Chapter 5 GDP

Expenditure Equals Income

Because firms pay out everything they receive as incomes to the factors of production, total expenditure equals total income

Consumption expenditure is the expenditure by households on consumption goods and services.

It includes expenditures on nondurable goods . Consumption expenditure also includes house and apartment rents, including the rental value of owner-occupied housing.

Firms' profits, which are included in the income approach, are net of depreciation,

so the income approach gives a net measure

Circular Flows in the U.S. Economy Four groups buy the final goods and services produced: households, firms, governments, and the rest of the world. Four types of expenditure correspond to these groups:

• Consumption expenditure • Investment • Government expenditure on goods and services • Net exports of goods and services

Other Influences on the Standard of Living The quantity of goods and services consumed is a major influence on the standard of living. But other influences are

• Health and life expectancy • Political freedom and social justice

Final good or service

A good or service that is produced for its final user and not as a component of another good or service.

Intermediate good or service

A good or service that is used as a component of a final good or service.

GDP measures the value of goods and services that are bought in markets. GDP excludes • Household production • Underground production • Leisure time • Environment quality

Because we don't buy these services in markets, they are not counted as part of GDP. The result is that GDP underestimates the value of the production.

Investment is the purchase of new capital goods (tools, instruments, machines, and buildings) and additions to inventories

Capital goods are durable goods produced by one firm and bought by another. Investment also includes the purchase of new homes by households. It is important to note that investment does not include the purchase of stocks and bonds

four expenditure flows: consumption expenditure from households to firms, government expenditure from governments to firms, and net exports from the rest of the world to firms. Investment flows from the financial markets, where firms borrow, to the firms that produce capital goods.

Consumption expenditure is by far the largest component of total expenditure; government expenditure is the next largest. Investment and exports are a similar size; and net exports is the smallest component.

The goal of calculating real GDP is to measure the extent to which total production has increased and remove from the nominal GDP numbers the influence of price changes

GDP categories: consumption expenditure (C), investment (I), and government expenditure (G). We'll ignore exports and imports by assuming that net exports (exports minus imports) is zero.

The expenditure approach measures GDP by using data on consumption expenditure, investment, government expenditure on goods and services, and net exports

GDP is the sum of consumption expenditure on goods and services (C), investment (I), government expenditure on goods and services (G), and net exports of goods and services (NX).

When Produced

GDP measures the value of production during a given time period. This time period is either a quarter of a year—called the quarterly GDP data—or a year—called the annual GDP data. The Federal Reserve and others use the quarterly GDP data to keep track of the short-term evolution of the economy, and economists use the annual GDP data to examine long-term trends. GDP measures not only the value of total production but also total income and total expenditure.

Net exports of goods and services The value of exports of goods and services minus the value of imports of goods and services.

If exports exceed imports, net exports are positive and expenditure on U.S.-produced goods and services increases. If imports exceed exports, net exports are negative and expenditure on U.S.-produced goods and services decreases.

Imports of goods and services Items that households, firms, and governments in the United States buy from the rest of the world.

Imports are produced in other countries, so expenditure on imports is not included in expenditure on U.S.-produced goods and services

Interest is the total income earned by capital,

Interest income is the interest that households receive on capital. A household's capital is equal to its net worth—its assets minus its borrowing.

Income

Labor earns wages, capital earns interest, land earns rent, and entrepreneurship earns profits. Households receive these incomes. Some part of total income, called undistributed profit, is a combination of interest and profit that firms retain and do not pay to households. But from an economic viewpoint, undistributed profit is income paid to households and then loaned to firms.

Net domestic product at factor cost The sum of the wages, interest, rent, and profit.

Net domestic product at factor cost is not GDP, and we must make two further adjustments to get to GDP: one from factor cost to market prices and another from net product to gross product.

Nominal GDP The value of final goods and services produced in a given year expressed in terms of the prices of that same year.

Nominal GDP is just a more precise name for GDP.

Where Produced

Only goods and services that are produced within a country count as part of that country's GDP.

Potential GDP The value of real GDP when all the economy's factors of production—labor, capital, land, and entrepreneurial ability—are fully employed.

