introduction to economic institutions econ 1500

Introduction to Economic InstitutionsECON 1500

Week 4 Lectures 1 & 2

18 & 20 September

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Topics covered

• Income and expenditure

• GDP and its components

• real vs nominal GDP

• is GDP a good measure of economic well-being?

• Reading: Mankiw, Chapter 10

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What is GDP?

• total income everyone is earning in the economy

• total expenditure on the economy’s output of goods andservices

• income = expenditure

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Income and expenditure

https://www.khanacademy.org/economics-finance-domain/

ap-macroeconomics/

economic-iondicators-and-the-business-cycle/21/v/

circular-flow-of-income-and-expenditures

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Income and expenditure

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Circular flow diagram

• What does it measure?• Illustrates various ways to measure GDP

I income approach, expenditure approachI value added approach

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Income and expenditure

• The circular flow diagram ignores

• firms that buy goods from other firms

• households that save

• governments that purchase goods

• foreign firms that sell goods to US consumers

• US firms that sell goods to foreign consumers

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Income approach to measure GDP

• income approach starts with the income earned (wages, rents,interest, profits) from the production of goods and services

• include the following categories taken from the U.S. “NationalIncome and Expenditure Accounts”: wages, salaries, andsupplementary labor income; corporate profits interest andmiscellaneous investment income; farmers’ income; andincome from non-farm unincorporated businesses

• Total National Income + Sales Taxes + Depreciation + NetForeign Factor Income

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Value added approach to measure GDP

• also called Net Product or Production Approach

• First gross value of output from all sectors is estimated: valueof all goods and services a nation produces

• intermediate consumption such as cost of materials, suppliesand services used in production final output is derived

• gross output is reduced by intermediate consumption todevelop net production

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Expenditure approach to measure GDP

• adds up the market value of all domestic expenditures madeon final goods and services in a single year

• consumption expenditures, investment expenditures,government expenditures, and net exports

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• use market prices to be able to compare goods

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GDP or not GDP?

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• comprehensive

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GDP or not GDP?

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• excludes intermediate goods to avoid double counting

• example: paper and paper cards

• inventories are accounted for

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GDP or not GDP?

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given periodof time

• both tangibles and intangibles

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• includes newly produced goods, but not items that are re-sold

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GDP or not GDP?

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• items produced domestically irrespective of nationality

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GDP or not GDP?

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GDP or GNP?

• other measures of income

• what is GNP?

• GDP is the market value of everything produced within acountry• GNP is the value of what’s produced by a country’s residents,

no matter where they live• The BEA continues to provide GNP figures, and it says the measure is particularly useful in looking at

topics such as income of U.S. residents and how income is used. There has not been a large differencebetween the two measures in this country, but in other nations, such as those with a high number offoreign investments, the GDP will be notably higher than GNP.

• Nowadays you are most likely to encounter GNP in an old book or speech, since it isn’t widely usedanymore. And for the United States, the two totals are not very different in practice. Right now, GNP isaround 101 percent of GDP, and since the 1950s, that ratio has only varied between 100 and 102 percent.But for some foreign countries that have more outside investment, the difference can be considerable.

• For example, a lot of the businesses located in Scotland are owned by companies based in England orelsewhere in the world. That means that if Scotland were an independent country, it’s GDP would beconsiderably higher than its GNP, which is potentially relevant to debates over Scottish independence.

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GDP or not GDP?

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What is GDP

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given periodof time

• either a quarter or a year

• Note: GDP presented for a quarter is usually at ”annual rate”

• seasonal adjustments to GDP

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GDP or not GDP?

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Components of GDP

National income accounting identityY = C + I + G + NX

Y = GDPC = consumptionI = investmentG = government purchasesNX = net exports

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Consumption

National income accounting identityY = C + I + G + NX

• spending by households on good and services

• NOT spending on housing

• but yes to spending on education

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Investment

National income accounting identityY = C + I + G + NX

• spending (mostly by firms) onI capital equipment (machines, tools)I structures (factories, offices)I IP property

• residential capital

• inventories

• new homes purchased by households

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The case of inventories

• Apple produces a computer: adds to inventory and it’sinvestment

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Government purchases

National income accounting identityY = C + I + G + NX

• Spending by local, state and federal governments onI good and servicesI salaries of government workersI public projects

• does NOT include transfer payments like social security orunemployment benefits

