©2012 The McGraw-Hill Companies, All Rights Reserved 1 Chapter 14: Spending, Income, and GDP.

©2012 The McGraw-Hill Companies, All Rights Reserved

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Chapter 14: Spending, Income, and GDP


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Learning Objectives

1. Explain how economist define and measure an economy's output

2. Use the expenditure method for measuring GDP to analyze economic activity

3. Define and compute nominal GDP and real GDP

4. Discuss the relationships between GDP and economic well-being


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Macroeconomics

Data on output, employment, prices Vital signs of the economy

Employment, unemployment, average work hours

Stock values and trends Prices and inflation

Reported often in the newsSystematic measurement of

economic output developed during World War II Common systems and measured used

virtually worldwide


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Measuring Output


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Market Value

A modern economy produces many different goods and services

Macroeconomists’ goal is to understand the behavior of the economy as a whole This is done through answers to the

following questions: Has the overall capacity of the economy to

produce goods and services increased over time?

If so, by how much?Economists aggregate the quantities

of the many different goods and services into a single number


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Market Value

Aggregate measure of quantities producedWeighs more expensive items more

Willingness to pay is an indication of benefit from the good

Orchardia's GDP = (4 apples$0.25/apple) + (6 bananas$0.50/banana) + (3 pairs of shoes$20.00/pair) = $64

Orchardia Apples Bananas Shoes

Price $0.25 $0.50 $20.00

Quantity 4 6 3

GDP contribution $1.00 $3.00 $60.00


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Market Value

Suppose now:

Orchardia's GDP (3 apples$0.25/apple) + (3 bananas$0.50/banana)+ (4 pairs of shoes$20.00/pair) = $82.25 > $64 The good whose production has increased

(shoes) is much more valuable than the goods whose production has decreased (apples and bananas)

Orchardia Apples Bananas Shoes

Price $0.25 $0.50 $20.00

Quantity 3 3 4

GDP contribution $0.75 $1.50 $80.00


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Female Labor Force Participation

The percentage of adult women working outside the home has increased dramatically over the past three decades in the Middle East and North Africa Women’s labor force participation:

Egypt: 7% in 1980 to about 26% in 2005 Morocco: 15% in 1982 to about 30% in 2007

Still it remains very low relative to other industrialized nations such as the US and the UK (60% and 70%)

If more women join the workforce, how is this change expected to affect measured GDP?


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Female Labor Force Participation

The entry of more women into the labor market can raise measured GDP in two ways: The goods and services that women produce in

their new jobs contribute directly to increasing GDP

Represents a genuine increase in economic activity The fact that paid workers take over previously

unpaid housework and childcare duties increases measured GDP by the amount paid to those workers

Reflects a transfer of existing economic activities from the unpaid sector to the market sector

Measured change in GDP overstates actual change


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Increasing Efficiency

Principle of Comparative Advantage applies to household tasks Produce at lowest opportunity cost Women with high opportunity cost of

household tasks find other ways to get the tasks completed

Feminist movement, civil rights concerns, increasing educational attainment, and loosening social constraints moved women into the work force Household tasks performed by paid specialists


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Some Non-Market Goods Included

Government goods and services are not sold in the market

Protection by the army / transportation / education

These goods have value Increase overall output Quantities are known Prices cannot be established

Government production is valued at cost Overstates GDP if there is waste and

inefficiency


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Final Goods and Services

Final goods are consumed by the ultimate user End products of production Included in GDP

Intermediate goods are used up in the production of final goods Not included in GDP

Avoids double countingA barber's assistant earns $2 per

haircut for providing services such as shampooing and sweeping up Barber charges $10 per haircut Haircut's contribution to GDP is $10


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Goods Can Be Final and Intermediate

Milk can be sold as: A final product: milk in the grocery store sold to

households An intermediate good: milk sold to restaurants

Count only the final goodsA capital good, difficult to classify, is

a long-lived good used in the production of other goods and services Houses, apartments, and motels Stoves in restaurants, cooking schools Delivery vehicles and taxis

Money is not a capital good


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Produced in a Country in a Period of Time

"Domestic" in GDP means the activity is measured within a country's borders Nationality of owners or company is not

relevantValue must be produced in the year

considered Sell a 20-year old house for $200,000

• House was not produced in the period of time studied

Pay $12,000 commission value added is $12,000

• Since the service was provided during the current year, the agent’s fee is counted in current-year GDP


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The Value Added Method for Measuring GDP

Value added is the market value of the product minus the cost of inputs purchased from other firms Count value added in the year it is

produced Suppose that the bread is the ultimate

product of three corporationsCompany

Revenues - Cost of Purchased Inputs = Value Added

ABC Grain $0.50 $0.00 $0.50

General Flour

$1.20 $0.50 $0.70

Hot'n'Fresh $2.00 $1.20 $0.80

Total $2.00


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The Expenditure Method for Measuring GDP

