Chapter 8 GDP Measuring total production and income Microeconomics the study of how households and firms make choices how they interact in markets and how the government attempts to influence their choices Macroeconomics the study of the economy as a whole including topics such as inflation unemployment and economic growth Business cycle alternating periods of economic expansion and economic recession Expansion the period of a business cycle during which total production and total employment are increasing Recession the period of a business cycle during which total production and total employment are decreasing Economic growth the ability of an economy to produce increasing quantities of goods and services Inflation rate the percentage increase in the price level from one year to the next Gross domestic product GDP the market value of all final goods and services produced in a country during a period of time typically one year GDP is measured using market values NOT quantities o Taking value of all goods and services produced GDP includes only the market value of final goods o Final good or service a good or service purchased by a final user o Intermediate good a good or service that is an input into another good or service GDP includes only current production o Takes place during the indicated time period Production income and circular flow diagram When we measure the value of total production in the economy by calculating GDP we are measuring the value of total income Circular flow diagram illustrates the interaction of firms and households in markets to illustrate the flow of spending and money in the economy Total Economic Income sum of wages interest rent and profit Transfer payments payments by the government to households for which the government doe not receive a new good or service in return Not included in GDP GDP total income received by households Components of GDP 1 Consumption spending by households on goods and services not including 2 spending on new houses Investment spending by firms on new factories office buildings machinery and additions to inventories plus spending by households and firms on new houses 3 Government purchases spending by federal state and local governments on goods and services such as teachers salaries highways and aircraft carriers 4 Net exports exports imports GDP Consumption Investment Gov purchase Net exports Y C I G NX Consumer spending on services is greater than the sum of spending on durable and nondurable goods 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 Value added the market value a firm adds to a product Shortcomings in GDP as a measure of total production GDP does not include production in the home and production in the underground economy Household production goods and services people produce for themselves 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 GDP is to measure a country s total production GDP is not a perfect measure of well being Increase in GDP lead to increase in the well being of the population o Value of leisure is not included in the GDP o GDP is not adjusted for pollution or 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 GDP vs Nominal GDP GDP is measured in value terms Nominal GDP the value of final goods and services evaluated at current Real GDP the value of final goods and services evaluated at base year prices year prices o Holds prices constant o Base year dollars The further away the current year is from the base year the worse the problem becomes Real GDP Nominal GDP in years before the base year Real GDP Nominal GDP in years after the base year In base year Real GDP Nominal GDP o Both calculated for the base year using the same prices and quantities GDP Deflator a measure of the price level calculated by dividing the nominal GDP by real GDP and multiplying by 100 GDP Deflator Nominal GDP x 100 Real GDP Price level a measure of the average prices of goods and services in the economy Prices of goods increase services increased production remain same o Nominal GDP increase o Real GDP remain constant More prices increase relative to increase in production the more nominal GDP increase relative to real GDP and higher the value for the GDP deflator Increase in GDP deflator allow economists to track increases in the price level over time Other measures of total production and total income National income accounting methods the BEA uses to track total production and total income in the economy Gross national product GNP o Value of final goods and services produced by residents of the US even if the production takes place outside the country National income Personal income o GDP depreciation consumption of fixed capital o Income received by households o Transfer payments interest on government bonds Disposable personal income o Personal income personal tax payments o Best measure of the income households actually have available to spend Gross domestic product GDP Division of Income o GDP calculated as the sum of income payments to households is sometimes referred to as Gross Domestic Income GDI o Wages compensation received by employees o Interest net interest received by households difference between the interest received on savings accounts government bonds and other investments and the interest paid on car loans home mortgages and other debts o Profits profits of sole proprietorship small businesses and profits of corporations o Largest component of GDI wages