Chapter 10 Measuring a Nation s Income Harcourt Brace Company Macroeconomics Macroeconomics is the study of the economy as a whole Its goal is to explain the economic changes that affect many households firms and markets at once Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets Harcourt Brace Company Understanding the Economy Identify the important areas Total output and income The average of prices Resource employment Measure the important areas using Real Gross Domestic Product Consumer Price Index Monthly unemployment rate Harcourt Brace Company The Circular Flow Diagram Product Market Households Businesses Harcourt Brace Company Market for Factors of Production Two Methods of Computing An Economy s Income Expenditure Approach Sum the total expenditures by households from the top portion of the circular flow Resource Cost or Income Approach Sum the total wages and profit paid by firms for resources from the bottom portion of the circular flow Harcourt Brace Company The Economy s Income and Expenditure When judging whether the economy is doing well or poorly it is natural to look at the total income that everyone in the economy is earning For an economy as a whole income must equal expenditure The forces of supply and demand determine the market equilibrium price and quantity that is produced and exchanged Harcourt Brace Company The Economy s Income and Expenditure A measure of the income and expenditures of an economy is Gross Domestic Product GDP Gross Domestic Product measures an economy s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services Harcourt Brace Company Gross Domestic Product The total market value of all final goods and services produced during a given period of time within a country region or state Harcourt Brace Company Important Features of GDP Output is valued at market determined prices Output is measured in dollar terms GDP records only the output of final goods We want to count production only once Represents the amount of money one would need to purchase a year s worth of the economy s production of all final goods 7 000 000 000 000 Harcourt Brace Company What Is and What Is Not Counted in GDP GDP includes all items produced in the economy and sold legally in markets GDP does not include items produced and consumed at home and never enter the marketplace It does not include items produced and sold illicitly such as illegal drugs Harcourt Brace Company Gross National Product The total market value of all final goods and services produced during a given period of time by the nation s residents regardless of the place produced Harcourt Brace Company Quick Quiz Which contributes more to GDP the production of a pound of hamburger or the production of a pound of caviar Why Harcourt Brace Company Three Other Measures of Income Net National Product NNP Total income of residents of a nation after subtracting capital consumption allowances Personal Income The income that households and noncorporate businesses receive Disposable Personal Income The income that household and noncorporate businesses have left after taxes Harcourt Brace Company The Components of GDP GDP Y is the sum of Consumption C Investment I Government Purchases G Net Exports NX Y C I G NX Harcourt Brace Company The Four Components of GDP Consumption C Is the spending by households on goods and services e g buying clothing food movie tickets Investment I Is the purchases of capital equipment and structures e g factory houses etc Harcourt Brace Company The Four Components of GDP Government Purchases G Includes spending on goods and services by local state and federal governments e g roads police etc Does not include transfer payments because it is not made in exchange for currently produced goods or services Net Exports NX Exports minus imports Harcourt Brace Company GDP Components of Measurement Harcourt Brace Company GDP Components of Measurement Consumption 69 Harcourt Brace Company GDP Components of Measurement Investment 13 Consumption 69 Harcourt Brace Company GDP Components of Measurement Investment 13 Consumption 69 Harcourt Brace Company Government Spending 19 GDP Components of Measurement Investment 13 Government Spending 19 Net Exports 1 Consumption 69 Harcourt Brace Company The Income Approach Components Wages 73 0 Interest 9 5 Rents 5 Profits 17 0 We must also include taxes and depreciation for accurate accounting Harcourt Brace Company Quick Quiz List the four components of expenditure Which is the largest Harcourt Brace Company Real versus Nominal GDP GDP is the market value of the economy s current production referred to as Nominal GDP Real GDP measures any given year s total output in constant prices An accurate view of the economy requires adjusting nominal to real GDP using the GDP Price Deflator Harcourt Brace Company Our Example of Real vs Nominal Year Price of Quantity Price of Quantity Milkbones Milikbones Rawhide Rawhide 1999 1 10 2 5 2000 2 10 4 5 2001 3 5 6 10 Harcourt Brace Company Nominal GDP Calculated as the sum of Prices in a year times quantities in a year 1999 1x10 2x5 20 2000 2X10 4x5 40 2001 3x5 6x10 75 Question Is this an accurate measure of how much we produce Compare 1999 and 2000 to see Harcourt Brace Company Real GDP Calculated as sum of base year prices times quantities each year Let s make 1999 the base year 1999 1x10 2x5 20 2000 1x10 2x5 20 2001 1x5 2x10 25 Is this a more accurate measure of output Harcourt Brace Company GDP Deflator Just the ratio of nomimal GDP to real GDP times 100 1999 20 20 x 100 100 This is an index always 100 for the base year 2000 40 20 x 100 200 2001 75 25 x 100 300 What does it mean Harcourt Brace Company GDP Price Deflator The GDP Price Deflator is a price index that uses a bundle of all final goods and services It tells us the rise in nominal GDP that is attributable to a rise in prices Converting Nominal GDP to Real GDP Real GDP19xx Nominal GDP19xx GDP deflator19xx X100 Harcourt Brace Company Quick Quiz Harcourt Brace Company Define Real and Nominal GDP Which is a better measure of economic wellbeing Why GDP and Economic Well Being GDP Per Person tells us the income and expenditure of the average person in the economy It is a good measure of the material wellbeing of the economy as a whole More Real GDP means we have a higher material standard of living by being able