micro economics chapter 07

7 Measuring Domestic Output and National Income McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Assessing the Economy’s Performance • National Income Accounting • LO1 • Assess health of economy • Track long run course • Formulate policy Gross Domestic Product (GDP): Total market value of all final goods and services produced within a country within a year Gross Domestic Product • Monetary measure • Avoid multiple counting • Market value final goods • Exclude intermediate goods • Value added counted LO1 Gross Domestic Product • Exclude financial transactions • Public transfer payments • Private transfer payments • Stock (and bond) market • LO1 transactions Exclude second hand sales Circular Flow RESOURCE MARKET •Households sell •Businesses buy BUSINESSES • buy resources • sell products HOUSEHOLDS • sell resources • buy products PRODUCT MARKET •Businesses sell •Households buy LO1 Circular Flow Revisited LO2 Two Approaches to GDP • Income approach • Count income derived from • LO2 production Expenditure approach • Count sum of money spent buying the final goods Two Approaches to GDP • GDP, output, and income all refer to the same thing and can be used interchangeably LO2 Expenditures Approach • Personal consumption expenditures • LO2 (C) • Durable goods • Nondurable goods • Services • Spending on houses is not included Largest component of GDP Expenditures Approach • Gross private domestic investment (Ig) • Machinery, equipment, and tools • All construction • Changes in inventories LO2 Changes in Inventories Changes in inventories represent the difference between what was produced during the year, and what was purchased LO2 Changes in Inventories • If inventories increase, more was produced than purchased, so the increase in inventories must be added to Ig and GDP • Vice versa if inventories fell LO2 Net Investment • Net Investment includes only added capital during the year • In = Ig – Depreciation • Consumption of Fixed Capital (Depreciation) – amount of capital goods used during the year LO2 Net Investment • Ig > CFC; therefore In > and economy is growing • Ig = CFC; therefore In = and economy is stagnant • Ig < CFC; therefore In < and economy is experiencing negative growth LO2 Expenditures Approach • Government purchases (G) • Goods and services • Publicly owned capital • Excludes transfer payments • Net exports (Xn) • Add exported goods • Subtract imported goods • Xn = exports - imports • GDP = C+Ig+G+Xn LO2 U.S Economy 2015 in Billions Receipts Expenditures Approach Allocations Income Approach Personal Consumption (C)$12,272 Compensation Gross Private Domestic Rents 657 Interest 524 Investment (Ig) 3,021 Government Purchases (G) 3,183 -529 Net Exports (Xn) $ 9,655 Proprietor’s Income 1,388 Corporate Profits 2,009 Taxes on Production and Imports 1,302 National Income $15,535 Net Foreign Factor Income (-) Consumption of Fixed 214 2,821 Capital (+) Statistical Discrepancy (+) Gross Domestic Product $ 17,947 Gross Domestic Product -195 $ 17,947 Source: Bureau of Economic Analysis, www.bea.gov LO2 Comparative GDP LO2 Other National Accounts • Net Domestic Product (NDP) • Measures what has been added to • LO2 the stock of capital and the new output National Income (NI) • Includes all income earned by U.S.-owned resources whether they are located in the United States or abroad Other National Accounts • Personal Income (PI) • Includes all income received • LO2 whether it was earned or unearned Disposable Income (DI) • Income that households receive and able to spend as they desire DI = C + S U.S Income Relationships 2015 Gross Domestic Product (GDP) Less: Consumption of Fixed Capital Equals: Net Domestic Product (NDP) Less: Statistical Discrepancy Plus: Net Foreign Factor Income Equals: National Income (NI) Less: Taxes on Production and Imports Less: Social Security Contributions Less: Corporate Income Taxes Less: Undistributed Corporate Profits Plus: Transfer Payments Equals: Personal Income (PI) Less: Personal Taxes Equals: Disposable Income (DI) LO2 $ 17,947 2,821 $ 15,126 -195 214 $ 15,535 1,177 1,203 530 591 3,306 $ 15,340 1,945 $ 13,395 Nominal vs Real GDP • Nominal GDP • Uses current prices • Real GDP • Adjusted for inflation • Use base year’s prices LO3 GDP Price Index • Use price index to determine real GDP Price Index In Given Year Real GDP LO3 Price Good in Specific Year =Price of Good In Base Year x 100 = Nominal GDP Price Index (in hundredths) Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • The underground economy • GDP and the environment • Composition and distribution of the output • Noneconomic sources of well-being LO4 Underground Economy LO4