Land
Labor
Four Factors of Production
Payments to
Factors of
Production
Entrepreneurship
Capital
Factors of Production
Rent
Goods and
Services
Wage
Sold
Land
Labor
Profit
Entrepreneurship
Interest
Capital
Should be determined
by the government
Should be determined by
the “free market”
Should be determined by free
market and the government
Total
Income
Communism
Capitalism
Socialism
Capitalism
Not owned by
Government
Economic system in which the means of
production are privately owned and
operated for private profit
Decisions are made by private actors in a
free market
Laissez-faire: free market
A market in which there is no economic
intervention and regulation by the
government,
Except to enforce private contracts and
the ownership of property.
to
Interest
Rent
Wages
Profits
Circular Flow Diagram
Pay
$
Pay
taxes
Households
Save
Buys goods
and
services
Firms
$
$
Buy goods
and services
$
Goods and
Services
$
$
$
Measuring Production
Gross Domestic Product
Goods
and
Services
17T
6
Why is this number
important?
The more goods and
services we produce, the
more Income is generated
and the better our ability
to satisfy needs.
Interest
Rent
Wages
Profits
Goods
and
Services
17T
7
GDP
Sum of expenditures on new, final
goods and services produced in the
U.S during the year.
GDP includes
ONLY NEW
Excludes used
production
goods
GDP is NOT
the sum of
total sales!
GDP = Total sales of
new goods…
GDP = Total sales of
new goods…
Car Manufacturer purchase new windows
from window manufacturer at $300 each
Consumer buys
new car for
$16,000.
Car Manufacturer purchase new
tires from tire manufacturer at
$200 each
GDP = Total sales of
4
Windows
new
goods…: $1200
+
4 tires : $800
Intermediate Goods
+
1 car: $16,000
=
Final Good
$18,000
Total Sales
of New
Goods
GDP excludes sales of
Include twicegoods
the value
of
intermediate
to avoid
the
tirescounting.
and the windows
double
Intermediate Good
A good (or service) that is used as an
input or component in the production
of another good.
A good that will be further processed
before sold as final good.
Goods and services purchased by
firms…
11
Final Good
A good (or service) purchased by
the final user
With no further transformation, use
or as an input in the production of
other goods.
12
GDP includes
ONLY Final goods
GDP
Sum of expenditures on new, final
goods and services produced in the
U.S during the year.
Excludes goods
purchased by firms to
produce final goods…
13
Firms purchase Capital Goods
Capital good: A manufactured
factor of production used to
produce other goods…
Examples: factories, buildings,
GDP excludes goods
trucks,
tools,
machinery,
and
purchased
by firms
to
produce final goods…
equipment.
14
Intermediate vs. Capital Goods
Flour
Sugar
Depreciation
Depreciation
Flour
Sugar
15
Investment
The purchase of
capital goods
16
GDP includes goods
purchased by consumsers
and capital gods purchased
by firms
GDP
Sum of expenditures on new, final
goods and services produced in the
U.S during the year.
Excludes Intermediate
goods purchased by
firms
17
Households
Firms
Government
Purchases
Consumer
Purchases
Goods and
Services
Unsold
Inventory
+
Purchase of
Capital Goods
Investment = Purchase of
• Equipment, tools, software.
• Non-residential construction:
shopping malls, factories, airports.
• Inventories and
• New homes and Condominiums
purchased by consumers
19
Saving = purchase of
paper goods
Households
Save
Buy goods
and services
Goods and
Services
GDP Excludes Paper Goods
GDP excludes purchases of Bonds,
stocks, Certificates of Deposit..
21
22
Goods Produced by the
Government are NOT sold
• All goods and services purchased by the
government are FINAL goods.
• Government production is included when the
government purchase the inputs necessary to
produce: services of government employees, raw materials,
tools, equipment.
• Government production is calculated at the
value of the inputs used.
24
Imports
U.S.
goods
U.S
goods
Households
Firms
U.S
goods
U.S
goods
Purchase of Foreign
Goods (IMPORTS)
should not be added as
U.S. production
U.S. Goods
and
Services
GDP does not include NonMarket Production
Goods or services produced but not
paid for.
