Macroeconomics Chapter 6
The four components of GDP
GDP= consumption(C) + private investment(I) + government purchases(G) + net exports(X sub n)
Stock variable
A stock variable is a variable that is independent of time Ex: Balance of a checking account, a figure independent of time
Value added
Another method to eliminate double counting: the amount by which the value of a firm's output exceeds the value of the goods and services the firm purchases from other firms.
4. The service sector contribution to real GDP is difficult to judge because A. its contribution to real GDP is small. B. what counts as a unit of output is hard to determine. C. of the large price fluctuations experienced in the service sector. D. of the close ties between the service sector and illegal activities.
B. what counts as a unit of output is hard to determine. Measuring units of output produced by the service sector is difficult because the output is intangible, and intangibles are hard to quantify.
8. Which of the following is NOT a component of GDP? A. Personal consumption B. Gross private domestic investment C. Government purchases D. Net exports E. imports
E. imports GDP is a measure of domestic economic activity. The four broad components used to measure gross domestic product are personal consumption, gross private domestic investment, government purchases, and net exports. Imports do not contribute to gross domestic product because the goods are produced in a different country.
Gross domestic income (GDI)
Gross domestic income (GDI) equals the total income generated in an economy by the production of final goods and services during a particular period. It is a flow variable. Because an economy's total output equals the total income generated in producing that output, GDP = GDI. We can estimate GDP either by measuring total output or by measuring total income.
Gross private domestic investment
Gross private domestic investment is the value of all goods produced during a period for use in the production of other goods and services. Like personal consumption, gross private domestic investment is a flow variable.
Imports
Imports are purchases of foreign-produced goods and services by a country's residents during a period.
Indirect Taxes
Indirect taxes are taxes imposed on the production or sale of goods and services or on other business activity.
Conceptual problems in the use of real GDP as a measure of economic well-being include the facts that it does not include nonmarket production and that it does not properly adjust for "bads" produced in the economy.
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GDP is the sum of final goods and services produced for consumption (C), private investment (I), government purchases (G), and net exports (Xn). Thus GDP = C + I + G + Xn.
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Rental Income
Rental income, such as the income earned by owners of rental housing or payments for the rent of natural resources, is the smallest component of GDI (about 3.5%); it is the smallest of the income flows to households. The meaning of rent in the computation of GDI is the same as its meaning in conventional usage; it is a charge for the temporary use of some capital asset or natural resource.[]
Measurement Problems in Real GDP:
Revisions The service sector
Net exports
Subtracting imports from exports yields net exports.
Direct tax
a direct tax is a tax imposed directly on income; the personal income and corporate income taxes are direct taxes.
Trade surplus
When exports exceed imports there is a trade surplus.
2. Benefits paid to employees count as part of: A. profits. B. indirect business expenses. C. employee compensation. D. depreciation.
C. employee compensation. Wages and salaries, along with benefits, are all part of employee compensation.
Profits
The profit component of income earned by households equals total revenues of firms less costs as measured by conventional accounting. Profits amounted to about 17% of GDI in 2015, down sharply from five decades earlier, when profits represented about 25% of the income generated in GDI.[] Profits are the reward the owners of firms receive for being in business. The opportunity to earn profits is the driving force behind production in a market economy.
5. The components of GDP for the country Estoria are as follows: personal consumption = $20,000, new home construction = $1,000, increase in inventories = $1,000, purchases of new plant and equipment by firms = $5,000, government purchases of goods and services = $1,000, government welfare payments = $1,000, exports = $500, and imports = $1,000. For Estoria, government purchases equal _____.
$1,000 Government's spending on goods and services counts as government purchases. The welfare payments are not counted as government purchases.
3. Land rental = $10,000, wages and salaries = $100,000, and value of sales to households = $150,000. If the information above completely describes the production costs and returns for this firm, business profits are:
$40,000 Profits are calculated by subtracting the costs of production (wages and salaries and land rental fee-$110,00 from the amount collected on sales ($150,000); in this case profits are $40,000.
