measuring a nation’s income · 2 harcourt, inc. items and derived items copyright © 2001 by...

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Measuring a Nation’sIncome

Copyright © 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of thework should be mailed to:

Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Microeconomics

!Microeconomics is the study of howindividual households and firms makedecisions and how they interact withone another in markets.

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Macroeconomics

! Macroeconomics is the study of theeconomy as a whole.! Its goal is to explain the economic changes

that affect many households, firms, andmarkets at once.


Macroeconomics

!Macroeconomics answers questions likethe following:! Why is average income high in some countries

and low in others?! Why do prices rise rapidly in some time periods

while they are more stable in others?! Why do production and employment expand in

some years and contract in others?

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The Economy’sIncome and Expenditure

When judging whether the economy isdoing well or poorly, it is natural tolook at the total income that everyonein the economy is earning.


The Economy’sIncome and Expenditure

! For an economy as a whole, incomemust equal expenditure because:! Every transaction has a buyer and a

seller.! Every dollar of spending by some buyer

is a dollar of income for some seller.

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! Gross domestic product (GDP) is ameasure of the income andexpenditures of an economy.

! It is the total market value of allfinal goods and services producedwithin a country in a given period oftime.

Gross Domestic Product


The Circular-Flow Diagram

The equality of income andexpenditure can be illustratedwith the circular-flow diagram.

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Firms Households

Market for Factors

of Production

Market for Goods

and Services

SpendingRevenue

Wages, rent,and profit

Income

Goods &Services sold

Goods &Servicesbought

Labor, land,and capital

Inputs forproduction


The Measurement of GDP

GDP is the market value of allfinal goods and services

produced within a country in agiven period of time.

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! Output is valued at market prices.! It records only the value of final goods,

not intermediate goods (the value iscounted only once).

! It includes both tangible goods (food,clothing, cars) and intangible services(haircuts, housecleaning, doctor visits).



! It includes goods and services currentlyproduced, not transactions involvinggoods produced in the past.

! It measures the value of productionwithin the geographic confines of acountry.

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! It measures the value of productionthat takes place within a specificinterval of time, usually a year or aquarter (three months).



What Is Counted in GDP?

GDP includes all itemsproduced in the economyand sold legally in markets.

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What Is Not Counted in GDP?

! GDP excludes most items that areproduced and consumed at home andthat never enter the marketplace.

! It excludes items produced and soldillicitly, such as illegal drugs.


Other Measures of Income

! Gross National Product (GNP)! Net National Product (NNP)! National Income! Personal Income! Disposable Personal Income

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Gross National Product

! Gross national product (GNP) is the totalincome earned by a nation’s permanentresidents (called nationals).

! It differs from GDP by including incomethat our citizens earn abroad andexcluding income that foreigners earnhere.


Net National Product (NNP)

! Net National Product (NNP) is thetotal income of the nation’s residents(GNP) minus losses from depreciation.

! Depreciation is the wear and tear onthe economy’s stock of equipment andstructures.

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National Income

! National Income is the total incomeearned by a nation’s residents in theproduction of goods and services.

! It differs from NNP by excluding indirectbusiness taxes (such as sales taxes) andincluding business subsidies.


Personal Income! Personal income is the income that

households and noncorporate businessesreceive.

! Unlike national income, it excludes retainedearnings, which is income that corporationshave earned but have not paid out to theirowners.

! In addition, it includes household’s interestincome and government transfers.

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Disposable Personal Income

! Disposable personal income is the incomethat household and noncorporatebusinesses have left after satisfying alltheir obligations to the government.

! It equals personal income minus personaltaxes and certain nontax payments.


The Components of GDP

GDP (Y ) is the sum of the following:! Consumption (C)! Investment (I)! Government Purchases (G)! Net Exports (NX)

Y = C + I + G + NX

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! Consumption (C):! The spending by households on goods and

services, with the exception of purchases ofnew housing.

! Investment (I):! The spending on capital equipment,

inventories, and structures, including new housing.



! Government Purchases (G):! The spending on goods and services by local,

state, and federal governments.! Does not include transfer payments because

they are not made in exchange for currentlyproduced goods or services.

! Net Exports (NX):! Exports minus imports.

