Econ: week 6

GDP and the circular flow of expenditure and income

GDP measures the value of production, which also equals total expenditure on final goods and total income. The equality of income and value of production shows the link between productivity and living standards.

GDP

Gross domestic product, used to assess the state of the economy and to make big decisions about business expansion, firms use forecasts of gdp.G GDP is the market value of all final goods and services produced in a country in a given time period.

Factors that influence the standard of living and that are not part of GDP are

Household, production, underground economic activity, health and life expectancy, leisure time, environmental quality

Households and firms

Households sell and firms buy the services of labor, capital and land in factors market. For these factor services, firms pay income to households; wages for labor services, interest for the use of capital, and rent for the use of land. A fourth factor of production, entrepreneurship receives profit.

Measuring GDP: Expenditure approach

The total amount paid for the use of factors of production: wages, interest, rent and profit. Expenditure approach = Personal consumption expenditure+gross private domestic investment + government expenditure on goods and services + Net export of goods and services Expenditure approach measures gdp as a sum of consumption expenditure, investment, government expenditure on goods and services and net exports. GDP = C+Q+G+(X-M)

Gross investment

The total amount spent on purchases of new capital and on replacing depreciated capital

Consumption expenditure

The total payment for consumer goods and services, shown by the red flow labeled C

Real GDP

The value of final goods and services produced in a given year when valued at the price of a reference base year. Currently the reference base year is '05. Quantities at the new year and the prices for the base year to find real GDP. By using real GDP we remove any influence that rising prices and rising cost of living might have had on our comparison

Nominal GDP

The value of goods and services produced during a given year valued at the prices that prevailed in that same year. Nominal GDP is just a more precise name for GDP

Measuring GDP

Two ways: GDP equals expenditure equals income. Total expenditure on final goods and services equals GDP. GDP = C+I+G+X+M Aggregate income equals the total amount paid for the usage of factors of production; wages, interest, rent and profit. Firms pay out all their receipts from the sale of final goods to income equals expenditure. Y=C+I+G+(X-M)

GDP's four parts

Market value(goods and services are valued at their market prices. We add the market values so we have a total value of output in dollars), final goods and services(A final good is an item bought by its final user during a specified time period. Excluding the value of the intermediate goods avouds double counting), produced with in a country(GDP measures production within a country--domestic production), in a given time period(gdp measures production during a specific time period, normally a year or a quarter of a year).

Measuring GDP: Income approach

Measures GDP by summing the incomes that firms pay households for the factors of production they hire. Includes: compensation of employees, net interest, rental income, corporate profits, proprietors income, net domestic income of factor cost, indirect taxes less subsidiaries, depreciation, net domestic income or market prices.

Recession

Moving downwards towards a dip, must occur for at least two quarters. A period during which real GDP decreases its growth rate is negative for at least two successive quarters.

Expansion

Moving up and away from a dip. Is a period during which real GDP increases from a trough(bottom of a dip) to a peak

Depreciation

The decrease in the value of a firm's capital that results from wear and tear obsolescence

Two features of expanding living standards are:

The growth of potential GDP per person and fluctuations of real GDP around potential GDP. The value of real GDP when all the economy's labor, capital, land and entrepreneurial ability are fully employed is called potential GDP. Potential GDP grows at a steady pace because the quantities of the factors of production and their productivity grow at a steady pace. Real GDP fluctuates around potential GDP

Net investment

The increase in the value of the firm's capital. Net investment = gross investment - depreciation

National income and expenditure account divide income into two broad categories

1. Compensation of employees: the payments for labor services. The sum of net wages plus taxes withheld social security and pension fund contributions 2. Net operating surplus: the sum of other factor incomes. Includes net interest, rental income, corporate profits, and proprietor's income.

Two adjustments made to get GDP

1. Compensation of employees: the payments of labor services. The sum of net wages plus taxes withheld social security and pension fund contributions. 2. Depreciation is added to get from net domestic income to gross domestic income.