Chapter 10: Measuring a Nations Income

Chapter 10: Measuring a Nations Income

AGEC 217 Patrick S. Ward
Purdue University

June 28, 2010

Chapter 10: Measuring a Nations Income Overview

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Overview

Moving from Microeconomics to Macroeconomics

Up till now, our study of economics has focused on microeconomics
Studying how individual households and rms make decisions and how they interact with one another in markets The focus is on individual decision-making units

We now move to study macroeconomics

Studying the economy as a whole The focus is on aggregated decision-making units Studying economy-wide phenomena including ination, unemployment and economic growth

Macroeconomics is intimately linked with microeconomics:

Changes in the overall economy arise from the decisions of individual households and rms

Chapter 10: Measuring a Nations Income Overview

Macroeconomics

Why study macroeconomics? The health of the overall economy aects us all We see reports of macroeconomic indicators and statistics all over the place Examples We want to be able to interpret these reports and statistics and understand how they will aect the economy

Chapter 10: Measuring a Nations Income Overview

The Goal of Macroeconomics

We want to be able to explain changes that aect many households, rms and market simultaneously How does a tax change aect productivity? How does productivity aect GDP? How does GDP growth aect ination? How does ination aect the exchange rate? What eect do exchange rates have on GDP?

Chapter 10: Measuring a Nations Income Income and Expenditure

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Income and Expenditure

National Income and Expenditure

When judging economic well-being, it is natural to look at the economys total income Gross Domestic Product: the market value of all nal goods and services produced within the borders of a country in a given period of time. Measures the countrys total overall economic output

Chapter 10: Measuring a Nations Income Income and Expenditure

Gross Domestic Product (GDP)

GDP measures two things at once

1 2

The total income of everyone in the economy The total expenditure on the economys goods and services

These two values are really the same because for the economy as a whole, income must equal expenditure Every dollar spent by consumers is income for the sellers

Chapter 10: Measuring a Nations Income Income and Expenditure

Income and Expenditure

Chapter 10: Measuring a Nations Income The Measurement of GDP

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income The Measurement of GDP

GDP is the market value...

GDP adds together many dierent kinds of products Uses market prices to determine the value of good and services Allows us to add apples and oranges

Chapter 10: Measuring a Nations Income The Measurement of GDP

...of all...
GDP is a very comprehensive measure Includes all items produced in the economy and sold legally in markets
Apples Oranges Pears Grapefruit Books Movies Healthcare etc.

Excludes items produced or sold illicitly Excludes items produced and consumed at home (that never enter the marketplace)

Chapter 10: Measuring a Nations Income The Measurement of GDP

...nal...

GDP only accounts for nal goodsnot intermediate goods This eliminates the problem of double counting Important exception:
If an intermediate good is held in inventory for use or sale at a later time, these goods are counted in GDP Additions to inventory add to GDP When the goods in inventory are later used or sold, they are subtracted from inventory and then subtracted from GDP

Chapter 10: Measuring a Nations Income The Measurement of GDP

...goods and services...

GDP includes both tangible goods and intangible services

Chapter 10: Measuring a Nations Income The Measurement of GDP

...produced...

GDP counts those goods and services that are currently produced Excludes anything produced in the past

Chapter 10: Measuring a Nations Income The Measurement of GDP

...within the borders of a country...

The items that are counted in GDP are conned to limited geographic areas Example: Foreign companies producing goods in the US
Subaru is a Japanese automobile manufacturing company Subaru has a large manufacturing facility in Lafayette The value of all of the cars produced in Lafayette are counted in GDP

Example: US companies with overseas operations

IBM is a US company Half of IBMs employees work outside the US producing valuable outputs None of the value of this output is counted in US GDP
It is instead counted in the GDP of the other countries where the goods are produced

Chapter 10: Measuring a Nations Income The Measurement of GDP

...in a given period of time.

Just as GDP is limited by geographic connes (borders), it is also limited by temporal constraints Usually a year or quarter Data are usually seasonally adjusted to remove any seasonal patterns

Chapter 10: Measuring a Nations Income Components of GDP

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Components of GDP

Components of GDP

Y = C + I + G + NX

Y = GDP C = Consumption G = Government purchases I = Investment NX = Net exports (exports - imports) Memorize this!!!!