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Week 4 Lecture 2

Date: 20 SeptemberLecture 2

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Announcements

• Front of the class is this week’s Problem Set 1I Due week from now, September 27th in classI it covers material up until today’s classI Mankiw Chapters 3, 4, 5, 6 (the tax part), 7, 8, 10I please everyone hand in your own answers, but you can work

on those together

• 1st Midterm will take place on Tuesday 2nd October duringclassI it covers material including next week’s lectures as well!I Mankiw Chapters 3, 4, 5, 6 (the tax part), 7, 8, 10 and 11

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Announcements

• Front of the class is this week’s Problem Set 1I Due week from now, September 27th in classI it covers material up until today’s classI Mankiw Chapters 3, 4, 5, 6 (the tax part), 7, 8, 10I please everyone hand in your own answers, but you can work

on those together

• 1st Midterm will take place on Tuesday 2nd October duringclassI it covers material including next week’s lectures as well!I Mankiw Chapters 3, 4, 5, 6 (the tax part), 7, 8, 10 and 11

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Recap

Gross Domestic Product (GDP) = The market value of all finalgoods and services produced within a country in a given period oftime

• adds up the market value of all domestic expenditures madeon final goods and services in a single year

• consumption expenditures, investment expenditures,government expenditures, and net exports

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Components of GDP

National income accounting identityY = C + I + G + NX

Y = GDPC = consumptionI = investmentG = government purchasesNX = net exports

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Net Exports

National income accounting identityY = C + I + G + NX

Y = C + I + G + X - IM

• Net exports is exports minus imports

• exports: purchases of domestic goods by foreigners

• imports: purchases of foreign goods by domestic householdsand firms

• Boeing sells airplane to BA ⇒ X↑ ⇒ NX↑ ⇒ Y↑• you buy a foreign car ⇒ C↑ & IM↑ ⇒ NX↓ ⇒ Y constant

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Clarifications and examples from Tuesday

• the case of inventories!

• when Apple produces a computer it adds to its inventoryrather than selling it purchases the computer for itself ⇒investment spending increasesY = C + I + G + NX

• If Apple later sells the computer out of inventory, it’sinvestment inventory ↓, but consumer spending will ↑• why measured this way? GDP measures the value of economy

production and good added to inventory add to production

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Clarifications and examples from Tuesday

• new vs used car saleI If a car dealer buys in a car for $10,000 and resells it after a

few weeks for $12,000, then the “value added” by this businesson this transaction would be $2,000 and that $2,000 would bethe contribution of the business to the economy’s GDPstemming from that particular transaction

I The business performed the service of providing a market tothe seller, taking the vehicle into stock, holding it for a periodof time and then making it available to a willing buyer

I BUT! If I have had a car for say 5 years and decide to sell itmyself to another private buyer rather than through a motordealer, then although I might be saving myself some money byadding the value of finding a buyer myself, this would not beinlcuded in the national GDP figure

• Businesses that buy things for resale are providing the serviceof linking the sellers of these things to the end buyers of thesethings and the value they add to the economy that’s includedin the GDP

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GDP in digital economy

• This is new emerging area in GDP calculations

• BEA (Bureau of Economic Analysis) is responsible forcalculating the GDP figures in the US economy

• In March 2018, BEA released, for the first time, preliminarystatistics and an accompanying report exploring the size andgrowth of the digital economy

• ”From 2006 to 2016, BEA estimates that digital economy realvalue added grew at an average annual rate of 5.6 percent,outpacing the average annual rate of growth for the overalleconomy of 1.5 percent. In 2016, the digital economy was anotable contributor to the overall economy—it accounted for6.5 percent of current-dollar GDP”

• https:

//www.bea.gov/data/special-topics/digital-economy

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GDP in digital economy

• OECD (Organisation for Economic Co-operation andDevelopment) has published a 25 page document outliningthe challenges in measuring GDP in digitalized economy

• underlying transaction of digital economy are themselves notnew. Households have long engaged in peer-to-peertransactions such as the provision of dwelling rental services,the provision of taxi services (often unlicensed), and the saleof second hand (and indeed new) goods (e.g. via car bootsales and classified adverts).

• ”The question ... is not whether the conceptual accountingframework for GDP includes these transactions, rather it iswhether the compilation practices currently employed tomeasure peer-to- peer transactions, and which were designedto measure low-scale, relatively insignificant, sums, aresufficiently robust to accurately measure them today.”

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GDP in digital economy

• ”whether the current tools available to statistical offices canaccurately capture the intermediation fees charged by the newdigital intermediaries. To the extent that the intermediaries(at least those with not insignificant revenues) are registeredin the national territory and, so, in scope for traditionalbusiness surveys, the answer must be that their activity islikely to be as well captured in the accounts as otherregistered entities.”

