FTC1 MACROECONOMICS Chapter 5, 6, 7 AND 9

REVIEW

-Standard of living is a measurement of the financial well-being of a given country based on how well its citizens are doing economically. -You can use GDP, GNP, and disposable income figures to measure standard of living. -GDP or GNP per person will give you an idea of standard of living based on national productivity. -Measuring standard of living against disposable income provides the standard of living based on how much money individuals have to spend on goods and services.

From Factor Cost to Market Price

-The expenditure approach values goods and services at market prices, -and the income approach values them at factor cost -the cost of the factors of production used to produce them. -Indirect taxes (such as sales taxes) and subsidies (payments by government to firms) make these two values differ. -Sales taxes make market prices exceed factor cost, and 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.

1. Classify each of the items in List 1 as a final good or service or as an intermediate good or service and identify which is a component of consumption expenditure, investment, or government expenditure on goods and services. .

-Banking services bought by a student • New cars bought by Hertz, the car rental firm • Newsprint bought by USA Today from International Paper • The purchase of a new aircraft for the vice president • New house bought by Beyoncé The student's banking service is a final service and part of consumption expenditure. Hertz's new cars are additions to capital, so they are part of investment and final goods. Newsprint is an input into the newspaper, so it is an intermediate good and not a final expenditure. The new aircraft for the vice president is a final good and part of government expenditure. The new house is a final good and part of investment.

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.

Consumption expenditure

-The expenditure by households on consumption goods and services. -Consumption expenditure also includes house and apartment rents, including the rental value of owner-occupied housing.

From Net to Gross

-The income approach measures net product and the expenditure approach measures gross product. - The difference is depreciation, which is the decrease in the value of capital that results from its use and from obsolescence. -Firms' profits, which are included in the income approach, are net of depreciation, so the income approach gives a net measure. - 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. -To get gross domestic product from the income approach, we must add depreciation to total income.

Gross domestic product (GDP)

-The market value of all the final goods and services produced within a country in a given time period. -GDP measures not only the value of total production but also total income and total expenditure.

Investment

-The purchase of new capital goods (tools, instruments, machines, buildings) and additions to inventories. -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.

Total Expenditure

-Total expenditure on goods and services produced in the United States is the sum of the four items that you've just examined. -We call 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.

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.

A business cycle is

-a periodic but irregular up-and-down movement of total production and other measures of economic activity such as employment and income.- - The business cycle isn't a regular, predictable, and repeating cycle like the phases of the moon. -The timing and the intensity of the business cycle vary a lot, but every cycle has two phases: Expansion Recession and two turning points: Peak Trough

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. - GDP equals net domestic product at factor cost plus indirect taxes less subsidies plus depreciation (capital consumption).

Political Freedom and Social Justice

A country might have a very large real GDP per person but have limited political freedom and social justice. For example, a small elite might enjoy political liberty and extreme wealth while the majority of people have limited freedom and live in poverty. Such an economy would generally be regarded as having a lower standard of living than one that had the same amount of real GDP but in which everyone enjoyed political freedom.

Gross National Product

A country's gross national product, or GNP, is 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 that country. For example, Nike's income from the capital that it supplies to its Vietnam shoe factory is part of U.S. GNP but not part of U.S. GDP. It is part of Vietnam's GDP. Similarly, Toyota's income on the capital it supplies to its Kentucky auto plant is part of U.S. GDP but not part of U.S. GNP. It is part of Japan's GNP.

Standard of Living

A country's standard of living is a measure of its health, or economic well-being. The overall level of economic well-being in a country could be very large but also spread over a large population. To compare the standard of living over time or across countries, it is therefore best to look at real GDP per person.

Final good or service is a what produced

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 is a what produced

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

Disposable personal income

Another measure of our standard of living is disposable personal income (DPI). What households have to spend on goods and services is a good indicator of how well they can live. DPI is the income received by households less personal income taxes paid. Using DPI and adjusting for PPP, U.S. households are more wealthy than most other countries. In 2009, the Organization for Economic Cooperation and Development reported that only Norway and Switzerland had higher incomes than the United States after adjusting for the purchasing power of each country's currency.

