Notes 08

Chapter 8
Measuring the
Economy’s
Performance
Copyright © 2010 Pearson Addison-Wesley. All rights reserved.
Introduction
For a number of years, measured U.S. business

investment spending on capital goods has declined
relative to total national expenditures on goods and
services.
Some economists argue that perhaps U.S. capital
investment is not correctly measured.
How are capital investment and other aggregate
economic quantities measured in the United States?
8-2
Learning Objectives
• Describe the circular flow of income and

output
• Define gross domestic product (GDP)
• Understand the limitations of using GDP as
a measure of national welfare
8-3
Learning Objectives (cont'd)
• Explain the expenditure approach to

tabulating GDP
• Explain the income approach to computing
GDP
• Distinguish between nominal GDP and real
GDP
8-4
Chapter Outline
• The Simple Circular Flow

• National Income Accounting
• Two Main Methods of Measuring GDP
• Other Components of National Income
Accounting
• Distinguishing Between Nominal and Real
Values
• Comparing GDP Throughout the World
8-5
Did You Know That...
• During the past half-century, manufactured

goods’ share of total U.S. output of goods
and services has declined by more than
one-half?
• The value of manufactured goods as a
percentage of gross domestic product (GDP)
has fallen from 28% in 1955 to >12%
today.
• The government conducts what has become
known as national income accounting.
8-6
The Simple Circular Flow
The concept of the circular flow of income

involves two principles:
1. In every economic exchange, the seller receives
exactly the same amount that the buyer
spends.
2. Goods and services flow in one direction and
money payments flow in the other.
8-7

(cont'd)
• Profits explained
– Question
• Why is profit a cost of production?
– Answer
• Profits are the return entrepreneurs receive for the risk
they incur when organizing productive activities.
8-8

(cont'd)
• Final Goods and Services
– Goods and services that are at their final stage of
production and will not be transformed into yet other
goods or services
8-9
Figure 8-1 The Circular Flow of
Income and Product
8-10

(cont'd)
• Product Markets
– Transactions in which households buy goods
8-11

(cont'd)
• Factor Markets
– Transactions in which businesses buy resources
8-12
(cont'd)
• Total Income
– Wages, rent, interest, profits
8-13

(cont'd)
• Question
– Why must total income be
identical to the dollar value
of total output?
• Answer
– Every transaction
simultaneously involves an
expenditure and a receipt.
8-14
National Income Accounting
• National Income Accounting

– A measurement system used to estimate
national income and its components
• Total Income
– The yearly amount earned by the nation’s
resources (factors of production)
8-15
(cont'd)
• Gross Domestic Product (GDP)
– The total market value of all final goods and
services produced by factors of production
located within a nation’s borders
8-16

(cont'd)
• Observations
– GDP measures the dollar value of final output.
– GDP measures the dollar value of final goods and
services produced per year by factors of
production located within a nation’s borders.
8-17

(cont'd)
• Stress on final output
– What is a final good?
• Wheat?
• Steel?
• Oil?
• Bread?
• Automobile?
• Gasoline?
8-18
(cont'd)
• Intermediate Goods
– Goods used up entirely in the production of final
goods
• Value Added
– The dollar value of an industry’s sales minus the
value of intermediate goods (for example, raw
materials and parts) used in production
8-19
Table 8-1 Sales Value and Value Added

at Each Stage of Donut Production
8-20

(cont'd)
Numerous transactions occur that have
nothing to do with final goods and services
being produced:
• Financial transactions
• Transfer Payments
• Secondhand Goods
8-21
(cont'd)
• Exclusion of financial transactions
– Securities
• Stocks and bonds
– Government transfer payments

• Social Security
• Unemployment compensation
– Private transfer payments

• Individual gifts
• Corporate gifts
8-22

(cont'd)
• Transfer of secondhand goods excluded
– Why not count the sale of a used computer,
guitar, or snowboard as part of GDP?
• Other excluded transactions

– Household production
– Legal and illegal underground transactions
8-23

(cont'd)
• GDP’s limitations
– Excludes non-market production
– It is not necessarily a good measure of the well-
being of a nation.
8-24
(cont'd)
• GDP is a measure of the value of production
in terms of market prices, and an indicator
of economic activity.
• GDP is not a measure of a nation’s overall
welfare.
8-25
International Example: Greece Pays a

Price for Broadening Its GDP Definition
• Greece’s government recently announced

that its official tabulation of GDP would
include production in black market
industries.
• Consequently, GDP rose by about 25% for
every year since 2000, which reduces the
amount of EU payments Greece is eligible
for by almost $600 million annually.
• Why is it harder now to compare Greek GDP
to the levels of other nations?
8-26
Two Main Methods of Measuring

