1. Slide 8-1 The Simple Circular Flow

2. Slide 8-2 The Simple Circular Flow

3. Slide 8-3 The Simple Circular Flow

4. Slide 8-4 The Simple Circular Flow

5. Slide 8-5 The Simple Circular Flow Figure 8.1

6. Slide 8-6 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.

7. Slide 8-7 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

8. Slide 8-8 The Simple Circular Flow Product Markets –Transactions in which households buy goods

9. Slide 8-9 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

10. Slide 8-10 The Simple Circular Flow Factor Markets –Transactions in which businesses buy resources

11. Slide 8-11 The Simple Circular Flow Total Income –The yearly amount earned by the nation’s factors of production

12. Slide 8-12 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

13. Slide 8-13 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

14. Slide 8-14 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

15. Slide 8-15 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

16. Slide 8-16 Two Main Methods of Measuring GDP Expenditure Approach

17. Slide 8-17 Two Main Methods of Measuring GDP Income Approach –A way of measuring national income by adding up income received by all factors of production

18. Slide 8-18 Two Main Methods of Measuring GDP Income Approach

19. Slide 8-19 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

20. Slide 8-20 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

21. Slide 8-21 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approach –Gross Private Domestic Investment (I) Fixed investment Inventory investment New residential structures

22. Slide 8-22 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approach –Government Expenditures (G) State, local, and federal Valued at cost

23. Slide 8-23 Two Main Methods of Measuring GDP Deriving GDP by the expenditure approach –Net Exports (Foreign Expenditures) Net exports (X) = total exports - total imports

24. Slide 8-24 Two Main Methods of Measuring GDP Mathematical representation using the expenditure approach GDP = C + I + G + X

25. Slide 8-25 GDP and Its Components Figure 8-3

26. Slide 8-26 Two Main Methods of Measuring GDP Deriving GDP by the income approach

27. Slide 8-27 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

28. Slide 8-28 Two Main Methods of Measuring GDP Gross Domestic Income (GDI) –Wages –Interest –Rent –Profits

29. Slide 8-29 Gross Domestic Product and Gross Domestic Income, 2000 (in billions of 2000 dollars per year) Figure 8-4 Source: U.S. Department of Commerce. First quarter preliminary data annualized.

30. Slide 8-30 Expenditure Point of View—Product Flow Expenditures by Different Sectors: Household sector Personal consumption expenses$6,661.5 Government sector Purchase of goods and services1,734.6 Business sector Gross private domestic investment (including depreciation)1,727.0 Foreign sector Net exports of goods and services-273.6 Gross Domestic Product$9,849.5 Gross Domestic Product and Gross Domestic Income, 2000 (in billions of 2000 dollars per year)

31. Slide 8-31 Income Point of View—Cost Flow Domestic Income (at factor cost): Wages All wages, salaries, and supplemental employee compensation$5,678.4 Rent All rental income of individuals plus implicit rent on owner-occupied dwellings155.4 Interest Net interest paid by business490.2 Profit Proprietorial income701.3 Corporate profits before taxes deducted952.0 Non-income expense items Indirect business taxes and other adjustments762.1 Depreciation1,215.4 Statistical discrepancy-105.3 Gross Domestic Income$9,849.5 Gross Domestic Product and Gross Domestic Income, 2000 (in billions of 2000 dollars per year)

32. Slide 8-32 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

33. Slide 8-33 Other Components of National Income Accounting Disposable Personal Income (DPI) –Personal income after personal income taxes have been paid

34. Slide 8-34 Billions of Dollars Gross domestic product (GDP)9,849.5 Minus depreciation-1,215.4 Net domestic product (NDP)8,634.1 Minus indirect business taxes-762.1 and other adjustments National Income (NI)7,872.0 Minus corporate taxes, Social Security contributions, corporate retained earnings-1,236.5 Plus government and business transfer payments+1,606.8 Personal Income (PI)8,242.3 Minus personal income tax and non-tax payments-1,253.2 Disposable personal income (DPI)6,989.1 Source: U.S. Department of Commerce Going from GDP to Disposable Income, 2000

35. Slide 8-35 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

36. Slide 8-36 Distinguishing Between Nominal and Real Values Real Values –Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars

37. Slide 8-37 Distinguishing Between Nominal and Real Values Correcting GDP for price index changes –Nominal (current) dollars GDP –Real (constant) dollars GDP *Price level: measured by the GDP deflator Real GDP =  = 100 nominal GDP price level*

38. Slide 8-38 19905,803.286.86,683.5 19915,986.289.86,669.2 19926,318.991.76,891.1 19936,642.394.27,054.1 19947,054.396.17,337.8 19957,400.598.27,537.1 19967,813.2100.07,813.2 19978,300.9101.78,165.1 19988,759.9102.98,516.3 19999,254.6104.4 8,867.0 2000 9,849.5106.4 9,256.2 (1)(2)(3) (4) = [(2)/(3)] x 100 Nominal GDPReal GDP (billions of(billions of dollars dollarsPrice Level Indexper year Yearper year)(base year 1992 = 100)in constant 1992 dollars ) Correcting GDP for Price Changes Source: U.S. Department of Commerce, Bureau of Economic Analysis

39. Slide 8-39 Distinguishing Between Nominal and Real Values Example –Base Year = 1992 –Price Index = 100

40. Slide 8-40 Distinguishing Between Nominal and Real Values Real GDP = nominal GDP in the base year Real 1992 GDP =  = 100 nominal GDP price index Real 1992 GDP =  = 100 = $6,020.2 billion $6,020.2 100

41. Slide 8-41 Distinguishing Between Nominal and Real Values 1993 –Price Index = 102.2 Real 1993 GDP =  = 100 = $6,206.8 billion $6,343.3 102.2

42. Slide 8-42 Distinguishing Between Nominal and Real Values 1987 –Price Index = 82.7 Real 1993 GDP =  = 100 = $5,489.6 billion $4,539.9 82.7

43. Slide 8-43 Nominal and Real GDP Figure 8-5 Source: U.S. Department of Commerce

44. Slide 8-44 Distinguishing Between Nominal and Real Values Per capita GDP –Adjusting for population growth Per capita real GDP = real GDP population

45. Slide 8-45 Distinguishing Between Nominal and Real Values Question –Is real per capita GDP a good indicator of social well-being?

46. Slide 8-46 Distinguishing Between Nominal and Real Values Some issues –The distribution of output –Changes in leisure time –Increased traffic congestion –Air pollution –Crime –Housework

47. Slide 8-47 Forecasting economists have done a relatively good job predicting long-run trends in real GDP. They have not done as well predicting recessions. Issues and Applications: How Well Do Economists Predict GDP?

48. Slide 8-48 Forecasted GrowthActual Growth Start of Recession Date of Forecast over the Next Year (%)in Real GDP (%) December 1969December 19691.5-.6 November 1973December 19731.5-1.8 January 1980December 1979-.7-.3 July 1990December 19892.1-.1 July 1991December 19902.2.7 Economic Forecasts: Missing the Mark Source: Business Week, September 30, 1992, p. 92

49. Slide 8-49 How Well Do Economists Predict GDP? Difficulties in predicting downturns –Trying to develop computer models for a changing multi-trillion dollar economy –Globalization –Data sources and methodology