11

Frank & BernankeFrank & Bernanke4th edition, 20094th edition, 2009

Ch. 4: Spending, Income, and GDPCh. 4: Spending, Income, and GDP

22

33

44

Why Measure A Nation’s IncomeWhy Measure A Nation’s Income

To have a sense of an economy’s size.To have a sense of an economy’s size.The well being of a citizen, on average, The well being of a citizen, on average,

depends on the nation’s income per person.depends on the nation’s income per person. http://www.youtube.com/watch?v=cZ7LzE3u7Bw&feature=feedu

As the income of the society increases, the As the income of the society increases, the average person will have a higher standard average person will have a higher standard of living.of living. One can drown in a lake of 3-ft average depth.One can drown in a lake of 3-ft average depth. Standard of living may not necessarily be the goods and Standard of living may not necessarily be the goods and

services a household can consume.services a household can consume.

55

Definition of GDPDefinition of GDP

Gross Domestic Product is the Gross Domestic Product is the market valuemarket value of all the of all the final goods and servicesfinal goods and services produced produced within a countrywithin a country in a year. in a year. How do you determine the value of child care?How do you determine the value of child care? How do you include the production of steel or How do you include the production of steel or

plastics?plastics? How do you include the sales of existing homes?How do you include the sales of existing homes? How do you account for $4 million paid at an How do you account for $4 million paid at an

auction for a Van Gogh painting?auction for a Van Gogh painting? How do you account for government services?How do you account for government services?

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Market ValueMarket Value

Suppose we live in an economy where only Suppose we live in an economy where only hamburgers, colas and fries are produced.hamburgers, colas and fries are produced.

Prices are: hamburgers $2; colas $1; fries Prices are: hamburgers $2; colas $1; fries $0.50.$0.50.

If this economy produces 100 hamburgers, If this economy produces 100 hamburgers, 150 colas and 200 fries, what is the market 150 colas and 200 fries, what is the market value?value?

What is the market value if 200 hamburgers, What is the market value if 200 hamburgers, 100 colas and 100 fries are produced?100 colas and 100 fries are produced?

Price Qty Value

Hmbgr $2 100 $200

Cola $1 150 $150

Fries $0.50 200 $100

GDP $450

77

Percentages of American Men and Women Percentages of American Men and Women over Age 16 Working Outside the Homeover Age 16 Working Outside the Home

• Increase in female labor force participation increases the demand for housekeeping and child care.

• Unpaid household work is not counted in GDP.• Paid household work is counted in GDP.• The increase in female labor force participation has overstated GDP growth.

“By 2010 women will be the majority.” Check at www.bls.gov

http://www.economist.com/opinion/displayStory.cfm?story_id=15174489&source=hptextfeature

Participation RatesParticipation Rates

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Labor Force Participation Rate is total employed plus unemployed divided by the labor force.

From 2000 to 2011 participation rates for men dropped from 75% to 70%.

From 2000 to 2011 participation rates for women dropped from 60% to 58%.

99

Why GDP Is Equal to Income?Why GDP Is Equal to Income?

How is my contribution to the US economy How is my contribution to the US economy calculated?calculated?The amount of educational service I create is The amount of educational service I create is

equal to my gross income.equal to my gross income.How is the income of a real estate agent How is the income of a real estate agent

calculated?calculated?When she sells a 25-yr old house, she gets a When she sells a 25-yr old house, she gets a

percent of the price as a payment for her percent of the price as a payment for her services.services.

1010

Why GDP Is Equal to Income?Why GDP Is Equal to Income?How is the GDP contribution of the How is the GDP contribution of the

textbook company calculated?textbook company calculated?After they pay the author, the paper company After they pay the author, the paper company

and the ink company, the amount of revenue and the ink company, the amount of revenue they get from textbook sales plus the value of they get from textbook sales plus the value of their book inventory (unsold books) is their book inventory (unsold books) is theirtheir contribution to the US GDP.contribution to the US GDP.

Their contribution is equal to wages, salaries, Their contribution is equal to wages, salaries, rent, interest and profits generated.rent, interest and profits generated.

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Value AddedValue Added

Calculate the contribution of the following Calculate the contribution of the following activities to GDP.activities to GDP.