Potential GDP is the level of real GDP when all the economy's factors of production—labor, capital, land, and entrepreneurial ability—are fully employed. When some factors of production are unemployed, real GDP is below potential GDP. And when some factors of production are over-employed and working harder and for longer hours than can be maintained in the long run, real GDP exceeds potential GDP.

Profit is the total income earned by entrepreneurship.

Profit includes the profits of corporations and the incomes of proprietors who run their own businesses. These incomes are a mixture of interest and profit.

Real GDP per person

Real GDP divided by the population.

Real GDP The value of the final goods and services produced in a given year expressed in terms of the prices in a base year.

Real GDP is the value of final goods and services produced in a given year expressed in terms of the prices in a reference base year. The reference base year is the year we choose against which to compare all other years

Rent is the total income earned by land

Rent includes payments for the use of land and other rented factors of production. It includes payments for rented housing and imputed rent for owner-occupied housing.

Saving is the amount of income that is not paid in net taxes or spent on consumption goods and services

Saving flows from households to financial markets

The Income Approach To measure GDP using the income approach, the Bureau of Economic Analysis uses income data collected by the Internal Revenue Service and other agencies.

The BEA takes the incomes that firms pay households for the services of the factors of production they hire—wages for labor services, interest for the use of capital, rent for the use of land, and profits for entrepreneurship—and sums those incomes.

Recession A period during which real GDP decreases for at least two successive quarters; or defined by the NBER as "a period of significant decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by contractions in many sectors of the economy."

The National Bureau of Economic Research (NBER), which dates the U.S. business cycle phases and turning points, defines a recession more broadly as "a period of significant decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by contractions in many sectors of the economy." This definition means that sometimes the NBER declares a recession even though real GDP has not decreased for two successive quarters

Statistical discrepancy

The discrepancy between the expenditure approach and the income approach estimates of GDP, calculated as the GDP expenditure total minus the GDP income total.

Market price

The expenditure approach values goods and services at market prices Sales taxes make market prices exceed factor cost

Standard of living

The level of consumption of goods and services that people enjoy, on average

Gross national product (GNP) GNP equals GDP plus net factor income received from or paid to other countries

The market value of all the final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country.

Gross domestic product (GDP)

The market value of all the final goods and services produced within a country in a given time period.

Business cycle A periodic but irregular up-and-down movement of total production and other measures of economic activity.

The timing and the intensity of the business cycle vary a lot, but every cycle has two phases: 1. Expansion 2. Recession and two turning points: 1. Peak 2. Trough

Also, we do not count as part of GDP spending on • Used goods • Financial assets

Used Goods: Expenditure on used goods is not part of GDP because these goods were part of GDP in the period in which they were produced and during which time they were new goods Financial Assets: When households buy financial assets such as bonds and stocks, they are making loans, not buying goods and services. The expenditure on newly produced capital goods is part of GDP, but the purchase of financial assets is not.

The U.S. National Income and Product Accounts divide incomes into two big categories: • Wage income • Interest, rent, and profit income

Wage income, called compensation of employees in the national accounts, is the total payment for labor services. It includes net wages and salaries plus fringe benefits paid by employers such as health-care insurance, Social Security contributions, and pension fund contributions.

Investment, which is included in the expenditure approach

includes the purchase of capital to replace worn out or obsolete capital, so the expenditure approach gives a gross measure

Difference between income approach and expenditure approach

is depreciation, which is the decrease in the value of capital that results from its use and from obsolescence

Total expenditure on goods and services produced in the United States is the sum of the four items

l consumption expenditure C, investment I, government expenditure on goods and services G, and net exports of goods and services NX. So total expenditure, which is also the total amount received by the producers of final goods and services, is Total expenditure = C + I + G + NX.

Net taxes equal taxes paid minus cash benefits received and are from households to governments

the circular flows of income and expenditure households allocate all their incomes after paying net taxes to consumption and saving,

The income approach measures net product

the expenditure approach measures gross product

Factor Cost

the income approach values them at factor cost—the cost of the factors of production used to produce them subsidies make factor cost exceed market prices

To convert the value at factor cost to the value at market prices

we must add indirect taxes and subtract subsidies.

The main influence on consumption expenditure is disposable personal income Income received by households minus personal income taxes paid.

which is the income received by households minus personal income taxes paid.