• ”Where the entities are not registered in the national territoryand, so, the transactions between households and theintermediary are cross border, other complications may arise”

• https://www.imf.org/external/np/seminars/eng/

2016/statsforum/pdf/Durand_paper.pdf

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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GDP in digital economy: Some examples

• AmazonI if you’re an official resale retailer who sells for a profit by providing service of linking buyers and

sellers, then the added value is part of the GDPI if you buy sth on Amazon and sell it to your friend for profit you do NOT add to GDPI what if your seller is from abroad? Which country GDP are we contributing to?

• UberI similar to taxi service

• AirbnbI there is already an item for rent services in GDP calculationsI These estimates assume that owner occupiers occupy their homes full-timeI AirBnB-type transactions will at least in part be covered by the imputation for owner- occupied

rentI some value of output will be lost, as short-term rentals are likely to fetch a higher value, charges in

return for the use of fixtures and fittings (e.g. furniture, Wi-Fi access) and associated labour input

• SpotifyI Note that the amounts involved here are the margins or service fees charged for the intermediation,

not the value of the transacted service itself

• e-BayI unincorporated enterprises or households conduct those transactions, the current assumption is

that re-selling the good does not have any value added, hence similar to the old car example above

• Uberpop or TaskRabbitI where the activities involve an agreement between the two parties to engage in a cash transaction

that avoids the payment of tax, notably VAT, it is unlikely that the activity will be recorded inGDP at all

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Exercise

As a result of each of the following economic events, pleaseindicate whether US GDP rises, falls and stays unchanged. Pleaseindicate, as well, which if any of the four main components ofGDP (consumption, investment, government purchases, and nextexports) change and in which direction (raising or falling)

1. Ford Motor Company produces a new car in the US, but addsit to its inventory of unsold vehicles instead of selling it to aUS consumer right away

2. the city of Logan, UT buys textbooks, printed in the US, forstudents to use in its public schools

3. The city of Logan, UT pays its public school teachers

4. You (as an individual, consumer in the US) buy a newcomputer, manufactures in Japan

5. General Electric, a US company, buys a piece of machinerymanufactures by another company located in Germany, andinstalls that machinery in one of its own factories in the US

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Exercise

As a result of each of the following economic events, pleaseindicate whether US GDP rises, falls and stays unchanged. Pleaseindicate, as well, which if any of the four main components ofGDP (consumption, investment, government purchases, and nextexports) change and in which direction (raising or falling)

1. Ford Motor Company produces a new car in the US, but addsit to its inventory of unsold vehicles instead of selling it to aUS consumer right away

2. the city of Logan, UT buys textbooks, printed in the US, forstudents to use in its public schools

3. The city of Logan, UT pays its public school teachers

4. You (as an individual, consumer in the US) buy a newcomputer, manufactures in Japan

5. General Electric, a US company, buys a piece of machinerymanufactures by another company located in Germany, andinstalls that machinery in one of its own factories in the US

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Exercise

As a result of each of the following economic events, pleaseindicate whether US GDP rises, falls and stays unchanged. Pleaseindicate, as well, which if any of the four main components ofGDP (consumption, investment, government purchases, and nextexports) change and in which direction (raising or falling)

1. Ford Motor Company produces a new car in the US, but addsit to its inventory of unsold vehicles instead of selling it to aUS consumer right away

2. the city of Logan, UT buys textbooks, printed in the US, forstudents to use in its public schools

3. The city of Logan, UT pays its public school teachers

4. You (as an individual, consumer in the US) buy a newcomputer, manufactures in Japan

5. General Electric, a US company, buys a piece of machinerymanufactures by another company located in Germany, andinstalls that machinery in one of its own factories in the US

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Exercise

As a result of each of the following economic events, pleaseindicate whether US GDP rises, falls and stays unchanged. Pleaseindicate, as well, which if any of the four main components ofGDP (consumption, investment, government purchases, and nextexports) change and in which direction (raising or falling)

1. Ford Motor Company produces a new car in the US, but addsit to its inventory of unsold vehicles instead of selling it to aUS consumer right away

2. the city of Logan, UT buys textbooks, printed in the US, forstudents to use in its public schools

3. The city of Logan, UT pays its public school teachers

4. You (as an individual, consumer in the US) buy a newcomputer, manufactures in Japan

5. General Electric, a US company, buys a piece of machinerymanufactures by another company located in Germany, andinstalls that machinery in one of its own factories in the US

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Exercise

As a result of each of the following economic events, pleaseindicate whether US GDP rises, falls and stays unchanged. Pleaseindicate, as well, which if any of the four main components ofGDP (consumption, investment, government purchases, and nextexports) change and in which direction (raising or falling)