Chapter 10: Measuring a Nations Income Components of GDP

Consumption

Spending by households on goods and services Excludes purchases of new housing Goods: tangible items
Durable goods: goods that continue to be serviceable for at least 3 years
Cars, refrigerators, washing machines, circular saw etc.

Nondurable goods: goods that are used up when used once, or that have a lifespan of less than 3 years
Food, clothing, pencils, etc.

Services: Nontangible items

Economics classes, doctor visits, haircuts

Chapter 10: Measuring a Nations Income Components of GDP

Investment

The purchase of good that will be used in the future to produce more goods and services Investment does not include things we normally think of as investments, like stocks and bonds Capital equipment:
Machines, computers, bulldozers, printing presses, etc.

Structures:
Factories, houses, warehouses, etc.

Inventories of goods produced but not yet sold Investment goods such as structures and vehicles used in production are not intermediate goods

Chapter 10: Measuring a Nations Income Components of GDP

Government Purchases

Spending on goods and services by local, state, and federal governments Salaries of government workers Expenditures on public works Does not include government transfers (like Social Security payments, welfare payments, or stimulus payments) because these are ultimately used either for consumption or investment

Chapter 10: Measuring a Nations Income Components of GDP

Net Exports

Foreign purchases of domestically produced goods minus domestic purchase of foreign-produced goods Exports minus imports Increasing exports adds to GDP Increasing imports subtracts from GDP

Chapter 10: Measuring a Nations Income Components of GDP

Test Your Understanding

In each of the following cases, determine how much GDP and each of its components is aected (if at all)
1

Debbie spends $200 to buy her husband dinner at the nest restaurant in Boston. Sarah spends $1,800 to purchase a new laptop to use in her publishing business. The laptop was built in China. Jane spends $1,200 on a computer to use in her editing business. She got last years model on sale for a great price from a local manufacturer. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them

Chapter 10: Measuring a Nations Income Components of GDP

Components of GDP in 2009

Gross Domestic Product, Y Consumption, C Investment, I Government Purchases, G Net Exports, NX

Total (in billions of dollars) $14,256.30 10,089.10 1,628.80 2,930.70 -392.40

Per Person (in dollars) $46,226.59 32,714.29 5,281.45 9,502.91 -1,272.37

Percent of Total 100% 71% 11% 21% -3%

Note: per person gures were derived by dividing the total dollar amount by the population (308.4 million at the end of 2009)

Chapter 10: Measuring a Nations Income Components of GDP

Components of GDP in 2009

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Nominal vs. Real GDP

There are two possible reasons for total spending to rise from one year to the next:
1

The economy may be producing a larger output of goods and services Goods and services could be selling at higher prices Economists want to know if output has changednot prices

Economists want to separate these two eects

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Nominal GDP

Nominal GDP is simply a measure of the value of goods and services produced in an economy during a period of time when the goods and services are valued using current market prices

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Real GDP

Real GDP answers the hypothetical question: What would be the value of the goods and services produced in an economy during a period of time if the goods and services were valued using the prices that prevailed in some specic year in the past? Real GDP adjusts the current value of output for ination Real GDP shows how the economys overall production of goods and services changes over time

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

GDP Deator
GDP Deator: a measure of the price level calculated as the ratio of the nominal GDP to real GDP times 100 GDP Deator = Nominal GDP 100 Real GDP

The GDP deator measures the current level of prices relative to the level of the base year The GDP deator will be exactly 100 in the base year, since Real GDP and Nominal GDP will be the same in that year With the GDP deator, we can calculate the rate of ination in the economy

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

GDP Deator and Ination

Ination: the situation in which the economys overall price level is rising We can calculate a measure of ination using the GDP deator Ination Rate = GDP Deator in year 2 - GDP Deator in year 1 GDP Deator in year 1

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating Nominal and Real GDP

Consider an economy that produces only two goods, pizza and lattes. The table below shows the prices and quantities produced of the two goods in 2008, 2009, and 2010. Year 2008 2009 2010 Pizza P Q $10.00 400 $11.00 500 $12.00 600 Latte P Q $2.00 1,000 $2.50 1,100 $3.00 1,200

What is the nominal GDP in each year?

