Macro Ch.7

government purchases have three components

(1) expenditures for goods and services that the government consumes in providing public services; (2) expenditures for publicly owned capital such as schools and highways, which have long lifetimes; and (3) government expenditures on R&D and other activities that increase the economy's stock of know-how.

This accounting helps economists and policymakers:

-Assess the economy's health by monitoring production and employment levels. -Track the economy's long-run growth trajectory. -Adjust economic policies to safeguard and improve the economy's health.

What are the 4 categories of expenditures in the national income

-Consumption -investment -Government purchases -net exports

National income accountants subdivide corporate profits into three categories:

-Corporate income taxes -Dividends -Undistributed corporate profits

The following items fall in the category of gross private domestic investment (Ig):

-Final purchases of plant, machinery, and equipment by business enterprises. -Residential construction. -Expenditures on the research and development (R&D) of new productive technologies. -Money spent on the creation of new works of art, music, writing, film, and software. -Changes in inventories.

Purely financial transactions include the following:

-Public transfer payments -Private transfer payments -stock market transactions

taxes on production and imports

A national income accounting category that includes such taxes as sales, excise, business property taxes, and tariffs that firms treat as costs of producing a product and pass on (in whole or in part) to buyers by charging a higher price.

nondurable good

A consumer good with an expected life (use) of less than three years.

durable good

A consumer good with an expected life (use) of three or more years.

service

An (intangible) act or use for which a consumer, firm, or government is willing to pay.

consumption of fixed capital

An estimate of the amount of capital worn out or used up (consumed) in producing the gross domestic product; also called depreciation.

price index

An index number that shows how the weighted-average price of a "market basket" of goods changes over time relative to its price in a specific base year.

Undistributed corporate profits

Any after-tax profits that are not distributed to shareholders are saved, or retained, by corporations to be invested later in new plants and equipment. Undistributed corporate profits are also called retained earnings.

Improved Product Quality

Because GDP is quantitative rather than qualitative, it fails to capture the full value of improvements in product quality. For example, a $500 cell phone purchased today is of much higher quality than a cell phone that cost $500 a decade ago. Quality improvement obviously has a great effect on economic well-being, an effect that goes above and beyond any increase in the quantity of output. Although the BEA adjusts GDP for the quality improvements of selected items, the vast majority of quality improvements are not yet reflected in GDP.

gross domestic profit formula

GDP = C + Ig + G + X − M.

Determine GDP by summing all incomes received for providing resources.

By the income or allocations approach, GDP is calculated as the sum of compensation to employees, rents, interest, proprietors' income, corporate profits, and taxes on production and imports, minus net foreign factor income, plus consumption of fixed capital and a statistical discrepancy.

Nonmarket activities

Certain productive activities do not take place in any market—the services of stay-at-home parents, for example, and the labor of carpenters who repair their own homes. Such activities do not show up in GDP because government accountants receive data only on economic transactions involving market activities—that is, transactions in which output or resources are traded for money. Consequently, GDP understates a nation's total output because it does not count unpaid work. There is one exception: The portion of farmers' output that farmers consume themselves is estimated and included in GDP.

Dividends

Dividends are the part of after-tax profits that corporations choose to pay out, or distribute, to their stockholders. They thus flow to households, which are the ultimate owners of all corporations.

The Underground Economy

Embedded in our economy is a flourishing, productive underground sector. Some of the people who conduct business there are bookies, smugglers, "fences" of stolen goods, and drug dealers. They have good reason to conceal their incomes. Most participants in the underground economy, however, engage in perfectly legal activities but choose illegally not to report their full incomes to the Internal Revenue Service (IRS). A barista at a coffee shop may report just a portion of the tips received from customers. Storekeepers may report only a portion of their sales receipts. Workers who want to hold onto their unemployment compensation benefits may take an "off-the-books" or "cash-only" job. A brick mason may agree to rebuild a neighbor's fireplace in exchange for the neighbor's repairing his boat engine. None of these transactions show up in GDP.Embedded in our economy is a flourishing, productive underground sector. Some of the people who conduct business there are bookies, smugglers, "fences" of stolen goods, and drug dealers. They have good reason to conceal their incomes. Most participants in the underground economy, however, engage in perfectly legal activities but choose illegally not to report their full incomes to the Internal Revenue Service (IRS). A barista at a coffee shop may report just a portion of the tips received from customers. Storekeepers may report only a portion of their sales receipts. Workers who want to hold onto their unemployment compensation benefits may take an "off-the-books" or "cash-only" job. A brick mason may agree to rebuild a neighbor's fireplace in exchange for the neighbor's repairing his boat engine. None of these transactions show up in GDP.

government purchases

Expenditures by government for goods and services that government consumes in providing public services as well as expenditures for publicly owned capital that has a long lifetime; the expenditures of all governments in the economy for those final goods and final services.

gross private domestic investment (Ig

Expenditures that increase the nation's stock of capital, which is the collection of physical objects and intangible ideas that help to produce goods and services. Includes spending on final purchases of plant, machinery, and equipment by business enterprises; residential construction; changes in inventories; expenditures on the research and development (R&D) of new productive technologies; and money spent on the creation of new works of art, music, writing, film, and software.