Trade deficit
Negative net exports constitute a trade deficit.
per capita real GNP or GDP
equals a country's real GNP or GDP divided by its population.
Disposable personal income
equals the income households have available to spend on goods and services.
1. Land rental = $10,000, wages and salaries = $100,000, and the value of sales to households = $150,000. If the information for the Malta Papaya Company completely describes the production costs and returns for this firm, the company generates _____ worth of income for the economy.
$150,000 Income results from employee compensation, interest payments, rent, and profits. In this case, employee compensation = $100,000; rents = $10,000; and profits = $40,000. Hence, the company generates income worth $150,000.
9. The components of GDP for the country Estoria are as follows: personal consumption = $20,000, new home construction = $1,000, increase in inventories = $1,000, purchases of new plant and equipment by firms = $5,000, government purchases of goods and services = $1,000, government welfare payments = $1,000, exports = $500, and imports = $1,000. For Estoria, private investment equals _____.
$7,000 Private investment is the sum of expenditures on new capital goods, new home construction, and changes in inventories.
Conceptual problems with Real GDP:
1. Household production Goods and services that are produced and exchanged in a market are counted; goods and services that are produced but that are not exchanged in markets are not. 2. Underground and Illegal Production 3. Leisure 4. The GDP Accounts Ignore "Bads" Conclusion: GDP and Human Happiness
Private investment accounts for about 15% of GDP—but, at times, even less. Despite its relatively small share of total economic activity, private investment plays a crucial role in the macroeconomy for two reasons:
1. Private investment represents a choice to forgo current consumption in order to add to the capital stock of the economy. Private investment therefore adds to the economy's capacity to produce and shifts its production possibilities curve outward. Investment is thus one determinant of economic growth. 2. Private investment is a relatively volatile component of GDP; it can change dramatically from one year to the next. Fluctuations in GDP are often driven by fluctuations in private investment.
Gross private domestic investment includes three flows that add to or maintain the nation's capital stock:
1. expenditures by business firms on new buildings, plants, tools, equipment, and software that will be used in the production of goods and services 2. expenditures on new residential housing 3. changes in business inventories.
Flow variable
A flow variable is a variable that is measured over a specific period of time. Ex: Income, related in dollars/hour. Time is needed to describe the amount
1. Which of the following statements is NOT true? A. Services are not included in measures of GDP because they do not involve materials in their production. B. Private investment is the most volatile component of GDP, driving fluctuations in total economic output. C. To compare output between nations requires conversion of GDP measures to a common currency. D. Net exports increase as the amount of imports falls.
A. Services are not included in measures of GDP because they do not involve materials in their production. Final goods and services are both included in GDP as both take factors of production to produce and both contribute to the output of the economy.
3. Which of the following does NOT explain why real GDP incorrectly measures the value of all economic activity in society? A. The exclusion of the value of intermediate goods causes real GDP to underestimate the nation's total production of goods and services. B. Overall increases in prices throughout the economy are not accounted for by real GDP. C. The household production of services, like cooking dinner, are not counted in GDP. D. Societal woes, like crime, are not captured by real GDP.
A. The exclusion of the value of intermediate goods causes real GDP to underestimate the nation's total production of goods and services. Calculations of GDP include only the value of final goods and services, not intermediate goods and services. Including both intermediate and final goods in GDP calculations would lead to double-counting. However, if GDP were being calculated by the value added approach, only the value added by the producer of the good at each stage of production would be included and this would avoid double-counting.
3. Which of the following will hold when the economy is growing? A. real GDP is increasing B. less home production may occur C. less pollution may be generated D. inflation has taken off
A. real GDP is increasing During economic growth (expansion), real GDP must increase because production of goods and services-not just price-increases.