Users of final goods can be divided into 4 groups Households(C) ■ Firms (I) Government (G) ■ Foreigners (NX)

All goods produced are purchased by one of these groups in a given year

Amount spent = market valueGDP can be measured two ways

Market value Total spending for final goods less value

of imports


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The Expenditure Method for Measuring GDP


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Consumption Expenditure

Spending by households for goods and services is divided into three subcategories Consumer durables are long-lived

consumer goods

Consumer non-durable goods are shorter-lived goods

Services are the largest component of consumer spending

Cars Furniture Appliances

Clothing Food Bedding

Education Taxi rides Haircuts


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Investment

Investment can be divided into three subcategories Business fixed investment is purchases

of new capital goods

Residential investment is construction of new homes and apartment buildings

Inventory investment is the change in unsold goods to the company's inventory

These goods are produced but not yet sold This entry can be positive or negative Negative inventory investment means less in

inventory at year-end than at the beginning

Plant Property Equipment


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Economic Investment and Financial Investment

The purchase of stocks and bonds do not represent an investment, as defined in this chapter. Rather, they are referred to as financial investments.

Financial investments include purchases of stocks, bonds, and other financial assets Purchase generally transfers ownership of a

portion of the firm's existing capital stock Does not correspond to any increase in physical

capital or production capacity, in most cases New stock issues can be an exception

Economic investment refers to the increase in the capital goods used to produce other goods This value is based on purchase price of the

capital goods, not on stock value


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Government Purchases

Federal, state, and local government purchase final goods and services

Excludes transfer payments Transfer payments are made by

government but the government receives no current goods or services

Pension benefits, unemployment No purchases of final goods and services

involved in transfer payments• Spending by recipients is included in GDP

Excludes interest paid on government debt

Fighter jets Teaching Office supplies


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Net Exports

Net exports are exports (X) minus imports (M) Exports are goods and services

produced domestically and sold abroad Exports reduce the amount available to the

domestic economy Imports are purchases of goods and

services produced abroad Imports can be consumption, investment, or

government spending Imports increase the amount available to the

domestic economy


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GDP Expenditures Equation

Terminology

Expenditure approach to measuring GDP

Y = C + I + G + NX

Y Gross Domestic Product or output

C Consumption Expenditure

I Investment

G Government Purchases

NX Net Exports


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GDP Example

Total production is 1 million cars valued at $15,000 each

Total Production value is 1 million × $15,000 = $15 billion

25,000 cars are unsold Investment in inventories increases by $0.375 billion

GDP Contribution

$10.500 billion

$3.000 billion

$0.750 billion

$0.375 billion

$14.625 billion

Sector # Cars Purchased

Consumers 700,000

Businesses 200,000

Government 50,000

Net exports 25,000

Total 975,000

Investment 225,000 $3.375 billion

Total 1,000,000 $15.000 billion


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Expenditure Components of GDP


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The Income Method for Measuring GDP

There are three ways to measure GDP Measure of total production Measure of total expenditure Measure of incomes of capital and

labor

All three methods should give the same final answer


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The Income Method for Measuring GDP

When a good is sold, its proceeds are distributed to workers or business owners

GDP = labor income + capital incomeLabor income is wages, salaries,

benefits, and incomes of the self-employed About 71 percent of GDP in the UAE (2008)

Capital income pays for physical capital and intangibles

Measured before taxes

Profits for business owners Rent for land

Interest for bond holders Royalties


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The Three GDP Approaches

Expenditure

Investment

Consumption

Government

purchasesNet exports

Income

Capital Income

Labor Income

Production

Market Value of

Final Goods

and Services


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Nominal GDP versus Real GDP

Compare GDP for different years to see how much output has changed

GDP changes over time because Prices change

AND / OR

Quantity of output changesTo see how much output has grown,

use only the changes in quantities Hold prices constant


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The Shirts and Skirts Economy

GDP in 2009 is $175; GDP in 2013 is $420 Only twice as many goods were produced in

2013 Comparing the GDP for the year 2009 to the

GDP for the year 2013, we might conclude that it is 2.4 times greater: 2.4 = ($420/$175)

Because of the increase in prices, the market value of production grew more than the physical volume of production

Number of Shirts

Price of Shirts

Number of Skirts

Price of Skirts

Nominal GDP

2009 10 $10 15 $5 $175

2013 20 $12 30 $6 $420


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Real GDP and Nominal GDP

Real GDP (RGDP) values output in the current year using the prices from the base year The base year is a reference year that

changes infrequently Real GDP measures the physical volume

of productionNominal GDP (NGDP) values

output in the current year using prices from the current year Nominal GDP is the current dollar value

of production


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Calculating Real GDP for 2013