Farmer sells cotton for $100.Farmer sells cotton for $100. Cotton is processed into thread and sold for Cotton is processed into thread and sold for

$130.$130. Thread is made into cloth and sold for $200.Thread is made into cloth and sold for $200. Cloth is made into shirts and sold for $300.Cloth is made into shirts and sold for $300.

$100

$30

$70

$100

300

Final value = Value added

1212

Circular FlowCircular Flow

HouseholdsFirms

Consumption expenditures of households

Income (wages, salaries, rent, interest, profit) earned by households

GDP from expenditure

GDP from income

1313

Circular FlowCircular Flow

Upper flow is equal to GDP.Upper flow is equal to GDP.Lower flow is equal to income.Lower flow is equal to income. If If GDP < IncomeGDP < Income, businesses will , businesses will

reduce productionreduce production and create less and create less income => unemployment.income => unemployment.

If If GDP > IncomeGDP > Income, businesses will want , businesses will want to to expand productionexpand production and create more and create more income => boom.income => boom.

1414

FIRMS

GOVERNMENT

FINANCIAL SYSTEM

HOUSEHOLDS

REST OF THE WORLD

Y=wages+salaries+rent+profits+interest

C

Spri

T>TR+INT+G :Sgov

T TR+INTI

NX<0 Sfor

EX IM

G

GDP

NX>0 -Sfor

-Sgov

1515

How Can We Measure GDP?How Can We Measure GDP?

Expenditure Approach: the upper flow.Expenditure Approach: the upper flow.

Y = C + I + G + NXY = C + I + G + NX Income Approach: the lower flow.Income Approach: the lower flow.

Y = Sum of factor incomesY = Sum of factor incomes

Y = Wages + Salaries + Rent + Interest + Y = Wages + Salaries + Rent + Interest + Profits Profits

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Components of ExpenditureComponents of Expenditure

ConsumptionConsumption includes spending on includes spending on food, entertainment, shelter, health food, entertainment, shelter, health care, transportation, clothing, household care, transportation, clothing, household items, insurance, education.items, insurance, education.

1717

Components of ExpenditureComponents of Expenditure

InvestmentInvestment includes purchases made by includes purchases made by firms to generate future income. firms to generate future income. Machinery, tools, buildings, trucks and Machinery, tools, buildings, trucks and cars are part of investment if they are cars are part of investment if they are bought to generate future income. By bought to generate future income. By convention, newly built houses and convention, newly built houses and inventory are included under investment.inventory are included under investment.

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Components of ExpenditureComponents of Expenditure

Government purchasesGovernment purchases are are expenditures of federal, state and expenditures of federal, state and local governments on goods and local governments on goods and services plus their payrolls.services plus their payrolls.

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Components of Expenditure Components of Expenditure ApproachApproach

Net exportsNet exports is exports minus imports.is exports minus imports.Dell Computer sales in China are part of Dell Computer sales in China are part of

US exports.US exports.Dell Computer purchases of plastic molds Dell Computer purchases of plastic molds

for their computers from China are part of for their computers from China are part of US imports.US imports.

2020

GDPGDP

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2004&LastYear=2008&3Place=N&Update=Update&JavaBox=no#Mid

2121

The Three Faces of GDPThe Three Faces of GDP

= =

Market Market value of value of

final final goods goods

and and servicesservices

Production Expenditure Income

InvestmentInvestment

ConsumptionConsumption

GovernmentGovernment

purchasespurchases

Net exportsNet exports

Capital Capital IncomeIncome

Labor IncomeLabor Income

= =

2222

A GDP Increase Always Increases A GDP Increase Always Increases The Size of the EconomyThe Size of the Economy

WRONGWRONG!!What if GDP in 2009 were 1000, in 2010 What if GDP in 2009 were 1000, in 2010

were 1500 but inflation was 50%?were 1500 but inflation was 50%? In this case, the increase in GDP is solely In this case, the increase in GDP is solely

attributable to price increases, not attributable to price increases, not improving the well being (standard of improving the well being (standard of living) of the average citizen.living) of the average citizen.

2323

Nominal vs. Real MeasuresNominal vs. Real Measures In macroeconomics, most variables are In macroeconomics, most variables are

measured in measured in real termsreal terms, not nominal , not nominal terms.terms.

Real variable eliminates the effect of Real variable eliminates the effect of inflation.inflation.

