Measuring A Nation's Income: Principles: Chapter 20

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Measuring a Nation’s Income

Principles: Chapter 20

PowerPoint Slides prepared by:


Andreea CHIRITESCU
Eastern Illinois University

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Economics
• Microeconomics
– Study of how households and firms
• Make decisions
• Interact in markets
• Macroeconomics
– Study of economy-wide phenomena
• Including inflation, unemployment, and
economic growth

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Economy’s Income & Expenditure
• Gross Domestic Product (GDP)
– Measures the total income of everyone in
the economy
– Measures the total expenditure on the
economy’s output of goods and services
• For an economy as a whole
– Income must equal expenditure
– Why? Look at circular flow diagram

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Circular flow dagram

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The Measurement of GDP
• Gross domestic product (GDP)
– Market value of all final goods and
services
– Produced within a country
– In a given period of time
• “GDP is the market value…”
– Market prices - reflect the value of the
goods

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The Measurement of GDP
• “… of all…”
– All items produced in the economy
• And sold legally in markets
– Excludes most items
• Produced and sold illicitly
• Produced and consumed at home

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The Measurement of GDP
• “… final…”
– Value of intermediate goods is already
included in the prices of the final goods
• “… goods and services…”
– Tangible goods & intangible services
• “… produced…”
– Goods and services currently produced

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The Measurement of GDP
• “… within a country…”
– Goods and services produced
domestically
• Regardless of the nationality of the producer
• “… in a given period of time”
– A year or a quarter

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The Components of GDP
• Y = C + I + G + NX
• Spending side of GDP:
• Y = GDP
• C = consumption
• I = investment
• G = government purchases
• NX = net exports

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The Components of GDP
• Consumption, C
– Spending by households on goods and
services
– Exception: purchases of new housing
• Investment, I
– Spending on capital equipment,
inventories, and structures
– Household purchases of new housing
– Inventory accumulation
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The Components of GDP
• Government purchases, G
– Government spending on goods and
services and capital (roads) at all levels
– Does not include transfer payments

• Net exports, NX = Exports - Imports


– Exports are spending on domestically
produced goods by foreigners
– Imports are spending on foreign goods by
domestic residents
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Real versus Nominal GDP
• Total spending rises from one year to the
next
– Economy - producing a larger output of
goods and services
– And/or goods and services are being sold
at higher prices
• Nominal GDP
– Production of goods and services
– Valued at current prices
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Real versus Nominal GDP
• Real GDP
– GDP valued at constant prices
– Designate one year as base year
– Not affected by changes in prices
• For the base year
– Nominal GDP = Real GDP

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Table 2
Real and Nominal GDP

This table shows


how to calculate
real GDP,
nominal GDP,
and the GDP
deflator for a
hypothetical
economy that
produces only
hot dogs and
hamburgers.

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Real versus Nominal GDP
• The GDP deflator (overall price level)
– Ratio of nominal GDP to real GDP times
100
– Is 100 for the base year
– Measures the current level of prices
relative to the level of prices in the base
year
– Can be used to take inflation out of
nominal GDP (“deflate” nominal GDP)

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Calculation
• Let’s now return to our numerical example.
• For year 2013, nominal GDP is €200, and real GDP is €200, so the
GDP deflator is 100.
• For the year 2014, nominal GDP is €600, and real GDP is €350, so
the GDP deflator is 171. Because the GDP deflator rose in year
2014 from 100 to 171, we can say that the price level increased by
71 per cent.

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Figure 2
Real GDP in the United States

This figure shows quarterly data on real GDP for the U.S. economy since 1965. Recessions—
periods of falling real GDP—are marked with the shaded vertical bars.
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GDP
• GDP – “the best single measure of the
economic well-being of a society”
– Economy’s total income
– Economy’s total expenditure
– Larger GDP
• Good life, better healthcare
• Better educational systems
– Measure our ability to obtain many of the
inputs into a worthwhile life
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GDP
• GDP – not a perfect measure of well-
being
– Doesn’t include
• Leisure
• Value of almost all activity that takes place
outside markets (at home for example)
• Quality of the environment
– Nothing about distribution of income

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International differences: GDP & quality of life
• Rich countries - higher GDP per person
– Better
• Life expectancy
• Literacy
• Internet usage
• Poor countries - lower GDP per person
– Worse
• Life expectancy
• Literacy
• Internet usage
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a 20
certain product or service or otherwise on a password-protected website for classroom use.
Table 3
GDP and the Quality of Life

The table shows GDP per person and three other measures of the quality of life for
twelve major countries.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a 21
certain product or service or otherwise on a password-protected website for classroom use.
Review questions

•1 Explain why an economy’s income must equal its expenditure.


•2 What is meant by the term GDP per capita and how is it
measured?
•3 Which contributes more to GDP – the production of an economy
car or the production of a luxury car? Why?
•4 A farmer sells wheat to a baker for €2. The baker uses the wheat
to make bread, which is sold for €3. What is the total contribution
of these transactions to GDP?
•Many years ago, Jamanda paid €500 to put together a record
collection. Today she sold her albums at a car boot sale for €100.
How does this sale affect current GDP?

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Review questions

•6 List the four components of GDP. Give an example of


each.
•7 Why do economists use real GDP rather than nominal
GDP to gauge economic well-being?
•8 Why is it desirable for a country to have a large GDP?
Give an example of something that would raise GDP and
yet be undesirable.
•9 What are the limitations of using GDP as a measure of
well-being for a country?

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