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Chapter 2
 

Chapter 2

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    Chapter 2 Chapter 2 Presentation Transcript

    • Chapter 2 The Measurement and Structure of the National Economy
    • National Income Accounting
      • National income accounts : an accounting framework used in measuring current economic activity.
      • These accounts are set up in a way that mirrors the structure of the economy, so they help us understand how the macroeconomy works.
    • How to measure economic activity ? Producers Consumers $ Output Produced Incomes received Expenditures
    • How to measure economic activity ?
      • Product Approach : measure the amount of output produced , excluding output used up in intermediate stages of production.
      • Income Approach : measure the incomes received by the producers of output.
      • Expenditure Approach : measure the amount of spending by the ultimate purchasers of output.
    • How to measure economic activity ?
      • In principle, the 3 approaches should yield the same measurement of current economic activity.
      • In practice, there might be some discrepancies due to incomplete or misreported data.
    • An Example OrangeInc JuiceInc Consumers $ orange orange $ juice
    • An Example
      • OrangeInc Transactions
      • Wage bill $15,000
      • Tax payment $ 5,000
      • Revenue
      • Orange sold to public $10,000
      • Orange sold to JuiceInc $ 25,000
      • Total $ 35,000
      • JuiceInc Transactions
      • Wage bill $ 10,000
      • Tax payment $ 2,000
      • Oranges purchased
      • from OrangeInc $ 25,000
      • Revenue $ 40,000
    • An Example : Income Approach
      • The income approach measures economic activity by adding all income generated by production, including
        • wages received by workers
        • (after-tax) profits received by owners of firms
        • tax revenues received by the government
    • An Example: Income Approach
      • OrangeInc Transactions
      • Wage bill $15,000
      • Tax payment $ 5,000
      • Revenue
      • Orange sold to public $10,000
      • Orange sold to JuiceInc $ 25,000
      • Total $ 35,000
      • Profits = Revenue - wage - tax
      • = $ 35,000 - $15,000 - $5,000
      • = $ 15,000
      • JuiceInc Transactions
      • Wage bill $ 10,000
      • Tax payment $ 2,000
      • Oranges purchased
      • from OrangeInc $ 25,000
      • Revenue $ 40,000
      • Profits = Revenue – wage – inputs
      • - tax
      • = $ 3,000
    • An Example : Income Approach
      • Total Income:
      • Profits for OrangeInc $ 15,000
      • Profits for JuiceInc $ 3,000
      • Wage received by
      • OrangeInc Employees $ 15,000
      • Wage received by
      • JuiceInc Employees $ 10,000
      • Taxes from OrangeInc $ 5,000
      • Taxes from JuiceInc $ 2,000
      • Total $ 50,000
    • An Example: Expenditure Approach
      • The expenditure approach measures activity by adding the amount spent by all ultimate users of output.
      • In this example, the ultimate users are the consumers.
      • Total Expenditures
        • Buy oranges from OrangeInc $ 10,000
        • Buy juices from JuiceInc $ 40,000
        • Total $ 50,000
    • An Example : Product Approach
      • The product approach measures the amount of output produced, excluding output used up in intermediate stages of production.
      • Q: In this example, is this the same as adding up the revenues of the OrangeInc and JuiceInc ?
      • A: NO.
    • An Example : Product Approach
      • For JuiceInc,
      Revenue / Output $40,000 Oranges $25,000 Value-added $15,000
    • An Example : Product Approach
      • The value added of any producer is the value of its output minus the value of the inputs it purchases from other producers ( intermediate goods ).
      • The product approach computes economic activity by summing the value added by all producers.
    • An Example: Product Approach
      • OrangeInc Transactions
      • Wage bill $15,000
      • Tax payment $ 5,000
      • Revenue
      • Orange sold to public $10,000
      • Orange sold to JuiceInc $ 25,000
      • Total $ 35,000
      • Value-added $ 35,000
      • JuiceInc Transactions
      • Wage bill $ 10,000
      • Tax payment $ 2,000
      • Oranges purchased
      • from OrangeInc $ 25,000
      • Revenue $ 40,000
      • Value-added $40,000-$25,000
      • = $15,000
      Total value added = $50,000
    • Gross Domestic Product (GDP)
      • GDP is the most commonly used measure of aggregate economic activity.
      • GDP data can be obtained from the following website:
        • http:// www.bea.gov/national/index.htm#gdp
    • Nominal GDP of the U.S., 1930-2006
    • GDP: Income Approach
        • The income approach calculates GDP by adding the incomes received by producers, including profits, and taxes paid to the government.
        • 8 categories of income
    • GDP: Income Approach
        • Compensation of employees is the before-tax income of workers (excluding the self-employed). [57% of GDP in 2005.]
        • Corporate Profits represent the remainder of the corporate revenue after wages, interest, rents and other costs have been paid but before taxes have been paid. [10.8% of GDP in 2005.]
        • Proprietor’s income is the income of the non-incorporated self-employed. [7.5% of GDP in 2005.]
