1010Measuring a Nation’s Income

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.

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.

THE MEASUREMENT OF GROSS DOMESTIC PRODUCT

• “GDP is the Market Value . . .”• Output is valued at market prices.

• “. . . Of All Final . . .”• It records only the value of final goods, not

intermediate goods (the value is counted only once).

• “. . . Goods and Services . . . “• It includes both tangible goods (food, clothing,

cars) and intangible services (medical, legal, retail sales).

THE MEASUREMENT OF GROSS DOMESTIC PRODUCT

• “. . . Produced . . .”• It includes goods and services currently produced,

not transactions involving goods produced in the past.

• “ . . . Within a Country . . .”• It measures the value of production within the

geographic confines of a country.

THE MEASUREMENT OF GROSS DOMESTIC PRODUCT

• “. . . In a Given Period of Time.”• It measures the value of production that takes place

within a specific interval of time, usually a year or a quarter (three months).

GDP vs GNP

• Domestic Product – within a country

• National Product – owned by country’s citizens

• Example – Subaru plant – US GDP, Japan’s GNP

• GNP - the market value of all final goods and services produced by factors owned by a country’s citizens in a given period of time.

Figure 1 The Circular-Flow Diagram

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods and services

•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

Calculating GDP

• Expenditure Approach

• Income Approach

THE COMPONENTS OF GDP

• GDP (Y) is the sum of the following:• Consumption (C)

• Durable goods• Non-durable Goods

• Investment (I)• Non-residential• Residential (Housing)• Inventories

• Government Purchases (G)• Net Exports (NX) = Exports - Imports

Y = C + I + G + NX

Table 1 GDP and Its Components (2010)

Total Percentage

GDP (Y) 14143.3 100%

Consumption (C) 9996.6 70%

Investment (I) 1558.6 11%

Government Purchases (G) 2926.8 21%

Net Exports (NX) -338.7 -2%

GDP and Its Components

Consumption 69%

Government Purchases

18% Net Exports -3 %

Investment16%

Income Approach

• National Income• Compensation of employees 57%

• Proprietor’s income 7%

• Corporate profits 9%

• Interest and rental income 7%

• Depreciation 13%

• Indirect Taxes and Subsidies 7%

• Net Factor Payments to rest of the world

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.

Table 2 Real and Nominal GDP

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 measures the changes in the price level.

The GDP Deflator

• The GDP deflator is calculated as follows:

G D P d efla to r =N o m in a l G D P

R eal G D P 1 0 0

The GDP Deflator

• Converting Nominal GDP to Real GDP• Nominal GDP is converted to real GDP as follows:

R eal G D PN o m in a l G D P

G D P d efla to r2 0 X X2 0 X X

2 0 X X

1 0 0

Figure 2 Real GDP in the United States

Billions of1996 Dollars

$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,0001970 1975 1980 1985 1990 20001995

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.

Limitations of GDP

• Measures only income – ignores quality of education, medical care, environment

• Excludes non-market production

• Excludes underground economy

Country Real GDP perperson (2005)

Life expectancy

Adult literacy(% of population)

Internet usage(% of population)

United StatesJapan GermanyRussia Mexico Brazil China Indonesia India Pakistan Bangladesh Nigeria

$41,890 31,26729,46110,84510,7518,4026,7573,8433,4522,3702,0531,128

78 years 8279657672727064656347

99%9999999289919061504769

63 %67451518199737

0.34

The table shows GDP per person and three other measures of the quality of life for twelve major countries.

Table 3 GDP, Life Expectancy, and Literacy

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 economy’s 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 calculated through four components of expenditure: consumption, investment, government purchases, and net exports.

Summary

• Nominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services.

• The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy.