Chapter 4 Spending Income and GDP The Basics GDP Measuring Total Production and Income o Establishing some background Macroeconomics the study of the economy as a whole including topics such as inflation unemployment and economic growth When new announcers politicians and commentators refer to the economy they are often addressing macroeconomic issues Most economies do not experience constant performance but uneven cyclical growth own cycles Certain industry sectors or regions may experience their o Expansion a period of increasing economic activity marked by rising levels total production and total employment o Recession the period of declining economics activity where levels of total production and total employment decrease o Business cycle Alternating periods of economic expansion and economic recession o Economic growth refers to the ability of an economy to produce increasing quantities of goods and services Gross Domestic Product Measures Total Production o GDP is the primary measure by which economist evaluate an economy o Gross Domestic Product the market value of all final goods and services produced in a country during a period of time typically one year Calculated by taking a summation of all output multiplied by the goods own price GDP is measured using market values not quantities o National income accounting a set of rules and definitions for measuring economic activity in the aggregate economy economy as a whole Way of measuring tot or aggregate production o GDP included only current production GDP includes only production that takes place during the indicated time period o Goods are classified primarily as Final Good or service a good or service purchased by a final user Intermediate good or service a good or service that is an input into another good or service such as a tire on a truck o Calculations do not measure total transactions in the economy it counts final output but not intermediate goods o Counting the sale of both final and intermediate goods would result in double counting of economic output o Two Ways to eliminate double counting Calculate only final output A firm would report how much it sold to consumers and how much it sold to producers intermediate goods Follow the value added approach Value added is the increase in value that a firm contributes to a product or service It is calculated by subtracting intermediate goods the cost of materials that a firm uses to produce a good or service from the value of its sales o Value added the market value a firm adds to a product o What is counted and not counted Not Counted Value of resale goods Government transfer payments Sales of stocks or bonds Work of house spouses Counted Value added by a used car dealer Commissions of stock brokers o Transfer Payments Payments by the government to individuals for which the government does not receive This will include social security and welfare Gross Domestic Product GDP o The total value of all final goods and services produce within a designed territory o Output produced within a country s borders Gross National Product GNP o The aggregate final output of citizens and businesses of a designed territory o Output produced by a country s citizens GNP GPD Net foreign factor income GDP Two Sides of One Coin Income Output o o The circular flow of labor and capital to make goods and services income from sales of those goods and services o The course of economic activity will result in the transfer of output and income between households and firms o Household provide labor receive wages and buy output o Firms hire labor pay wages sell goods o During the exchange of labor wages and goods Taxes levied to find government Money saved to create investment capital Interest payments on capital borrowed Exports and imports to other nations o Regardless of analysis complexity a circular flow of income and output remains true Four Primary Categories of GDP o Consumption Personal Consumption Expenditures Spending by households on goods and services not including spending on new houses o Investment Gross Private Domestic Investment Spending by firms on new factories office buildings machinery and additions to inventories and spending by households on new houses o Government Spending Government consumption and Gross Investment Spending by federal state and local governments on goods and services o Net exports Net exports of Goods and services Exports minus imports o GDP consumption investment Government Spending Net Exports An equation for GDP and Some Actual Values o Consumer spending on services is greater than the sum of spending on durable and nondurable goods o Business fixed investment is the largest component of investment purchases made by state and local governments are greater than purchases made by the federal government Imports are greater than exports so net exports are negative o Shortcomings in GDP as a Measure of Total Production o Household Production Household production refers to goods and services people produce for themselves o Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal Shortcomings of GDP as a Measure of Well Being o The value of leisure is not included in GDP o GDP is not adjusted for pollution or other negative effects of production o GDP is not adjusted for changes in crime and other social problems o GDP measures the size of the pie but not how the pie is divided up Real World US GDP during WWII o Before U S Experienced severe economic turmoil o Economy suffered continued contraction during the first half of the century Great Depression Stock Market Crash 1929 o Events in WWII creased an intense demand for goods and services never before seen Real GDP vs Nominal GDP o o Inflation rising price levels for the same goods and services Inflation rate percentage increase in the price level from one year to the next o Calculating real GDP Real GDP the value of final goods and services in a given year at a designated base year level P base level x Q current year Nominal GDP the value of final goods and services of a given year using same year prices P current year x Q current year o Why does it matter If the effects of price increase are not taken into account then aggregate output value will not mean the same thing across years By controlling for inflation output can be compared across years and actual changes in output maybe