Frank & Bernanke
4th edition, 2009
Ch. 4: Spending, Income, and GDP
1
2
3
Why Measure A Nation’s Income
To have a sense of an economy’s size.
 The well being of a citizen, on average,
depends on the nation’s income per person.

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http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu
As the income of the society increases, the
average person will have a higher standard
of living.


One can drown in a lake of 3-ft average depth.
Standard of living may not necessarily be the goods and
services a household can consume.
4
Definition of GDP

Gross Domestic Product is the market value
of all the final goods and services produced
within a country in a year.
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

How do you determine the value of child care?
How do you include the production of steel or
plastics?
How do you include the sales of existing homes?
How do you account for $4 million paid at an
auction for a Van Gogh painting?
How do you account for government services?
5
Market Value

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

Suppose we live in an economy
where only hamburgers, colas and
fries are produced.
Prices are: hamburgers $2; colas $1;
fries $0.50.
If this economy produces 100
hamburgers, 150 colas and 200 fries,
what is the market value?
What is the market value if 200
hamburgers, 100 colas and 100 fries
are produced?
Price
Qty
Value
Hmbgr
$2
100
$200
Cola
$1
150
$150
Fries
$0.50
200
$100
GDP
$450
6
Percentages of American Men and Women
over Age 16 Working Outside the Home
“By 2010 women will
be the majority.”
Check at
www.bls.gov
http://www.economist.com
/opinion/displayStory.cfm?
story_id=15174489&sourc
e=hptextfeature
• Increase in female labor force participation increases the demand for
housekeeping and child care.
• Unpaid household work is not counted in GDP.
• Paid household work is counted in GDP.
• The increase in female labor force participation has overstated GDP growth.
7
Participation Rates
Labor Force Participation Rate is
total employed plus unemployed
divided by the labor force.
From 2000 to 2011 participation
rates for men dropped from 75%
to 70%.
From 2000 to 2011 participation
rates for women dropped from
60% to 58%.
8
Why GDP Is Equal to Income?

How is my contribution to the US economy
calculated?


The amount of educational service I create is
equal to my gross income.
How is the income of a real estate agent
calculated?

When she sells a 25-yr old house, she gets a
percent of the price as a payment for her
services.
9
Why GDP Is Equal to Income?

How is the GDP contribution of the
textbook company calculated?
After they pay the author, the paper company
and the ink company, the amount of revenue
they get from textbook sales plus the value of
their book inventory (unsold books) is their
contribution to the US GDP.
 Their contribution is equal to wages, salaries,
rent, interest and profits generated.

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Value Added

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Calculate the contribution of the following
activities to GDP.
Farmer sells cotton for $100.
Cotton is processed into thread and sold for
$130.
Thread is made into cloth and sold for $200.
Cloth is made into shirts and sold for $300.
$100
$30
$70
$100
300
Final value = Value added
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Circular Flow
GDP from expenditure
Consumption expenditures of households
Households
Firms
Income (wages, salaries, rent, interest, profit)
earned by households
GDP from income
12
Circular Flow
Upper flow is equal to GDP.
 Lower flow is equal to income.
 If GDP < Income, businesses will
reduce production and create less
income => unemployment.
 If GDP > Income, businesses will want
to expand production and create more
income => boom.

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GDP
HOUSEHOLDS
FIRMS
Y=wages+salaries+rent+profits+interest
C
IM
EX
FINANCIAL SYSTEM
I
T
TR+INT
REST OF THE WORLD
GOVERNMENT
G
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How Can We Measure GDP?
Expenditure Approach: the upper flow.
Y = C + I + G + NX
 Income Approach: the lower flow.
Y = Sum of factor incomes
Y = Wages + Salaries + Rent + Interest +
Profits
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Components of Expenditure

Consumption includes spending on
food, entertainment, shelter, health
care, transportation, clothing, household
items, insurance, education.
16
Components of Expenditure

Investment includes purchases made by
firms to generate future income.
Machinery, tools, buildings, trucks and
cars are part of investment if they are
bought to generate future income. By
convention, newly built houses and
inventory are included under investment.
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Components of Expenditure

Government purchases are
expenditures of federal, state and
local governments on goods and
services plus their payrolls.
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Components of Expenditure
Approach
Net exports is exports minus imports.
 Dell Computer sales in China are part of
US exports.
 Dell Computer purchases of plastic molds
for their computers from China are part of
US imports.