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating Nominal GDP

Nominal GDP is the value of the economys output valued at current prices 2008: $10.00 400 + $2.00 1, 000 = $6, 000 2009: $11.00 500 + $2.50 1, 100 = $8, 250 2010: $12.00 600 + $3.00 1, 200 = $10, 800

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating Nominal GDP Growth

By what percent did the economy grow from 2008 to 2009? From 2009 to 2010?

%Y =

Y2 Y1 100% Y1

GDP Growth from 2008 to 2009: Y %Y = Y200920082008 100% = 8,2506,000 100% = Y 6,000 0.375 100% = 37.5% GDP Growth from 2009 to 2010: Y %Y = Y201020092009 100% = 10,8008,250 100% = Y 8,250 0.309 100% = 30.9%

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating Real GDP

To calculate Real GDP, we rst have to choose the base year. We then use the prices from this base year to value the output of all years. The prices in the base year provide the basis for comparing quantities in dierent years Lets use 2008 as the base year Real GDP is the value of output measured at constant prices (in this case, 2008 prices) 2008: $10.00 400 + $2.00 1, 000 = $6, 000 2009: $10.00 500 + $2.00 1, 100 = $7, 200 2010: $10.00 600 + $2.00 1, 200 = $8, 400

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating Real GDP Growth

By what percent did the economy grow from 2008 to 2009 in real terms? From 2009 to 2010? Real GDP Growth from 2008 to 2009: Y %Y = Y200920082008 100% = 7,2006,000 100% = Y 6,000 0.200 100% = 20.0% Real GDP Growth from 2009 to 2010: Y %Y = Y201020092009 100% = 8,4007,200 100% = Y 7,200 0.167 100% = 16.7%

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Calculating the GDP Deator and Rates of Ination

Recall the formula for calculating the GDP deator is: GDP Deator = Nominal GDP 100 Real GDP
6,000 6,000 100 = 100 8,250 7,200 100 = 114.58 10,800 8,400 100 = 128.57

GDP Deator for 2008 = GDP Deator for 2009 = GDP Deator for 2010 =

Chapter 10: Measuring a Nations Income Real vs. Nominal GDP

Nominal vs. Real GDP

Figure: Nominal GDP and Real GDP (2005 Dollars)

Chapter 10: Measuring a Nations Income Is GDP a Good Measure of Economic Well-Being?

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Is GDP a Good Measure of Economic Well-Being?

GDP and Well-Being

GDP is considered the best single measure of the economic well-being of a society ...but there are a lot of things that are left out of GDP that may be more indicative of quality of life. Health Education Leisure So how can GDP be a good measure of well-being if it omits these important factors?

Chapter 10: Measuring a Nations Income Is GDP a Good Measure of Economic Well-Being?

GDP and Well-Being

Countries with large GDP can aord Better healthcare Better education More leisure time GDP also says nothing about the distribution of income GDP per capita is the income of the average person Nor does it say anything about the degradation of the environment

Chapter 10: Measuring a Nations Income Conclusion

Overview Income and Expenditure The Measurement of GDP Components of GDP Real vs. Nominal GDP Is GDP a Good Measure of Economic Well-Being? Conclusion

Chapter 10: Measuring a Nations Income Conclusion

Conclusion I

GDP is the best single measure we have for the well-being of a society ...but it is not a perfect measure GDP measures an economys total expenditures on newly produced goods and services and the total income earned from the production of these goods and services GDP is the market value of all nal goods and services produced within the borders of a country in a given period of time GDP = C + I + G + NX

Chapter 10: Measuring a Nations Income Conclusion

Conclusion II

Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy Nominal GDP uses current prices to value economic output Real GDP uses constant prices or the prices from a pre-determined base year to value economic output

Chapter 10: Measuring a Nations Income Conclusion

Examples

Examples of macroeconomic indicators in the news U.S. Jobless Claims Drop but Remain at Elevated Levels (New York Times) U.S. economys growth revised lower (CNN) Housing Market: Falling again (The Economist) Fed Grows More Wary on Economy (Wall Street Journal)
Return