CHAPTER 6 Measuring GDP, Inflation, and Economic Growth

1. CHAPTER6Measuring GDP, Inflation, and Economic Growth Chapter 23 in Economics

2. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

3. Learning Objectives (cont.) • Explain how the Consumer Price Index (CPI) and GDP deflator are measured • Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

4. Learning Objectives (cont.) • Explain how real GDP is measured • Explain the shortcomings of real GDP growth as a measure of improvements in living standards

5. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

6. Gross Domestic Product • Gross domestic product (GDP) is the value of the aggregate production of goods and services in a country during a given time period.

7. Gross Domestic Product • Flows and Stocks 1) A flow is the quantities per unit of time. • GDP 2) A stock is a quantity that exists at a point in time

8. Gross Domestic Product • Flows and Stocks • Capital is the key macroeconomic stock. • Capital • The plant, equipment, buildings, and inventories of raw materials and semifinished goods that are used to produce other goods and services.

9. Gross Domestic Product • Depreciation • The decrease in the stock of capital that results from wear and tear and obsolescence. • Otherwise known as capital consumption

10. Gross Domestic Product • Gross Investment • The total amount spent on adding to the stock of capital and on replacing depreciated capital • Net Investment • The amount spent on adding to the stock of capital • Gross Investment minus Depreciation

11. Capital and Investment 4 3 2 Initial capital less depreciation Initial capital 1 Sewing machines 0

12. Capital and Investment 4 3 Initial capital 2 Initial capital less depreciation Initial capital 1 Sewing machines 0 Jan. 1, 1997 Time

13. Capital and Investment 4 3 Initial capital Depreciation 2 Initial capital less depreciation Initial capital less depreciation Initial capital 1 Sewing machines 0 Jan. 1, 1997 During 1997 Time

14. Capital and Investment 4 Gross Investment 3 Initial capital Depreciation 2 Initial capital less depreciation Initial capital less depreciation Initial capital 1 Sewing machines 0 Jan. 1, 1997 During 1997 Time

15. Capital and Investment 4 Gross Investment Net investment during 1997 3 Initial capital Depreciation 2 Initial capital less depreciation Initial capital less depreciation Initial capital 1 Sewing machines 0 Jan. 1, 1997 During 1997 Dec. 31, 1997 Time

16. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

17. Gross Domestic Product • Wealth is another macroeconomic stock • Wealth • The value of all the things that people own • Related to their earnings (a flow)

18. Gross Domestic Product • Consumption Expenditure • The amount spent on consumption goods and services • Saving • The amount of an income after meeting consumption expenditures

19. Gross Domestic Product • Income, Expenditure, and the Value of Production 1) Households sell their labor, capital, land, and entrepreneurship to firms 2) Firms sell consumer goods and services 3) Firms buy and sell capital goods 4) Firms borrow to finance investment

20. Gross Domestic Product • Governments • Government purchases are purchases of goods and services by governments • Paid for with tax revenue • Net taxes are taxes paid to governments minus transfer payments received from governments and minus interest payments from the government on its debt.

21. Gross Domestic Product • Rest of World Sector • Net exports is the value of exports minus the value of imports • Gross Domestic Product • Production can be valued by what: • Buyers pay for it • It costs producers to make it

22. The Circular Flow ofIncome and Expenditure

23. Learning Objectives • Distinguish between the stocks of capital and wealth and the flows of production, income, investment and saving • Explain why aggregate income, expenditure, and product are equal • Explain how GDP is measured

24. Gross Domestic Product • Expenditure Equals Income Y = C + I + G + NX

25. Gross Domestic Product • How Investment is Financed 1) National saving is the amount of saving by households and businesses plus government saving National saving = S + (T – G) 2) Borrowing from the rest of the world

26. Gross Domestic Product • Measuring U.S. GDP 1) Expenditure Approach 2) Income Approach

27. Gross Domestic Product • Expenditure Approach • Uses data on consumption expenditure, investment, government purchases, and net exports

28. Gross Domestic Product • Expenditure Approach • Personal consumption expenditures are the expenditures by households on goods and services produced in the United States and the rest of the world

29. Gross Domestic Product • Expenditure Approach • Gross domestic investment is expenditure on capital equipment and buildings by firms and expenditure on new homes by households. Also, it includes the change in inventories.