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GDP
http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N
&3Place=N&FromView=YES&Freq=Year&FirstYear=2004&LastYear=2008&3Place=N&Update=Update&JavaBox=no#
Mid
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The Three Faces of GDP
Production
Market
value of
final
goods
and
services
Expenditure
Income
Consumption
Labor Income
=
=
=
=
Investment
Government
purchases
Capital
Income
Net exports
21
A GDP Increase Always Increases
The Size of the Economy
WRONG!
 What if GDP in 2009 were 1000, in 2010
were 1500 but inflation was 50%?
 In this case, the increase in GDP is solely
attributable to price increases, not
improving the well being (standard of
living) of the average citizen.

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Nominal vs. Real Measures
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In macroeconomics, most variables are
measured in real terms, not nominal
terms.
Real variable eliminates the effect of
inflation.
Nominal variable includes the effect of
inflation.
GDP comparisons are always made with
real GDP.
Nominal GDP uses current prices.
Real GDP uses base year prices.
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Real and Nominal GDP
The Economy Produces 2 Goods: Pizza and Soda
Year
2007
2008
2009
Pp
10
11
13
Qp Ps
1000 2
1000 3
1200 4
Qs Nominal GDP Real GDP GDP Deflator
5000 $20,000.00 $20,000.00
100.0
6000 $29,000.00 $22,000.00
131.8
7000 $43,600.00 $26,000.00
167.7
Nominal GDP is calculated by adding the amounts spent on each
Product. Real GDP is calculated by using the 2007 prices of pizza
and soda to calculate the amounts spent in future years.
GDP Deflator is Nominal GDP/Real GDP.
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Real and Nominal GDP
25
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What Is Wrong With Real GDP?

Real GDP increases if you sell your services
rather than provide them free.

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If you build a house through Habitat for Humanity
your work doesn’t count as part of GDP. If you get
paid for the same work, it counts.
If you pollute during production and someone
pays to clean the environment, the GDP will
be higher than if the producer tried to reduce
pollution during production so no clean-up
was necessary.
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Underground Economy
If market transactions cannot be tracked
by data collectors, they may be ignored.
 Transactions with high cash usage and
no paper trail can remain hidden from
the government.
 GDP may actually be much higher than
government statistics if there is a large
underground economy.

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Real GDP is not the Same
as Economic Well-Being

Leisure Time
Shorter work week
 Start working later
 Retire earlier
 Check the debate on leisure in EU conducted
by The Economist.

http://www.economist.com/debate/days/view/438&sa_campaign=debateseries/debate38/events/hp/pa
nel/?source=hpevents
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Real GDP is not the Same
as Economic Well-Being

Nonmarket Economic Activities
Household production
 Volunteer services
 Nonmarket activities are more important in
poor countries
 Underground economy

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Real GDP is not the Same
as Economic Well-Being

Environmental Quality and Resource
Depletion
Benefits of environment quality are not
measured.
 GDP is not adjusted for resource depletion.

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Real GDP is not the Same
as Economic Well-Being

Quality of Life
Crime rates
 Traffic congestion
 Civic organizations
 Open space

32
Real GDP is not the Same
as Economic Well-Being

Poverty and Economic Inequality

GDP does not capture the effects of income
inequality
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GDP & Basic Indicators of Well-Being
All developing
countries
Least developed
countries
GDP per person
(U.S. dollars)
3,530
1,170
25,860
Life expectancy at
birth (years)
64.5
51.7
78.0
Infant mortality rate
(per 1,000 live births)
61
100
6
Under-5 mortality rate
(per 1,000 live births)
89
159
6
Doctors
(per 100,000 people)
78
30
252
Incidence of HIV/Aids
(% in 15-49 age group)
1.3
4.3
0.3
Undernourished
people (%)
18
38
Negligible
Primary enrollment
rate (as % of age group)
85.7
60.4
99.9
Secondary enrollment
rate (as % of age group)
60.4
31.2
96.2
Adult literacy rate (%)
72.9
51.7
98.6
Indicator
Industrialized
countries
34
http://hdr.undp.org/en/media/HDR_2009_EN_Indicators.pdf
http://hdr.undp.org/en/data/map/
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