measuring a nation’s income n the economy’s income & expenditure n the measurement of gross...
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Measuring a Nation’s Income
The Economy’s Income & Expenditure The Measurement of Gross Domestic
Product (GDP) The Components of GDP Real versus Nominal GDP GDP and Economic Well-Being
The Economy’s Income & Expenditure
GDP measures two things simultaneously: total income in the economy and total expenditure in the economy
Recall that circular flow illustrates value of output = expenditures = income
The Economy’s Income & Expenditure
Leakage: Income earned, but not spent on goods and services
Injection: Expenditures on goods and services that do not come from household sector
The Economy’s Income & Expenditure
In spite of leakages and injections, every transaction has a buyer and seller, so income and expenditure will always be equal
This means we can measure GDP by adding up all expenditures in the economy or by adding up all incomes in the economy
The Measurement of Gross Domestic Product
GDP is the market value of all final goods and services produced within a country in a given time period
The Measurement of Gross Domestic Product
“Market value” implies we will be using prices as the value of goods and services
GDP tries to includes all final goods and services produced– Ignores household production– Ignores underground economy– Intermediate goods are excluded
The Measurement of Gross Domestic Product
GDP includes final goods– Intermediate goods are excluded in order
to avoid double counting
The Measurement of Gross Domestic Product
Money Value
Farmer grows wheat & sells to miller 0.12 0.12
Miller mills wheat & sells to baker 0.28 0.16
Baker converts to bread & sells to store 0.60 0.32
Store sells bread to consumer 0.75 0.15
TOTALS 1.75 0.75
The Measurement of Gross Domestic Product
GDP includes goods produced in the current time period– Used goods are excluded
GDP measures the value of output produced within a nation – This is different from GNP which measures
the value of output produced by a nation’s current residents
The Components of GDP
GDP can be divided into various components– Consumption– Investment– Government purchases– Net exports
The Components of GDP
Consumption is spending by households on goods and services with the exception of new housing Largest component
Investment is spending on capital equipment, inventories, and structures, including household purchases of new housing Least stable component
The Components of GDP
Government purchases is spending on goods and services by state, local, and federal government Excludes transfer payments
Net exports is spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)
The Components of GDP
GDP can be expressed as:
Y = C + I + G + NX This equation is an identity - true by
definition
Real versus Nominal GDP
A change in GDP does not mean that there has been a change in the level of output GDP is P x Q
GDP can change because of a change in price, a change in quantity, or a change in both
Real versus Nominal GDP
Distinguish between nominal and real GDP
Nominal GDP is output valued in current dollars or current prices Can change because of a change in output
or a change in prices
Real versus Nominal GDP
Real GDP is output valued in constant dollars or constant prices (prices of some base period) Can change only because of a change in
output (we are essentially holding prices constant)
Real versus Nominal GDPYear P of Pizza Q of Pizza P of Coke Q of Coke
1999 $1 100 $.50 50
2000 $1.50 175 $.60 75
Nom GDP1999 = (1.00 X 100) + (.5 X 50) = 125.00
Nom GDP2000 = (1.50 X 175) + (.6 X 75) = 307.50
Real GDP1999 = (1.00 X 100) + (.5 x 50) = 125.00
Real GDP2000 = (1.00 X 175) + (.5 X 75) = 212.50
Real versus Nominal GDP The GDP deflator is a measure of the
price level It measures the current level of prices
relative to the base year level of prices The GDP deflator is calculated as the
ratio of nominal GDP to real GDP multiplied by 100
The deflator for the base year will always be 100
Real versus Nominal GDP
The deflator can be use to examine price changes that have occurred since the base year
A GDP deflator of 106.7 means prices are 6.7% higher than in base period
Real versus Nominal GDP
The GDP deflator can be used to calculate changes in prices over some period of time other than the base
Current deflator - Old deflator X 100
Old deflator
Real versus Nominal GDP
Example Price index 1995 = 120 Price index 1999 = 135 Change in price is:
135 - 120 X 100
120
Real versus Nominal GDP
15 X 100
120
= .125 X 100
= 12.5 percent change in prices
GDP and Economic Well-Being
GDP is an indicator of economic well-being
Should be aware that it is a flawed indicator
Does not include leisure, quality of the environment, types of goods we produce, value of goods that are produced outside markets, etc.
GDP and Economic Well-Being
(Gross domestic product) does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud to be Americans. ----- Robert Kennedy