30. Gross Domestic Product • Expenditure Approach • Government purchases of goods and services are the purchases of goods and services by all levels of government. • Does not include transfer payments

31. Gross Domestic Product • Expenditure Approach • Net exports of goods and services are the value of exports minus the value of imports

32. GDP: The Expenditure Approach Amount in 1996 (billions of Percentage Item Symbol dollars of GDP Personal consumption expenditures C 5, 152 68.0 Gross private domestic investment I 1,116 14.7 Government purchase of goods and services G 1,407 18.6 Net exports of good and services NX –99 – 1.3 Gross domestic product Y 7,576 100.0

33. Gross Domestic Product • Expenditures Not in GDP 1) Intermediate goods and services 2) Used goods 3) Financial assets

34. Gross Domestic Product • Income Approach • Measures GDP by summing the incomes that firms pay households for the resources they hire

35. Gross Domestic Product • Income Approach • Compensation of employees is the payment for labor services • Includes net wages and salaries plus taxes withheld on earnings plus fringe benefits such as social security and pension fund contributions

36. Gross Domestic Product • Income Approach • Net interest is the interest households receive on loans they make minus the interest households pay on their own borrowing • Rental income is the payment for the use of land and other rented inputs.

37. Gross Domestic Product • Income Approach • Corporate profits are the profits of corporations. • Proprietors’ income is a combination of all of these.

38. Gross Domestic Product • Net Domestic Income at Factor Cost • The sum of the five categories of income We must convert factor cost to market prices.

39. Gross Domestic Product • Income Approach • Indirect taxes are taxes paid by consumers when they buy goods and services • Due to this additional cost, the market price is greater than the factor cost value for measuring GDP.

40. Gross Domestic Product • Income Approach • Subsidies are payments by the government to a producer. • Due to this payment, the factor cost is greater than the market price for measuring GDP. We must convert from Net Domestic Product to Gross Domestic Product.

41. Gross Domestic Product • Income Approach • Net profit of businesses--profit after subtracting depreciation—is a component of aggregate incomes. • To get gross domestic product, we must add depreciation to aggregate income.

42. Learning Objectives (cont.) • Explain how the Consumer Price Index (CPI) and GDP deflator are measured • Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

43. Aggregate Expenditure,Output, and Income 100 80 60 40 Percentage of GDP 20 0

44. Aggregate Expenditure,Output, and Income 100 NX GDP G I 80 C 60 40 Percentage of GDP 20 0 Aggregate expenditure GDP

45. Aggregate Expenditure,Output, and Income 100 NX G I 80 C 60 40 Percentage of GDP 20 0 Aggregate expenditure

46. GDP: The Income Approach Amount in 1996 Percentage Item (billions ofdollars of GDP Compensation of employees 4,449 58.7 Net Interest 405 5.4 Rental Income 127 1.7 Corporate Profits 650 8.6 Proprietors’ income 518 6.8 Indirect taxes less subsidies 569 7.5 Capital consumption (depreciation) 858 11.3 Gross domestic 7,576 100.0 product

47. Learning Objectives (cont.) • Explain how the Consumer Price Index (CPI) and GDP deflator are measured • Explain how the shortcomings of the CPI and the GDP deflator as measures of inflation

48. Aggregate Expenditure,Output, and Income 100 NX Depreciation GDP G Indirect taxes less subsidies I 80 Proprietor’s incomes Interest C Profits 60 Rent Wages and other labor income 40 Percentage of GDP 20 0 Aggregate expenditure GDP Aggregate income

49. Gross Domestic Product • Valuing the Output of Industries • Value added is the value of a firm's production minus the value of the intermediate goods that the firm buys from other firms.

50. Value Added andFinal Expenditure Value added Farmer’s value added Farmer Intermediate expenditure Final expenditure