Explain some limitations of the GDP measure.

GDP is a reasonably accurate and very useful indicator of a nation's economic performance, but it has its limitations. It fails to account for nonmarket and illegal transactions, changes in leisure and in product quality, the composition and distribution of output, the environmental effects of pollution, noneconomic sources of well-being, and economic activity at earlier stages of production and distribution.

Determine GDP by summing all expenditures on final goods and services.

GDP may be calculated by summing total expenditures on all final output or by summing the income derived from the production of that output. By the expenditures approach, GDP is determined by adding consumer purchases of goods and services, gross investment spending by businesses, government purchases, and net exports: GDP = C + Ig + G + Xn. Personal consumption expenditures consist of expenditures on goods (durable goods and nondurable goods) and services. About 60 percent of consumer expenditures in the United States are on services, leading economists to refer to the U.S. economy as a service economy. Gross investment is divided into (a) replacement investment (required to maintain the nation's stock of capital at its existing level) and (b) net investment (the net increase in the stock of capital). In most years, net investment is positive, and therefore the economy's stock of capital and production capacity increase.

nominal gross domestic product (GDP)

GDP measured in terms of the price level at the time of measurement; GDP not adjusted for inflation. Compare with real gross domestic product (real GDP). real GDP Gross domestic product adjusted for inflation; gross domestic product in a year divided by the GDP price index for that year, the index expressed as a decimal. Compare with nominal GDP.

Net domestic product (NDP) is the market value of

GDP minus consumption of fixed capital (depreciation).

Define and measure gross domestic product (GDP).

Gross domestic product (GDP), a basic measure of an economy's economic performance, is the market value of all final goods and services produced within a nation's borders in a year. Final goods are those purchased by end users, whereas intermediate goods are those purchased for resale or for further processing or manufacturing. Intermediate goods, nonproduction transactions, and secondhand sales are excluded in calculating GDP.

net domestic product (NDP)

Gross domestic product less the part of the year's output that is needed to replace the capital goods worn out in producing the output; the nation's total output available for consumption or additions to the capital stock.

net private domestic investment

Gross private domestic investment less consumption of fixed capital; the addition to the nation's stock of capital during a year.

The Bureau of Economic Analysis (BEA), an agency of the U.S. Commerce Department, compiles the

National Income and Product Accounts (NIPA) for the U.S. economy.

Describe the relationships among GDP, net domestic product, national income, personal income, and disposable income.

Net domestic product (NDP) is GDP minus the consumption of fixed capital. National income (NI) is total income earned by a nation's Page 151resource suppliers plus taxes on production and imports; it is found by subtracting a statistical discrepancy from NDP and adding net foreign factor income to NDP. Personal income (PI) is the total income paid to households before they pay personal taxes. Disposable income (DI) is personal income after households have paid personal taxes. DI measures the amount of income available to households to consume or save.

Distinguish between nominal GDP and real GDP.

Nominal (current-dollar) GDP measures each year's output valued in terms of the prices prevailing in that year. Real (constant-dollar) GDP measures each year's output in terms of the prevailing prices in a selected base year. Because real GDP is adjusted for price-level changes, differences in real GDP are due only to differences in production activity. Economists use a GDP price index to convert nominal GDP to real GDP.

Shortcomings of GDP

Nonmarket activities Leisure Improved product quality The underground economy GDP and the environment Composition and distribution of the output Noneconomic sources of well-being

intermediate goods and services

Products that are purchased for resale or further processing or manufacturing.

final goods and services

Products that have been purchased for final use (rather than for resale or further processing or manufacturing.)

Secondhand Sales

Secondhand sales contribute nothing to current production and are therefore excluded from GDP. Suppose you sell your 2012 Ford Mustang to a friend. That transaction will not be counted in this year's GDP because it generates no current production.

Leisure and Psychic Income

The average workweek (excluding overtime) in the United States has declined since the beginning of the 1900s—from about 53 hours to about 35 hours. Moreover, workers today have more paid vacations, holidays, and leave time. This increase in leisure time has clearly had a positive effect on overall well-being. But our system of national income accounting understates well-being by ignoring leisure's value. Nor does the system accommodate the satisfaction—the "psychic income"—that many people derive from their work.