Nominal variable includes the effect of Nominal variable includes the effect of inflation.inflation.

GDP comparisons are always made with GDP comparisons are always made with real GDP.real GDP.

Nominal GDP uses current prices.Nominal GDP uses current prices. Real GDP uses base year prices.Real GDP uses base year prices.

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Real and Nominal GDPReal and Nominal GDP

The Economy Produces 2 Goods: Pizza and Soda

Year Pp Qp Ps Qs Nominal GDP Real GDP GDP Deflator

2007 10 1000 2 5000 $20,000.00 $20,000.00 100.02008 11 1000 3 6000 $29,000.00 $22,000.00 131.82009 13 1200 4 7000 $43,600.00 $26,000.00 167.7

Nominal GDP is calculated by adding the amounts spent on eachProduct. Real GDP is calculated by using the 2007 prices of pizzaand soda to calculate the amounts spent in future years.GDP Deflator is Nominal GDP/Real GDP.

2525

Real and Nominal GDP

2626

2727

What Is Wrong With Real GDP?What Is Wrong With Real GDP?

Real GDP increases if you sell your services Real GDP increases if you sell your services rather than provide them free.rather than provide them free. If you build a house through Habitat for Humanity If you build a house through Habitat for Humanity

your work doesn’t count as part of GDP. If you get your work doesn’t count as part of GDP. If you get paid for the same work, it counts.paid for the same work, it counts.

If you pollute during production and someone If you pollute during production and someone pays to clean the environment, the GDP will pays to clean the environment, the GDP will be higher than if the producer tried to reduce be higher than if the producer tried to reduce pollution during production so no clean-up pollution during production so no clean-up was necessary.was necessary.

2828

Underground EconomyUnderground Economy

If market transactions cannot be tracked If market transactions cannot be tracked by data collectors, they may be ignored.by data collectors, they may be ignored.

Transactions with high cash usage and Transactions with high cash usage and no paper trail can remain hidden from no paper trail can remain hidden from the government.the government.

GDP may actually be much higher than GDP may actually be much higher than government statistics if there is a large government statistics if there is a large underground economy.underground economy.

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Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Leisure TimeLeisure TimeShorter work weekShorter work weekStart working laterStart working laterRetire earlierRetire earlierCheck the debate on leisure in EU conducted Check the debate on leisure in EU conducted

by by The EconomistThe Economist..http://www.economist.com/debate/days/view/438&sa_campaign=debateseries/debate38/events/hp/panel/?source=hpevents

3030

Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Nonmarket Economic ActivitiesNonmarket Economic ActivitiesHousehold productionHousehold productionVolunteer servicesVolunteer servicesNonmarket activities are more important in Nonmarket activities are more important in

poor countriespoor countriesUnderground economyUnderground economy

3131

Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Environmental Quality and Resource Environmental Quality and Resource DepletionDepletionBenefits of environment quality are not Benefits of environment quality are not

measured.measured.GDP is not adjusted for resource depletion.GDP is not adjusted for resource depletion.

3232

Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Quality of LifeQuality of LifeCrime ratesCrime ratesTraffic congestionTraffic congestionCivic organizationsCivic organizationsOpen spaceOpen space

3333

Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Poverty and Economic InequalityPoverty and Economic InequalityGDP does not capture the effects of income GDP does not capture the effects of income

inequalityinequality

3434

GDP & Basic Indicators of Well-BeingGDP & Basic Indicators of Well-Being

IndicatorAll developing

countries

GDP per person 3,530 1,170 25,860(U.S. dollars)

Life expectancy at 64.5 51.7 78.0birth (years)

Infant mortality rate 61 100 6(per 1,000 live births)

Under-5 mortality rate 89 159 6(per 1,000 live births)

Doctors 78 30 252(per 100,000 people)

Incidence of HIV/Aids 1.3 4.3 0.3(% in 15-49 age group)

Undernourished 18 38 Negligiblepeople (%)

Primary enrollment 85.7 60.4 99.9rate (as % of age group)

Secondary enrollment 60.4 31.2 96.2rate (as % of age group)

Adult literacy rate (%) 72.9 51.7 98.6

Least developed countries

Industrialized countries

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http://hdr.undp.org/en/media/HDR_2009_EN_Indicators.pdf

http://hdr.undp.org/en/data/map/