Chapter 4 Spending, Income, and GDP - PowerPoint Presentation

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Chapter 4

Spending, Income, and GDP

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Macroeconomics: Data and Issues

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Learning Objectives

Explain how economist define and measure an economy's output

Use the expenditure method for measuring GDP to analyze economic activity

Define and compute nominal GDP and real GDP

Discuss the relationships between GDP and economic well-being

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Measuring Output

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Market Value

Aggregate measure of quantities producedWeighs more expensive items moreWillingness to pay is an indication of benefit from the goodOrchardia's GDP is $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

A convenient way to aggregate the many different goods and services produced in a modern economy.

However, non-market activities are not counted in GDP

Unpaid work of a homemaker

paid house keeping and child care services

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Women's labor force participation and GDP measurement

Women's labor force participation increased since 1960

Measured GDP increased

Working women's output measured and counted

a real addition to GDP

Paid workers provide previously unpaid childcare

Not a real addition to goods and services produced

Measured change in GDP overstates actual change

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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 counting

A 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, not $12.

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Value-added Method

Value added is the market value of the product minus the cost of inputs purchased from other firmsCount value added in the year it is producedHot'n'Fresh buys flour and other inputs to make bread that sells for $2.00

CompanyRevenuesCost of Purchased InputsValue AddedABC Grain $0.50$0.00$0.50General Flour$1.20$0.50$0.70Hot'n'Fresh$2.00$1.20$0.80Total$2.00

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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 relevant

Value must be produced in the year considered

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

Pay $12,000 commission

Value added is $12,000

House was not produced in the period of time studied

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Expenditure Method for GDP

Four users of final goods

Households

■

Firms

Government

■

Foreigners

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

Amount spent = market value

GDP can be measured by:

Total spending for final goods less value of imports

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Consumption

$9,732.0 Durable Goods $1,079.6 Non-durable Goods 2,833.0 Services 5,819.4

Government Purchases 2,691.4

Investment 2,132.3 Business Fixed Investment 1,483.2 Residential 641.5 Inventory 7.6

Net Exports – 712.7 Exports 1,640.3 Imports 2,353.0GDP $13,843.0

US GDP, 2007

(billions of dollars)

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Consumption Expenditure

Spending by households for goods and servicesConsumer durables are long-lived consumer goodsConsumer non-durable goods are shorter-lived goodsServices are the largest component of consumer spending

CarsFurnitureAppliances

ClothingFoodBedding

Education

Taxi rides

Haircuts

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Investment

Business fixed investment is purchases of new capital goodsResidential investment is construction of new homes and apartment buildingsInventory investment is the change in unsold goods to the company's inventoryThese goods are produced but not yet soldThis entry can be positive or negativeNegative inventory investment means less in inventory at year-end than at the beginning

machinery

Business

Buildings

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Economic Investment and Financial Investment

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

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 servicesExcludes transfer paymentsTransfer payments are made by government but the government receives no current goods or servicesSpending by recipients is included in GDPExcludes interest paid on government debt

Fighter jetsTeachingOffice supplies

Food Stamps

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Net Exports

Net exports are exports minus imports

Exports are goods and services produced domestically and sold abroad

Exports reduce the amount available to the domestic economy

Imports are purchases in the US of goods and services produced abroad

Imports increase the amount available to the domestic economy

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GDP Expenditures Equation

Terminology

Expenditure approach to measuring GDPY = 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, $15,000 eachProduction value is 1 million times $15,000 = $15 billion25,000 cars are unsoldInvestment in inventories increases by $0.375 billion, In what category is this number included?

GDP Contribution $10.500 billion $3.000 billion $0.750 billion $0.375 billion $14.625 billion

Sector # Cars PurchasedConsumers 700,000Businesses 200,000Government 50,000Net exports 25,000Total 975,000

Investment 225,000 $3.375 billion

Total

1,000,000

$15.000 billion

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Income Approach to GDP

When a good is sold, its proceeds are distributed to workers or business ownersGDP = labor income + capital incomeLabor income is wages, salaries, benefits, and incomes of the self-employedAbout ⅔ of GDPCapital income pays for physical capital and intangiblesMeasured before taxes

Profits for business owners

Rent for land

Interest for bond holders

Royalties

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Three GDP Approaches

Expenditure

Investment

Consumption

Government purchases

Net exports

Income

Capital Income

Labor Income

Production

Market Value of Final Goods and Services

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Adjusting for Price Changes

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

GDP changes over time because

Prices

change AND

Quantity of output

changes

To see how much output has grown, use only the changes in quantities

Hold prices constant

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The Pizza and Calzone Economy

GDP in 2009 is $175; GDP in 2013 is $420GDP in 2013 is 2.4 times the GDP in 2009Only twice as many pizzas and calzones were produced in 2013Market value of output grew faster than the physical volume of output

Number of Pizzas

Price of Pizza

Number of Calzones

Price of Calzones

2009

10

$10

15

$5

2013

20

$12

30

$6

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Real GDP and Nominal GDP

Nominal GDP

values output in the current year using

prices from the current year

Nominal GDP is the current dollar value of production

Real GDP

values output in the current year using the

prices from the base year

Real GDP measures the physical volume of production

Nominal GDP

adjusted for

inflation

Comparisons of economic activity at different times

should always be done using real GDP.

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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 pricesReal GDP in 2013 is(20 pizzas) ($10) + (30 calzones) (5) = $350Real GDP doubled between 2009 and 2013

Number of Pizzas

Price of Pizza

Number of Calzones

Price of Calzones

2009

10

$10

15

$5

2013

20

$12

30

$6

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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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Environmental Quality and resource depletion

Suppose a factory is built in your town

People are employed and output is produced

Productive activity is included in

GDP

the factory creates pollution

No adjustment is made for the decline in resource availability when mining

is

done

One more barrel of oil on the market means one less barrel for future use

Environmental 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 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

Inequality

matters and it is increasing in the US

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GDP as a Welfare Measure

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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Spending, Income, and GDP

Gross Domestic Product

Expenditure Method

Income Method

Real and Nominal Values

GDP and Well-Being

Production Method