Macroeconomics
ECON 2301
Fall 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 8
Extra Credit Opportunity #7
 Find out who won the Nobel Prize for
Economics – announced Monday, Oct. 12.
 Find out what research strand(s) the prize
is recognizing.
 Send me that info in an email, before class
Wednesday, October 21.
4 points possible
Macro in the News:
If you haven’t yet received an email
response from me about receiving
your paper, I may not have received
it. Find the email you sent me before
class last Monday, with your paper
attached, and FORWARD that
email to me.
Macro in the News:
Check your email to see if you have received
an email from me with the subject line
“ECON 2301: Problem with your paper!”
If you have, you need to come see me right
away to discuss the problem & to see about
writing a revision!!!
Midterm Grades
 My midterm grades for you are due this
Thursday.
 The only grading that I’ve completed for all
of you is the 1st exam, along with some
quizzes.
 The grade I will assign for you is based on
your 1st exam and the first 3 quizzes.
Chapter 8: Measuring the Economy’s
Performance
Learning Objectives
1. Describe the circular flow of income and output
2. Define gross domestic product (GDP)
3. Understand the limitations of using GDP as a
measure of national welfare
4. Explain the expenditure approach to tabulating
GDP
5. Explain the income approach to computing GDP
6. Distinguish between nominal GDP and real GDP
The Simple Circular Flow
 Two observations
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.
The Simple Circular Flow
(cont'd)
 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
8-9
The Simple Circular Flow
(cont'd)
 Product Markets
Transactions in which households buy goods
8-10
The Simple Circular Flow
(cont'd)
 Total Income
Wages, rent, interest, profits
8-11
The Simple Circular Flow
(cont'd)
 Factor Markets
Transactions in which businesses buy resources
8-12
The Simple Circular Flow
(cont'd)
8-13
National Income Accounting
 National Income Accounting: A
measurement system used to estimate national
income and its components
 Total Income: The yearly amount earned by the
nation’s resources (factors of production)
8-14
National Income Accounting
(cont'd)
 Gross Domestic Product (GDP): 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.
8-15
National Income Accounting
(cont'd)
 Stress on final output
What is a final good?
• Wheat?
• Steel?
• Oil?
• Bread?
• Automobile?
• Gasoline?
8-16
National Income Accounting
(cont'd)
 Intermediate Goods: Goods used up entirely
in the production of final goods
 Value Added: The dollar value of an industry’s
sales minus the value of intermediate goods (for
example, raw materials and parts) used in
production
8-17
Table 8-1 Sales Value and Value Added at
Each Stage of Donut Production
8-18
National Income Accounting
(cont'd)
 We exclude financial transactions, transfer
payments, and secondhand goods
Numerous transactions occur that have
nothing to do with final goods and services
being produced.
8-19
National Income Accounting
(cont'd)
 Exclusion of financial transactions
Securities – e.g., Stocks and bonds
Government transfer payments, e.g.:
• Social Security
• Unemployment compensation
Private transfer payments
• Individual gifts
• Corporate gifts
8-20
National Income Accounting
(cont'd)
 Transfer of secondhand goods excluded
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
8-21
National Income Accounting
(cont'd)
 GDP’s limitations
Excludes non-market production
Excludes non-reported (illegal) market production
It is not necessarily a good measure of the well-being
of a nation.
 GDP is a measure of the value of production in
terms of market prices, and an indicator of
economic activity.
 GDP is not a measure of a nation’s overall
welfare.
8-22
National Income Accounting
(cont'd)
 GDP is a measure of the value of
production in terms of market prices,
and an indicator of economic activity.
 GDP is not a measure of a nation’s
overall welfare.
8-23
2 Main Methods of Measuring GDP
1. Expenditure Approach to measuring
GDP: Computing GDP by adding up the dollar
value at current market prices of all final goods
and services
8-24
2 Main Methods of Measuring GDP(cont'd)
2. Income Approach of measuring GDP:
Measuring GDP by adding up all components of
national income, including wages, interest, rent,
and profits
8-25
2 Main Methods of Measuring GDP(cont'd)
1. Deriving GDP by the expenditure approach
a. Consumption Expenditure (C)
b. Gross Private Domestic Investment
c. Government purchases of goods and
services
d. Net Exports
8-26
2 Main Methods of Measuring GDP (cont'd)
1. Deriving GDP by the expenditure approach
a. Consumption Expenditure (C)
• Durable Consumer Goods
– Life span of more than three years
• Nondurable Consumer Goods
– Goods that are used up in three years
• Services
– Mental or physical help
8-27
2 Main Methods of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
b. Gross Private Domestic Investment (I)
• The creation of capital goods, such as factories and
machines, that can yield production and hence
consumption in the future
– Also included: changes in business inventories
and repairs made to machines, buildings
8-28
2 Main Methods of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
b. Gross Private Domestic Investment (I), cont’d
• Producer Durables or Capital Goods
– Life span of more than three years
• Fixed Investment
– Purchases by business of newly produced
producer durables or capital goods
• Inventory Investment
– Changes in stocks of finished goods and goods
in process, as well as changes in raw materials
2 Main Methods of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
c. Government Expenditures (G)
• State, local, and federal
• Valued at cost
8-30
2 Main Methods of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
d. Net Exports (Foreign Expenditures)
Net exports (X) = Total exports – Total imports
8-31
2 Main Methods of Measuring GDP (cont'd)
 Presenting the expenditure approach
Where
a. C
=
consumption expenditures
b. I
=
investment expenditures
c. G
=
government expenditures
d. X
=
net exports (exports – imports)
GDP = C + I + G + X
8-32
Figure 8-2
GDP and 3 of Its Components
8-33
2 Main Methods of Measuring GDP (cont'd)
 Depreciation and net domestic product
Deducting for depreciation (capital
consumption allowance): Reduction in the
value of capital goods over a one-year period
due to physical wear and tear, and also to
obsolescence
NDP = GDP – Depreciation
8-34
2 Main Methods of Measuring GDP (cont'd)
Deriving GDP by the Income Approach
2 Main Methods of Measuring GDP (cont’d)
Deriving GDP by the Income Approach
 Gross Domestic Income (GDI): The sum
of all income (wages, interest, rent, and profits)
paid to the four factors of production.