    • GDP: Income Approach
        • Taxes on production and imports include indirect business taxes (such as sales taxes) as well as custom duties and taxes on residential real estate. [6.8% of GDP in 2005.]
        • Net interest is interest earned by individuals from businesses and foreign sources minus interest paid by individuals. [4.0% of GDP in 2005.]
    • GDP: Income Approach
        • Rental income of persons
        • Business current transfer payments
        • Current surplus of government enterprises.
        • (See Chapter 2 for details)
    • GDP: Expenditure Approach
      • The expenditure approach measures GDP as total spending on final goods and services produced within a nation during a specified period of time.
      • 4 major categories of spending:
        • Consumption (C)
        • Investment (I)
        • Government purchases of goods and services (G)
        • Net exports (NX)
      • Income-expenditure identity:
      • Y = C + I + G + NX
    • Table 2.1 Expenditure Approach to Measuring GDP in the United States, 2005
    • GDP: Expenditure Approach
      • Consumption: spending by domestic households on final goods and services , including those produced abroad (i.e. imports).
      • 3 categories of consumption spending:
        • Consumer durables , e.g. cars, DVD players, ipod.
        • Nondurable goods , e.g. food, clothing.
        • Services , e.g. education, health care, transportation.
    • GDP: Expenditure Approach
      • Q: In the definition, you said we only count the spending on final goods and services produced within a nation . But now you said we also include imports in the consumption component.
      • A: We include imports in Consumption (C) but we take these out in Net Exports (NX). So imports are cancelled out in C + NX.
    • GDP: Expenditure Approach Domestic Producers Foreign Producers Domestic Households Foreign Households (1) (2) (3) (4) Import = (2) Export = (3) Consumption (C) = (1) + (2) Net Export (NX) = (3) – (2) C + NX = (1) + (3)
    • GDP: Expenditure Approach
      • Investment:
        • Fixed investment: spending for new capital goods
          • Business fixed investment : spending by businesses on structures, equipment and software etc..
          • Residential investment : spending on the construction of new houses and apartment buildings.
          • How about investment made by the government ?
        • Inventory investment: increases in firm’s inventory holdings.
    • GDP: Expenditure Approach
      • Government purchases of goods and services : any expenditure by the government for a currently produced good or service, foreign or domestic.
      • Not all government spending is included in here
        • Transfers (such as Social Security and Medicare benefits, welfare payments) are excluded.
        • Interest payments on the national debt are also excluded.
    • GDP: Product Approach
      • Product Approach :
        • The product approach defines a nation’s GDP as the market value of final goods and services newly produced within a nation during a fixed period to time.
    • GDP: Product Approach
      • Market value (or current value):
        • the value of goods and services at the prices at which they are sold ( market prices ).
        • If we think of market-determined prices as measures of relative economic values , then using market value to measure production will take into account differences in the relative economic importance of different items.
    • GDP: Product Approach
      • Market value:
        • Q: What if some commodities are not sold in formal markets ?
        • A: They are either not included or only partially included in GDP.
        • Examples:
        • Child care performed within the family without pay.
        • Activities that improve the environment.
        • Activities in the underground economy.
    • GDP: Product Approach
      • Final goods and services:
        • Intermediate goods are those used up in the production of other goods in the same period that they themselves were produced.
        • Capital good : good that is itself produced, used to produce other goods but is not used up in the same period that it is produced. Examples: buildings, machinery, software.
        • Capital goods are classified as final goods in the national income accounts.
    • GDP: Product Approach
      • Final goods and services:
        • Inventories are stock of unsold finished goods and raw materials held by firms.
        • Inventory investment is the amount by which inventories increase during the year.
        • Inventory investment is treated as final good.
    • GDP: Product Approach
      • Q: Which of the following is included in the GDP of 2006 ?
        • The sale of a car produced in 2006.
        • The sale of a used car in 2006.
        • The sale of an unused car from a
        • manufacturer’s inventory.
        • The sale of a machine used to produce
        • cars.
        • Services provided by private day-care
        • center.
      YES NO NO YES YES
    • Real vs Nominal GDP
        • So far, all the components in GDP are measured in terms of current market values (current prices).
        • Such variables are called nominal variables .
        • Changes in nominal GDP over time can be due to
          • Changes in the prices of goods and services
          • Changes in the quantities
        • How can we remove the effects of price changes ?
    • Real GDP: An Example
        • 2005 2006
      • Quantity
      • Computers 5 10
      • Bicycles 200 250
      • Price
      • Computers $1,200@ $600@
      • Bicycles $200@ $240@
      • Value
      • Computers 5 x $1200 = $6,000 10 x $600 = $6,000
      • Bicycles 200 x $200 = $40,000 250 x $240 = $60,000
      • Nominal GDP $6,000 + $40,000 $6,000 + $ 60,000
      • = $46,000 = $ 66,000
    • Real GDP: An Example
      • Percentage change of Nominal GDP
        • from 2005 to 2006
        • New Value – Old Value
        • Old Value
        • $ 66,000 - $ 46,000
        • $ 46,000
        • = 43.5%
      x 100% = = x 100%
    • Real GDP & Price Indices
        • To remove the effects of price changes:
          • Pick one year as the base year
          • Calculate the value of production in each year by using the prices from the base year.
