Spending, Income, and GDP - PowerPoint Presentation

Slide1

Spending, Income, and GDP

Chapter 15

McGraw-Hill/Irwin

Copyright ©

2015

by

McGraw-Hill Education (Asia).

All rights reserved.Slide2

Learning Objectives

Explain how economists define and measure an economy's outputApply the expenditure method for measuring GDP to analyze economic activityDefine and compute nominal GDP and real GDPDiscuss the relationships between GDP and economic well-beingSlide3

Macroeconomics

Data on output, employment, pricesVital signs of the economyEmployment, unemployment, average work hoursStock values and trendsPrices and inflationReported often in the newsSystematic measurement of economic output developed during World War IICommon systems and measures used virtually worldwideSlide4

Measuring OutputSlide5

Market Value

Aggregate measure of quantities producedMore expensive items receive a higher weightingWillingness to pay is an indication of benefit received from the goodOrchardia's GDP is $64Orchardia

Apples

Bananas

Shoes

Price

$0.25

$0.50

$20.00

Quantity

4

6

3

GDP contribution

$1.00

$3.00

$60.00Slide6

Some Non-Market Goods Included

Government goods and services are not sold in the marketThese goods have valueIncrease overall outputQuantities are knownPrices cannot be establishedGovernment production is valued at costOverstates GDP if there is waste and inefficiencySlide7

Final Goods and Services

Final goods and services are consumed by the ultimate userEnd products of production Included in GDPIntermediate goods and services are used up in the production of final goodsNot included in GDP to avoid double countingA barber's assistant earns $2 per haircut for providing services such as shampooing and sweeping upBarber charges $10 per haircutHaircut's contribution to GDP is $10Slide8

Goods Can Be Final and Intermediate

Milk can be sold as a final product or used as an intermediate goodLiters of milk in the storeLiters of milk sold to restaurantsCount only the final goodsA capital good is a long-lived good used in the production of other goods and servicesHouses, apartments, and motelsStoves in restaurants, cooking schoolsDelivery vehicles and taxisMoney is not a capital goodSlide9

Value Added

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 $2.00Company

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

$2.00Slide10

Produced in a Country in a Period of Time

"Domestic" in GDP means the activity is measured within a country's bordersNationality of owners or company is not relevantValue must be produced in the year consideredSell a 20-year old house for $200,000Pay $12,000 commissionValue added is $12,000House was not produced in the period of time studiedCount income generated from the sale of used goodsSlide11

Expenditure Method for Measuring GDP

Four users of final goodsHouseholds ■ FirmsGovernment ■ ForeignersAll goods produced are purchased by one of these groups in a given yearAmount spent = market valueGDP can be measured two waysMarket valueTotal spending for final goods less value of importsSlide12

Consumption

$10,350.6

Durable Goods

$1,089.3

Non-durable Goods

2,337.4

Services

6,923.9

Government Purchases

3,000.3

Investment

1,822.5

Business Fixed Investment

1,413.2

Residential

340.4

Inventory

68.9

Net Exports

–

515.7

Exports

1,838.5

Imports

2,354.1

GDP

$14,657.8

US GDP, 2010

(billions of dollars)Slide13

Consumption Expenditure

Consumption expenditure is 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 spendingCarsFurniture

Appliances

Clothing

Food

Bedding

Education

Taxi rides

HaircutsSlide14

Investment

Investment is spending by firms on final goods and servicesBusiness 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 negativePlantProperty

EquipmentSlide15

Economic Investment and Financial Investment

Financial investment includes purchases of stocks, bonds, and other financial assetsPurchase generally transfers ownership of a portion of the firm's existing capital stockDoes not correspond to any increase in physical capital or production capacity, in most casesNew stock issues can be an exceptionEconomic investment refers to the increase in the capital goods used to produce other goodsThis value is based on the purchase price of the capital goods, not on stock valueSlide16

Government Purchases

Government purchases are final goods and services bought by central, state, and local governmentsExcludes transfer paymentsTransfer payments are made by government but the government receives no current goods or servicesNo purchases of final goods and services involved in transfer paymentsSpending by recipients is included in GDPExcludes interest paid on government debtFighter jets

Teaching

Office supplies

Social Security

Food StampsSlide17

Net Exports

Net exports equal exports minus importsExports are goods and services produced domestically and sold abroadExports reduce the amount available to the domestic economyImports are purchases in the domestic economy of goods and services produced abroadImports can be consumption, investment, or government spendingImports increase the amount available to the domestic economySlide18

