6

THE DATA OF MACROECONOMICS

Measuring a Nations
Income

15

Distinction between Microeconomics and

Macroeconomics
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.

Macroeconomics
Macroeconomics answers the following
questions:
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?

THE ECONOMYS INCOME AND

EXPENDITURE
How do we know whether the economy as a
whole is doing well or poorly?
One measure is the total income that everyone in the
economy is earning.

For an economy as a whole, income must equal

expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar of
income for some seller.

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.
If someone pays someone else $100 to mow a lawn,
the expenditure on the lawn service ($100)
is exactly equal to the income earned from the production
of the lawn service ($100).

The equality of income and expenditure can be

illustrated with the circular-flow diagram.

The Circular-Flow Diagram

MARKETS
FOR
GOODS AND SERVICES
Firms sell
Goods
Households buy
and services
sold
Revenue

Wages, rent,
and profit

Goods and
services
bought

HOUSEHOLDS
Buy and consume
goods and services
Own and sell factors
of production

FIRMS
Produce and sell
goods and services
Hire and use factors
of production

Factors of
production

Spending

MARKETS
FOR
FACTORS OF PRODUCTION
Households sell
Firms buy

Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars

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.
What does it mean?

MORE ON THE DEFINITION OF THE GDP

GDP IS THE MARKET VALUE . . .
To add together different items, market values are used.
Market values are calculated by using market prices.

. . . OF ALL. . .
GDP includes all items produced and sold legally in the
economy.
The value of housing services is somewhat difficult to
measure.
If housing is rented, the value of the rent is used to measure the value
of the housing services.
For housing that is owned (or mortgaged), the government estimates
the rental value and uses this figure to value the housing services.

GDP does not include illegal goods or services or items that

are not sold in markets.
When you hire someone to mow your lawn, that production is included
in GDP.
If you mow your own lawn, that production is not included in GDP.

MORE ON THE DEFINITION OF THE GDP

. . . FINAL . . .
Intermediate goods are not included in GDP (the value is counted only
once).
The value of intermediate goods is already included as part of the value of
the final good.
Investment goods (such as structures and vehicles used in production) are not
intermediate goods.
Investment goods represent products purchased for final use by business firms.

Exception: Intermediate Goods that are placed into inventory are

considered to be final and included in GDP as a firms inventory
investment.
Goods that are sold out of inventory are counted as a decrease in inventory
investment.
The goal is to count the production when the good is finished, which is not
necessarily the same time that the product is sold.

. . . GOODS AND SERVICES . . .

It includes both tangible goods (food, clothing, cars) and intangible
services (haircuts, housecleaning, doctor visits).

MORE ON THE DEFINITION OF THE GDP

. . . PRODUCED . . .
It includes goods and services currently produced, not transactions
involving goods produced in the past.

. . . WITHIN A COUNTRY . . .
GDP measures the production that takes place within the
geographical boundaries of a particular country.
If a Mexican citizen works temporarily in the United States, the value of his
output is included in GDP for the United States.
If an American owns a firm in Mexico, the value of the production of that
firm is not included in U.S. GDP.
The production of a German firm operating in the United States is part of
U.S. GDP.
Even though it is a foreign firm, the firms workers are living in the United States
and buying clothes, groceries, and other goods in the United States.
Thus, the workers in the foreign firm operating in the United States are fueling
the domestic economy.

MORE ON THE DEFINITION OF THE GDP

. . . IN A GIVEN PERIOD OF TIME.

The usual interval of time used to measure GDP is a
quarter (three months).
When the government reports GDP, the data is
generally reported on an annual basis.
In addition, data are generally adjusted for regular
seasonal changes (such as Christmas).

Other Measures of Income

Gross National Product (GNP) is the total income earned by a nations permanent
residents.
GNP includes income that American citizens earn abroad.
GNP excludes income that foreigners earn in the United States.

Net National Product (NNP) is the total income of a nations residents (GNP) minus losses
from depreciation (wear and tear on an economys stock of equipment and structures).

National income is the total income earned by a nations residents in the production of
goods and services.
National income differs from NNP by excluding indirect business taxes and including business
subsidies.
NNP and national income also differ due to statistical discrepancy.

Personal income is the income that households and noncorporate businesses receive.
Unlike National Income, PI excludes retained earnings, corporate income taxes and
contribution to social insurance.
But includes the interest income of households from their holding of government debt and
from government transfers.

Disposable personal income is the income that households and noncorporate businesses
have left after taxes and other obligations to the government.

