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7. 7. CHAPTER. CHAPTER. GDP: Measuring Total Production and Income. In the more than 100 years that Ford Motor Company has been in business, its experiences have often mirrored those of the U.S economy. Prepared by:. Fernando Quijano. 7. 7. Chapter Outline and Learning Objectives.

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  1. 7 7 CHAPTER CHAPTER GDP: Measuring Total Production and Income In the more than 100 years that Ford Motor Company has been in business, its experiences have often mirrored those of the U.S economy. Prepared by: Fernando Quijano

  2. 7 7 Chapter OutlineandLearning Objectives CHAPTER CHAPTER GDP: Measuring Total Production and Income

  3. GDP: Measuring Total Production and Income Microeconomics The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Business cycle Alternating periods of economic expansion and economic recession.

  4. GDP: Measuring Total Production and Income Expansion The period of a business cycle during which total production and total employment are increasing. Recession The period of a business cycle during which total production and total employment are decreasing. Economic growth The ability of an economy to produce increasing quantities of goods and services. Inflation rate The percentage increase in the price level from one year to the next.

  5. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Measuring Total Production: Gross Domestic Product Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year. GDP Is Measured Using Market Values, Not Quantities The word value is important in the definition of GDP.

  6. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Measuring Total Production: Gross Domestic Product GDP Includes Only the Market Value of Final Goods Final good or service A good or service purchased by a final user. Intermediate good or service A good or service that is an input into another good or service, such as a tire on a truck. GDP Includes Only Current Production GDP includes only production that takes place during the indicated time period.

  7. 7.1 LEARNING OBJECTIVE • YOUR TURN:For more practice, do related problem 1.12 at the end of this chapter. Explain how total production is measured. 7-1 Solved Problem Calculating GDP

  8. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Production, Income, and the Circular-Flow Diagram FIGURE 7-1 The Circular Flow and the Measurement of GDP The circular-flow diagram illustrates the flow of spending and money in the economy. Firms sell goods and services to three groups: domestic households, foreign firms and households, and the government. To produce goods and services, firms use factors of production: labor, capital, natural resources, and entrepreneurship. Households supply the factors of production to firms in exchange for income in the form of wages, interest, profit, and rent. Firms make payments of wages and interest to households in exchange for hiring workers and other factors of production. The sum of wages, interest, rent, and profit is total income in the economy. We can measure GDP as the total income received by households.

  9. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Production, Income, and the Circular-Flow Diagram FIGURE 7-1 (continued) The Circular Flow and the Measurement of GDP The diagram also shows that households use their income to purchase goods and services, pay taxes, and save. Firms and the government borrow the funds that flow from households into the financial system. We can measure GDP either by calculating the total value of expenditures on final goods and services or by calculating the value of total income.

  10. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Production, Income, and the Circular-Flow Diagram Transfer payments Payments by the government to individuals for which the government does not receive a new good or service in return.

  11. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Components of GDP Personal Consumption Expenditures, or “Consumption” Consumption Spending by households on goods and services, not including spending on new houses. Gross Private Domestic Investment, or “Investment” Investment Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households and firms on new houses. Don’t Let This Happen to YOU!Remember What Economists Mean by Investment • YOUR TURN:Test your understanding by doing related problem 1.8 at the end of this chapter.

  12. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Components of GDP Government Consumption and Gross Investment, or “Government Purchases” Government purchasesSpending by federal, state, and local governments on goods and services.

  13. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Components of GDP Net Exports of Goods and Services, or “Net Exports” Net exports Exports minus imports. An Equation for GDP and Some Actual Values

  14. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production An Equation for GDP and Some Actual Values FIGURE 7-2 Components of GDP in 2008 Consumption accounts for 70 percent of GDP, far more than any of the other components. In recent years, net exports typically have been negative, which reduces GDP.

  15. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production An Equation for GDP and Some Actual Values • • Consumer spending on services is greater than the sum of spending on durable and nondurable goods. • • Business fixed investment is the largest component of investment. • Purchases made by state and local governments are greater than purchases made by the federal government. • Imports are greater than exports, so net exports are negative.

  16. 7.1 LEARNING OBJECTIVE • YOUR TURN:Test your understanding by doing related problem 1.11 at the end of this chapter. MakingtheConnection Explain how total production is measured. Will U.S. Consumers Be Spending Less?