2. Which of the following would NOT be counted as part of GDP? A. A take-out pizza eaten by a family at home B. A tire purchased by an automobile manufacturer that will become part of an automobile it is producing for future sale C. A computer purchased by an accountant to help her complete customers' tax returns D. Government spending on a new battleship
B. A tire purchased by an automobile manufacturer that will become part of an automobile it is producing for future sale The tire would be counted only indirectly in GDP because it's an intermediate good. The domestically-produced vehicle on which it is installed is a final good and would be included in GDP.
2. Which of the following statements is false? A. An increase in government purchases, ceteris paribus, tends to expand the size of the economy. B. An increase in home production always generates greater income. C. When calculating real GDP, the quantity of services produced is estimated by the amount of labor used in the production of services. D. The United States has consistently run trade deficits for the past 15 years.
B. An increase in home production always generates greater income. The value of all production that is sold on the market can be broken down into component income terms. However, home production (cleaning, laundry, gardening) is not sold on the market and therefore does not increase incomes in the economy. GDP does not count the value of your efforts to clean your own house, to wash your own car, or to grow your own vegetables. In general, GDP omits the entire value added by members of a household who do household work themselves.
Net Interest
Businesses both receive and pay interest. GDI includes net interest, which equals interest paid less interest received by domestic businesses, plus interest received from foreigners less interest paid to foreigners. Interest payments on mortgage and home improvement loans are counted as interest paid by businesses, because homeowners are treated as businesses in the income accounts. In 2015, net interest accounted for nearly 4% of GDI.
5. Which of the following statements is true? A.GDP measures the value of all production in the economy. B. The cost imposed on society by an increase in crime is captured by GDP. C. Changes in real GDP provide an indication of the direction of movement in total output. D. The value of the illegal drugs sold in the United States is included in our measures of GDP.
C. Changes in real GDP provide an indication of the direction of movement in total output. Real GDP provides a reasonable measure of the output of an economy, with changes in real GDP indicating whether total output is increasing or decreasing.
1. An increase in time spent watching movies, participating in sports, or playing with one's children rather than working A. will lead to an increase in GDP. B. will make people less happy. C. may represent an improvement in the quality of life even if it causes real GDP to fall. D. encourages a rightward shift in the production possibilities curve.
C. may represent an improvement in the quality of life even if it causes real GDP to fall. GDP does not provide a perfect measure of the quality of life or the amount of human happiness. GDP does provide a measure of the goods and services produced. Often more products available will alter the quality of life, but it is not a perfect relationship. In this case, more leisure time may reduce GDP as people spend less time working, but less work may improve their quality of life. This is not a guaranteed relationship, but if the extra leisure time is freely chosen it is a likely relationship.
Employee compensation
Compensation of employees in the form of wages, salaries, and benefits makes up the largest single component of income generated in the production of GDP. In 2015, employee compensation represented over 50% of GDI.
4. Which of the following statements is true? A. All goods and services produced by firms are final goods and services. B. A trade surplus exists when an economy imports more than it exports. C. An automobile purchased and used by a real estate company for showing homes to prospective buyers is an example of personal consumption. D. An economy with high levels of investment often experiences economic growth.
D. An economy with high levels of investment often experiences economic growth Private investment represents a choice to forgo current consumption in order to add to the capital stock of the economy. Private investment therefore adds to the economy's capacity to produce and shifts its production possibilities curve outward. Investment is thus an important contributor to economic growth.
6. Which of the following would be counted as part of GDP? A. The cost of the plastic that goes into the construction of a new airplane B. Unemployment compensation spending by the government C. The value of Yosemite National Park D. The purchase of a domestically-produced automobile by a foreign government
D. The purchase of a domestically-produced automobile by a foreign government Regardless of who buys it, a domestically-produced automobile is a final good and would thus be included in GDP. The tire is a component of the final good.
4. Which of the following is NOT included when calculating gross domestic income (GDI)? A. Profits B. Depreciation C. Employee compensation D. Transfer payments
D. Transfer payments Gross domestic income, which is equal to gross domestic product, includes employee compensation, rental income, net interest, profits, depreciation, and indirect business taxes.
