Macroeconomics
ECON 2301
Spring 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 8
Assignment Deadline Today,
before Class!!!
 Tuesday, March 3 everyone will be turning
in an assignment, BEFORE CLASS
STARTS:
Junior Achievement: Teacher Confirmation
Form (pink ½ sheets), signed by the teacher
Economics in the News: First Research Paper,
emailed to marilyn.spencer@tamucc.edu
Extra Credit Opportunity #6
 Read a thorough news article that
explains the provisions of the mortgage
bailout plan for home owners.
 Summarize the most important parts, in
50-100 words (needn’t be in complete
sentences).
 Email this summary to me by Thurs.,
Mar. 5, at marilyn.spencer@tamucc.edu,
for up to 4 points of extra credit.
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
8-7
Figure 8-1 The Circular Flow
of Income and Product
8-8
The Simple Circular Flow
(cont'd)
 Product Markets
Transactions in which households buy goods
8-9
The Simple Circular Flow
(cont'd)
 Factor Markets
Transactions in which businesses buy resources
8-10
The Simple Circular Flow
(cont'd)
 Total Income
Wages, rent, interest, profits
8-11
The Simple Circular Flow
(cont'd)
8-12
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)
8-13
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.
8-14
National Income Accounting
(cont'd)
 Stress on final output
What is a final good?
• Wheat?
• Steel?
• Oil?
• Bread?
• Automobile?
• Gasoline?
8-15
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
8-16
Table 8-1 Sales Value and Value Added at
Each Stage of Donut Production
8-17
National Income Accounting
(cont'd)
 Exclusion of financial transactions, transfer
payments, and secondhand goods
Numerous transactions occur that have
nothing to do with final goods and services
being produced.
8-18
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
8-19
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
8-20
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.
8-21
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.
8-22
Two Main Methods
of Measuring GDP
 Expenditure Approach
Computing GDP by adding up the dollar value
at current market prices of all final goods and
services
8-23
Two Main Methods
of Measuring GDP (cont'd)
Expenditure Approach
8-24
2 Main Methods of Measuring GDP(cont'd)
 Income Approach
Measuring GDP by adding up all components
of national income, including wages, interest,
rent, and profits
8-25
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
1. Consumption Expenditure (C)
2. Gross Private Domestic Investment
3. Government purchases of goods and
services
4. Net Exports
8-26
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
1. 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
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
2. 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
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
Gross Private Domestic Investment (I)
• 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
8-29
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
3. Government Expenditures (G)
• State, local, and federal
• Valued at cost
8-30
Two Main Methods
of Measuring GDP (cont'd)
 Deriving GDP by the expenditure approach
4. Net Exports (Foreign Expenditures)
Net exports (X) = Total exports – Total imports
8-31
Two Main Methods
of Measuring GDP (cont'd)
 Presenting the expenditure approach
Where
• C = consumption expenditures
• I = investment expenditures
• G = government expenditures
• X = net exports
GDP = C + I + G + X
8-32
Figure 8-2
GDP and 3 of Its Components
8-33
Two 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 oneyear period due to physical wear and tear, and also
to obsolescence
NDP = GDP – Depreciation
8-34
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
8-35
Table 8-2 Going from GDP
to Disposable Income, 2007
8-36
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
8-38
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.”
8-39
Table 8-3 Correcting GDP
for Price Index Changes
8-40
Figure 8-4 Nominal and Real GDP
Source: U.S. Department of Commerce
8-41
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
8-42
Comparing GDP
Throughout the World
 Foreign Exchange Rate
The price of one currency in terms of another
 Foreign exchange rate
• $1.25 = 1 euro; or $1 = 0.80 euros
• French per capita income = 23,168.80 euros
• French per capita income in terms of dollars equals
23,168.80 euros x $1.25 = $28,961
8-43
Table 8-4
Comparing GDP Internationally
8-44
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?
8-45
Figure 8-5 Effects of Revisions in GDP
Estimates on Measured GDP Growth Rates
8-46
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
8-48
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
8-49
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.
8-50
Assignment to be completed
before class March 10:
Read Chapter 9 & also read end-ofchapter Problems 9-4, 9-5, 9-7, 9-8
& 9-13 on pp. 237-238.