Cleaning, cooking, home improvement
projects, child care, volunteering
27
GDP does not include
unreported production
Goods or services produced and paid
for but not reported
Illegal goods and services
Legal unreported goods and services
28
Total Production is larger than
GDP
U.S. Goods and
Services
29
GDP is NOT equal to total sales
GDP excludes:
• Sales of intermediate goods
• Sales of paper goods
• Sales of used goods
• Sales of illegal goods
• Non- market goods and services.
30
Limitations of GDP
• Excludes non-market production of goods
or services
– Child care, elderly care, cooking, cleaning,
gardening, home projects, farming.
• Excludes underground production of
goods or services
– Illegal and legal goods and services not
reported to tax authority.
31
Limitations of GDP continued…
 GDP does not ”subtract”.
 Deforestation.
 Contamination.
 Destruction of animal and plant life.
 Destruction of assets.
Germany
3T
China
China
9T
China
9TChina
9T
9T
32
Limitations of GDP continued…
Leisure is not accounted for.
EU
17T
Worked 11 months
USA
17T
Worked 12 months
34
Does this mean that the U.S.
grows faster than any other
country?
2012
2014
36
Does this mean Americans are
the richest in terms of income
per person?
2013
U.S
Drops
from #1
to #13
Does it mean all Americans
earn $53,000/year?
~Half the population make
less than $50,000/year
40
0: Perfect Equality
100: Perfect Inequality
GDP alone is not a good measure of
wellbeing
We need to know how this income is
distributed.
Can not be used for cross country
comparisons unless we add both:
income distribution and population size.
42
Foreign
Production
in the US
GDP includes goods and services produced
by other countries inside the U.S.
GDP excludes goods and services produced
by Americans outside the U.S
Includes goods and services produced by U.S.
companies anywhere in the world
Excludes goods and services produced by other
countries inside the U.S.
Foreign Production
in the US
Add Income
earned
abroad
Subtract Income
earned by foreign
companies in the
U.S. Domestic
From
to National
Investment
Net I = Gross I – Depreciation
Gross
Investment
Purchase of new
capital goods.
Net
Investment
Purchase of new
capital goods
minus
Depreciation.
Gross Domestic Product
Gross Investment
47
NET DOMESTIC PRODUCT
NDP
Gross Investment – Depreciation
48
From Gross to Net
Gross
Domestic
Product
Gross
Domestic
Product
Subtract Depreciation
Add Depreciation
Net
Domestic
Product
Net
Domestic
Product
49
GDP
We want to know quantity produced
We can not add quantities produced
because
We can not add apples and computers
and web pages…
One pear is not the same as one
computer: there is more value embodied in
the computer…
50
Prices provide the best “weight”
to approximate value.
Prices allow us to add apples
and computers.
Calculating
GDP
Nominal GDP
GDP at current
prices
Multiply quantities purchased by the
price at which they sold on that year.
Example: For 2009 GDP, we use prices paid in 2009.
Because we use prices of 2009 to compute GDP for 2009 ,
we say that we used “current” prices.
53
REAL VERSUS NOMINAL GDP
54
The Sum of expenditures on all
goods produced over the year
Year Good X
2009
Good Y
Price Quantity Price Quantity
GDP
PriceXQuantity
$1 100 $3 50 (1X100)+(3X50) = 250
Quantities
produced are
the same
Year
Good X
If prices rise…
Good Y
2009
Price Quantity Price Quantity
2010
Prices
distort
$1 100
$3our 50
view of true
Price Quantity
Price Quantity
quantity
produced
$2
100 $6
50
GDP
PriceXQuantity
(1X100)+(3X50) = 250
PriceXQuantity
(2X100)+(6X50) = 500
• We have to use prices
• We must eliminate the effect of
changing prices.