10. A _ variable is measured over a specific period of time, and a _ variable is measured independent of time. A. stock, flow B, flow, persistent C. economic, persistent D. flow, stock
D. flow, stock Flow variables are measured over a specific period of time, such as a financial quarter or a person's income. Stock variables are measured independent of time such as the balance in a checking account. The balance of a checking account is the balance at a specific point in time. It is not measured over time.
Depreciation
Depreciation is a measure of the amount of capital that wears out or becomes obsolete during a period. Depreciation is referred to in official reports as the consumption of fixed capital. Depreciation is a cost of production, so it represents part of the price charged for goods and services. It is therefore counted as part of the income generated in the production of those goods and services. Depreciation represented about 15.5% of GDI in 2015.
Components of GDI
Factor income: - Employee compensation - Profit - Rent - Interest Charges for deprecation Taxes associated with production
Government purchases
Government purchases are the sum of purchases of goods and services from firms by government agencies plus the total value of output produced by government agencies themselves during a time period. Government purchases make up about 20% of GDP.
Gross national product (GNP)
Gross national product (GNP) is the total value of final goods and services produced during a particular period with factors of production owned by the residents of a particular country.
Net Exports in the Circular Flow
Net exports represent the balance between exports and imports. Net exports can be positive or negative. If they are positive, net export spending flows from the rest of the world to firms. If they are negative, spending flows from firms to the rest of the world.
GDP + net factor earnings from abroad = gross national product (GNP) GNP − depreciation (consumption of fixed capital) = net national product (NNP) NNP − statistical discrepancy = national income (NI) NI − income earned but not received [e.g., taxes on production and imports, social security payroll taxes, corporate profit taxes, and retained earnings] + transfer payments and other income received but not earned in the production of GNP = personal income (PI) PI − personal income taxes = disposable personal income (DPI)
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GDP can be viewed in the context of the circular flow model. Consumption goods and services are produced in response to demands from households; investment goods are produced in response to demands for new capital by firms; government purchases include goods and services purchased by government agencies; and net exports equal exports less imports.
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GDP is the measure most often used to assess the economic well-being of a country. Besides measuring the pulse of a country, it is the figure used to compare living standards in different countries. Of course, to use GDP as an indicator of overall economic performance, we must convert nominal GDP to real GDP, since nominal values can rise or fall simply as a result of changes in the price level.
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GDP plus net income received from other countries equals GNP. GNP is the measure of output typically used to compare incomes generated by different economies.
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GNP= GDP + net income received from abroad by residents of a nation
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Government purchases are not the same thing as government spending.
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Gross domestic product, GDP, equals gross domestic income, GDI, which includes compensation, profits, rental income, indirect taxes, and depreciation.
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In principle, GDP and GDI should be equal, but their estimated values never are, because the data come from different sources.
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Note that Social Security and welfare payments to households are transfer payments. They do not represent payments to household factors of production for current output of goods and services, and therefore are not included in GDI.
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Per capita real GDP or GNP can be used to compare economic performance in different countries.
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Problems in the measurement of real GDP, in addition to problems encountered in converting from nominal to real GDP, stem from revisions in the data and the difficulty of measuring output in some sectors, particularly the service sector.
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Real GDP or real GNP is often used as an indicator of the economic well-being of a country.
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The difference between GDP and GNP is a subtle one. The GDP of a country equals the value of final output produced within the borders of that country; the GNP of a country equals the value of final output produced using factors owned by residents of the country. Most production in a country employs factors of production owned by residents of that country, so the two measures overlap. Differences between the two measures emerge when production in one country employs factors of production owned by residents of other countries.
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The term "investment" can generate confusion. In everyday conversation, we use the term "investment" to refer to uses of money to earn income. We say we have invested in a stock or invested in a bond. Economists, however, restrict "investment" to activities that increase the economy's stock of capital.