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GDP and Its Components (1998)

Total(in billions of dollars)

Per Person(in dollars) % of Total

Gross domestic product, Y $8,511 $31,522 100 percent

Consumption, C 5,808 21,511 68

Investment, I 1,367 5,063 16

Government purchases, G 1,487 5,507 18

Net exports, NX -151 -559 -2



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Consumption 68 %


Investment16%


Consumption 68 %

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Consumption 68 %

Government Purchases

18%


Investment16%


Net Exports -2 %


Consumption 68 %

Investment16%

Government Purchases18%

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Real versus Nominal GDP

! Nominal GDP values the production ofgoods and services at current prices.

! Real GDP values the production ofgoods and services at constant prices.


Real versus Nominal GDP

An accurate view of the economyrequires adjusting nominal to realGDP by using the GDP deflator.

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GDP Deflator

! The GDP deflator measures the currentlevel of prices relative to the level ofprices in the base year.

! It tells us the rise in nominal GDP that isattributable to a rise in prices rather thana rise in the quantities produced.


GDP Deflator

100GDP Real

GDP Nominal=deflator GDP ×

The GDP deflator is calculated as follows:

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100X )deflator (GDP) GDP (Nominal =GDP Real

20xx

20xx20xx

Converting Nominal GDP to RealGDP

Nominal GDP is converted to realGDP as follows:


Real and Nominal GDP

YearPrice ofHot dogs

Quantity ofHot dogs

Price of Hamburgers

Quantity ofHamburgers

2001 $1 100 $2 50

2002 $2 150 $3 100

2003 $3 200 $4 150

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Calculating Nominal GDP:

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200





Calculating Real GDP (base year 2001):




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Calculating the GDP Deflator:

2001 ($200/$200) x 100 = 100

2002 ($600/$350) x 100 = 171

2003 ($1200/$500) x 100 = 240


(Periods of falling real GDP)

Real GDP in the United States

1970 1975 1980 1985 1990 19953,000

4,000

5,000

6,000

7,000

Billions of1992 Dollars

2000

8,000

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GDP and EconomicWell-Being

! GDP is the best single measure of theeconomic well-being of a society.

! GDP per person tells us the incomeand expenditure of the average personin the economy.



! Higher GDP per person indicates ahigher standard of living.

! GDP is not a perfect measure of thehappiness or quality of life, however.

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! Some things that contribute to well-being arenot included in GDP.! The value of leisure.! The value of a clean environment.! The value of almost all activity that takes place

outside of markets, such as the value of the timeparents spend with their children and the value ofvolunteer work.


GDP, Life Expectancy, and LiteracyCountry Real GDP per

Person (1997)LifeExpectancy

AdultLiteracy

United States $29,010 77 years 99%

Japan 24,070 80 99

Germany 21,260 77 99

Mexico 8,370 72 90

Brazil 6,480 67 84

Russia 4,370 67 99

Indonesia 3,490 65 85

China 3,130 70 83

India 1,670 63 53

Pakistan 1,560 64 41

Bangladesh 1,050 58 39

Nigeria 920 50 59

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Summary

! Because every transaction has a buyer anda seller, the total expenditure in theeconomy must equal the total income inthe economy.

! Gross Domestic Product (GDP) measuresan economy’s total expenditure on newlyproduced goods and services and the totalincome earned from the production ofthese goods and services.


Summary

! GDP is the market value of all final goodsand services produced within a countryin a given period of time.

! GDP is divided among four componentsof expenditure: consumption, investment,government purchases, and net exports.

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Summary

! Nominal GDP uses current prices tovalue the economy’s production. RealGDP uses constant base-year prices tovalue the economy’s production of goodsand services.

! The GDP deflator--calculated from theratio of nominal to real GDP--measuresthe level of prices in the economy.


Summary

! GDP is a good measure of economic well-being because people prefer higher tolower incomes.

! It is not a perfect measure of well-beingbecause some things, such as leisure timeand a clean environment, aren’tmeasured by GDP.

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GraphicalReview



Firms Households

Market for Factors

of Production

Market for Goods

and Services

SpendingRevenue

Wages, rent,and profit

Income

Goods &Services sold

Goods &Servicesbought

Labor, land,and capital

Inputs forproduction

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Net Exports -2 %

Consumption 68 %

Investment16%

Government Purchases18%


Real GDP in the United States

(Periods of falling real GDP)

1970 1975 1980 1985 1990 19953,000

4,000

5,000

6,000

7,000

Billions of1992 Dollars

2000

8,000

measuring a nation’s income · 2 harcourt, inc. items and derived items copyright © 2001 by...

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