GDP is divided in to four main categories of spending:

CONSUMPTION INVESTMENT GOVERNMENT PURCHASES NET EXPORTS

CONSUMPTION

Consumption is spending by households, excluding the purchase of a house. These are called personal consumption expenditures. This GDP component includes both durable goods meant to last three or more years and nondurable goods. For example, spending by households on refrigerators and televisions constitutes durable goods purchases, whereas grocery items or restaurant meals are nondurable goods purchases.

Household production is the production of goods and services (mainly services) in the home.

Examples of this production are preparing meals, changing a light bulb, cutting grass, washing a car, and helping a student with homework. 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.

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. For example, a 2008 automobile was part of GDP in 2008. If the car is traded on the used car market in 2012, the amount paid for the car is not part of GDP in 2012.

During a business cycle, expansion comes after peak.

FALSE

Nominal GDP uses prices for a given base year to value the economy's production of goods and services, whereas real GDP uses current prices to value the economy's production of goods and services.

FALSE

The value of new home construction is included in the consumption component of GDP.

FALSE

The growth of real GDP will show changes in the amounts being produced and inflation.

FALSE Changes in real GDP reflect only changes in the amounts being produced.

TIME PERIOD

Finally, GDP is measured for a particular time period. Just as your personal income is measured over some set time period, like weeks or months, the value of GDP is stated for a given time period. In the United States, GDP is estimated quarterly and stated in annual terms.

MARKET VALUE

First, GDP measures market value. That is, only goods sold in the marketplace are counted as part of an economy's GDP. GDP does not include illegal goods or any services that are not sold in clearly identified and measurable markets. Many other items and services are never actually sold. When you pay someone to clean your house, it is included in GDP, but it is not counted when you do the work yourself.

Used goods

First, used goods, which are bought and sold in many markets, are not included in the calculation of GDP. Although many economic decisions are made when consumers shop for a used car or pick up a bargain at a garage sale, these items were not produced. We would be double counting if we included used goods. Used goods were part of GDP during the period in which they were produced.

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

Goods and Services Omitted from GDP

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

Other Measures of the Standard of Living Real GDP is not the only measure of our nation's income. There are two other ways to measure the standard of living in our country:

GROSS NATIONAL PRODUCT DISPOSABLE PERSONAL INCOME

Health and Life Expectancy

Good health and a long life—the hopes of everyone—do not show up directly in real GDP. A higher real GDP enables us to spend more on medical research, health care, a good diet, and exercise equipment. As real GDP has increased, our life expectancy has lengthened. But we face new health and life expectancy problems every year. Diseases, such as AIDS, and drug abuse are taking young lives at a rate that causes serious concern. When we take these negative influences into account, real GDP growth might overstate the improvements in the standard of living.

Gross national product

Gross national product (GNP) is the market value of all 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. A U company producing airplane parts in Asia would be part of U.S. GNP but not its GDP. GNP considers the value of production based on ownership, not location.

The Limitations of GDP Many things are omitted from GDP but nonetheless are very important for a nation's standard of living.

HEALTH POLITICS

U.S. real GDP in 1971

In 1971, real GDP was approximately $4.5 trillion, and the population stood at 209 million people. Real GDP per person in 1971 was then approximately $21,500.

INCOME APPROACH

In a market, every sale must have a buyer and a seller. Therefore, the total of all expenditure must be equal to the total of all income earned in an economy. If every buyer has a seller, then expenditures must equal income. Therefore, the expenditure approach to measuring economic activity must be equivalent to the income approach. Measuring GDP using the income approach begins with wage income, interest, rental income, and profit income. These income measures are then adjusted to remove the affect of government taxes and transfers. Another item, depreciation, which is the decrease in the value of capital that results from its use and obsolescence, is added back to income to yield GDP.