GDP Expenditures Equation

TerminologyExpenditure approach to measuring GDPY = C + I + G + NX

Y

Gross Domestic Product or output

C

Consumption Expenditure

I

Investment

G

Government Purchases

NX

Net ExportsSlide19

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 billionGDP 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

Businesses

225,000

$3.375 billion

Total

1,000,000

$15.000

billionSlide20

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 taxesProfits for business owners

Rent for land

Interest for bond holders

RoyaltiesSlide21

Three GDP Approaches

Expenditure

Investment

Consumption

Government purchases

Net exports

Income

Capital Income

Labor Income

Production

Market Value of Final Goods and ServicesSlide22

Adjusting for Price Changes

Compare GDP for different years to see how much output has changedGDP changes over time becausePrices change ANDQuantity of output changesTo see how much output has grown, use only the changes in quantitiesHold prices constantSlide23

The Donut and Cupcake Economy

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

Number of Donuts

Price of Donut

Number of Cupcakes

Price of Cupcake

2009

10

$10

15

$5

2013

20

$12

30

$6Slide24

Real GDP and Nominal GDP

Real GDP values output in the current year using the prices from the base yearThe base year is a reference year that changes infrequentlyReal GDP measures the physical volume of productionNominal GDP values output in the current year using prices from the current yearNominal GDP is the current dollar value of productionSlide25

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 donuts) ($10) + (30 cupcakes) (5) = $350Real GDP doubled between 2009 and 2013

Number of Donuts

Price of Donut

Number of Cupcakes

Price of Cupcake

2009

10

$10

15

$5

2013

20

$12

30

$6Slide26

Observations on Real and Nominal GDP

Usually, nominal and real GDP increase each yearNominal GDP can go up and real GDP go downFewer goods and services produced ANDPrices increase faster than output decreasedNominal GDP will be smaller than real GDP if the prices in the current year are less than in the base yearUsually true for years before the base yearReal GDP could rise and nominal GDP fall, but this is rarePrices are falling faster than output is increasingSlide27

Real GDP and Economic

Well-BeingReal GDP is a flawed measure of well-beingIt values only market transactionsOmits illegal transactions, volunteer work, and household productionMaximizing GDP will not necessarily maximize national well-beingWhether increases in output increase welfare is a case-by-case issueSlide28

GDP Does Not Value Leisure

Amount of leisure time has increased in the past 100 yearsWork weeks are shorter People enter the labor force at an older agePeople retire earlierLeisure produces no goods for marketGDP places a value of zero on all leisure timeOpportunity cost of an hour of leisure is your hourly wageOmission of the value of leisure time makes GDP seem smallerSlide29

Nonmarket Economic Activities

GDP omits services that are not traded in marketsHousehold productionVolunteer servicesValuing these services would be difficultNonmarket activities are important in poor countriesSelf-sufficient households and bartered goods and servicesSlide30

Underground Economy

Underground economy is all unreported transactions, legal and illegalCasual labor is often paid in cashFailure to report transaction reduces taxesIncludes baby sitters, tutoring, home repair, etc.Some underground activity is illegalA service of value is providedDrug dealers, bookies, fences, prostitution, etcEstimates suggest the underground economy is large regardless of national income levelSlide31

Environmental Quality

Suppose a factory is built in your townPeople are employed and output is producedProductive activity is included in GDPSuppose further that the factory creates pollutionYour city hires a company to restore the environment to its initial conditionClean-up activities are included in GDPGets environment back to its starting point, not betterSlide32

Resource Depletion

No adjustment is made for the decline in resource availability when mining or other harvesting is doneOne more barrel of oil on the market means one less barrel for future useEnvironmental quality and resource depletion are difficult to valueThey have value and that value is omitted from GDPSlide33

Other Quality of Life Considerations

GDP does not account for intangibles people valueCrime ratesTraffic congestionCivic organizationsOpen spaceSense of communitySlide34

Poverty and Economic Inequality

GDP does not capture the effects of income inequalityMost would prefer living in a relatively equal society to one with a few wealthy and many poorUS uses an absolute standard of povertyIn 2011, a family of four was poor if their income was less than $22,350Inequality matters and it is increasing in the USThe case of the beat-up carSlide35

GDP as a Welfare Measure

GDP omits and undervalues some goods and servicesGDP per capita is positively associated with several measures of well-beingMaterial standard of living: more goods and servicesHealth and life expectancyResidents of industrialized countries fare better than residents of developing countries in a range of health measuresEducationLiteracy and school enrollment rates are higher in high-income countriesSlide36

Spending, Income, and GDP

Gross Domestic ProductExpenditure MethodIncome MethodReal and Nominal Values

GDP and Well-Being

Production Method