuring GDP
Expenditure Approach
A way of computing national income by adding up the dollar value at current market prices of all final goods and services

25. Two Main Methods of Measuring GDP
Expenditure Approach

26. Two Main Methods of Measuring GDP
Income Approach
A way of measuring national income by adding up income received by all factors of production

27. Two Main Methods of Measuring GDP
Income Approach

28. Two Main Methods of Measuring GDP
Deriving GDP by the expenditure approach
Consumption Expenditure (C)
Durables
Life span of more than three years
Nondurables
Life span of less than three years
Services
Intangible commodities

29. Two Main Methods of Measuring GDP
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

30. Two Main Methods of Measuring GDP
Deriving GDP by the expenditure approach
Government Expenditures (G)
State, local, and federal
Valued at cost

31. Two Main Methods of Measuring GDP
Deriving GDP by the expenditure approach
Net Exports (Foreign Expenditures)
Net exports (X) = total exports - total imports

32. Two Main Methods of Measuring GDP
Mathematical representation using the expenditure approach
GDP = C + I + G + X

33. GDP and Its Components
Figure 8-4

34. Two Main Methods of Measuring GDP
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

35. Two Main Methods of Measuring GDP
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

36. Two Main Methods of Measuring GDP
Deriving GDP by the income approach

37. 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

38. Two Main Methods of Measuring GDP
Gross Domestic Income (GDI)
Wages
Interest
Rent
Profits

39. Two Main Methods of Measuring GDP
Gross domestic product equals gross domestic income plus indirect business taxes and depreciation.
These last items are called nonincome expense items.

40. Gross Domestic Product and Gross Domestic Income, 2005 (in billions of 2005 dollars per year)
Figure 8-5
Source: U.S. Department of Commerce. First quarter preliminary data annualized.

41. 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

42. Other Components of National Income Accounting
Disposable Personal Income (DPI)
Personal income after personal income taxes have been paid

43. Going from GDP to Disposable Income, 2005
Source: U.S. Department of Commerce, and author’s estimates
Table 8-2

44. 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

45. Distinguishing Between Nominal and Real Values
Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars

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

47. Example: Correcting GDP for Price Index Changes
Source: U.S. Department of Commerce, Bureau of Economic Analysis, and author’s estimates
Table 8-3

48. Source: U.S. Department of Commerce
Nominal and Real GDP
Figure 8-6
Source: U.S. Department of Commerce

49. Distinguishing Between Nominal and Real Values
Per capita GDP
Adjusting for population growth
Per capita real GDP =
real GDP
population

50. Nominal and Real GDP
The Bureau of Economic Analysis now uses a chain-weighted measure of real GDP.
This means that changes in the prices and output levels of a certain good will contribute to overall changes in GDP to the extent that the good accounts for a significant share of overall economic activity.

51. Distinguishing Between Nominal and Real Values
Some issues
The distribution of output
Changes in leisure time
Increased traffic congestion
Air pollution
Crime
Housework

52. Comparing GDP Throughout the World
Example
France
$1.25 = 1 euro
Per capita income = 23, euros
France per capita income in terms of dollars equals 23, x 1.25 = $28,961.

53. Comparing GDP Throughout the World
True purchasing power
Accounting for goods and services that are not traded in the world market
Purchasing Power Parity
Adjustments in exchange rate conversions that takes into account differences in the true cost of living across countries

54. International Example: Purchasing Power Parity Comparisons of Incomes
Table 8-4
Source: World Bank

55. Summary Discussion of Learning Objectives
The circular flow of income and output
In every economic transaction, receipts exactly equal expenditures
Goods and services flow in one direction and money payments flow in the other
Gross Domestic Product (GDP)
The total market value of a nation’s final output of goods and services produced in a year using factors of production located within its borders

56. Summary Discussion of Learning Objectives
The limitations of using GDP as a measure of national welfare
Excludes non-market transactions
Does not measure national well-being
The expenditure approach to tabulating GDP
GDP = C + I + G + X

57. Summary Discussion of Learning Objectives
The income approach to computing GDP
The sum of wages, rent, interest, profit, depreciation, and indirect business taxes
Distinguishing between nominal GDP and real GDP
Nominal GDP is the value of newly produced final output in the current year measured in current market prices.
Real GDP adjusts nominal GDP into constant dollars by correcting for price level changes.

58. Measuring the Economy’s Performance
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.