57
Nominal GDP: use current prices
Year Price X Quantity X Price Y Quantity Y $worthX $worthY
Nominal GDP
Px * Qx Py * Qy
2008 1 100 2 50 11x100+22x50 = 200
3
2009 2 150 3 100 22x150+3x100=
600
4
2010 3 200 4 150 33x200+4x150=
1200
58
Year Price X Quantity X Price Y Quantity Y $worthX $worthY Nominal GDP
Px * Qx Py * Qy
2008 1 100 2 50 1x100+ 2x50 = 200
2009 2 150 3 100 2x150+3x100 = 600
2010 3 200 4 150 3x200+4x150 = 1200
The Short vs. The Long Run
Above Full
employment
Total Production
At Full
employment
Potential GDP
GDP at Full
Employment
Below Full
employment
Time
Three Ways of
Calculating GDP
The Incomes
Approach
The
Expenditures
Approach
Interest +
Rent +
Wages +
Profits
C+I+G
+X-M
61
Value Added Approach
Value
Added:
Produced
Sold it for:
Indian community owns
forest
tree
$2
2-0=$2
Logging Company buys tree
transforms into log
log
$10
10-2=$8
Wood Company buys logs
transforms into plywood
plywood
$15
15-10=$5
Furniture Manufacturer buys
plywood makes table
table
$30
30-15=$15
Macy's buys table places on
showroom for display
table in showroom
$35
35-30=$5
Sum of Value Added
$35
Sum of Value Added = Price paid by final user = $35
Growth
Increases in GDP come from:
Growth ininGDP
come from:
Increases
the number
of
Growth
in the labor
force and/or
workers
and/or
Growth
in the country’s
stock ofofcapital
Increases
in the number
and/or
factories and/or
Improvements in technology
Improvements in technology
63
Real GDP = Hours of work X Output per hour
Real GDP = Hours of work x Labor productivity
Growth rate of potential GDP = Growth
rate of labor force x Growth rate of labor
productivity
Real GDP ~$ 14T
Hours of work per year ~250 B
Labor productivity ~$14T/250 B
= $ 56 per hour.
64
64
Personal Consumption Expenditures
Depreciation
Wages
Indirect Business Taxes
Rental Income
Gross Private Domestic Investment
Profits
Exports
Government Purchases
9,734
1,687
7,874
C
Domestic and
foreign wages
1,041
65
2,125
2,638
1,643
2,690
Domestic and
foreign Rent
I
Domestic and
foreign Profits
X
G
Domestic and
foreign Interest
M
603
Interest
Imports
2,351
Income received from other countries
818
Income paid to other countries
722
GDP = C + I + G + X -M
13,841
National Income = Wages +
Domestic and
12,221
Interest+Rents+Profits+Indirect Business Taxes
foreign Income
Should be
Statistical
Discrepancy
= Income received
GNP = GDP - income paid to other
countries
+
13,937
equal
NNP – NI =29
income received from other countries
by U.S. Nationals
NNP = GNP - Depreciation
12,250
Personal Consumption Expenditures
Depreciation
Wages
Indirect Business Taxes
Rental Income
Gross Private Domestic Investment
Profits
Exports
Government Purchases
Interest
Imports
Income received from other countries
Income paid to other countries
9,734
1,687
8,031
1,062
66.3
2,168
2,691
1,676
2,744
615.06
2,398
834.36
736.44
GDP = C + I + G + X -M
National Income = Wages + Interest+Rents+Profits+Indirect
Business Taxes
GNP = GDP - income paid to other countries + income
received from other countries
66
Personal Consumption Expenditures
Depreciation
Wages
Indirect Business Taxes
Rental Income
Gross Private Domestic Investment
Profits
Exports
Government Purchases
Interest
Imports
Income received from other countries
Income paid to other countries
GDP = C + I + G + X -M
National Income = Wages + Interest+Rents+Profits+Indirect
Business Taxes
GNP = GDP - income paid to other countries + income
received from other countries
9,734
1,687
8,031
1,062
66.3
2,168
2,691
1,676
2,744
615.06
2,398
834.36
736.44
14,118
12,465
14,216
67
A bakery’s purchases
Did you use it
entirely into the
pie?
No: Capital Good
Yes: Intermediate
Include this purchase Good. Do not include
in GDP
this purchase in GDP
Sugar
Flour
Apples
Coffee
Water
Scotch tape
Pens
Notepads
Scissors
Shredder
Phone
Computer
Oven
68
1. Bullet proof vests
purchased by military.
2. Bullet proof vest
purchased by Security
Company.
3. Leather
4. Bicycle purchased by
Gym.
5. Computer
6. Newly produced goods
no one purchased
7. House new
8. Tools
9. Cash for clunkers
10.Computer purchased
by the City of Santa
Monica.
11.Coffee and pastries
purchased LAPD.
12.Coffee and pastries
purchased by Ford for
their offices.