    • Real GDP: An Example
        • 2005 (Base Year) 2006
      • Quantity
      • Computers 5 10
      • Bicycles 200 250
      • Price
      • Computers $1,200@ $1,200@
      • Bicycles $200@ $200@
      • Value
      • Computers 5 x $1200 = $6,000 10 x $1,200 = $12,000
      • Bicycles 200 x $200 = $40,000 250 x $200 = $50,000
      • Real GDP $6,000 + $40,000 $12,000 + $ 50,000
      • = $46,000 = $ 62,000
      • (No change)
    • Real GDP: An Example
        • 2005 2006 (Base Year)
      • Quantity
      • Computers 5 10
      • Bicycles 200 250
      • Price
      • Computers $600@ $600@
      • Bicycles $240@ $240@
      • Value
      • Computers 5 x $600 = $3,000 10 x $600 = $6,000
      • Bicycles 200 x $240 = $48,000 250 x $240 = $60,000
      • Real GDP $3,000 + $48,000 $12,000 + $ 50,000
      • = $51,000 = $ 62,000
      • (No change)
    • Real GDP: An Example
        • 2005 2006 % change
      • Nominal GDP $ 46,000 $ 66,000 43.5%
      • Real GDP $ 46,000 $ 62,000 34.8%
      • (Base year = 2005)
      • Real GDP $ 51,000 $ 66,000 29.4%
      • (Base year = 2006)
    • Real GDP: An Example
      • % change of Nominal GDP = 43.5%
      • % change of Real GDP using 2005 as base year
        • $ 62,000 - $ 46,000
        • $ 46,000
      • % change of Real GDP using 2006 as base year
      • $ 66,000 - $ 51,000
      • $ 51,000
      x 100% = 34.8 % = = x 100% = 29.4 %
    • Real and Nominal GDP in the U.S., 1930-2006 . Real GDP Nominal GDP
    • Real vs Nominal GDP
      • To summarize:
        • Real GDP measures the physical volume of an economy’s final production using the prices of a base year.
        • Nominal GDP is the dollar value of an economy’s final output measured at current market prices.
        • Nominal GDP = Real GDP for the base year.
    • Price Indexes & Inflation
      • A price index is a measure of the average level of prices for some specified set of goods and services , relative to the prices in a specified base year.
      • Inflation is the percentage change in the price index per period.
      • Two most common price indexes:
        • GDP Deflator
        • Consumer Price Index (CPI)
    • GDP Deflator
      • The GDP deflator is a price index that measures the overall level of prices of goods and services included in GDP.
      • Like real GDP, the measurement of the GDP deflator depends on the choice of a base year.
      GDP Deflator = Nominal GDP Real GDP x 100
    • GDP Deflator: An Example
        • 2005 2006 % change
      • Nominal GDP $ 46,000 $ 66,000 43.5%
      • Real GDP $ 46,000 $ 62,000 34.8%
      • (Base year = 2005)
      • GDP Deflator 100 106.5 6.5%
      • (Inflation)
    • Consumer Price Index (CPI)
      • CPI measures the prices of consumer goods .
      • Every month the Bureau of Labor Statistics collect the current prices of a fixed basket of consumer goods an services such as food, housing and fuel.
      • The BLS also collects information on consumers’ expenditure patterns.
      • This information is used to weight the prices.
    • Consumer Price Index (CPI)
      • The CPI is intended to reflect the costs of living.
      • Many government payments and taxes are tied, or indexed, to the CPI. For example, social security benefits are raised every year by the same % as the CPI.
      • But there are reasons to believe that increases in the CPI might overstate the actual rate at which the cost of living rises.
    • Consumer Price Index (CPI)
      • This can arise when the CPI fails to account for quality improvements in goods and services.
      • Example:
        • The processing speed of computer is increased by 10% and the price of computer increases accordingly.
        • The price increase should not be considered as an increase in the cost of living.
        • If the BLS fail to account for the improved quality of computer but simply note the price increase, then the price change will be incorrectly interpreted as inflation.
    • Consumer Price Index (CPI)
      • Monthly data on the CPI can be obtained from the following website:
      • http:// www.bls.gov
    • What we have learned in this chapter ?
      • The 3 approaches to measure economic activity, namely the product approach, the income approach and the expenditure approach.
      • How to use these approaches to measure GDP.
      • Real vs Nominal GDP
    • Preparing for the Quiz
      • Be familiar with the following concepts:
        • Product, income and expenditure approach
        • Value added of producers
        • Intermediate goods
        • Capital goods
        • Inventory and inventory investment
        • Consumption, investment, government purchases and net export (GDP = C + I + G + NX)
        • Market value of final goods and services
        • Real and nominal variables
        • Price index
    • Preparing for the Quiz
      • Know the differences between
        • Intermediate goods vs Capital goods
        • GDP vs GNP
        • GDP deflator vs Consumer Price Index
      • Know how to compute
        • Nominal GDP
        • Real GDP
        • GDP deflator
        • % Changes in these variables