MEASURING AGGREGATE ECONOMIC ACTIVITY

1. MEASURING AGGREGATE ECONOMIC ACTIVITY

2. National Income Accounting • Why measure? • National income accounting • A way of measuring total, or aggregate production. • Gross Domestic Product (GDP) • The total value of all final goods and services produced in an economy in a one-year period.

3. Calculating GDP • Adding together millions of goods and services. • Adding apples and oranges • All of the quantities of goods and services produced are multiplied (weighted) by their market price per unit to determine a value measure of that good or service. • The sum of all of these values is GDP.

4. The Expenditure Approach • GDP is the sum of four categories of expenditures. GDP = C + I + G + (X – M) • Consumption • Investment • Includes inventories • Government Spending • Valued at cost • Excludes transfer payments • Net exports

5. CALCULATING GDP Suppose that consumption is $1150, investment is $400, and government purchases are $500. Exports are $100 and imports are $150. How much is Gross Domestic Product? GDP = C + I + G + (X – M) by substitution, GDP = 1150 + 400 + 500 + (100-150) GDP = $2000

6. GDP IN THE U.S. vs. BELGIUM GDP = C + I + G + Exports - Imports U.S. $14,000 B = 70% + 17% + 19% + 11% - 17% Belgium $365 B = 53% + 21% + 23% + 87% - 84%

7. Flows vs. Stocks • Flows • Involves a time period • GDP is reported on an annualized basis • About $14 Trillion ($14,000,000,000,000) • Stocks • An amount at a point in time • Wealth accounts—assets minus liabilities • About $50 Trillion ($50,000,000,000,0000)

8. GDP Measures Final Output • Final vs. Intermediate goods and services • Final output – goods and services purchased for final use. • Intermediate products are used as an input in the production of some other product. • GDP counts only final goods and services • Counting both final and intermediate goods would result in double counting.

9. Two Ways of Eliminating Double Counting • Calculate only final output. • A firm would report how much it sold to consumers and how much it sold to producers (intermediate goods). • Follow the value added approach. • Value added is the increase in value that a firm contributes to a product or service. • It is calculated by subtracting intermediate goods (the cost of materials that a firm uses to produce a good or service) from the value of its sales.

10. Value Added Approach Participants Cost of Value of Value Added Materials Sales Farmer $ 0 $ 100 $ 100 Cone factory 150 100 250 and ice Cream maker Middleperson 250 400 150 Vendor 400 500 100 Totals $ 750 $1,250 $500

11. What is Counted in GDP? • Not counted • Value of resold goods • Government transfer payments • Sales of stocks or bonds • Non-market transactions---e.g., work of housespouses • Counted • Value added by a used car dealer • Commissions of stock brokers

12. GDP and NDP • Net domestic product is GDP adjusted for depreciation – the amount of capital used up in producing that year’s GDP. NDP = C + (I – depreciation) + G + (X-M) • NDP measures output available for purchase.

13. GDP AND GNP • Gross Domestic Product (GDP) • Total value of all final goods and services produced in country in a one-year period. • Gross National Product (GNP) • Total value of all final goods and services produce by the citizens and businesses of a country in a one- year. • When is the difference important?

14. The Income Approach • Aggregate income is the total income earned by citizens and businesses in a country in a year. • Aggregate income consists of: • employee compensation • rent paid to households (But not to businesses) • interest paid to households (But not to businesses) • profits

15. The Income Approach • United States Aggregate Income $14 Trillion Employee compensation 70% Rents 1% Interest 5% Profits 24%

16. Income = Expenditures • Whenever a good or service is produced (output), somebody receives income for producing it. • Aggregate Income = Aggregate Production • Profit is a residual that makes income and expenditures equal.

17. Comparing GDP Among Countries • Per capita GDP • Used to compare relative standards of living among various countries. • Because of differences in nonmarket activities and difference in product prices, per capita GDP may be a misleading measure of living standards. • Purchasing power parity • Adjusts for relative price differences before making comparisons.

18. Economic Welfare Over Time • If increases in GDP are due to increases in prices, then welfare does not increase. • Changes in welfare over time are best indicated by changes in real GDP, nominal GDP adjusted for inflation. • And % ∆ in Nominal GDP = % ∆ in Real GDP + inflation

19. CALCULATING REAL GDP Suppose that in year 1 nominal GDP is $1200; in year 2, $1300. The GDP deflator is 110 and 115, respectively. Find the change in nominal GDP. How much of the change is due to a real increase in output and how much is due to price changes?

20. Limitations of National Income Accounting • GDP measures economic activity, not welfare. • GDP does not measure happiness, nor does it measure economic welfare. • Non-market activities are not included • Subcategories are often interdependent. • For example, the line between consumption and investment may be unclear. • Measurement problems exist.

21. Genuine Progress Indicator • The genuine progress indicator (GPI) makes a variety of adjustments to GDP to better measure the progress of society rather than just economic activity. • The GPI includes social goals such as pollution reduction, education, and health.