ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 8
Chapter 8:
Measuring
the Economy’s Performance
Materials include content from Pearson Addison-Wesley which has been modified by the
instructor and displayed with permission of the publisher. All rights reserved.
1
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.
8-2
The Simple Circular Flow
(cont'd)

Profits explained
 Question

Why is profit a cost of production?
 Answer

Profits are the return entrepreneurs receive
for the risk they incur when organizing productive
activities.
8-3
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
8-4
The Simple Circular Flow
(cont'd)

Product Markets
 Transactions
in which households buy goods
8-5
The Simple Circular Flow
(cont'd)

Total Income
 Wages,
rent, interest, profits
8-6
The Simple Circular Flow
(cont'd)

Factor Markets
 Transactions
in which businesses buy resources
8-7
Figure 8-1 The Circular Flow
of Income and Product
8-8
The Simple Circular Flow
(cont'd)

Question


Why must total income
be identical to the dollar
value of total output?
Answer

Every transaction
simultaneously involves
an expenditure and
a receipt.
8-9
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)
8-10
National Income Accounting

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.
8-11
National Income Accounting
(cont'd)

Stress on final output
 What
is a final good?

Wheat?

Steel?

Oil?

Bread?

Automobile?

Gasoline?
8-12
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
8-13
Table 8-1 Sales Value and Value Added of Donut Production
8-14
National Income Accounting


Numerous transactions occur that have nothing to do
with final goods and services being produced.
Exclusion of financial transactions
 Securities

Stocks and bonds
 Government
transfer payments

Social Security

Unemployment compensation
 Private
transfer payments

Individual gifts

Corporate gifts
8-15
National Income Accounting

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
 Legal
production
and illegal underground transactions
8-16
National Income Accounting

GDP’s limitations
 Excludes
non-market production
 It
is not necessarily a good measure of the
well-being of a nation.
 GDP
is not a measure of a nation’s overall
welfare.
 GDP
is a measure of the value of production
in terms of market prices, and an indicator of
economic activity.
8-17
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
8-18
Two Main Methods
of Measuring GDP (cont'd)
Expenditure Approach
8-19
Two 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
8-20
Two Main Methods
of Measuring GDP (cont'd)
Income Approach
8-21
Two Main Methods
of Measuring GDP (cont'd)

Deriving GDP by the expenditure approach
 Consumption

Durable Consumer Goods


Life span of more than three years
Nondurable Consumer Goods


Expenditure (C)
Goods that are used up in three years
Services

Mental or physical help
8-22
Two Main Methods
of Measuring GDP (cont'd)

Deriving GDP by the
expenditure approach
 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
8-23
Two Main Methods
of Measuring GDP (cont'd)

Deriving GDP by the expenditure approach
 Gross

Producer Durables or Capital Goods


Life span of more than three years
Fixed Investment


Private Domestic Investment (I)
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
8-24
Two Main Methods
of Measuring GDP (cont'd)

Deriving GDP by the
expenditure approach
 Government
Expenditures (G)

State, local, and federal

Valued at cost
 Net
Exports (Foreign Expenditures)
Net exports (X) = Total exports – Total imports
8-25
Two Main Methods
of Measuring GDP (cont'd)

Presenting the expenditure approach
 Where

C = consumption expenditures

I

G = government expenditures

X = net exports
= investment expenditures
GDP = C + I + G + X
8-26
Figure 8-2 GDP and Its Components
Note unique scale on vertical axis.
8-27
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
8-28
Two Main Methods
of Measuring GDP (cont'd)

NDP = GDP – Depreciation

GDP = C + I + G + X

NDP = C + I + G + X – Depreciation

Net Investment = I – Depreciation
 Domestic
investment minus an estimate
of the wear and tear on the existing
capital stock

NDP = C + Net I + G + X
8-29
Two Main Methods
of Measuring GDP (cont'd)

Deriving GDP by the income approach
8-30
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

Wages: salaries and labor income

Rent: farms, houses, stores

Interest: savings accounts

Profits: sole proprietorships, partnerships,
corporations
8-31
Two Main Methods of Measuring GDP

Gross domestic product equals gross domestic
income plus indirect business taxes and
depreciation

These last items are called non-income expense
items

Indirect business taxes
 All
business taxes except the tax on corporate profits
 Include
sales and business property taxes
8-32
Figure 8-3 Gross Domestic Product and Gross Domestic
Income, 2007 (in billions of 2007 dollars per year)
Source: U.S. Department of Commerce. First quarter preliminary data annualized.
8-33
Figure 8-3 Gross Domestic Product and Gross Domestic
Income, 2007 (in billions of 2007 dollars per year)
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
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
8-37
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
 Real
(current) dollars GDP
(constant) dollars GDP
Nominal GDP
x 100
Real GDP =
Price level*
*Price level: measured by the GDP deflator
8-39
Table 8-3 Correcting GDP for Price Index Changes
8-40
Distinguishing Between Nominal
and Real Values (cont'd)

Per capita GDP
 Adjusting
for population growth
Real GDP
Per capita real GDP =
Population
8-41
Figure 8-4 Nominal and Real GDP
Source: U.S. Department of Commerce
8-42
Comparing GDP Throughout the World

Foreign Exchange Rate
 The
price of one currency in terms
of another

Foreign exchange rate & comparing GDP

$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
Comparing GDP
Throughout the World (cont'd)

Purchasing Power Parity
 Adjustments
in exchange rate conversions
that takes into account differences in the true
cost of living across countries
8-44
Table 8-4 Comparing GDP Internationally
8-45
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 8
Chapter 8:
Measuring
the Economy’s Performance
Materials include content from Pearson Addison-Wesley which has been modified by the
instructor and displayed with permission of the publisher. All rights reserved.
46