Norway's real GDP per person in 2009 United States' real GDP per person in 2009 United Kingdom's real GDP per person in 2009 Japan's real GDP per person in 2009

In order of highest GDP PER PERSON FOR COUNTRIES.

An expansion is a period during which real GDP increases.

In the early stage of an expansion, real GDP remains below potential GDP and as the expansion progresses, real GDP eventually exceeds potential GDP.

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.

Leisure Time

Leisure time is an economic good that is not valued as part of GDP. Yet the marginal hour of leisure time must be at least as valuable to us as the wage we earn for working. If it were not, we would work instead. Over the years, leisure time has steadily increased as the workweek gets shorter, more people take early retirement, and the number of vacation days increases. These improvements in our standard of living are not measured in real GDP.

List Important terms in GDP's Definition

Market Value; Final goods and Services; Within a country; In a specific time period.

Interest, Rent, and Profit Income

Interest, rent, and profit income, called net operating surplus in the national accounts, is the total income earned by capital, land, and entrepreneurship. 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. 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. (Imputed rent is an estimate of what homeowners would pay to rent the housing they own and use themselves. By including this item in the national accounts, we measure the total value of housing services, whether they are owned or rented.) 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.

Suppose an economy produces only bread and fish. In 2010, 20 units of bread are produced and sold at $5 each, whereas 10 units of fish are produced and sold at $15 each. In the previous year, 2009, the base year, bread sold for $4 each and fish was $10 per unit. What is the real GDP and nominal GDP of this economy for 2010?

Nominal GDP is $250 and real GDP is $180

Nominal GDP

Nominal GDP is the value of the final goods and services produced in a given year expressed in terms of the prices in that same year. EX. COMPARING ITEMS FROM 2006 & 2014, 2006 WILL USE 2006 PRICES AND 2014 WILL USE 2014 PRICES

Where produced

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

Politics

Political freedom and social justice are not measured by real GDP, but both factors tend to increase along with higher levels of real GDP. Studies have shown that, although some countries with very authoritative governments experience periods of high growth in real GDP per person, the highest level of income occurs in open societies. Also, countries with high real GDP growth experience the lowest incidents of poverty and corruption. Higher real GDP is correlated with higher social justice.

Environment Quality

Pollution is an economic bad (the opposite of a good). The more we pollute our environment, other things remaining the same, the lower is our standard of living. This lowering of our standard of living is not measured by real GDP.

Measuring Economic Growth Recall that GDP is the value of all the goods and services produced in a country. However, there are two different ways to measure the value:

REAL GDP NOMINAL GDP

Real GDP per person

Real GDP divided by the population.

Real GDP

Real GDP is the value of final goods and services produced in a given year expressed in terms of the prices in a base year. Real GDP allows the quantities of production to be compared across time. EX COMPARING ITEMS FROM 2006 & 2014, USING THE 2006 BASE PRICES TO CALCULATE ITEMS IN BOTH YEARS

Real GDP per person

Real GDP per person is the standard of living measured by the value of goods and services people enjoy on average. By dividing real GDP by a given population, we get an idea as to how well the average citizen is doing compared to previous periods, called real GDP per person.

FINAL GOODS

Second, GDP counts only final goods. The wheat sold by the farmer and used to make flour for baking your bread is not included in GDP. However, the value of this wheat has not been lost. This value is included in the market price of the bread that is finally bought and consumed. Wheat is just one example of an intermediate good. Even if a final good, like the bread, is made but not sold, it will be counted in GDP. These final goods are said to be in inventory. When businesses buy up goods to store on their shelves, economists say they have made an investment for later sale. Investments are included in GDP.

Financial assets

Second, when investors purchase financial assets, such as stocks or bonds, these expenditures are not part of GDP. Although money is changing hands, these investment decisions are not expenditures on goods and services.

Health

Such omissions include health, life expectancy, and protected civil liberties. GDP will rise with more production, even if higher levels of production pollutes the air or water, workers are dying from unsafe working conditions, or all workers are forced to produce. Fortunately, these measures of our standard of living have improved along with increases in real GDP. Overall health of the population and infant mortality rates have improved dramatically in the past few decades. For example, life expectancy in the United States was 70 years in the 1940s. Today, U.S. citizens can expect to live past their 80th birthday and longer.