GDP
• Expenditure Approach
– Computing GDP by adding up the dollar value at
current market prices of all final goods and
services
8-27
GDP (cont'd)
Expenditure Approach
8-28

GDP (cont'd)
• Income Approach
– Measuring GDP by adding up all components of
national income, including wages, interest, rent,
and profits
8-29

GDP (cont'd)
Income Approach
8-30
GDP (cont'd)
Deriving GDP by the Expenditure Approach
– Consumption Expenditure (C)
• Durable Consumer Goods
– Life span of more than three years
• Nondurable Consumer Goods

– Goods that are used up in three years
• Services
– Mental or physical help
8-31

GDP (cont'd)
– Gross Private Domestic Investment (I)
• The creation of capital goods, such as factories and
machines, that can yield production and hence
consumption in the future
– Also included: changes in business inventories and repairs
made to machines, buildings
8-32

GDP (cont'd)
– Gross Private Domestic Investment (I)
• Producer Durables or Capital Goods
– Life span of more than three years
• Fixed Investment
– Purchases by business of newly produced producer
durables or capital goods
• Inventory Investment
– Changes in stocks of finished goods and goods in process,
as well as changes in raw materials
8-33
GDP (cont'd)
– Government Expenditures (G)
• State, local, and federal
• Valued at cost
8-34

GDP (cont'd)
– Net Exports (Foreign Expenditures)
Net exports (X) = Total exports – Total imports
8-35

GDP (cont'd)
Presenting the Expenditure Approach
– Where
• C = consumption expenditures
•I = investment expenditures
• G = government expenditures
• X = net exports
GDP = C + I + G + X
8-36
Figure 8-2 GDP and Its
Components
8-37

GDP (cont'd)
Presenting the Expenditure Approach

• Depreciation and net domestic product
– Deducting for depreciation (capital consumption
allowance)
• Reduction in the value of capital goods over a
one-year period due to physical wear and tear,
and also to obsolescence
NDP = GDP – Depreciation
8-38

GDP (cont'd)
• NDP = GDP – Depreciation
• GDP = C + I + G + X
• NDP = C + I + G + X – Depreciation
• Net Investment = I – Depreciation
– Domestic investment minus an estimate of the
wear and tear on the existing capital stock
• NDP = C + Net I + G + X
8-39
GDP (cont'd)
Deriving GDP by the Income Approach
8-40

GDP (cont’d)
• Gross Domestic Income (GDI)
– The sum of all income (wages, interest, rent,
and profits) paid to the four factors of
production.
8-41

GDP (cont'd)
• Gross Domestic Income (GDI)
– Wages: salaries and labor income
– Rent: farms, houses, stores
– Interest: savings accounts
– Profits: sole proprietorships, partnerships,
corporations
8-42
GDP (cont'd)
• Gross domestic product equals gross
domestic income plus indirect business
taxes and depreciation
• These last items are called nonincome
expense items
8-43

GDP (cont'd)
• Indirect business taxes
– All business taxes except the tax on corporate
profits
– Include sales and business property taxes
8-44
Figure 8-3 Gross Domestic Product and Gross

Domestic Income, 2009 (in billions of 2009
dollars per year)
Sources: U.S. Department of Commerce and author’s estimates.

8-45
Figure 8-3 Gross Domestic Product and Gross
Domestic Income, 2009 (in billions of 2009
dollars per year)
Sources: U.S. Department of Commerce and author’s estimates.

8-46
Other Components of National

Income Accounting
• National Income (NI)
– The total of all factor payments to resource
owners
• Personal Income (PI)

– The amount of income that households actually
receive before they pay personal income taxes
8-47
Other Components of National

Income Accounting (cont'd)
• Disposable Personal Income (DPI)
– Personal income after personal income taxes
have been paid
8-48
Table 8-2 Going from GDP to
Disposable Income, 2009
8-49
Distinguishing Between Nominal

and Real Values
• Nominal Values
– Measurements in terms of the actual market
prices at which goods are sold; expressed in
current dollars, also called money values
• Real Values
– Measurements after adjustments have been
made for changes in the average of prices
between years; expressed in constant dollars
8-50

and Real Values (cont'd)
• Constant Dollars
– Dollars expressed in terms of real purchasing
power
– This price-corrected GDP is the real GDP.
8-51
Example: Correcting GDP for
Price Index Changes
• Correcting GDP for price index changes
– Nominal (current) dollars GDP
– Real (constant) dollars GDP
Nominal GDP
Real GDP = x 100
Price index*
*Price index: measured by the GDP deflator
8-52
Table 8-3 Correcting GDP for Price

Index Changes
8-53

and Real Values (cont'd)
• Per capita GDP
– Adjusting for population growth
Real GDP
Per capita real GDP =
Population
8-54
Figure 8-4 Nominal and Real GDP
Source: U.S. Department of Commerce