Composition and Distribution of Output

The composition of output is undoubtedly important for well-being, but GDP does not tell us whether the currently produced mix of goods and services is enriching or potentially detrimental to society. GDP assigns equal weight to an assault rifle and a laptop computer, as long as both sell for the same price. Moreover, GDP reveals nothing about the distribution of output. Does 90 percent of the output go to 10 percent of the households, for example, or is output more evenly distributed? The distribution of output may make a big difference for society's overall well-being.

gross output (GO)

The dollar value of the economic activity taking place at every stage of production and distribution. By contrast, gross domestic product (GDP) only accounts for the value of final output.

personal income (PI)

The earned and unearned income available to resource suppliers and others before the payment of personal taxes.

personal consumption expenditures (C)

The expenditures of households for both durable and nondurable consumer goods.

GDP and the environment

The growth of GDP is sometimes accompanied by an increase in "gross domestic by-products," including dirty air and polluted water, toxic waste, congestion, and noise. The social costs of the negative by-products reduce our economic well-being. Because those costs are not deducted from total output, GDP overstates our national well-being. Ironically, when money is spent to clean up pollution and reduce congestion, those expenses are added to GDP!

expenditures approach

The method that adds all expenditures made for final goods and final services to measure the gross domestic product.

income approach

The method that adds all the income generated by the production of final goods and final services to measure the gross domestic product.

national income accounting

The techniques used to measure the overall production of a country's economy as well as other related variables.

gross domestic product (GDP)

The total market value of all final goods and final services produced annually within the boundaries of a nation.

value added

The value of a product sold by a firm less the value of the products (materials) purchased and used by the firm to produce that product.

base year

The year with which other years are compared when an index is constructed; for example, the base year for a price index.

Corporate income taxes

These taxes are levied on corporations' profits. They flow to the government.

national income

Total income earned by resource suppliers for their contributions to gross domestic product plus taxes on production and imports; the sum of wages and salaries, rent, interest, profit, proprietors' income, and such taxes.

multiple counting

Wrongly including the value of intermediate goods in the gross domestic product; counting the same good or service more than once.

To determine GDP using the expenditures approach, we

add up all the spending on final goods and services that has taken place throughout the year.

The primary measure of an economy's performance is its

aggregate output, or total output, of goods and services

government purchases include

all government expenditures (federal, state, and local) on final goods as well as all direct purchases of resources, including labor. They do not include government transfer payments because, as we have seen, such payments merely transfer money to certain households and generate no production. National income accountants use the symbol G to signify government purchases.

The GDP price index compares the price (market value) of

all the goods and services included in GDP in a given year to the price of the same market basket in a reference year.

The major limitations of GDP

as an indicator of well-being are that it fails to account for nonmarket and illegal transactions, changes in leisure and in product quality, the composition and distribution of output, the environmental effects of pollution, and economic activity at earlier stages of production and distribution.

Nominal GDP is output valued at

current prices. Real GDP is output valued at constant base-year prices.

disposable income (DI)

disposable income (DI)

The income approach to GDP sums compensation to

employees, rent, interest, proprietors' income, corporate profits, and taxes on production and imports to obtain national income, and then subtracts net foreign factor income and adds consumption of fixed capital and a statistical discrepancy to obtain GDP.

Net export formula

exports - imports

The account called taxes on production and imports includes

general sales taxes, excise taxes, business property taxes, license fees, and customs duties.

Net investment formula

gross investment-depreciation

Disposable income (DI) is all income received by

households minus personal taxes.

Personal income (PI) is all income received by

households, whether earned or not.

National income (NI) is all income earned through the use

of American-owned resources, whether located at home or abroad. NI also includes taxes on production and imports.

The economywide amount of depreciation is called consumption of fixed capital because

it accounts for capital that has been "consumed" in producing the year's GDP

The most direct way of avoiding multiple counting is by

making sure that you are adding together the sales values of final products only.

GDP can be obtained by adding together the

market selling prices of all final goods and services or by adding up the values added at each stage of production.

The economy's stock of private capital expands when

net investment is positive; stays constant when net investment is zero; and declines when net investment is negative.

Nominal GDP can be transformed into

real GDP by dividing the nominal GDP by the GDP price index expressed in hundredths.

GDP is a

reasonably accurate and very useful indicator of a nation's economic performance but should not be interpreted as a comprehensive measure of well-being.

Gross output (GO) sums together the

sales values received by firms at each stage of production

National income accounting measures

the economy's overall performance

Net private domestic investment measures only

the net additions to the economy's total stock of capital.

GDP can be calculated as either

the sum of all the money spent purchasing final goods and services (expenditures approach) or as the sum of all the incomes earned from providing the resources that went into producing those final goods and services (income approach).

Gross domestic product (GDP) is a measure of the

total market value of all final goods and services produced domestically in a specific quarter or year.

The expenditures approach to GDP sums the

total spending on final goods and services: GDP = C + Ig + G + Xn.