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Total output can be measured two ways: as the sum of the values of final goods and services produced and as the sum of values added at each stage of production.
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We can use GDP, a measure of total output, to compute disposable personal income, a measure of income received by households and available for them to spend.
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to get from GDP to disposable personal income, we first convert GDP to GNP. Then, we subtract depreciation to obtain net national product and subtract the statistical discrepancy to arrive at national income (i.e., gross national income [GNI] net of depreciation and the statistical discrepancy). Next, we subtract components of GNP and GNI that do not represent income actually received by households, such as taxes on production and imports, corporate profit and payroll taxes (contributions to social insurance), and corporate retained earnings. We add items such as transfer payments that are income to households but are not part of GNP and GNI. The adjustments shown are the most important adjustments in going from GNP and GNI to disposable personal income; several smaller adjustments (e.g., subsidies, business current transfer payments [net], and current surplus of government enterprises) have been omitted. Table 6.3 From GDP to Disposable Personal Income
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Personal consumption
Personal consumption is a flow variable that measures the value of goods and services purchased by households during a time period. Purchases by households of groceries, health-care services, clothing, and automobiles—all are counted as consumption. The production of consumer goods and services accounts for about 70% of total output.
Personal consumption circular flow pattern
Personal consumption spending flows from households to firms. In return, consumer goods and services flow from firms to households. To produce the goods and services households demand, firms employ factors of production owned by households. There is thus a flow of factor services from households to firms, and a flow of payments of factor incomes from firms to households.
Private Investment in the Circular Flow
Private investment constitutes a demand placed on firms by other firms. It also generates factor incomes for households. (look up diagram)
Government Purchases in the Circular Flow
Purchases of goods and services by government agencies create demands on firms. As firms produce these goods and services, they create factor incomes for households.
Exports
Sales of a country's goods and services to buyers in the rest of the world during a particular time period represent its exports.
The value of an economy's output in any period can thus be estimated in either of two ways:
The values of final goods and services produced can be added directly The values added at each stage in the production process can be added.
Chapter 6 Summary
This chapter focused on the measurement of GDP. The total value of output (GDP) equals the total value of income generated in producing that output (GDI). We can illustrate the flows of spending and income through the economy with the circular flow model. Firms produce goods and services in response to demands from households (personal consumption), other firms (private investment), government agencies (government purchases), and the rest of the world (net exports). This production, in turn, creates a flow of factor incomes to households. Thus, GDP can be estimated using two types of data: (1) data that show the total value of output and (2) data that show the total value of income generated by that output. In looking at GDP as a measure of output, we divide it into four components: consumption, investment, government purchases, and net exports. GDP equals the sum of final values produced in each of these areas. It can also be measured as the sum of values added at each stage of production. The components of GDP measured in terms of income (GDI) are employee compensation, profits, rental income, net interest, depreciation, and indirect taxes. We also explained other measures of income such as GNP and disposable personal income. Disposable personal income is an important economic indicator, because it is closely related to personal consumption, the largest component of GDP. GDP is often used as an indicator of how well off a country is. Of course, to use it for this purpose, we must be careful to use real GDP rather than nominal GDP. Still, there are problems with our estimate of real GDP. Problems encountered in converting nominal GDP to real GDP were discussed in the previous chapter. In this chapter we looked at additional measurement problems and conceptual problems. Frequent revisions in the data sometimes change our picture of the economy considerably. Accounting for the service sector is quite difficult. Conceptual problems include the omission of nonmarket production and of underground and illegal production. GDP ignores the value of leisure and includes certain "bads." We cannot assert with confidence that more GDP is a good thing and that less is bad. However, real GDP remains our best single indicator of economic performance. It is used not only to indicate how any one economy is performing over time but also to compare the economic performance of different countries.
Transfer payments
payments that do not require the recipient to produce a good or service in order to receive them. Transfer payments include Social Security and other types of assistance to retired people, welfare payments to poor people, and unemployment compensation to people who have lost their jobs