Changes in real GDP better gauge the change in economic well-being than changes in nominal GDP.

TRUE

GDP measures two things at once: the total income of everyone in the nation and the total expenditure on this nation's output of goods and services.

TRUE

If real GDP rises in value, then only the amount of goods and services produced has risen.

TRUE

Depreciation

The decrease in the value of capital that results from its use and from obsolescence.

GNP equals GDP plus net factor income received from or paid to other countries.

The difference between U.S. GDP and GNP is small. But in an oil-rich Middle Eastern country such as Bahrain, where a large amount of capital is owned by foreigners, GNP is much smaller than GDP; and in a poor country such as Bangladesh, whose people work abroad and send income home, GNP is much larger than GDP.

INVESTMENT

The second category, investment, contains all spending on equipment, inventories, and structures, including houses. This value includes all private investments in things such as equipment, including computers and printers, as well as buildings, such as offices and warehouses. Also included in this component are the purchases of new homes by households and the additions to inventories at businesses. For example, when a car dealer purchases a new car and parks it on the lot for sale, business inventories rise. When firms add unsold items to their inventory, the items are counted as part of the investment component of GDP.

Net domestic product at factor cost

The sum of the wages, interest, rent, and profit.

Statistical Discrepancy

The expenditure approach and income approach do not deliver exactly the same estimate of GDP. If a taxi driver doesn't report all his tips, they get missed in the income approach, but they get caught by the expenditure approach when he spends his income. So the sum of expenditures might exceed the sum of incomes. But most income gets reported to the Internal Revenue Service on tax returns while many items of expenditure are not recorded and must be estimated. So the sum of incomes might exceed the sum of estimated expenditures. The discrepancy between the expenditure approach and the income approach is called the statistical discrepancy, and it is calculated as the GDP expenditure total minus the GDP income total.

The Expenditure Approach

The expenditure approach measures GDP by using data on consumption expenditure, investment, government expenditure on goods and services, and net exports. This approach is like attaching a meter to the circular flow diagram on all the flows running through the goods markets to firms and measuring the magnitudes of those flows.

Government expenditure on goods and services

The expenditure by all levels of government on goods and services.

NET EXPORTS

The fourth category of expenditures, net exports, measures the spending on the goods and services a country exports less the spending by residents here on goods and services they import. Exports of goods and services are anything U.S. firms produce and sell to the rest of the world. Imports are anything that households, firms, and governments buy from the rest of the world. For example, U.S. farmers produce a large amount of wheat, much of which is sold to other countries. These export sales add to GDP. In contrast, U.S. households purchase a large amount of clothing made in China and other countries. These imports subtract from GDP.

GOVERNMENT PURCHASES

The third category, government purchases, includes spending by all levels of government: local, state, and federal. These expenditures include payments by the government for services or the purchase of things such as military equipment. For example, when the government purchases a new submarine for service in the navy or a new limousine for the president, the government purchase component of GDP rises. Only what the government buys are included here. Transfer payments made by the government, such as Social Security benefits and unemployment insurance, are not included in this category.

Net exports of goods and services

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

Standard of living

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

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

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. In the United States today, the reference base year is 2005.

Real GDP focuses on a base year, whereas nominal GDP focuses on the same year of the measurement.

The result is that real GDP is a better measure of quantities of production, making it a more accurate and reliable indicator of a rise in standard of living. The market value of production and hence GDP can increase because either the production of goods and services is higher or the prices of goods and services are higher.

Nominal GDP

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

EXPENDITURE APPROACH

These four categories are called the expenditure approach for measuring GDP. Overall economic activity for a given period is found with this method by summing each of the four spending categories. The figure shows the May 2011 BEA report on the GDP broken down into the four main categories of spending. Recall that GDP is the market value of the goods and services purchased in each of these four groups.

