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Tracking the U.S. Economy

Tracking the U.S. Economy. National Income Accounting Expenditure approach to GDP Income approach to GDP Circular flow of income and expenditure Leakages and injections Limitations of GDP. National income accounting (NIA) is the measurement of aggregate or total economic activity.

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Tracking the U.S. Economy

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  1. Tracking the U.S. Economy National Income Accounting Expenditure approach to GDP Income approach to GDP Circular flow of income and expenditure Leakages and injections Limitations of GDP

  2. National income accounting (NIA) is the measurement of aggregate or total economic activity. NIA is useful for assessing the performance of the macroeconomy. NIA is also helpful in evaluating the effectiveness of policy initiatives such as the Bush tax cuts.

  3. “One person’s spending is another person’s income” Every dime I spend for new goods and services must be received as income (wages, salaries, rent, interest, or profit) by resource owners.

  4. Aggregate spending for new, final goods and services = GDP = Aggregate income received by resource owners (national Income) • Expenditure approach to GDP: Add together all spending on new, final goods and services produced within the nation’s borders in a year. • Income approach: Add all earnings from all resources used to produce output within the nation’s borders in a year.

  5. Expenditure approach GDP = C + I + G + (X – M) Where, Cis personal consumption expenditure;Iis gross private domestic investment;Gis government expenditure (local, state, and federal)Xis exports, and;M is imports

  6. Gross Domestic Product (GDP) The market value of all final goods and services and services produced during a year by resources located within the country, regardless of who owns the resources. Final goods and services are sold to final, or end, users. For example, tires purchased by a consumer are final goods. Tires purchased by Ford Motor are intermediate goods. Production in a Toyota Plant in Kentucky is counted in U.S. GDP. Production in a Ford Plant in Mexico is counted in Mexican GDP.

  7. Consumption • Household spending for newly-produced goods and services is defined as consumption. We distinguish between 3 categories or types: • Spending for consumer durables • Spending for consumer nondurables • Spending for consumer services.

  8. Consumer Spending by Type, 2007 (in billions) Total spending byU.S. householdsin 2007 was a $9.9trillion Source: Bureau of Economic Analysis

  9. Gross private domestic investment (I) • Business spending for newly built equipment, software , and structures. • Net additions to business inventories of raw materials , semifinished goods, and finished goods. • New residential housing construction.

  10. Investment does NOT include • The purchase of stocks, bonds, or other financial assets. • Secondhand sales Remember that investment only happens when there is production of new tangible capital goods

  11. Government Expenditures All expenditures for newly produced, final goods and services by all levels of government. For purposes of computing GDP, G DOES NOT include transfer payments such as social security or food stamps.

  12. Net Exports (X – M) We subtract imports from GDP since we do not want to count foreign output in domestic GDP

  13. Net Exports (NX) of the U.S. (Monthly)

  14. MEASURING U.S. GDP The Expenditure Approach

  15. Value-added At each stage of production, the selling price of a product minus the cost of intermediate goods purchased from other firms. Value-added is equivalent to the factor income earned by resource owners at a particular stage of production (like oil drilling).

  16. The value added at each stage of production is the sale price at that stage minus the cost of intermediate goods, or column (1) minus column (2). The value added at each stage sum to the market value of the final good. Computation of value added for a new desk

  17. The Income Approach • The NIA divides earned income into 2 categories: • Wages or compensation of employees: Includes wages and salaries plus fringe benefits—such as health insurance, pension, and social security contributions. • Interest, Rent, and Profit or the net operating surplus: the sum of the incomes earned by capital, land, and entrepreneurship.

  18. Interest, Rent, and Profit • Interest is the income households receive on loans they make minus the interest they pay on their borrowing. • Rent includes payments for the use of land and other rented inputs. • Profit includes the profits of corporations and small businesses.

  19. Net Domestic Product at Factor Cost: The sum of factor payments—wages, interest, rent and profits. We must make two adjustments to get from net domestic product at factor cost to GDP • From factor cost to market price; • From gross to net.

  20. From Factor Cost to Market Price • The expenditure approach values goods at market prices; the income approach values them at factor cost. • Indirect taxes (such as sales taxes) make market prices exceed factor cost. • Subsidies (payments by government to firms) 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

  21. From Gross to Net • The expenditure approach measures gross product; the income approach measures net product. • Gross profit is a firm’s profit before subtracting the depreciation of capital. • Net profit is a firm’s profit after subtracting the depreciation of capital. • Depreciationis the decrease in the value of capital that results from its use and from obsolescence.

  22. MEASURING U.S. GDP: The Income Approach

  23. Disposable Income (DI)and Net Taxes (NT) Disposable income (DI) is the income households have available to spend or save after paying taxes and receiving transfer payments. Net taxes (NT) are tax payments minus transfer payments received Note that: GDP = DI + NT and: DI = C + S

  24. Leakages and Injections Leakages are any diversion from the domestic spending stream; includes saving, taxes, and imports. Injections are expenditure in domestic goods markets by spending agents other than domestic households; includes investment, government expenditure, and exports.

  25. Leakages Equal Injections National Income accounting identities: C + I + G + (X – M) = DI + NT (1) DI = C + S (2) Substitute (2) into (1) to obtain: C + I + G + (X – M) =C + S + NT (3) Canceling out C’s and adding M to both sides: I + G +X = C + S + M (4)

  26. 1: GDP=aggregate income 2: Taxes leak 3: Transfer payments enter Net taxes: NT = taxes – transfers 4: Disposable income flows to households DI = aggregate income – NT 5: Households spend or save DI Consumption enters Savings leak 6: Investment enter 7: Government purchases enter 8: Imports leak 9: Exports enter 10: Consumption + Investment + Government purchases + Net export = Aggregate expenditure Circular flow of income and expenditure

  27. Expenditure and income statement for the US economy in 2006 (in trillions of dollars)

  28. Deriving net domestic product and national income in 2006 (in trillions of dollars)

  29. Deriving personal income and disposable income in 2006 (in trillions of dollars)

  30. Limitations of (real) GDP as a measure of the standard of living • Household (non-market) production • The underground economy • Leisure time • Environment quality

  31. Economist Quality of Life Index The Economist Index weighs the following factors • Income • Health • Freedom • Unemployment • Family life • Climate, • Political stability and security • Gender equality • Family and community life

  32. Index ranges from 1 to 10. Source: The Economist 1 Out of 111 countries rated

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