2. 1 Frank & Bernanke 4th edition, 2009 Ch. 4: Spending, Income, and GDP

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5. 4 Why Measure A Nation’s Income To have a sense of an economy’s size. To have a sense of an economy’s size. The well being of a citizen, on average, depends on the nation’s income per person. The well being of a citizen, on average, depends on the nation’s income per person. http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu As the income of the society increases, the average person will have a higher standard of living. As the income of the society increases, the average person will have a higher standard of living. One can drown in a lake of 3-ft average depth. One can drown in a lake of 3-ft average depth. Standard of living may not necessarily be the goods and services a household can consume. Standard of living may not necessarily be the goods and services a household can consume.

6. 5 Definition of GDP Gross Domestic Product is the market value of all the final goods and services produced within a country in a year. Gross Domestic Product is the market value of all the final goods and services produced within a country in a year. How do you determine the value of child care? How do you determine the value of child care? How do you include the production of steel or plastics? How do you include the production of steel or plastics? How do you include the sales of existing homes? How do you include the sales of existing homes? How do you account for $4 million paid at an auction for a Van Gogh painting? How do you account for $4 million paid at an auction for a Van Gogh painting? How do you account for government services? How do you account for government services?

7. 6 Market Value Suppose we live in an economy where only hamburgers, colas and fries are produced. Suppose we live in an economy where only hamburgers, colas and fries are produced. Prices are: hamburgers $2; colas $1; fries $0.50. Prices are: hamburgers $2; colas $1; fries $0.50. If this economy produces 100 hamburgers, 150 colas and 200 fries, what is the market value? If this economy produces 100 hamburgers, 150 colas and 200 fries, what is the market value? What is the market value if 200 hamburgers, 100 colas and 100 fries are produced? What is the market value if 200 hamburgers, 100 colas and 100 fries are produced? PriceQtyValue Hmbgr$2100$200 Cola$1150$150 Fries$0.50200$100 GDP$450

8. 7 Percentages of American Men and Women over Age 16 Working Outside the Home Increase in female labor force participation increases the demand for housekeeping and child care. Unpaid household work is not counted in GDP. Paid household work is counted in GDP. The increase in female labor force participation has overstated GDP growth. “By 2010 women will be the majority.” Check at www.bls.gov www.bls.gov http://www.economist.com /opinion/displayStory.cfm? story_id=15174489&sourc e=hptextfeature

9. Participation Rates 8 Labor Force Participation Rate is total employed plus unemployed divided by the labor force. From 2000 to 2011 participation rates for men dropped from 75% to 70%. From 2000 to 2011 participation rates for women dropped from 60% to 58%.

10. 9 Why GDP Is Equal to Income? How is my contribution to the US economy calculated? How is my contribution to the US economy calculated? The amount of educational service I create is equal to my gross income. The amount of educational service I create is equal to my gross income. How is the income of a real estate agent calculated? How is the income of a real estate agent calculated? When she sells a 25-yr old house, she gets a percent of the price as a payment for her services. When she sells a 25-yr old house, she gets a percent of the price as a payment for her services.

11. 10 Why GDP Is Equal to Income? How is the GDP contribution of the textbook company calculated? How is the GDP contribution of the textbook company calculated? After they pay the author, the paper company and the ink company, the amount of revenue they get from textbook sales plus the value of their book inventory (unsold books) is their contribution to the US GDP. After they pay the author, the paper company and the ink company, the amount of revenue they get from textbook sales plus the value of their book inventory (unsold books) is their contribution to the US GDP. Their contribution is equal to wages, salaries, rent, interest and profits generated. Their contribution is equal to wages, salaries, rent, interest and profits generated.

12. 11 Value Added Calculate the contribution of the following activities to GDP. Calculate the contribution of the following activities to GDP. Farmer sells cotton for $100. Farmer sells cotton for $100. Cotton is processed into thread and sold for $130. Cotton is processed into thread and sold for $130. Thread is made into cloth and sold for $200. Thread is made into cloth and sold for $200. Cloth is made into shirts and sold for $300. Cloth is made into shirts and sold for $300. $100 $30 $70 $100 300 Final value = Value added

13. 12 Circular Flow Households Firms Consumption expenditures of households Income (wages, salaries, rent, interest, profit) earned by households GDP from expenditure GDP from income

14. 13 Circular Flow Upper flow is equal to GDP. Upper flow is equal to GDP. Lower flow is equal to income. Lower flow is equal to income. If GDP unemployment. If GDP unemployment. If GDP > Income, businesses will want to expand production and create more income => boom. If GDP > Income, businesses will want to expand production and create more income => boom.

15. 14 FIRMS GOVERNMENT FINANCIAL SYSTEM HOUSEHOLDS REST OF THE WORLD Y=wages+salaries+rent+profits+interest C S pri T>TR+INT+G :S gov TTR+INT I NX<0 S for EX IM G GDP NX>0 -S for -S gov

16. 15 How Can We Measure GDP? Expenditure Approach: the upper flow. Expenditure Approach: the upper flow. Y = C + I + G + NX Income Approach: the lower flow. Income Approach: the lower flow. Y = Sum of factor incomes Y = Wages + Salaries + Rent + Interest + Profits

17. 16 Components of Expenditure Consumption includes spending on food, entertainment, shelter, health care, transportation, clothing, household items, insurance, education. Consumption includes spending on food, entertainment, shelter, health care, transportation, clothing, household items, insurance, education.