  17. 7.1 LEARNING OBJECTIVE Explain how total production is measured. Gross Domestic Product Measures Total Production Measuring GDP by the Value-Added Method Value added The market value a firm adds to a product. Table 7-1 Calculating Value Added

  18. 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being. Does GDP Measure What We Want It to Measure? Shortcomings in GDP as a Measure of Total Production Household Production Household production refers to goods and services people produce for themselves. The Underground Economy Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

  19. 7.2 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 2.6 at the end of this chapter. Discuss whether GDP is a good measure of well-being. Why Do Many Developing CountriesHave Such Large Underground Economies? A large informal sector can be a sign of government policies that are retarding economic growth. In some developing countries, more than half the workers may be in the underground economy.

  20. 7.2 LEARNING OBJECTIVE Discuss whether GDP is a good measure of well-being. Does GDP Measure What We Want It to Measure? Shortcomings of GDP as a Measure of Well-Being The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

  21. 7.2 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 2.8 at the end of this chapter. Discuss whether GDP is a good measure of well-being. Did World War II Bring Prosperity? World War II was a period of extraordinary sacrifice and achievement by the “greatest generation.” But statistics on GDP may give a misleading indication of whether it was also a period of prosperity.

  22. 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP. Real GDP versus Nominal GDP Calculating Real GDP Nominal GDP The value of final goods and services evaluated at current-year prices. Real GDP The value of final goods and services evaluated at base-year prices.

  23. 7.3 LEARNING OBJECTIVE 7-3 Solved Problem Discuss the difference between real GDP and nominal GDP. Calculating Real GDP • YOUR TURN:For more practice, do related problem 3.3 at the end of this chapter.

  24. 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP. Real GDP versus Nominal GDP Comparing Real GDP and Nominal GDP FIGURE 7-3 Nominal GDP and Real GDP, 1990–2008 Currently, the base year for calculating GDP is 2005. In the years before 2005, prices were, on average, lower than in 2005, so nominal GDP was lower than real GDP. In 2005, nominal and real GDP were equal. After 2005, prices have been, on average, higher than in 2005, so nominal GDP is higher than real GDP.

  25. 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP. Real GDP versus Nominal GDP The GDP Deflator Price level A measure of the average prices of goods and services in the economy. GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100.

  26. 7.3 LEARNING OBJECTIVE Discuss the difference between real GDP and nominal GDP. Real GDP versus Nominal GDP The GDP Deflator From these values for the deflator, we can calculate that the price level increased by 1.9 percent between 2007 and 2008:

  27. 7.4 LEARNING OBJECTIVE Become familiar with other measures of total production and total income. Other Measures of Total Production and Total Income Gross National Product (GNP) Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. National Income National income is calculated as GDP minus the consumption of fixed capital, or depreciation. Personal Income Personal income is income received by households. Disposable Personal Income Disposable personal income is equal to personal income minus personal tax payments.

  28. 7.4 LEARNING OBJECTIVE Become familiar with other measures of total production and total income. Other Measures of Total Production and Total Income FIGURE 7-4 Measures of Total Production and Total Income, 2008 The most important measure of total production and total income is gross domestic product (GDP). As we will see in later chapters, for some purposes, the other measures of total production and total income shown in the figure turn out to be more useful than GDP.

  29. 7.4 LEARNING OBJECTIVE Become familiar with other measures of total production and total income. Other Measures of Total Production and Total Income The Division of Income FIGURE 7-5 The Division of Income We can measure GDP in terms of total expenditure or as the total income received by households. The largest component of income received by households is wages, which are more than three times as large as the profits received by sole proprietors and the profits received by corporations combined.

  30. AN INSIDE LOOK >> Falling Auto Purchases Lead to Lower GDP A Slowing Descent: Auto Sales Fell 37Percent, but Improved Slightly Real GDP declined for three consecutive quarters beginning in the third quarter of 2008.

  31. KEY TERMS Macroeconomics Microeconomics Net exports Nominal GDP Price levelReal GDP Recession Transfer payments Underground economy Value added Business cycle Consumption Economic growth Expansion Final good or service GDP deflator Government purchases Gross domestic product (GDP) Inflation rate Intermediate good or serviceInvestment

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