Carlos Andres Rodriguez Herrera 2 1 23 Principles of Macroeconomics ECON 2002 01 Chapter 8 Measuring the Economy s Performance Introduction Some commentators are already referring to the twenty first century as the Asian century It has been suggested that China s economy will be larger than the U S economy by 2020 How do we go about measuring the size of an economy And how do we make international comparisons with regard to this measure The concept of gross domestic product which is a key concept of Chapter 8 is the starting point for contemplating these questions Learning Objectives Describe the circular flow of income and output Define gross domestic product GDP Understand the limitations of using GDP as a measure of national welfare Explain the expenditure approach to tabulating GDP Explain the income approach to computing GDP Distinguish between nominal GDP and real GDP Chapter Outline The Simple Circular Flow National Income Accounting Two Main Methods of Measuring GDP Other Components of National Income Accounting Distinguishing Between Nominal and Real Values Comparing GDP Throughout the World The Simple Circular Flow The concept of Simple Circular Flow of income involves two principles 1 In every economic exchange the seller receives exactly the same amount that the buyer spends 2 Goods and services flow in one direction and money payments flow in the other Profits Explained Question Answer Product Markets Factor Markets a Why is profit a cost of production a Profits are the return entrepreneurs receive for the risk they incur when organizing productive activities Transactions in which households buy goods Transactions in which businesses buy resources The Ohio State University 1 Total Income The yearly amount earned by the nation s resources factors of production Includes wages rent interest payments and profits received by workers landowners capital owners and entrepreneurs respectively Final Goods and Services Goods and services that are at their final stage of production and will not be transformed into yet other goods or services Question Answer Why must the dollar value of total output equal total income Every transaction simultaneously involves expenditure and a business receipt National Income Accounting National Income Accounting Gross Domestic Product GDP Observations A measurement system used to estimate national income and its components The total market value of all final goods and services produced by factors of production located within a nation s borders GDP measures the dollar value of final output GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation s borders Stress on final output What is a final good a Wheat b Steel c Crude oil d Bread e Automobile f Gasoline Intermediate Goods Value Added Goods used up entirely in the production of final goods The dollar value of an industry s sales minus the value of intermediate goods for example raw materials and parts used in production Numerous transactions occur that have nothing to do with final goods and services being produced Financial transactions Transfer of secondhand goods Others excluded transactions Financial transactions Securities a Stocks and bonds Government transfer payments a Social Security b Unemployment compensation Private transfer payments a Individual gifts b Corporate gifts Transfer of secondhand goods Carlos Andres Rodriguez Herrera 2 1 23 Why not count the sale of a used computer guitar or snowboard as part of GDP Other excluded transactions Household production Legal and illegal underground transactions GDP s limitations GDP Excludes non market production It is not necessarily a good measure of the well being of a nation Is a measure of the value of production in terms of market prices and an indicator of economic activity Is not a measure of a nation s overall welfare Two Main Methods of Measuring GDP Expenditure Approach Income Approach Computing GDP by adding up the dollar value at current market prices of all final goods and services Measuring GDP by adding up all components of national income including wages interest rent and profits Deriving GDP by the Expenditure Approach Consumption Expenditure C a Durable Consumer Goods i Items that last more than three years automobiles furniture b Nondurable Consumer Goods i Goods that are used up in three years gasoline food c Services Gross Private Domestic Investment I i Mental or physical help a The creation of capital goods such as factories and machines that can yield production and hence consumption in the future i Also includes changes in business inventories and repairs made to machines buildings b Producer Durables or Capital Goods i Life span of more than three years c Fixed Investment i Purchases by business of newly produced producer durables or capital goods d Inventory Investment i Changes in stocks of finished goods and goods in process as well as changes in raw materials Government Expenditures G a State local and federal b Valued at cost Net Exports X Presenting the expenditure approach C consumption expenditures I investment expenditures G government expenditures X net exports Net Domestic Product NDP Allowing for depreciation capital consumption allowance The Ohio State University 3 a The amount that businesses would have to save in order to take care of deteriorating machines and other equipment Because NDP GDP Depreciation and GDP C I G X NDP C I G X Depreciation NDP C net I G X Where net I net investment I Depreciation a Domestic investment minus an estimate of the wear and tear on the existing capital stock b The change in the capital stock over a one year period Deriving GDP by the Income Approach Gross Domestic Income GDI a The sum of all income wages interest rent and profits paid to the four factors of production Gross Domestic Income GDI a Wages salaries and labor income b Rent farms houses and stores c Interest savings accounts d Profits sole proprietorships partnerships and corporations Gross domestic product equals gross domestic income plus indirect business taxes and depreciation These last items are called non income expense items Indirect business taxes a All business taxes except the tax on corporate profits b Include sales and business property taxes Other Components of National Income Accounting National Income NI Personal Income PI The total of all factor payments to resource owners The amount of income that households actually