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6THE DATA OF MACROECONOMICS
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15Measuring a NationsIncome
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Distinction between Microeconomics andMacroeconomics
Microeconomics
Microeconomics is the study of how individual
households and firms make decisionsand how they
interact with one anotherin markets.
Macroeconomics
Macroeconomics is the study of the economy as a
whole.
Its goal is to explain the economic changes thataffect many households, firms, and markets at once.
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Macroeconomics
Macroeconomics answers the followingquestions:
Why is average income high in some countries and
low in others?
Why do prices rise rapidly in some time periods
while they are more stable in others?
Why do production and employment expand in some
years and contract in others?
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THE ECONOMYS INCOME AND
EXPENDITURE
How do we know whether the economy as awholeis doing well or poorly?
One measure is the total incomethat everyone in the
economy is earning.
For an economy as a whole, income must equal
expenditurebecause:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar of
income for some seller.
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THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
Gross domestic product (GDP) is a measure ofthe income andexpenditures of an economy.
It is the total market value of all final goods and
services produced within a country in a given period
of time.
If someone pays someone else $100 to mow a lawn,
the expenditure on the lawn service ($100)
is exactly equal to the income earned from the productionof the lawn service ($100).
The equality of income and expenditure can be
illustrated with the circular-flow diagram.
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The Circular-Flow Diagram
Spending
Goods and
services
bought
Revenue
Goods
and services
sold
Labor, land,and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Factors ofproduction
Wages, rent,
and profit
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS
Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
Firms sell
Households buy
MARKETSFOR
GOODS AND SERVICES
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THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
GDP is the market value of all final goods andservices produced within a country in a given
period of time.
What does it mean?
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MORE ON THE DEFINITION OF THE GDP
GDP IS THE MARKET VALUE . . . To add together different items, market values are used. Market values are calculated by using market prices.
. . . OF ALL. . . GDP includes all items produced and sold legally in the
economy. The value of housing services is somewhat difficult to
measure. If housing is rented, the value of the rent is used to measure the value
of the housing services.
For housing that is owned (or mortgaged), the government estimatesthe rental value and uses this figure to value the housing services.
GDP does not include illegal goods or services or items thatare not sold in markets. When you hire someone to mow your lawn, that production is included
in GDP.
If you mow your own lawn, that production is not included in GDP.
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MORE ON THE DEFINITION OF THE GDP
. . . FINAL . . .
Intermediate goods are not included in GDP (the value is counted onlyonce).
The value of intermediate goods is already included as part of the value of
the final good.
Investment goods (such as structures and vehicles used in production) are not
intermediate goods.
Investment goods represent products purchased for final use by business firms.
Exception: Intermediate Goods that are placed into inventory are
considered to be final and included in GDP as a firms inventory
investment.
Goods that are sold out of inventory are counted as a decrease in inventory
investment.
The goal is to count the production when the good is finished, which is not
necessarily the same time that the product is sold.
. . . GOODS AND SERVICES . . .
It includes both tangible goods (food, clothing, cars) and intangibleservices (haircuts, housecleaning, doctor visits).
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MORE ON THE DEFINITION OF THE GDP
. . . PRODUCED . . .
It includes goods and services currently produced, not transactions
involving goods produced in the past.
. . . WITHIN A COUNTRY . . .
GDP measures the production that takes place within thegeographical boundaries of a particular country.
If a Mexican citizen works temporarily in the United States, the value of his
output is included in GDP for the United States.
If an American owns a firm in Mexico, the value of the production of that
firm is not includedin U.S. GDP. The production of a German firm operating in the United States is part of
U.S. GDP.
Even though it is a foreign firm, the firms workers are living in the United States
and buying clothes, groceries, and other goods in the United States.
Thus, the workers in the foreign firm operating in the United States are fuelingthe domestic economy.
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MORE ON THE DEFINITION OF THE GDP
. . . IN A GIVEN PERIOD OF TIME. The usual interval of time used to measure GDP is a
quarter (three months).
When the government reports GDP, the data is
generally reported on an annual basis.
In addition, data are generally adjusted for regular
seasonal changes (such as Christmas).
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Other Measures of Income Gross National Product (GNP)is the total income earned by a nations permanent
residents.
GNP includes income that American citizens earn abroad.
GNP excludes income that foreigners earn in the United States.
Net National Product (NNP)is the total income of a nations residents (GNP) minus losses
from depreciation (wear and tear on an economys stock of equipment and structures).
National incomeis the total income earned by a nations residents in the production of
goods and services. National income differs from NNP by excluding indirect business taxes and including business
subsidies.
NNP and national income also differ due to statistical discrepancy.
Personal incomeis the income that households and noncorporate businesses receive.
Unlike National Income, PI excludes retained earnings, corporate income taxes andcontribution to social insurance.
But includes the interest income of households from their holding of government debt and
from government transfers.
Disposable personal incomeis the income that households and noncorporate businesses
have left after taxes and other obligations to the government.
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Example One day Barry the Barber, Inc. collects $400 for haircuts. Over this
day, his equipment depreciates in value by $50. Of the remaining$350, Barry sends $30 to the government in sales taxes, takes home$320 in wages, and retains $100 in his business to add new equipmentin the future. From the $220 that Barry takes home he pays $70 inincome taxes. Based on this information, compute Barryscontribution to the following measures of income.
