Chapter 5 - Measuring a Nation's Income

GDP deflator

- A measure of the overall level of prices. - Measures the current level of prices relative to the level of prices in the base year

Government purchases (G)

- All spending on the goods and services purchased by the government • At the federal, state, and local levels. - Excludes transfer payments • Such as Social Security or unemployment insurance benefits. • They are not purchases of goods and services

Economy's inflation rate

- Compute the percentage increase in the GDP deflator from one year to the next

Net exports (NX = exports - imports)

- Exports: foreign spending on the economy's goods and services - Imports: are the portions of C, I, and G that are spent on goods and services produced abroad • Adding up all the components of GDP gives: Y = C + I + G + NX

Preliminaries:

- Factors of production are inputs like labor, land, capital, and natural resources. - Factor payments are payments to the factors of production (e.g., wages, rent).

GDP is : Final

- Final goods: intended for the end user - Intermediate goods: used as components or ingredients in the production of other goods - GDP only includes final goods—they already embody the value of the intermediate goods used in their production.

Income equals expenditure

- For the economy as a whole - Because every dollar a buyer spends is a dollar of income for the seller.

GDP is : All

- GDP includes all items produced in the economy and sold legally in markets - GDP excludes most items produced and sold illicitly. It also excludes most items that are produced and consumed at home.

GDP is : Produced

- GDP includes currently produced goods, not goods produced in the past.

GDP is : Goods and Services

- GDP includes tangible goods (like DVDs, mountain bikes, beer) - and intangible services (dry cleaning, concerts, cell phone service).

GDP is : Within a Country

- GDP measures the value of production that occurs within a country's borders, whether done by its own citizens or by foreigners located there.

Gross Domestic Product (GDP)

- Measures total income of everyone in the economy. - Also measures total expenditure on the economy's output of goods and services.

The Circular-Flow Diagram

- Simple depiction of the macroeconomy - Illustrates GDP as spending, revenue, factor payments, and income

Macroeconomics

- Study of economy-wide phenomena • Including inflation, unemployment, and economic growth

Microeconomics

- Study of how households and firms • Make decisions • Interact in markets

GDP Does Not Value:

- The quality of the environment - Leisure time - Non-market activity, such as the child care a parent provides at home - An equitable distribution of income

Consumption, C

- Total spending by households on goods and services Note on housing costs: • For renters, C includes rent payments. • For homeowners, C includes the imputed rental value of the house, but not the purchase price or mortgage payments - Not included in C: purchases of new housing

Investment, I

- Total spending on goods that will be used in the future to produce more goods • Business capital: business structures, equipment, and intellectual property products • Residential capital: landlord's apartment building; a homeowner's personal residence • Inventory accumulations: goods produced but not yet sold "Investment" does not mean the purchase of financial assets like stocks and bonds.

GDP is : In a Given Period of Time

- Usually a year or a quarter (3 months)

Nominal GDP

- Values output using current prices - Not corrected for inflation

Real GDP

- Values output using the prices of a base year - Is corrected for inflation

Real GDP per capita

Main indicator of the average person's standard of living

For the base year

Nominal GDP = Real GDP

But GDP is not a perfect measure of well-being.

Robert Kennedy issued a very eloquent yet harsh criticism of GDP:

GDP is : The Market value

• Goods are valued at their market prices, so: - All goods measured in the same units (e.g., dollars in the U.S.) - Things that don't have a market value are excluded, e.g., housework you do for yourself.

Summary

• Gross Domestic Product (GDP) measures a country's total income and expenditure. • The four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports. • Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year and is corrected for inflation. • GDP is the main indicator of a country's economic well-being, even though it is not perfect.

Then Why Do We Care About GDP?

• Having a large GDP enables a country to afford - Better schools, a cleaner environment, health care, etc. • Many indicators of the quality of life are positively correlated with GDP. For example...

The Components of GDP

• Recall: GDP is total spending. • Four components: - Consumption (C) - Investment (I) - Government Purchases (G) - Net Exports (NX) • These components add up to GDP (denoted Y): Y = C + I + G + NX

What This Diagram Omits

• The government What This Diagram Omits - Collects taxes, buys goods and services • The financial system - Matches savers' supply of funds with borrowers' demand for loans • The foreign sector - Trades goods and services, financial assets, and currencies with the country's residents