Measuring a Nation’s Income AUCA.

Sabyrbekov
Copyright © 2004 South-Western

What you will learn today?
• How to measure economic performance of a country? • What is GDP? • How do we calculate it?

Copyright © 2004 South-Western

Measuring a Nation’s Income
• Microeconomics
• Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.

• Macroeconomics
• Macroeconomics is 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.

Copyright © 2004 South-Western

Measuring a Nation’s Income
• 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?

Copyright © 2004 South-Western

• link Copyright © 2004 South-Western . it is natural to look at the total income that everyone in the economy is earning.THE ECONOMY’S INCOME AND EXPENDITURE • When judging whether the economy is doing well or poorly.

THE ECONOMY’S INCOME AND EXPENDITURE • For an economy as a whole. • Every dollar of spending by some buyer is a dollar of income for some seller. Copyright © 2004 South-Western . income must equal expenditure because: • Every transaction has a buyer and a seller.

Copyright © 2004 South-Western .THE MEASUREMENT OF 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.

budget and trade deficits. etc…) • Economic Policy making Copyright © 2004 South-Western . inflation. value of currency. wages.THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • Why Do We Care? • – Because output is related to (at certain times/ways) with things we care about (standard of living. unemployment.

THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • The equality of income and expenditure can be illustrated with the circular-flow diagram. Copyright © 2004 South-Western .

Figure 1 The Circular-Flow Diagram MARKETS FOR GOODS AND SERVICES •Firms sell Goods •Households buy and services sold Revenue Spending Goods and services bought FIRMS •Produce and sell goods and services •Hire and use factors of production HOUSEHOLDS •Buy and consume goods and services •Own and sell factors of production Factors of production Wages. and capital Income = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western . land. rent. and profit MARKETS FOR FACTORS OF PRODUCTION •Households sell •Firms buy Labor.

Copyright © 2004 South-Western .THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • GDP is the market value of all final goods and services produced within a country in a given period of time.

Copyright © 2004 South-Western . ― • It includes both tangible goods (food. . . doctor visits). cars) and intangible services (haircuts. clothing. Goods and Services . Of All Final . • ―. . . . . . • ―. .‖ • Output is valued at market prices. not intermediate goods (the value is counted only once).‖ • It records only the value of final goods. . housecleaning.THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • ―GDP is the Market Value . .

Copyright © 2004 South-Western . • ― .THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • ―. not transactions involving goods produced in the past. . . . . . Produced .‖ • It measures the value of production within the geographic confines of a country.‖ • It includes goods and services currently produced. . . . Within a Country .

Copyright © 2004 South-Western .THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • ―. In a Given Period of Time. . usually a year or a quarter (three months). .‖ • It measures the value of production that takes place within a specific interval of time.

Copyright © 2004 South-Western .THE COMPONENTS OF GDP • GDP includes all items produced in the economy and sold legally in markets.

• It excludes items produced and sold illicitly. such as illegal drugs. Copyright © 2004 South-Western .THE COMPONENTS OF GDP • What Is Not Counted in GDP? • GDP excludes most items that are produced and consumed at home and that never enter the marketplace.

profits)+ Government Income (taxes) • Expenditure Method: Spending by consumers (C) + Spending by businesses (I) + Spending by government (G) + Net Spending by foreign sector (NX) • • Fundamental identity of national income account: • total production = total income = total expenditure Copyright © 2004 South-Western . interest. dividends.THE Measurement OF GDP • Production Method: Measure the Value Added summed across all firms (value added = sale price less cost of raw materials) • Income Method: Labor Income (wages/salary) + Capital Income (rent.

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 Copyright © 2004 South-Western .

including new housing. • Investment (I): • The spending on capital equipment. inventories.THE COMPONENTS OF GDP • Consumption (C): • The spending by households on goods and services. and structures. Copyright © 2004 South-Western . with the exception of purchases of new housing.

and federal governments.THE COMPONENTS OF GDP • Government Purchases (G): • The spending on goods and services by local. Copyright © 2004 South-Western . state. • Does not include transfer payments because they are not made in exchange for currently produced goods or services. • Net Exports (NX): • Exports minus imports.

