1. Introduction to Macroeconomics Unit 5

2. Circular Flow and GDP Measuring a Nation’s Product and Income

3.  Macroeconomics = The study of the nation’s economy as a whole.  Focuses on a few key issues: 1.Gross Domestic Product (GDP) 2. Inflation 3. Unemployment 4. Economic Growth Macroeconomics

4.  Every day people go to work, where they produce or sell goods/services, and return home with a paycheck  They use their income to purchase all of the things necessary to conduct a modern life  We have investigated the specifics that determine how individual producers or firms decide how much to produce/consume  Now we step back and look at the entire economy as a whole  In order to understand the relationship between production of goods/services and income for the consumers for an entire economy, we must return to the circular flow diagram Production and Income

5.  The important point to remember is that production generates income  Firms pay for inputs, generating income for workers, land owners, other firms, etc  Any profit is income for the owners of the firm Production and Income

6.  Example: Your taxes pay for a school district to hire principals, teachers, and other staff  Your taxes also pay for the school to rent buildings or property, and to pay interest on any money borrowed  The income  These individuals provide education for the students in the district  The production Circular Flow

7.  How do we measure the production of an entire economy?  GDP = the total market value of all final goods and services produced in an economy in a given year  “Total market value” = take the quantity of each good produced and multiply it by the $ value of each  “Final goods and services” = goods that are sold to final consumers, as opposed to goods that are used in the production process  Example: the steel used to manufacture cars.  Steel = intermediate good, car = final good  “In a given year” = we do not keep a running total of all goods produced by an economy…why?  Allows us to measure growth of an economy Measuring Production

8.  How is GDP affected by price and quantity?  If the price of goods and services increases, GDP will increase, even if the quantity produced stys the same  If the quantity produced increases, GDP will increase, even if price stays the same  And vise-versa  So…if only the prices increase, is this economy growing? Is it a stronger economy?  Economists apply the Reality Principle to GDP  Consider real GDP GDP

9.  Reality Principle = what matters to people is the real value of money or income – its purchasing power – not its the face value  Real GDP = a measure of GDP that accounts for changes in the price of goods  Nominal GDP = a measure of GDP using current prices only (i.e. does not account for price changes from year to year) Real GDP

10.  Example: Consider the computers produced by an economy  In year 1: 10 computers sold at $1,000 each  In year 2: 12 computers sold at $1,100 each  Nominal GDP for year 1 and 2 is?  $10,000; $13,200  Is this economic growth?  To calculate real GDP we simply use the year 1 prices for both years  Real GDP for year 1 and 2 is?  $10,000; $12,000  The real GDP has grown by a factor of 1.2 Real GDP

11.  Economic growth = sustained increased in the real production of an economy over a period of time Real GDP & Economic Growth

12.  There are four main components to GDP: 1.Consumption of Expenditures; Purchases by consumers 2.Private Investment expenditures; purchases by firms 3.Government purchases; Purchases by federal, state, and local government 4.Net exports; net purchases by the foreign sector, or domestic exports minus domestic imports Components of GDP

13.  Consumption Expenditures = Purchasers by consumers of currently produced goods and services, either domestic or foreign  Examples: TV sets, DVD players, cars, clothing, hair-styling services, movie tickets, food, and all other consumer items  Can be sub-divided into 3 categories:  Durable goods (last for a long time – cars)  Non-Durable Goods (last a short time – food)  Services (fastest growing category)  Overall, consumption expenditures account for a large % of GDP (%67 – USA) 1. Consumption Expenditures

15.  Private investment expenditures = Purchases of newly produced goods and services by firms  There are three components to private investment expenditures: 1.Spending on new equipment and facilities within a year 2.Spending on a newly produced home 3.An increase in inventories 2. Private Investment Expenditures

16.  Gross investment = the total of all NEW investments within the year  BUT, in order to determine the true investment by the private sector, we also have to consider the deterioration of previous investments (machines, facilities, etc)  Depreciation = the wear and tear of capital as it is used in production  Example: a mold used to shape a plastic product cracks and must be replaced  The net investment = total investment – depreciation  Net investment (not gross investment) is used to calculate GDP 2. Private Investment Expenditures

17.  Government purchases = purchases of newly produced goods and services by all levels of government  Example: increase in wages associated with hiring more government workers  This component does NOT include transfers. Why?  This is money that is simply moved around  It does not represent production when we are discussing the entire economy  However, transfers do make up large % of a governments annual budget, and contribute to deficit 3. Government Purchases

18.  For open economies, or economies that trade with other nations, exports and imports must be factored into GDP  Net exports = total exports – total imports  If a good/service is not produced in a nation’s economy, then it can not be included in the GDP  Therefore we must subtract imports  Net exports can be negative if more goods/services are imported into a country then exported 4. Net Exports