Chapter 4(8) – Measuring the Economy’s Performance_Level of GDP _measures the level of economic activity._GDP per capita = GDP/population measures standard of living_% _ measures Economic GrowthThe Circular-Flow Diagram : a visual model of the _economy_. Economy is the mechanism that _distributes_ the _scarce resources and goods & services_.The main way in which resources are distributed in the U.S. are through _markets_. (assume no government initially) Two types of “actors”: 1. _Households_ own and sell _resources_ Buy ________________2. _business_ sell ______________ Buy_____________ Two markets:1. Resource market 2. BusinessHouseholdsResource MarketSince every dollar a buyer spends is a dollar of _income_ for the seller this implies that: Total _spending_ Total _income_ earnedBy households on by households Goods and Services The value of the goods produced is called _GDP_, Thus GDP measures both1. Spending on goods and Services 2. Income earned producing goods and services.Gross Domestic Product (GDP)is the _market _(1) value of all _final _(2) goods and services __produced_(3), _domestically_(4) in a given period (quarterly or annually)1) Goods are valued at their _market_ prices, so that all goods are measured in the _same_($) units.Problem is that things that don’t have a market value are _excluded (non market activities)_ from GDP. This includes: 1. Goods and services that are produced _at home_ and (mowing lawn, home child care)2.Goods and services that are sold _in the black market (unreported activity)_.2 - Final goods: intended for the _final_ user Intermediate goods: used as _ingredients_ in the production of other goods GDP only includes _final_goods – they already embody the value of the _intermediate goods_used in their production. (counting intermediate goods results in _double counting_)Example: flour bought by bakery not included in GDP. Flour bought by household should be included3 – Produced – only includes _newly produced_ goods.Excludes _old_ goods.4 – Domestically ( Within a Country)- regarless of who _produces the good_Excludes _imported goods_ even if produced by _a domestic ( a American company)_producer.Important questions to ask are:1. Does this activity generate new economic activity in the domestic economy?2. Has it already been counted?3. Can it be measured?In Class Example: Say whether or not the following transactions would be counted in 2010 GDP.1. McDonalds buys buns for it’s Big Macs. (Excluded(intermediate))2. You hire a maid to clean your house (yes)3. You mow your own lawn.(no( home production))4. You buy a new BMW that was built in Ohio. Yes5. You buy an IBM computer that was made in China. no6. You buy a 2006 Subaru Tribeca for $20,000. No used7. You buy stock issued by Google. No (no goods or services exchanged) savings or investments not counted in GDPSummary: Goods Excluded From GDP1. Intermediate 2. Used goods3. Imported goods 4. Financial transactions5. Non market activitiesGDP as a measure of Economic well-being.Higher GDP means higher _income earned_- and higher _spending on G&S_. This may imply that an economy has more money to spend on _education, health care, infrastructure_.GDP is usually _positive_ related with other measure of Quality of life.. such as life expectancy_GDP is an imperfect measure of well-being…Limitations : It ignores things like: 1. The quality of the _environment(negative) _. 2. _distribution_ of IncomeThus GDP may _overstate_ well-being3. _leisure_ time. (has increased but not consideredin GDP)4. _household_ production. But GDP may also _understate_ well-beingMany countries are looking for a better measure of Society’s well-being that incorporates many measures of well-being.GNH – Gross National Happiness value is proposed tobe an index function of the total average per capita of the following measures:1.Economic Wellness: 2.Environmental Wellness: 3.Physical Wellness: 4.Mental Wellness: 5.Workplace Wellness: 6. Social Wellness: 7. PoliticalWellness: How is GDP measured?GDP measures both: _income earned by producing the goods_ and _spending on the goods & services_.Method I. Expenditure Method ofComputing GDPGDP is measured by adding up all of the _spending_ by all _the different sectors_ of the economy.GDP- marked value of all final goods and services produced domesticallyFour Sectors spending1. Households Consumption-C2. Businesses Investment-I 3. Government Government-G4. International sector. Net ExportsThese spending levels all add up toGDP (denoted Y)Y= C+I+G+NXConsumption, C – Spending by households on goods and services: 1. _Durable goods (1+years) _, 2._ Nondurable(foods…)_ 3_Services_Exception: purchases of _ new homes_.Investment – I – Additions to_productive_ Capacity1. Capital Expenditures-Cap ExA. Fixed structures Exports-InportsINVESTMENT SPENDINGRent and estimated value of living in own homeDone mostly by firmsB. Non fixed equip., software, and vehicles2.Residential structures3. Change in inventory(Inventory are goods produce but not _yet sold_)Change in inventories can be positive or negative. If inventories are increasing then they will be _Positive_.If inventories are being used up then they should be _Negative_.Government Purchases (G) – Spending on the goods and services provided by the government at the _federal, state and local_ level such as spending on _roads, bridged, education, etc.…This will exclude spending by the government on _transfer payments_ such as _social security, unemployment, food stamp, and etc.… _because_no good or service is received in return_.Net Exports (NX) = _Exports-imports_ where exports represent goods produced _domestically but_ and imports are the portions of C, I, and G that are spent on Goods and Services _produced abroad_. Adding up all the components of GDP givesGDP = Y = C+I+G+NXIf positive add to GDPIf negative don’t want to count in GDP-already countedThe largest component of GDP has always been _consumption_. The most volatile component of GDP is _Investment spending_ and has recently made up a _smaller_ part of GDP.A. C up by 200 andGDP up by 200Method II.Measuring GDP using the IncomeApproachGDP is measured by adding up all of the Income earned by the different _resources_. (Mostly)Four Resources Income1. Labor Wages2. Land Rent3. Capital Interest4. Entrepreneurship Profits Gross Domestic Income (GDI)= Wages + rent + interest + ProfitsA few