Chapter 7 Taking the Nation s Economic Pulse GDP A Measure of Output Gross Domestic Product GDP The market value of all final goods and services produced within a country during a specific period GDP measures the market value of production that flows through the economy s factories and shops each year or quarter To avoid double counting one must take care to differentiate between intermediate goods and final market goods and services Only final goods and services count Intermediate Goods Goods purchased for resale or for use in producing another good or service Final Market Goods and Services Goods and services purchased by their ultimate user Sales at intermediate stages of production are not counted by GDP because the value of the intermediate goods is embodied within the final user good Only transaction involving production count Financial transactions and income transfers are excluded because they merely move ownership from one party to another They do not involve current production and are therefore not included in GDP The purchases and sales of stocks bonds and U S securities are not included in GDP Neither are private and public sector income transfers Government income transfer payments such as social security welfare and veterans are also omitted Only production within the country is counted It counts only goods and services produced within the geographic borders of the country When foreigners earn income within U S borders it adds to the GDP of the United States Only goods produced during the current period are counted Transactions involving the exchange of goods or assets produced during earlier periods are omitted because they do not reflect current production As in the case of financial transactions sales commissions earned by those helping to arrange the sale of used cars home or other assets are included in GDP because they reflect services provided during the current period Each good produced increases output by the amount the purchaser pays for the good The total spending on all goods and services produced during the year is then summed in dollar terms to obtain the annual GDP GDP as a Measure of Both Output and Income The GDP of an economy can be reached by totaling the expenditures on goods and services produced during the year or the GDP can be calculated by summing the income payments to the resource suppliers of the things used to produce those goods and services The dollar flow of expenditures on final goods The dollar flow of income from final goods GDP is a measure of both 1 the market value of the output produced and 2 the income generated by those who produced the output This highlights a very important point Increases in output and growth of income are linked An expansion in output that is the additional production of goods and services that people value is the source of higher income levels When derived by the expenditure approach GDP has four components 1 personal consumption expenditures 2 gross private domestic investment 3 government consumption and gross investment and 4 net export to foreigners Consumer Price Index CPI An indicator of the general level of prices It attempts to compare the cost of purchasing the market basket bought by a typical consumer during a specific period with the cost of purchasing the same market basket during an earlier period GDP Deflator A broader price index than the CPI It is designed to measure the change in the average price of the market basket of goods included in GDP Inflation Rate This year s PI Last year s PI Last year s PI X 100 Real GDP Nominal GDP X Old GDP Deflator New GDP Deflator Chapter 16 Creating an Environment for Growth Prosperity Per Capita GDP Income per person Increases in income per person are vital for the achievement of higher living standards Rule of 70 If a variable grows at a rate of x percent per year 70 x will approximate the number of years required for the variable to double Key Sources for Economic Growth Gains from Trade When individuals and businesses are permitted to trade over a broader market area they will be able to produce a larger output and consume a more diverse bundle of goods Conversely obstacles that restrict trade either domestic or international will reduce output income and the general living standard of the populace Entrepreneurship New ideas that increase the value of resources by creating enough value to consumers to offset the opportunity cost of production generate economic profits for the entrepreneurs who discover them In contrast ideas that drain resources away from other more valuable uses and turn them into something not as valuable to consumers result in losses which will provide entrepreneurs with a strong incentive to discontinue such projects Investment in Physical and Human Capital Investment in both physical capital machines and human capital knowledge and skills can expand the productive capacity of a worker In turn people who produce more goods and services valued by others will tend to have higher incomes Other factors that may influence growth and income Growth of population natural resources foreign aid and climate and location The institutional and policy environment exerts a major impact on growth and income The following institutions and policies provide the foundation for efficient use of resources economic growth and the achievement of high levels of income 1 legal system that protects property rights and enforces contracts in an even handed manner 2 competitive markets 3 monetary and price stability 4 minimal regulation 5 avoidance of high tax rates 6 openness to international trade Chapter 17 Institutions Policies Cross Country Differences Purchasing Power Parity Method PPP Method in which the relative purchasing power of each currency is determined by comparing the amount of each currency required to purchase a common bundle of goods and services in the domestic market This information is then used to convert the GDP of each nation to a common monetary unit like the U S dollar The world s fastest growing economies were almost all low income less developed countries a couple of decades ago China and India with a third of the world s population are included in the fast growing group of LCDs But there is also a large number of LCDs that have experienced falling incomes in recent decades A legal structure that protects property rights and enforces contracts in an evenhanded manner is vitally important Without such a legal system people will
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