– Does Not Include Purchases of New Housing. Non-Durables and Services Purchased Domestically by Businesses – Includes Business and Residential Structures. Equipment and Inventory Investment – Land purchases are NOT counted as part of GDP (land is not produced!!) – Stock purchases are NOT counted as part of GDP (stock transactions do NOT represent production – they are saving!) There is a difference between financial and economic investment!!!!!!! Copyright © 2004 South-Western . Refrigerators (durables). – Includes Haircuts (services). individual consumers).THE COMPONENTS OF GDP • • • • • Consumption (C): – The Sum of Durables. and Apples (non-durables). Non-Durables and Services Purchased Domestically by NonBusinesses and Non-Governments (ie. • Investment (I): • • • • • – The Sum of Durables.

Nothing is Produced in this Case. • – Exports: The Amount of Domestically Produced Goods Sold on Foreign Soil • – Imports: The Amount of Goods Produced on Foreign Soil Purchased Domestically. Copyright © 2004 South-Western . • • For the U. snow plowing) and 1/3 is at the federal level (President. school teachers. Post Office. 2/3 of this is at the state level (police and fire protection. Missiles). These are Transfer Payments. • • NOTE: Welfare and Social Security are NOT Government Spending..THE COMPONENTS OF GDP • • Government Spending (G): Goods and Services Purchased by the domestic government. • • Net Exports (NX): Exports (X) .Imports (IM).S.

Table 1 GDP and Its Components Copyright©2004 South-Western .

GDP and Its Components (2001) Government Purchases 18% Net Exports Investment -3 % 16% Consumption 69% Copyright © 2004 South-Western .

REAL VERSUS NOMINAL GDP • Nominal GDP values the production of goods and services at current prices. Copyright © 2004 South-Western . • Real GDP values the production of goods and services at constant prices.

REAL VERSUS NOMINAL GDP • An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator. Copyright © 2004 South-Western .

Table 2 Real and Nominal GDP Copyright©2004 South-Western .

Table 2 Real and Nominal GDP Copyright©2004 South-Western .

Table 2 Real and Nominal GDP Copyright©2004 South-Western .

• It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.The GDP Deflator • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. Copyright © 2004 South-Western .

The GDP Deflator • The GDP deflator is calculated as follows: Nominal GDP GDP deflator = 100 Real GDP Copyright © 2004 South-Western .

The GDP Deflator • Converting Nominal GDP to Real GDP • Nominal GDP is converted to real GDP as follows: Real GDP20XX Nominal GDP20XX   100 GDP deflator20XX Copyright © 2004 South-Western .

Table 2 Real and Nominal GDP Copyright©2004 South-Western .

000 4.Figure 2 Real GDP in the United States Billions of 1996 Dollars $10.000 8.000 9.000 7.000 1970 1975 1980 1985 1990 1995 2000 Copyright © 2004 South-Western .000 6.000 3.000 5.

• GDP per person tells us the income and expenditure of the average person in the economy. Copyright © 2004 South-Western .GDP AND ECONOMIC WELLBEING • GDP is the best single measure of the economic well-being of a society.

• GDP is not a perfect measure of the happiness or quality of life.GDP AND ECONOMIC WELLBEING • Higher GDP per person indicates a higher standard of living. Copyright © 2004 South-Western . however.

such as the value of the time parents spend with their children and the value of volunteer work. • The value of a clean environment. • The value of leisure. • The value of almost all activity that takes place outside of markets. Copyright © 2004 South-Western .GDP AND ECONOMIC WELL-BEING • Some things that contribute to well-being are not included in GDP.

Table 3 GDP. Life Expectancy. and Literacy Copyright©2004 South-Western .

Copyright © 2004 South-Western .Summary • Because every transaction has a buyer and a seller. • Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services. the total expenditure in the economy must equal the total income in the economy.

• GDP is divided among four components of expenditure: consumption. government purchases. Copyright © 2004 South-Western .Summary • GDP is the market value of all final goods and services produced within a country in a given period of time. and net exports. investment.

Summary • Nominal GDP uses current prices to value the economy’s production. • The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy. Real GDP uses constant base-year prices to value the economy’s production of goods and services. Copyright © 2004 South-Western .

aren’t measured by GDP. Copyright © 2004 South-Western . such as leisure time and a clean environment.Summary • GDP is a good measure of economic well-being because people prefer higher to lower incomes. • It is not a perfect measure of well-being because some things.

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