Macroeconomics Rittenberg Chapter 6: “Measuring Total Output and Income” Dolan, Economics Combined Version 4e, Ch. 19 1. MEASURING TOTAL OUTPUT Learning Objectives 1. Define gross domestic product and its four major spending components and illustrate the various flows using the circular flow model. 2. Distinguish between measuring GDP as the sum of the values of final goods and services and as the sum of values added at each stage of production. 3. Distinguish between gross domestic product and gross national product. GDP = C + I +G + XN • C = Consumption (household spending) • I = Gross Private Domestic Investment • Fixed Investment (real Capital Purchases) • Inventory Investment (changes in inventory of finished products, intermediate products, or raw materials) • G = Government Purchases • excludes transfer payments • XN = Net Exports (Exports – Imports) 1.1 The Components of GDP GDP = C + I + G + Xn • • A flow variable is a variable that is measured over a specific period of time. A stock variable is a variable that is independent of time. © 2013, published by Flat World Knowledge 1.1 The Components of GDP • Personal consumption is a flow variable that measures the value of goods and services purchased by households during a time period. Personal consumption Consumer goods and services Households Firms Factors of production (labor, capital, and natural resources) © 2013, published by Flat World Knowledge Factor incomes (wages, interest, profit, and rent) 1.1 The Components of GDP • Gross private domestic investment is the value of all goods produced during a period for use in the production of other goods and services. Personal consumption Private investment Firms © 2013, published by Flat World Knowledge Factor incomes Households 1.1 The Components of GDP • Government purchases are the sum of purchases of goods and services from firms by government agencies plus the total value of output produced by government agencies themselves during a time period. • Transfer payments – (excluded in Government Purchases) are payments that do not require the recipient to produce a good or service (in that time period) in order to receive them. – Examples: Welfare, Unemployment, Student Financial Aid, Military Retirement, Social Security, ETC. © 2013, published by Flat World Knowledge Clicker: Which of the following would not count in the G (Government Purchases) component of GDP? A. Money spent to build a new bridge B. Pensions paid to retired presidents C. Salaries paid to state college professors D. Paper supplies purchased by the IRS E. All of these are part of Government Purchases 1.1 The Components of GDP Personal consumption Private investment Firms Households Government purchases Government agencies Factor incomes © 2013, published by Flat World Knowledge 1.1 The Components of GDP • • Exports are the sales of a country’s goods and services to buyers in the rest of the world during a particular time period. Imports are purchases of foreign-produces goods and services by a country’s residents during a period. • Net Exports are exports minus imports. • • Exports (X) – imports (M) = net exports (Xn) A trade deficit occurs when there are negative net exports. A trade surplus occurs when there are positive net exports. © 2013, published by Flat World Knowledge 1.1 The Components of GDP • • • • • Exports are the sales of a country’s goods and services to buyers in the rest of the world during a particular time period. Imports are purchases of foreign-produces goods and services by a country’s residents during a period. Net Exports are exports minus imports. Exports (X) – imports (M) = net exports (Xn) A trade deficit occurs when there are negative net exports. A trade surplus occurs when there are © 2013, published by Flat World Knowledge positive net exports. 1.1 The Components of GDP Private investment Personal consumption Firms Government purchases Government agencies Households Net Exports Factor incomes Rest of the world © 2013, published by Flat World Knowledge 1.1 The Components of GDP © 2013, published by Flat World Knowledge 1.2 Final Goods and Value Added • The Value added is the amount by which the value of a firm’s output exceeds the value of the goods and services the firm purchases from other firms. Good Produced by Purchased by Price Value Added Logs Logger Sawmill $12,000 $12,000 Lumber Sawmill Construction firm $25,000 $13,000 House Construction firm Household $125,000 $100,000 FINAL VALUE $125,000 SUM OF VALUES ADDED © 2013, published by Flat World Knowledge $125,000 1.3 GNP: An Alternative Measure of Output • Gross national product (GNP) is the total value of final goods and services produced during a particular