8-55
Comparing GDP Throughout the

World
• Foreign Exchange Rate
– The price of one currency in terms of another
8-56

World (cont'd)
• Foreign exchange rate
• $1.50 = 1 euro, or $1 = .67 euros
• French income per capita = 24,120 euros
• French per capita income in terms of dollars equals
24,120 euros x $1.50 = $36,180
8-57
World (cont'd)
• Purchasing Power Parity
– Adjustments in exchange rate conversions that
takes into account differences in the true cost of
living across countries
8-58
Table 8-4 Comparing GDP

Internationally
8-59
International Example: Purchasing Power

Parity Comparisons of World Incomes
• The International Monetary Fund accepted the

purchasing power parity approach a few years ago.
• It started presenting the statistics on each country’s
GDP relative to others and based on the purchasing
power parity relative to the dollar.
• Why is China’s per capita GDP higher based on
purchasing power parity?
8-60
Issues and Applications: Is U.S.
Fixed Investment Understated?
• Some economists argue that limiting business fix

investment only to tangible items is inappropriate.
• These economists contend that several other types
of business expenditures are forms of intangible
that should also be included as forms of business
fixed investment.
• Figure 8-5 illustrates how altering the present
definition of business fixed investment by adding
intangible forms of investment would change
business fixed investment’s share of GDP since
1950.
8-61
Issues and Applications: Is U.S. Fixed

Investment Understated? (cont’d)
• If intangibles were included today, business

fixed investment’s share of GDP would more
than double, from just over 8% to more
than 17%.
• What would happen to the level of GDP if
intangible forms of investment were
included within the current official definition
of business fixed investment?
8-62
Figure 8-5 U.S. Business Fixed Investment as a

Percentage of GDP Since 1950, Excluding and Including
Intangible Forms of Investment
Source: Carol Corrado, Dan Sickel, and Charles Hulten, “Intangible Capital and Economic Growth,”
Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System,
2006; author’s estimates.
8-63
Summary Discussion of Learning
Objectives
• The circular flow of income and output
– In every economic transaction, receipts exactly
equal expenditures
– Goods and services flow in one direction and
money payments flow in the other
• Gross domestic product (GDP)

– The total market value of a nation’s final output
of goods and services produced in a year using
factors of production located within its borders
8-64

Objectives (cont'd)
• The limitations of using GDP as a measure
of national welfare
– Excludes non-market transactions
– Does not measure national well-being
• The expenditure approach to tabulating GDP

– GDP = C + I + G + X
8-65

Objectives (cont'd)
• The income approach to computing GDP
– The sum of wages, rent, interest, profits
• Distinguishing between nominal GDP and

real GDP
– Nominal GDP is the value of newly produced final
output measured in current market prices.
– Real GDP adjusts nominal GDP into constant
dollars by correcting for price level changes.
8-66

Notes 08

Uploaded by

Copyright:

Available Formats

You might also like

Notes 08

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Notes 08

Uploaded by

Copyright:

Available Formats

Chapter 8

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.

For a number of years, measured U.S. business

• Describe the circular flow of income and

• Explain the expenditure approach to

• The Simple Circular Flow

Did You Know That...

• During the past half-century, manufactured

The concept of the circular flow of income

The Simple Circular Flow

The Simple Circular Flow

The Simple Circular Flow

The Simple Circular Flow

The Simple Circular Flow

National Income Accounting

• National Income Accounting

National Income Accounting

National Income Accounting

Table 8-1 Sales Value and Value Added

National Income Accounting

– Government transfer payments

– Private transfer payments

National Income Accounting

• Other excluded transactions

National Income Accounting

International Example: Greece Pays a

• Greece’s government recently announced

Two Main Methods of Measuring

Two Main Methods of Measuring

Two Main Methods of Measuring

• Nondurable Consumer Goods

Two Main Methods of Measuring

Two Main Methods of Measuring

Two Main Methods of Measuring

Net exports (X) = Total exports – Total imports

Two Main Methods of Measuring

Two Main Methods of Measuring

Presenting the Expenditure Approach

NDP = GDP – Depreciation

Two Main Methods of Measuring

Two Main Methods of Measuring

Two Main Methods of Measuring

Two Main Methods of Measuring

Figure 8-3 Gross Domestic Product and Gross

Sources: U.S. Department of Commerce and author’s estimates.

Sources: U.S. Department of Commerce and author’s estimates.

Other Components of National

• Personal Income (PI)

Other Components of National

Distinguishing Between Nominal

Distinguishing Between Nominal

Table 8-3 Correcting GDP for Price

Distinguishing Between Nominal

Source: U.S. Department of Commerce

Comparing GDP Throughout the

Comparing GDP Throughout the

Table 8-4 Comparing GDP

International Example: Purchasing Power