Use 2009 as the base yearNominal GDP for 2009 is $175 and

for 2013, $420Calculate real GDP using current

year quantities and base year prices

Number of Shirt

Price of Shirts

Number of Skirts

Price of Skirts

2009 10 $10 15 $5

2013 20 $12 30 $6


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Calculating Real GDP for 2013

Now we can determine how much real production has actually grown over the four-year period

By using RGDP, we have eliminated the effects of price changes and obtained a reasonable measure of the actual change in physical production over the four-year span


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Chain Weighting

Another method to calculate RGDP RGDP from a chain weighting approach is

Less sensitive to the choice of the base year Chain weighting is similar to the simpler

process Geometric average (where the subscript

is the price year)

Consistent with the income method, RGDP doubles between 2009 and 2013.


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Observations on Real and Nominal GDP

Usually, nominal and real GDP increase each year

Nominal GDP can go up and real GDP go down Fewer goods and services produced AND Prices increase faster than output decreased

Nominal GDP will be smaller than real GDP if the prices in the current year are less than in the base year Usually true for years before the base year

Real GDP could rise and nominal GDP fall, but this is rare Prices are falling faster than output is increasing


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Calculating the Price Level

RGDP measures the change in output by constant prices.

In a world of rising prices, nominal GDP is deflated by a factor, that we call GDP Deflator. The GDP deflator captures output

prices in a particular year relative to a selected base year.


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GDP Deflator

The GDP deflator represents a measure of the overall price level of produced goods and services.

The GDP deflator is equal to 100 in the base year.

It is greater than 100 when the current year’s prices exceed the base year’s prices.

It is less than 100 when the current year’s prices are lower than the base year’s prices.


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Calculating Inflation

Following the previous example we have

The percent change column shows that prices have increased by 20%


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Real GDP and Economic Well-Being

Real GDP is a flawed measure of well-being It values only market transactions

Omits illegal transactions, volunteer work, and household production

Maximizing GDP will not necessarily maximize national well-being Whether increases in output increase

welfare is a case-by-case issue


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GDP Does Not Value Leisure

Amount of leisure time has increased in the past 100 years Work weeks are shorter People enter the labor force at an older age People retire earlier

Leisure produces no goods for market GDP places a value of zero on all leisure time Opportunity cost of an hour of leisure is your

hourly wage Omission of the value of leisure time makes

GDP seem smaller


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Nonmarket Economic Activities

GDP omits services that are not traded in markets Household production

This is of particular importance to developing countries where services are commonly traded for others

Volunteer servicesValuing these services would be difficultNonmarket activities are important in

poor countries Self-sufficient households and bartered

goods and services


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Underground economy

Underground economy is all unreported transactions, legal and illegal

Casual labor is often paid in cash Failure to report transaction reduces taxes Includes baby sitters, lawn care, home repair,

etc.Some underground activity is illegal

A service of value is provided Drug dealers, etc

Estimates suggest the underground economy is large regardless of national income level


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Environmental Quality

Suppose a factory is built in your town People are employed and output is

produced Productive activity is included in GDP

Suppose further that the factory creates pollution Your city hires a company to restore the

environment to its initial condition Clean-up activities are included in GDP

Gets environment back to its starting point, not better


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Resource Depletion

No adjustment is made for the decline in resource availability when mining or other harvesting is done One more barrel of oil on the market

means one less barrel for future useEnvironmental quality and resource

depletion are difficult to value They have value and that value is

omitted from GDP


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Other Quality of Life Considerations

GDP does not account for intangibles people value Crime rates Traffic congestion Civic organizations Open space Sense of community


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Poverty and Economic Inequality

GDP measures the total quantity of goods and services produced and sold in an economy, but it conveys no information about who gets to enjoy those goods and services

Two countries may have identical GDPs but differ radically in the distribution of economic welfare across the population

GDP does not capture the effects of income inequality Most would prefer living in a relatively equal

society to one with a few wealthy and many poor


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GDP as a Welfare Measure

GDP omits and undervalues some goods and services

GDP per capita is positively associated with several measures of well-being Material standard of living: more goods

and services Health and life expectancy

Residents of industrialized countries fare better than residents of developing countries in a range of health measures

Education Literacy and school enrollment rates are

higher in high-income countries


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GDP as a Welfare Measure

©2012 The McGraw-Hill Companies, All Rights Reserved 1 Chapter 14: Spending, Income, and GDP.

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Transcript of ©2012 The McGraw-Hill Companies, All Rights Reserved 1 Chapter 14: Spending, Income, and GDP.