Measuring a Nation’s Income

1. Measuring a Nation’s Income Chapter 5

2. Learning Objectives • Describe the origins of macroeconomics and the problems it deals with • Describe the long-term trends and short-terms fluctuations in economic growth, unemployment, inflation, and government and international deficits

3. Learning Objectives (con't.) • Explain why economic growth, unemployment, inflation, and deficits matter • Identify the macroeconomic policy challenges and describe the tools available for meeting them

4. 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

5. Learning Objectives • Describe the origins of macroeconomics and the problems it deals with • Describe the long-term trends and short-terms fluctuations in economic growth, unemployment, inflation, and government and international deficits

6. Microeconomics Microeconomicsis the study of how individual households and firms make decisions and how they interact with one another in markets.

7. Macroeconomics • Macroeconomicsis the study of the economy as a whole. • Its goal is to explain the economic changes that affect many households, firms, and markets at once.

8. Macroeconomics • Macroeconomics answers questions like the following: • Why is average income high in some countries and low in others? • Why do prices rise rapidly in some time periods while they are more stable in others? • Why do production and employment expand in some years and contract in others?

9. Origins and Issues of Macroeconomics • Modern macroeconomics emerged during the Great Depression. • People began to doubt the free market economy. • John Maynard Keynes, in 1936, published The General Theory of Employment, Interest, and Money.

10. Origins and Issues of Macroeconomics • Macroeconomic Problems 1) Economic Growth 2) Unemployment 3) Inflation 4) Deficits

11. Origins and Issues of Macroeconomics • Short-Term Versus Long-Term Goals • Keynes focused on the short-term primarily • He felt the depression was caused by insufficient private spending • Government should increase its spending

12. Origins and Issues of Macroeconomics • Short-Term Versus Long-Term Goals • Long-term consequences were virtually disregarded • “In the long run, we’re all dead”

13. Origins and Issues of Macroeconomics • Short-Term Versus Long-Term Goals • Today, macroeconomics is concerned with: • Long-term economic growth and inflation • Short-term business fluctuations and unemployment

14. Origins and Issues of Macroeconomics • The Road Ahead • The focus of macroeconomics has shifted: • Depression • Inflation of the 1970’s • International economics of today

15. Economic Growth in theUnited States • Fluctuations Around Potential GDP • The business cycle is the periodic but irregular up-and-down movement in production.

16. Economic Growth in theUnited States • Phases of the Business Cycle • Recession • Period during which real GDP decreases for two successive quarters • Expansion • Period during which real GDP increases

17. Economic Growth in theUnited States • Turning Points • Peak • Expansion ends, recession begins • Trough • Recession ends, expansion begins

18. Long-Term Economic Growthin the United States

19. Economic Growth Aroundthe World • Real GDP per person • The growth rate of real GDP divided by the population is used to compare growth rates over time and across countries.

20. Benefits and Costs ofEconomic Growth • Benefits • Expanded production possibilities • health care • medical research • space exploration • roads • environmental improvements (if resources are devoted to solving environmental problems)

21. Benefits and Costs ofEconomic Growth • Costs 1) Foregone consumption 2) Depletion of natural resources 3) Increased pollution 4) More frequent job and location changes

22. Macroeconomic Policy Challenges and Tools • Policy Challenges 1) Boost economic growth 2) Stabilize the business cycle 3) Reduce unemployment 4) Keep inflation low 5) Reduce the government and international deficits

23. Macroeconomic Policy Challenges and Tools • Policy Tools 1) Fiscal policy • Making changes in taxes and government spending • Long term growth • Smooth the business cycle

24. Macroeconomic Policy Challenges and Tools • Policy Tools 2) Monetary policy • Changing interest rates and the amount of money in the economy • Control inflation • Smooth business cycle

25. The Economy’s Income and Expenditure When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.

26. The Economy’s Income and Expenditure • For an economy as a whole, income must equal expenditurebecause: • Every transaction has a buyer and a seller. • Every dollar of spending by some buyer is a dollar of income for some seller.

27. Gross Domestic Product • Gross domestic product (GDP) is a measure of the income and expenditures of an economy. • It is the total market value of all final goods and services produced within a country in a given period of time.

28. The Circular-Flow Diagram The equality of income and expenditure can be illustrated with thecircular-flow diagram.

29. Revenue Spending Goods & Services sold Goods & Services bought Inputs for production Labor, land, and capital Wages, rent, and profit Income The Circular-Flow Diagram Market for Goods and Services Firms Households Market for Factors of Production

30. The Measurement of GDP GDP is the market value of all final goods and services produced within a country in a given period of time.

31. The Measurement of GDP • Output is valued at market prices. • It records only the value of final goods, not intermediate goods (the value is counted only once). • It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

32. The Measurement of GDP • It includes goods and services currently produced, not transactions involving goods produced in the past. • It measures the value of production within the geographic confines of a country.

33. The Measurement of GDP • It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

34. What Is Counted in GDP? GDP includes all items produced in the economy and sold legally in markets.

35. What Is Not Counted in GDP? • GDP excludes most items that are produced and consumed at home and that never enter the marketplace. • It excludes items produced and sold illicitly, such as illegal drugs.

36. Other Measures of Income • Gross National Product (GNP) • Net National Product (NNP) • National Income • Personal Income • Disposable Personal Income

37. Gross National Product • Gross national product (GNP) is the total income earned by a nation’s permanent residents (called nationals). • It differs from GDP by including income that our citizens earn abroad and excluding income that foreigners earn here.

38. Net National Product (NNP) • Net National Product (NNP) is the total income of the nation’s residents (GNP) minus losses from depreciation. • Depreciation is the wear and tear on the economy’s stock of equipment and structures.

39. National Income • National Income is the total income earned by a nation’s residents in the production of goods and services. • It differs from NNP by excluding indirect business taxes (such as sales taxes) and including business subsidies.

40. Personal Income • Personal income is the income that households and noncorporate businesses receive. • Unlike national income, it excludes retained earnings, which is income that corporations have earned but have not paid out to their owners. • In addition, it includes household’s interest income and government transfers.

41. Disposable Personal Income • Disposable personal income is the income that household and noncorporate businesses have left after satisfying all their obligations to the government. • It equals personal income minus personal taxes and certain nontax payments.

42. The Components of GDP GDP (Y ) is the sum of the following: • Consumption (C) • Investment (I) • Government Purchases (G) • Net Exports (NX) Y = C + I + G + NX

43. The Components of GDP • Consumption (C): • The spending by households on goods and services, with the exception of purchases of new housing. • Investment (I): • The spending on capital equipment, inventories, and structures, including new housing.

44. 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

45. Capital and Investment Initial capital

46. The Components of GDP • Government Purchases (G): • The spending on goods and services by local, state, and federal governments. • Does not include transfer payments because they are not made in exchange for currently produced goods or services. • Net Exports(NX): • Exports minus imports.

47. GDP and Its Components (1998)

48. 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

49. GDP and Its Components (1998)

50. GDP and Its Components (1998) Consumption 68 %