1. Ford Motor Company produces a new car in the US, but addsit to its inventory of unsold vehicles instead of selling it to aUS consumer right away

2. the city of Logan, UT buys textbooks, printed in the US, forstudents to use in its public schools

3. The city of Logan, UT pays its public school teachers

4. You (as an individual, consumer in the US) buy a newcomputer, manufactures in Japan

5. General Electric, a US company, buys a piece of machinerymanufactures by another company located in Germany, andinstalls that machinery in one of its own factories in the US

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GDP comparisons 2017: billions of $US

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GDP growth

GDP growth rate= (FinalGDP − InitialGDP)/(InitialGDP)× 100

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US GDP growth annual

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US GDP growth quarterly

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US GDP growth quarterly

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US GDP growth quarterly

US GDP growth quarterly releases

• ”Advance Estimate” end of January

• ”Second Estimate” end of February

• ”Third Estimate” end of March

https://www.bea.gov/newsreleases/glance.htm

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US components of GDP

In 2017

• C: 70%

• I: 17%

• G: 17%

• NX: -4%

https://www.thebalance.com/

components-of-gdp-explanation-formula-and-chart-3306015

• If you’re interested in just how complex the calculation ofGDP is

https://www.bea.gov/national/pdf/all-chapters.pdf

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US GDP components: 2016 detailed

Component Amount (trillions) Percent

Personal Consumption $11.89 78%

Goods $4.23 25%

Durable Goods $1.70 10%

Non-durable Goods $2.58 15%

Services $7.68 45%

Business Investment $2.95 17%

Fixed $2.92 17%

Non-Residential $2.31 14%

Commercial $0.47 3%

Capital Goods $1.10 6%

Intellectual (Software) $0.75 4%

Residential $0.60 3%

Change in Inventories $0.02 0%

Net Exports ($0.62) (4%)

Exports $2.19 13%

Imports $2.81 16%

Government $2.90 17%

Federal $1.12 7%

Defense $0.67 4%

State and Local $1.79 10%

TOTAL GDP $17.10 100%

0

services used to contribute 30% in 1950s51 / 60

Real and Nominal GDP

• GDP measures total spending on good and services• if spending↑

I the economy is producing larger output of goods and servicesI goods and services are sold at higher prices

• we are interested in both effects• real GDP: the production of goods and services valued at

constant pricesI this is the one which is used to calculate GDP growth rates

• nominal GDP: the production of goods and services valued atcurrent prices

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Real and Nominal GDP: Example

year price of hot dogs

quantity of hot dogs

price of burgers

quantity of burgers

2016 1 100 2 50 2017 2 150 3 100 2018 3 200 4 15

0

• calculate nominal GDP:

• calculate real GDP (which year to use as base year?)

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Real and Nominal GDP: Deflator

• GDP deflator: a measure of the price level calculated as theratio of nominal GDP to real GDP times 100

• Can we use the example above to calculate the GDP deflator?

• GDP is used to monitor the average level of prices in theeconomy ⇒ rate of inflation

• why the name? it can be used to take inflation out of nominalGDP

• generally about half of US growth in nominal GDP reflectsrising prices, not raising production

https://www.thebalance.com/

what-is-real-gdp-how-to-calculate-it-vs-nominal-3306040

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Real GDP: USA

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Nominal GDP: USA

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GDP and well-being

• GDP measures both total income and total expenditure in theeconomy ⇒ calculate for average person

• it allows us measure the ability to obtain many of theintangible inputs even if it does not measure them directly• BUT! GDP counts ”bads” as well as ”goods.” and GDP does

not account forI leisureI volunteer workI houseworkI environmental qualityI equality and income distributionI changes in the quality of goods over timeI benefits of technology (CBS news)

• GDP is highly correlated with other measures of quality of life:life expectancy, literacy, overall life satisfaction, avg years ofschooling

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GDP and well-being

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GDP and well-being

• Nobel Prize-winning economist Joseph Stiglitz proposesalternatives to Gross Domestic Product (GDP) as ameasurement of national economic success.

• Joseph Stiglitz was chief economist at the World Bank untilJanuary 2000. Before that he was the chairman of PresidentClinton’s Council of Economic Advisers. He was awarded theNobel Prize in economics in 2001. He is currently a financeand economics professor at Columbia University.

• https://www.youtube.com/watch?v=QUaJMNtW6GA

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GDP vs life satisfaction

https://ourworldindata.org/happiness-and-life-satisfaction

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