13.Goods manufactured
in other countries.
14.The State of Florida
purchase oil from
Venezuela
15.Venezuela purchase
corn from Iowa
farmers.
69
5. Determine if the following items are included in GDP and under what
component C, I, G, X or M?
a.
Jane buys newly issued shares of stock in Macro.com. Inc.
b.
Ross buys a new pair of jeans at a local department store.
c.
Joey has his mustache trimmed at his hair salon.
d.
Rachel buys an antique chest at a resale shop.
e.
Phoebe grows her own herbs on her apartment balcony.
f.
Michael travels to France and buys French wine.
g.
John, a stay-at-home dad, takes care of his 4 year old twins.
h.
Mary sends her 3 year old to pre-school.
i.
Rose volunteers at a homeless shelter.
j.
Government pays farmers a 10 cent/pound subsidy.
k.
Amazon. COM buys books from a publisher.
l.
Mark buys a book from a publisher.
m.
Mitsubishi Co. builds a car in Illinois and ships it to Japan for sale.
n.
Mike bets $500 on a basketball game.
o.
You buy land to build a home.
Good A
Year
Quantity
Price per unit
Good B
Quantity
Price per unit
1
2,000
0.1
75
1
2
2,400
0.15
60
1.1
3
2,600
0.25
75
1.2
6. Calculate: Nominal GDP for year 2, Real GDP for
year 2 (use year 1 as base), GDP growth rate in
Real GDP for year 2.
Item
Personal Consumption Expenditures
Depreciation
Wages
Indirect Business Taxes
Rental Income
Gross Private Domestic Investment
Profits
Exports
Government Purchases
Interest
Imports
Income received from other countries
Income paid to other countries
GNP =
National Income (NNP) =
Billions $
9,734
1,687
7,874
1,041
65
2,125
2,638
1,643
2,690
603
2,351
818
722
GDP =
Label A-M
E
D
L
F
M
G
J
K
C
I
H
A
B
Practice
1. What is GDP? What is included? What is
excluded? What are its limitations?
2. Explain the difference between GDP & GNP, NDP
& GDP, between real GDP and nominal GDP.
Provide an example to illustrate your answer.
3. Explain how a loaf of bread can be considered
both a final good and an intermediate good. Provide
an example to illustrate your answer.
4. Is the purchase of a home included in the
calculation of GDP? If yes how and why? If not, why
not?
74
5. What would happen in a country in which the value
of depreciation is larger than the value of gross
investment?
6. Why do we calculate GDP in dollars instead of
computing GDP in pounds or units produced?
7. When would NX be a negative number and what
implication does this have for the computation of
GDP?
8.
9.
Why do we have to subtract imports in the calculation of
GDP? Hint: We could simply not add M into GDP = C+I
+G +X. But why do we have to subtract them from the
above calculation
GDP = C + I + G + X – M?
What would be the effect on GDP with legalization of
marijuana, cocaine, prostitution and gambling?
10.Are there key differences between an increase in
the capital stock and an improvement in the level of
technology?
11.Describe how the labor force, the nation's capital
stock, and the rate of technical progress contribute
to potential GDP growth and labor productivity.
12.During the course of the twentieth century, the
average workweek in the United States has gotten
shorter and Americans have enjoyed greater
amounts of leisure time. How has this development
affected potential GDP and labor productivity?
76
Why NNP and income are not the
same?
• They are constructed using different sources of
information which produce different results due
to:
– Sampling errors
– Coverage differences
– Timing differences when expenditures and incomes
are recorded.
• The overall difference between GDP and
GDI is known as the statistical discrepancy
77
1. Net Investment includes all business’ purchases of new
equipment, buildings, software. ______
2. Gross Investment includes only business’ purchases of new
equipment which add to the stock of capital. ______
3. Gross Domestic product includes all business’ purchases of
new equipment, buildings and software as part of the
Investment component______
4. Net Domestic Product includes only production inside U.S.
borders regardless of national ownership. ______
5. Gross National Product includes production of goods and
services by U.S. nationals regardless of where in the world
production takes place. ______
6. If the value of depreciation is greater than the value of
gross investment, then the stock of capital will decrease.
______
7. If the value of depreciation is greater than the value of
gross investment, then Net Investment is negative.
78
______