2 Main Methods of Measuring GDP (cont'd)
Deriving GDP by the Income Approach
2. Gross Domestic Income (GDI)
a. Wages: salaries and labor income
b. Rent: farms, houses, stores
c. Interest: savings accounts
d. Profits: sole proprietorships, partnerships,
corporations
2 Main Methods of Measuring GDP (cont'd)
Deriving GDP by the Income Approach
 Gross domestic product equals gross
domestic income plus indirect business
taxes and depreciation
 These last items are called non-income
expense items
2 Main Methods of Measuring GDP (cont'd)
Deriving GDP by the Income Approach
 Indirect business taxes: All business taxes
except the tax on corporate profits
Include sales and business property taxes
Figure 8-3 Gross Domestic Product and Gross Domestic
Income, 2009 (in billions of 2009 dollars per year)
Sources: U.S. Department of Commerce and Miller’s estimates
Other Components of
National Income Accounting
 National Income (NI): The total of all factor
payments to resource owners
 Personal Income (PI): The amount of income
that households actually receive before they pay
personal income taxes
 Disposable Personal Income (DPI): Personal
income after personal income taxes have been paid
8-41
Table 8-2 Going from GDP
to Disposable Income, 2007
8-42
GDP Measures Total Production, expenditure
& Income
Some Actual Values
Go to a page of the Bureau of Economic Analysis Web site
to look at each of these components:
http://www.bea.gov/national/nipaweb/TableView.asp?Select
edTable=5&FirstYear=2007&LastYear=2008&Freq=Qtr
http://www.bea.gov/national/nipaweb/TableView.asp?Select
edTable=1&FirstYear=2007&LastYear=2008&Freq=Qtr
Distinguishing Between Nominal
and Real Values
 Nominal Values
Measurements in terms of the actual market prices at
which goods are sold; expressed in current dollars, also
called money values
 Real Values
Measurements after adjustments have been made for
changes in the average of prices between years;
expressed in constant dollars
 Constant Dollars
Dollars expressed in terms of real purchasing power
8-44
Example: Correcting GDP
for Price Index Changes
 Correcting GDP for price index changes
Nominal (current) dollars GDP
Real (constant) dollars GDP
Nominal GDP x 100
Real GDP =
Price level*
*Price level: measured by the GDP deflator
Go to http://www.bea.gov/national/index.htm#gdp and click
on “Current Dollar & ‘Real’ GDP.”
8-45
Table 8-3 Correcting GDP
for Price Index Changes
8-46
Figure 8-4 Nominal and Real GDP
Source: U.S. Department of Commerce
8-47
Go to
ftp://ftp.bls.gov/pub/special.requests/cpi/cp
iai.txt for historical data.
 Per capita GDP
Adjusting for population growth
Real GDP
Per capita real GDP =
Population
8-48
Comparing GDP
Throughout the World
 Foreign Exchange Rate
The price of one currency in terms of another
 Foreign exchange rate
Suppose $1.50 = 1 euro, or $1 = .67 euros.
French income per capita = 24,120 euros.
French per capita income in terms of dollars equals
24,120 euros x $1.50 = $36,180.
8-49
Table 8-4
Comparing GDP Internationally
8-50
Issues and Applications: The Art of
Estimating GDP Often Requires Touch-Ups
 The Bureau of Economic Analysis gives an
advance estimate of quarterly GDP.
 The estimate receives considerable attention from
the news media.
 Nevertheless, the estimate is updated at least two
times.
 How different is the final result?
8-51
Figure 8-5 Effects of Revisions in GDP
Estimates on Measured GDP Growth Rates
8-52
Unemployment Data from the
Bureau of Labor Statistics
Go to:
http://data.bls.gov/cgi-bin/surveymost?ln and
click on the table(s) of interest.
Be sure to click on the tables for “Average
Weeks Unemployed”.
Summary of Learning Objectives
 The circular flow of income and output
In every economic transaction, receipts exactly
equal expenditures
Goods and services flow in one direction and
money payments flow in the other
 Gross domestic product (GDP)
The total market value of a nation’s final output
of goods and services produced in a year using
factors of production located within its borders
Summary of Learning Objectives(cont'd)
 The limitations of using GDP as a measure
of national welfare
Excludes non-market transactions
Does not measure national well-being
 The expenditure approach to tabulating
GDP
GDP = C + I + G + X
Summary of Learning Objectives(cont'd)
 The income approach to computing GDP
The sum of wages, rent, interest, profits
 Distinguishing between nominal GDP and
real GDP
Nominal GDP is the value of newly produced
final output measured in current market prices.
Real GDP adjusts nominal GDP into constant
dollars by correcting for price level changes.
Assignment to be completed
before class October 26:
Read Chapter 14 & also read these end-ofchapter Problems:
14th ed: 14-1, 14-2, 14-4, 14-7, 14-9, 14-12,
14-13 & 14-14 on pp. 362-364.
15th ed: 14-1, 14-2, 14-4, 14-6, 14-8, 14-9,
14-10 & 14-11 on pp. 363-364.