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Unit 4
John Maynard
Keynes
and
Fiscal Policy
Lesson 3Krugman, Module 10 pp. 101-110
Module 11 pp. 112-116
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Module Objectives• What is GDP?• How is GDP Measured?• The Income Method • The Expenditures Method.• Limitations of the GDP Measure
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KEYNE’S THREE QUESTIONS
• WHERE ARE WE NOW?
• WHERE WERE WE?
• WHERE SHOULD WE BE?
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ExpenditureApproach
IncomeApproach
GDP
= =
+
HouseholdConsumption
BusinessInvestment
GovernmentPurchases
ExpendituresBy Foreigners
+
+
+
+
+
Wages
Rents
Interest
Profits
National Income Accounting
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Gross Domestic Product GDP
• National Income Accounting– A Monetary Measure
– Exclude • Previous year transactions
• Intermediate Goods
• Non-productive transactions
• Non-recorded transactions
• Other countries goods (imports)
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Expenditure Approach
Who Buys Our Stuff?
• Four components:
– Consumption (C)
– Investment (I)
– Government Purchases (G)
– Exports (X)
• These components add up to GDP:
Y = C + I + G + XNY = C + I + G + XN
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Expenditure ApproachPutting It All Together:
GDP = C + Ig + G + Xn
Gross Investment
Ig = Net Investment + Depreciation
(KCA)
Net Exports
Xn = Exports (X) – Imports (M)
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Expenditure Approach
January 1 Year’s GDP December 31
Consumption& Government
Spending
Depreciation
NetInvestment
GrossInvestment
Stock ofCapital
Increased
Stock ofCapital
Gross InvestmentDepreciation
Net Investment
-=
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Income Approach• National Income (NY)
– wages
– rent
– interest
– profits
• Kapital Consumption Allowance
• Indirect Business Taxes
Putting It All Together:
GDP = NY + KCA + IBT
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GDP Approaches Compared
Wages
Rent
Interest
Individual Profit
Corporate Profit
National Income
Indirect Business Taxes
Depreciation
Gross Domestic Product $625
$ 300
25
50
75
95
$545
30
50
Personal Consumption (C)
Gross Private Domestic
Investment (Ig)
Government Purchases (G)
Net Exports (Xn)
Gross Domestic Product
Accounting Statement for the U.S. Economy, 2005in Billions
ReceiptsExpenditures Approach
AllocationsIncome Approach
$ 300
200
150
-25
$ 625
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Then Why Do We Care About GDP?
• Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc.
• Many indicators of the quality of life are positively correlated with GDP. For example…
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GDP and Life Expectancy in 12 Countries
50
55
60
65
70
75
80
85
90
$0 $10,000 $20,000 $30,000 $40,000
Life expectancy
(in years)
Real GDP per capita, 2002
U.S.
Germany
Japan
Nigeria
Mexico
Russia
Brazil
China
Pakistan
Bangladesh
India
Indonesia
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GDP and Economic Well-Being
• Real GDP per capita is the main indicator of the average person’s standard of living.
• But GDP is not a perfect measure of well-being.
• Robert Kennedy issued a very eloquent yet harsh criticism of GDP:
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Gross Domestic Product…
“… does not allow for the health of
our children, the quality of their
education, or the joy of their play. It
does not include the beauty of our
poetry or the strength of our faith, the
intelligence of our public debate or the
integrity of our public officials. It
measures neither our courage, nor our wisdom, nor our
devotion to our country. It measures everything, in short,
except that which makes life worthwhile, and it can tell us
everything about America except why we are proud that
we are Americans.”- Senator Robert Kennedy, 1968
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GDP Does Not Value:
• the quality of the environment
• leisure time
• non-market activity, such as the child care a parent provides his or her child at home
• an equitable distribution of income
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Shortcomings of GDP
• Nonmarket Activities
• Leisure
• Improved Product Quality
• The Underground Economy
• GDP and the Environment
• Composition and Distribution of the Output
• Noneconomic Sources of Well-Being
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Shortcomings of GDP
Source: Journal of Economic Literature
Underground Economy as a Percentage of GDP - Select Nations
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United Kingdom
Japan
United States
Switzerland
0 5 10 15 20 25 30 Percentage of GDP
GLOBAL PERSPECTIVE