Chapter 8- Measuring Total Production & Income. Distribution of GDP

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1 Chapter 8- Measuring Total Production & Income Distribution of GDP 1

2 Keeping Tabs on the Economy You must be able to measure and track the economy in order to understand what is going on and react appropriately. In the U.S. the Bureau of Economic Analysis compiles this data. 2

3 National Income Accounts The Bureau of Economic Analysis (BEA) compiles data in what we call the national income and product accounts. National Accounts: Keep track of the flow of money between different sectors of the economy. 3

4 National Income Accounting- a set of rules and definitions for measuring economic activity in the aggregate economy (economy as a whole) 4

5 GDP (Gross Domestic Product)- the total market value of all final goods/services produced in an economy in a one-year period Measures values, not quantities GDP measures only final goods- a good/service purchased by a final user Intermediate good- a good/service that is an input to another good/service GDP only includes current production 5

6 GNP (Gross National Product)- Aggregate final output of citizens and businesses of an economy in a one-year period. Citizens working over seas not counting in GDP Economic output produced by citizens 6

7 GDP: Measuring Total Production and Income Expansion: The period of a business cycle during which total production and total employment are increasing. Recession: The period of a business cycle during which total production and total employment are decreasing. Economic growth: The ability of an economy to produce increasing quantities of goods and services. 7

8 GDP: Measuring Total Production and Income Business cycle Alternating periods of economic expansion and economic recession. 8

9 Production, Income, and the Circular Flow Diagram The Circular Flow and the Measurement of GDP 9

10 Four Components of GDP Consumption (C) Government Spending (G) Investment (I) International Spending (NX) 10

11 Households (C) Consumer Spending: Household spending on goods and services, not including spending on new houses. Consumer spending on services is greater than the sum of spending on durable and nondurable goods. Most households receive the majority of their income from wages, but some receive investment income in the form of profits, interest, and rents. 11

12 Gross Domestic Product Measures Total Production Production, Income, and the Circular Flow Diagram Transfer payments: Payments by the government to individuals for which the government does not receive a new good or service in return. 12

13 Households cont d Government Transfers: Cash payments by the government to individuals. Disposable Income: Money available to spend on consumption and savings. DI = Income + Government Transfers - Taxes 13

14 Households cont d Private Savings: What consumers have left of disposable income after consuming. S-private = Disposable Income - Spending The total flow of money out of households must equal the total flow of money in. 14

15 Government (G) Government purchases: Spending by federal, state, and local governments on goods and services. Governments, just like other institutions, purchases goods and services. Government Borrowing: If the government can t afford it s programs, it must turn to financial markets to borrow. Purchases made by state and local governments are greater than purchases made by the federal government. 15

16 Making the Connection Spending on Homeland Security Government spending on homeland security more than doubled between 2001 and 2006.

17 Business Investment (I) Investment: Spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses. Business fixed investment is the largest component of investment Don t Let This Happen to YOU! Remember What Economists Mean by Investment 17

18 International Sector (NX) Exports: Goods and services sold to residents of other countries. Imports: Goods and services purchased from other countries. Net Exports: The difference between the value of exports and the value of imports. NX = Exports - Imports Imports are greater than exports, so net exports are negative. 18

19 GDP GDP=Y=C+I+G+NX GDP is used as a measure of the size of an economy and can be used to both track the economy and to compare with others. U.S. GDP 2007: $13,768.8 billion U.S. GDP 2009: $14,256 billion U.S. GDP 2011: $15,094 billion 19

20 Gross Domestic Product Measures Total Production Components of GDP in 2010

21 2 Ways to Measure GDP 1. Measuring GDP by the Value-Added Method Value added : The market value a firm adds to a product. Calculating Value Added FIRM VALUE OF PRODUCT VALUE ADDED Cotton Farmer Value of raw cotton = $ Value added by cotton farmer = 1 Textile Mill Shirt Company L.L. Bean Value of raw cotton woven into cotton fabric = $3 Value of cotton fabric made into a shirt = $15 Value of shirt for sale on L.L. Bean s Web site = $35 Value added by cotton textile mill = ($3 $1) = 2 Value added by shirt manufacturer = ($15 $3) = 12 Value added by L.L. Bean = ($35 $15) = 20 Total Value Added = $35 21

22 Does GDP Measure What We Want It to Measure? GDP doesn t count all forms of production. Household Production Household production refers to goods and services people produce for themselves. The Underground Economy Underground economy: Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. 22

23 The Underground Economy is Growing! 23

24 Does GDP Measure What We Want It to Measure? Shortcomings of GDP as a Measure of Well-Being The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution or Other Negative Effects of Production GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up 24

25 Making the Connection Did World War II Bring Prosperity?

26 Real GDP versus Nominal GDP Calculating Real GDP Real GDP The value of final goods and services evaluated at base-year prices. Nominal GDP The value of final goods and services evaluated at current-year prices. 26

27 Example 1 Year Nominal GDP GDP Deflator 1998 $8, $9, $9, $10, Find Real GDP in Find Real GDP in Find Real GDP in Find Real GDP in 2001 Note: (We could calculate the percentage change between each year to find how much production of goods/services change.) 27

28 Real GDP versus Nominal GDP Nominal GDP and Real GDP,

29 Real GDP versus Nominal GDP The GDP Deflator Price level A measure of the average prices of goods and services in the economy. GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. GDP deflator Nominal GDP Real GDP

30 Example 2 Nominal GDP Real GDP Deflator 1999 Level $9,274.3 $8, Level $9,824.6 $ % Change 30

31 Other Measures of Total Production and Total Income Net National Product (NNP) National Income Personal Income 31