18. 17 Components of Expenditure Investment includes purchases made by firms to generate future income. Machinery, tools, buildings, trucks and cars are part of investment if they are bought to generate future income. By convention, newly built houses and inventory are included under investment. Investment includes purchases made by firms to generate future income. Machinery, tools, buildings, trucks and cars are part of investment if they are bought to generate future income. By convention, newly built houses and inventory are included under investment.

19. 18 Components of Expenditure Government purchases are expenditures of federal, state and local governments on goods and services plus their payrolls. Government purchases are expenditures of federal, state and local governments on goods and services plus their payrolls.

20. 19 Components of Expenditure Approach Net exports is exports minus imports. Net exports is exports minus imports. Dell Computer sales in China are part of US exports. Dell Computer sales in China are part of US exports. Dell Computer purchases of plastic molds for their computers from China are part of US imports. Dell Computer purchases of plastic molds for their computers from China are part of US imports.

21. 20 GDP http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N &3Place=N&FromView=YES&Freq=Year&FirstYear=2004&LastYear=2008&3Place=N&Update=Update&JavaBox=no# Mid

22. 21 The Three Faces of GDP == Market value of final goods and services ProductionExpenditureIncomeInvestment Consumption Governmentpurchases Net exports Capital Income Labor Income = =

23. 22 A GDP Increase Always Increases The Size of the Economy WRONG! WRONG! What if GDP in 2009 were 1000, in 2010 were 1500 but inflation was 50%? What if GDP in 2009 were 1000, in 2010 were 1500 but inflation was 50%? In this case, the increase in GDP is solely attributable to price increases, not improving the well being (standard of living) of the average citizen. In this case, the increase in GDP is solely attributable to price increases, not improving the well being (standard of living) of the average citizen.

24. 23 Nominal vs. Real Measures In macroeconomics, most variables are measured in real terms, not nominal terms. In macroeconomics, most variables are measured in real terms, not nominal terms. Real variable eliminates the effect of inflation. Real variable eliminates the effect of inflation. Nominal variable includes the effect of inflation. Nominal variable includes the effect of inflation. GDP comparisons are always made with real GDP. GDP comparisons are always made with real GDP. Nominal GDP uses current prices. Nominal GDP uses current prices. Real GDP uses base year prices. Real GDP uses base year prices.

25. 24 Real and Nominal GDP Nominal GDP is calculated by adding the amounts spent on each Product. Real GDP is calculated by using the 2007 prices of pizza and soda to calculate the amounts spent in future years. GDP Deflator is Nominal GDP/Real GDP.

26. 25 Real and Nominal GDP

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28. 27 What Is Wrong With Real GDP? Real GDP increases if you sell your services rather than provide them free. Real GDP increases if you sell your services rather than provide them free. If you build a house through Habitat for Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it counts. If you build a house through Habitat for Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it counts. If you pollute during production and someone pays to clean the environment, the GDP will be higher than if the producer tried to reduce pollution during production so no clean-up was necessary. If you pollute during production and someone pays to clean the environment, the GDP will be higher than if the producer tried to reduce pollution during production so no clean-up was necessary.

29. 28 Underground Economy If market transactions cannot be tracked by data collectors, they may be ignored. If market transactions cannot be tracked by data collectors, they may be ignored. Transactions with high cash usage and no paper trail can remain hidden from the government. Transactions with high cash usage and no paper trail can remain hidden from the government. GDP may actually be much higher than government statistics if there is a large underground economy. GDP may actually be much higher than government statistics if there is a large underground economy.

30. 29 Real GDP is not the Same as Economic Well-Being Leisure Time Leisure Time Shorter work week Shorter work week Start working later Start working later Retire earlier Retire earlier Check the debate on leisure in EU conducted by The Economist. Check the debate on leisure in EU conducted by The Economist. http://www.economist.com/debate/days/view/438&sa_campaign=debateseries/debate38/events/hp/pa nel/?source=hpevents

31. 30 Real GDP is not the Same as Economic Well-Being Nonmarket Economic Activities Nonmarket Economic Activities Household production Household production Volunteer services Volunteer services Nonmarket activities are more important in poor countries Nonmarket activities are more important in poor countries Underground economy Underground economy

32. 31 Real GDP is not the Same as Economic Well-Being Environmental Quality and Resource Depletion Environmental Quality and Resource Depletion Benefits of environment quality are not measured. Benefits of environment quality are not measured. GDP is not adjusted for resource depletion. GDP is not adjusted for resource depletion.

33. 32 Real GDP is not the Same as Economic Well-Being Quality of Life Quality of Life Crime rates Crime rates Traffic congestion Traffic congestion Civic organizations Civic organizations Open space Open space

34. 33 Real GDP is not the Same as Economic Well-Being Poverty and Economic Inequality Poverty and Economic Inequality GDP does not capture the effects of income inequality GDP does not capture the effects of income inequality

35. 34 GDP & Basic Indicators of Well-Being Indicator All developing countries GDP per person 3,5301,17025,860 (U.S. dollars) Life expectancy at 64.551.778.0 birth (years) Infant mortality rate 611006 (per 1,000 live births) Under-5 mortality rate 891596 (per 1,000 live births) Doctors 7830252 (per 100,000 people) Incidence of HIV/Aids1.34.30.3 (% in 15-49 age group) Undernourished1838Negligible people (%) Primary enrollment85.760.499.9 rate (as % of age group) Secondary enrollment60.431.296.2 rate (as % of age group) Adult literacy rate (%)72.951.798.6 Least developed countries Industrialized countries

36. 35 http://hdr.undp.org/en/media/HDR_2009_EN_Indicators.pdf http://hdr.undp.org/en/data/map/