Example

One day Barry the Barber, Inc. collects $400 for haircuts. Over this
day, his equipment depreciates in value by $50. Of the remaining
$350, Barry sends $30 to the government in sales taxes, takes home
$320 in wages, and retains $100 in his business to add new equipment
in the future. From the $220 that Barry takes home he pays $70 in
income taxes. Based on this information, compute Barrys
contribution to the following measures of income.
Gross domestic product
GDP equals the dollar amount Barry collects, which is $400.

Net national product

NNP = GDP depreciation = $400 - $50 = $350.

National Income
National income = NNP - sales taxes = $350 - $30 = $320.

Personal Income
Personal income = national income - retained earnings = $320 - $100 = $220.

Disposable personal income.

Disposable personal income = personal income - personal income tax = $220 $70 = $150.

THE COMPONENTS OF GDP

GDP includes all items produced in the economy
and sold legally in markets.
What Is Not Counted in GDP?
GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
Products created and consumed within households

It excludes items produced and sold illicitly, such as

illegal drugs.

THE COMPONENTS OF GDP

GDP (Y) is the sum of the following:
Y = C + I + G + NX
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.

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.

US GDP and Its Components in 2009

This table shows total GDP for the U.S. economy in 2009 and
the breakdown of GDP among its four components. When
reading this table, recall the identity
Y = C + I + G + NX.
What do the negative numbers in the net exports column
mean?

The components of U.S. GDP

2009, GDP of the U.S. = $14 trillion
GDP per person = $46,372

Consumption = $32,823 per person

Investment = $5,278 per person
Government purchases = $9,540 per person
Net exports = $1,269 per person

19

GDP and Its Components (2011)

Government Purchases
18%
Net Exports
Investment
-3
%
16%

Consumption
69%

REAL VERSUS NOMINAL GDP

Nominal GDP values the production of goods and
services at current prices.
Real GDP values the production of goods and services
at constant prices.
There are two possible reasons for total spending to rise from
one year to the next.
The economy may be producing a larger output of goods and
services.
Goods and services could be selling at higher prices.

When studying GDP over time, economists would like to

know if output has changed (not prices).
=> economists measure real GDP by valuing output using a
fixed set of prices.
An accurate view of the economy requires adjusting nominal to real
GDP by using the GDP deflator.

Table 2 Real and Nominal GDP

Nominal GDP values the production of goods and services at

current prices.

Table 2 Real and Nominal GDP

Real GDP values the production of goods and services at constant prices.

Lets assume that the base year is 2010.

Because real GDP is unaffected by changes in prices over time, changes in real GDP
reflect changes in the amount of goods and services produced.
When there is inflation, nominal GDP can increase while real GDP actually declines.

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.
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 is calculated as follows:

Nominal GDP
GDP deflator =
100
Real GDP

Converting Nominal GDP to Real GDP

Nominal GDP is converted to real GDP as follows:

Real GDP2006

Nominal GD P2006
=
100
GDP deflator2006

Table 2 Real and Nominal GDP

Nominal GDP and real GDP will be equal in the base year.
Therefore GDP deflator for the base year will always be
equal to 100.

Figure 2 Real GDP in the United States

1. Figure 2 shows quarterly data on real GDP for the United States since
1970.
2. Notice that real GDP has increased over time.
3. Notice also that there are times (shaded bars) when real GDP
declines. These periods are called recessions.

GDP AND ECONOMIC WELL-BEING

GDP is the best single measure of the economic
well-being of a society.
GDP per person tells us the income and
expenditure of the average person in the
economy.
Higher GDP per person indicates a higher
standard of living.
However, GDP is not a perfect measure of the
happiness or quality of life.

GDP AND ECONOMIC WELL-BEING

Some things that contribute to well-being
are not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes
place outside of markets, such as the value of
the time parents spend with their children and
the value of volunteer work.

GDP, Life Expectancy, and Literacy

The Table shows real GDP per person, life expectancy, and adult literacy rates for
12 countries.
In rich countries, life expectancy is higher and adult literacy rates are also high.
In poor countries, people typically live only into their 50s and only about half of
the adult population is literate.

Summary
Because every transaction has a buyer and a
seller, the total expenditure in the economy must
equal the total income in the economy.
Gross Domestic Product (GDP) measures an
economys total expenditure on newly produced
goods and services and the total income earned
from the production of these goods and services.

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

Summary
Nominal GDP uses current prices to value the
economys production. Real GDP uses constant
base-year prices to value the economys
production of goods and services.
The GDP deflatorcalculated from the ratio of
nominal to real GDPmeasures the level of
prices in the economy.

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, such as leisure time and a clean
environment, arent measured by GDP.