period with factors of production owned by the residents of a particular country. EQUATION 1.3 GDP + net income received from abroad by residents of a nation = GNP © 2013, published by Flat World Knowledge Clicker: • GDP Accounting: • A ton of oranges grown in Tulare County CA and purchased by a wholesale firm in Tokyo, Japan would be counted in: A. Consumption B. Net exports as a + C. Net exports as a – D. Investment © 2013, published by Flat World Knowledge Clicker: 2 points • GNP/GDP Accounting: • A ton of oranges grown in Tulare County CA by a us farmer and and ultimately sold by a grocery chain in Kanas would count as: A. Consumption B. Net exports as a + C. Net exports as a – D. Investment © 2013, published by Flat World Knowledge Clicker: • GNP/GDP Accounting: • A ton of strawberries grown in Mexico by DOLE, (a US firm) and brought into the US by a wholesale produce firm. A. Is part of Mexico’s GDP B. Is part of US GDP C. Is part of Mexico’s consumption D. Is counted as Government purchases in the US GDP © 2013, published by Flat World Knowledge Clicker: • GNP/GDP Accounting: • A ton of strawberries grown in Mexico by DOLE, (a US firm) and brought into the US by a wholesale produce firm. A. Is part of Mexico’s GNP B. Is part of US GNP © 2013, published by Flat World Knowledge 2. MEASURING TOTAL INCOME Learning Objectives 1. Define gross domestic income and explain its relationship to gross domestic product. 2. Discuss the components of gross domestic income. 3. Define disposable personal income and explain how to calculate it from GDP. © 2013, published by Flat World Knowledge 2.1 The Components of GDI • Gross domestic income (GDI) is the total income generated in an economy by the production of final goods and services during a particular period. – Employee compensation – Profits – Rental income – Net interest – Depreciation – Indirect taxes © 2013, published by Flat World Knowledge 2.1 The Components of GDI GDP and GDI, 2011 Gross domestic product Personal Consumption Expenditures $15,176.1 Gross Domestic Income 10,784.5 Compensation of Employees $15,214.8 8,347.3 Gross Private Domestic Investment 1,906.6 Profits 2,633.0 Government consumption expenditures and gross investment 3,047.3 Rental income of persons 406.3 Net exports of goods and services –562.3 Net interest 710.3 Taxes on production and imports 1,155.1 Consumption of fixed capital (depreciation) 1,962.8 Statistical discrepancy © 2013, published by Flat World Knowledge –38.7 2.2 Tracing Income from the Economy to Households • Disposable personal income is the income households have available to spend on goods and services. From GDP to Disposable Personal Income GDP + net factor earnings from abroad =gross national product (GNP) GNP – depreciation (consumption of fixed capital) =net national product (NNP) NNP – statistical discrepancy =national income (NI) NI – income earned but not received [e.g., taxes on production and imports, social security payroll taxes, corporate profit taxes, and retained earnings] + transfer payments and other income received but not earned in the production of GNP =personal income (PI) PI – personal income taxes =disposable personal income (DPI) © 2013, published by Flat World Knowledge 3. GDP AND ECONOMIC WELL-BEING Learning Objectives 1. Discuss and give examples of measurement and conceptual problems in using real GDP as a measure of economic performance and of economic well-being. 2. Explain the use of per capita real GNP or GDP to compare economic performance across countries and discuss its limitations. © 2013, published by Flat World Knowledge 3.1 Measurement Problems in Real GDP • There are two measurement problems, other than those associated with adjusting for price level changes, in using real GDP to assess domestic economic performance. – – Revisions The Service Sector © 2013, published by Flat World Knowledge 3.2 Conceptual Problems with Real GDP • A second set of limitation or real GDP stems from problems inherent in the indicator itself. – Household Production – Underground and Illegal Production – Leisure – The GDP Accounts Ignore “Bads” (e.g. crime spending, negative externalities, environmental pollution) • More GDP cannot necessarily be equated with more human happiness. © 2013, published by Flat World Knowledge 3.3 International Comparisons of Real GDP and GNP • • Per capita real GNP or GDP is a country’s real GNP or GDP divided by its population. Comparing one country’s output to another presents additional challenges. That said, when the data suggest huge disparities in levels of GNP per capita, for example, we observe real differences in living standards. © 2013, published by Flat World Knowledge