Gross domestic product GDP equals the dollar amount Barry collects, which is $400.
Net national product NNP = GDPdepreciation = $400 - $50 = $350.
National Income National income = NNP - sales taxes = $350 - $30 = $320.
Personal Income Personal income = national income - retained earnings = $320 - $100 = $220.
Disposable personal income.
Disposable personal income = personal income - personal income tax = $220 -$70 = $150.
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THE COMPONENTS OF GDP
GDP includes all items produced in the economyand sold legallyin markets.
What Is Not Counted in GDP?
GDP excludes most items that are produced andconsumed at home and that never enter the
marketplace.
Products created and consumed within households
It excludes items produced and sold illicitly, such asillegal drugs.
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THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Y = C + I + G + NX Consumption (C):
The spending by households on goods and services, with theexception of purchases of new housing.
Investment (I): The spending on capital equipment, inventories, and
structures, including new housing.
Government Purchases (G):
The spending on goods and services by local, state, andfederal governments.
Does notinclude transfer payments because they are not madein exchange for currently produced goods or services.
Net Exports (NX):
Exports minus imports.
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US GDP and Its Components in 2009
This table shows total GDP for the U.S. economy in 2009 and
the breakdown of GDP among its four components. When
reading this table, recall the identityY = C + I + G + NX.
What do the negative numbers in the net exports column
mean?
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The components of U.S. GDP
2009, GDP of the U.S. = $14 trillion GDP per person = $46,372
Consumption = $32,823 per person
Investment = $5,278 per person Government purchases = $9,540 per person
Net exports =$1,269 per person
19
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GDP and Its Components (2011)
Consumption69%
Government Purchases
18%Net Exports
-3 %Investment
16%
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REAL VERSUS NOMINAL GDP
Nominal GDP values the production of goods andservices at current prices.
Real GDP values the production of goods and servicesat constant prices. There are two possible reasons for total spending to rise from
one year to the next. The economy may be producing a larger outputof goods and
services.
Goods and services could be selling at higher prices.
When studying GDP over time, economists would like toknow if output has changed (not prices).
=>economists measure real GDP by valuing output using afixed set of prices. An accurate view of the economy requires adjusting nominal to real
GDP by using the GDP deflator.
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Table 2 Real and Nominal GDP
Nominal GDP values the production of goods and services atcurrent prices.
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Table 2 Real and Nominal GDP
Real GDP values the production of goods and services at constant prices.
Lets assume that the base year is 2010.
Because real GDP is unaffected by changes in prices over time, changes in real GDP
reflect changes in the amount of goods and services produced.
When there is inflation, nominal GDP can increase while real GDP actually declines.
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The GDP Deflator
The GDP deflator is a measure of the price levelcalculated as the ratio of nominal GDP to real
GDP times 100.
It tells us the rise in nominal GDP that is attributable
to a rise in prices rather than a rise in the quantities
produced.
The GDP deflator is calculated as follows:
GDP deflator =Nominal GDP
Real GDP100
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Converting Nominal GDP to Real GDP
Nominal GDP is converted to real GDP as follows:
Real GDP Nominal GD PGDP deflator
20062006
2006
= 100
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Table 2 Real and Nominal GDP
Nominal GDP and real GDP will be equal in the base year.
Therefore GDP deflator for the base year will always be
equal to 100.
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Figure 2 Real GDP in the United States
1. Figure 2 shows quarterly data on real GDP for the United States since
1970.
2. Notice that real GDP has increased over time.
3. Notice also that there are times (shaded bars) when real GDPdeclines. These eriods are called recessions.
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GDP AND ECONOMIC WELL-BEING
GDP is the best single measure of the economicwell-being of a society.
GDP per persontells us the income and
expenditure of the average person in the
economy.
Higher GDP per person indicates a higher
standard of living.
However, GDP is not a perfect measure of the
happiness or quality of life.
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GDP AND ECONOMIC WELL-BEING
Some things that contribute to well-beingare not included in GDP.
The value of leisure.
The value of a clean environment. The value of almost all activity that takes
place outside of markets, such as the value of
the time parents spend with their children andthe value of volunteer work.
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GDP, Life Expectancy, and Literacy
The Table shows real GDP per person, life expectancy, and adult literacy rates for
12 countries.
In rich countries, life expectancy is higher and adult literacy rates are also high.
In poor countries, people typically live only into their 50s and only about half of
the adult population is literate.
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Summary
Because every transaction has a buyer and aseller, the total expenditure in the economy must
equal the total income in the economy.
Gross Domestic Product (GDP) measures an
economys total expenditure on newly produced
goods and services and the total income earned
from the production of these goods and services.
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Summary
GDP is the market value of all final goods andservices produced within a country in a given
period of time.
GDP is divided among four components of
expenditure: consumption, investment,
government purchases, and net exports.
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Summary
Nominal GDP uses current prices to value theeconomys production. Real GDP uses constant
base-year prices to value the economys
production of goods and services.
The GDP deflatorcalculated from the ratio of
nominal to real GDPmeasures the level of
prices in the economy.
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Summary
GDP is a good measure of economic well-beingbecause people prefer higher to lower incomes.
It is not a perfect measure of well-being because
some things, such as leisure time and a clean
environment, arent measured by GDP.