DOMESTIC PRODUCTION

Third, GDP is a measure of domestic production. GDP measures the production that takes place within the geographical boundaries of a particular country. If a foreign citizen comes to the United States and works temporarily, the value of that worker's output is included in the U.S. GDP. Conversely, if a U.S. citizen works in another country, the value of that production is not included in U.S. GDP. Only what is produced in the United States counts.

Comparing Across Countries

To compare real GDP per person across countries we have to use a common set of prices. Real GDP is calculated in different countries using that nation's own currency. djusting real GDP for the differences in currency values gives a standard of living measure with purchasing power parity (PPP). This conversion of real GDP values eliminates the differences in price levels between the countries.

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. This approach is like attaching a meter to the circular flow diagram on all the flows running through factor markets from firms to households and measuring the magnitudes of those flows. Let's see how the income approach works. The U.S. National Income and Product Accounts divide incomes into two big categories: • Wage income • Interest, rent, and profit income

Value Produced

To measure total production, we must add together the production of apples and oranges, bats and balls. Just counting the items doesn't get us very far. Which is the greater total production: 100 apples and 50 oranges or 50 apples and 100 oranges? GDP answers this question by valuing items at their market value—at the prices at which the items are traded in markets. If the price of an apple is 10 cents and the price of an orange is 20 cents, the market value of 100 apples plus 50 oranges is $20 and the market value of 50 apples and 100 oranges is $25. By using market prices to value production, we can add the apples and oranges together.

The Standard of Living Among Countries

To use real GDP per person to compare the standard of living among countries, we must convert the numbers for other countries into U.S. dollars. To calculate real GDP, we must also use a common set of prices—called purchasing power parity prices—for all countries. The International Monetary Fund performs these calculations

Expenditures Not in GDP

Total expenditure (and GDP) does not include all the things that people and businesses buy. GDP is the value of final goods and services, so spending that is not on final goods and services is not part of GDP. Spending on intermediate goods and services is not part of GDP, although it is not always obvious whether an item is an intermediate good or a final good (see Eye on the U.S. Economy below). Also, we do not count as part of GDP spending on • Used goods • Financial assets

U.S. real GDP in 2010

U.S. real GDP in 2010 was approximately $13.4 trillion, using 2005 prices. The U.S. population in 2010 was just over 311 million people. Thus, real GDP per person was approximately $43,000. That is, the average income for a U.S. citizen in 2010 was approximately $43,000.

What Is Not Included? Because GDP measures the market value of all final goods produced within a country, not all of the country's economic activity is counted in the GDP:

USED GOODS FINANCIAL ASSETS

GDP HAS definition has four parts

Value produced, What produced, Where produced, and When produced.

Wage 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.

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.

Underground production is the production of goods and services hidden from the view of government

because people want to avoid taxes and regulations or their actions are illegal. Because underground production is unreported, it is omitted from GDP. Examples of underground production are the distribution of illegal drugs, farm work that uses illegal workers who are paid less than the minimum wage, and jobs that are done for cash to avoid paying income taxes. This last category might be quite large and includes tips earned by cab drivers, hairdressers, and hotel and restaurant workers.

To make comparisons of real GDP between two countries we must_____.

convert the real GDP of one country into the same currency units as the real GDP of the other country, and use the same prices to value the goods and services in the countries being compared.

In years when people buy many shares of stock, investment will be high and so will GDP.

false

If real GDP for one country is higher than another, it must be true that the standard of living is also higher.

false, to compare real GDP per person across countries, we have to use a common set of prices and measure GDP per person.

GNP measures the market value of all 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.

false, The definition is incomplete. GNP measures the market value of all 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.

Identify which GDP component it belongs to: Cisco decides to build up a new factory in North Carolina *

investment

When the economy is in recession, the real GDP is_____. *

less than the potential GDP minus potential GDP is negative

GDP omits things that are very important for a nation's standard of living.

true

Suppose the base year is 2005. Real GDP in 2011 is what the total expenditure would have been in 2011 if prices had remained the same as they

true