CHAPTER 5 ( Measuring National Income and Output

Macroeconomics

Is the study of the relationships between aggregate economic variables, and the choices made by policy makers to influence those variables

What is the most important measure of output in the economy?

Gross Domestic Product (GDP)

What do Measures of Output include?

Nominal GDP and Real GDP, And Gross National Product

What does the Change in Output Determine?

Whether the economy is in expansion or recession

What is it called when the tendency for GDP to fluctuate around a trend called?

Business Cycle

Nominal GDP

Measure the output produced using CURRENT PRICES

Real GDP

Measures of Output produced using CONSTANT PRICES/BASE YEAR PRICES

Gross National Product ( GNP )

Measures the output by the COUNTRIES CITIZENS no matter WHERE they are

Gross Domestic Product ( GDP )

Measure production IN THE COUNTRY no matter who it is

Inflation

Sustained increase in the average level of prices in an economy over time. Decreasing in the value of MONEY

What are the 4 primary measures of price level in the United States?

• The Bureau of Economic Analysis (BEA) : publishes GDP price deflator

• Personal Consumption Expenditure (PCE) : Price Index

• The Bureau of Labor Statistics (BLS) : Consumer Price Index and Producer Price Index (2 measures of inflation)

• The Consumer Price Index (CPI) : Most widely reported Inflation measures

• Producer Price Index (PPI) : Measures changes in wholesale prices received by producers

GDP Price Deflator

Measures overall inflation in the economy. Shows how much prices have changed compared to base year

The Unemployment Rate

Measure of the percentage of the labor force that is actively seeking for work but not finding work

• (Number actively seeking but not finding work / Number in Labor force ) X 100

Can Foreign investor affect the value of assets in the home country and the cost of borrowing money?

Yes

Net Exports

Included in GDP. Important in determining how quickly economy is expanding or contracting

What are the important measure of the International Economy?

• The Balance of payments

• The Current Account

• Exchange Rates

The Balance of Payments

The record of a country’s flows of goods, services, income , gifts, capital, and financial assets with rest of world

The Current Account

Is a subset of the balance of payments that’s used to measure a country’s trade deficit or surplus. Also measures flows of goods, services, gifts and income with rest of the world.

• Current Account positive = Country has a trade SURPLUS

• Current Account negative = Country has a trade DEFICIT

Exchange Rates

The value of one country’s currency in terms of another country’s currency

• Currency is traded in Currency Markets or Foreign Exchange Markets

Interest Rate :

The Price of money, or the cost of borrowing funds/ the benefit of lending funds

Money Supply :

The Quantity of money in circulation at a given point of time. The rate of change in the money supply is an important determinant of several economic variables

3 major Macro Policy goals in : The Full employment and Stabilization Act of 1946 and the Humphrey Hawkins Act of 1978

• Stable rate of GDP growth

• High Employment ( or low unemployment)

• A stable Price Level ( or low inflation )

How are these goals achieved?

The governments 2 policy tools:

• Fiscal Policy

• Monetary Policy

Fiscal Policy :

A change in government spending or taxes to influence a macroeconomic variable like GDP/ Inflation

• Used by Administration

• Can be used to to attempt in fights of recession

• Aiming to promote growth, reduce unemployment and manage inflation

Monetary Policy :

Change in the money supply or interest rates to influence a macroeconomic variable

• Exercised by the Federal Reserve System

• Less of a lag for monetary policy compared to fiscal policy

Federal Government can use their tools of fiscal and monetary policy to help maintain a stable Macroeconomy

Gross Domestic Product (GDP) :

The Markets ALL FINAL GOODS AND SERVICES PRODUCED within a country’s borders in a year

What are the issues of Calculating GDP?

• Market Value

• Final Goods and Services

• Value-added Approach

• Produced within a country’s borders

• In a Year

• Non-Market Transactions are Excluded

• Non-Productive Transactions are excluded

• Second- Hand Goods are Excluded

• Goods produced not sold

Market Value:

• Some goods may not be market prices that exist to measure the value

Final Goods and Services :

• Some goods may not be market prices that exist to measure the value

Value- Added Approach :

• Measures the value that is ADDED to GDP stage of production process

Produced Within a Country’s Borders :

• GDP measures ALL of the final output produced on a country’s soil, or domestically/ regardless of which country actually owns the resources used in the production

In a Year :

• GDP is flow variable

• Even though GDP stats are measured quarterly, they measure the amount of output that would be produced in a year if economy was operated at a quarterly rate

Non-Market Transaction :

• Some transactions are excluded from GDP stats even though they provided value to economy

—> EX : value of domestic labor / work done inside the household by household members. If I cleaned my house and the other person cleans their house, they are excluded from GDP. If we pay to clean eachothers houses and reported an income from it , then it would be included in GDP

Non-Productive Transactions are excluded :

• Exchanges that do not increase production are not included in GDP

—> EX: Gov’t transfer payments such as Social Security, Temporary assistance to Needy Families (TANF). These represent a redistribution of wealth from taxpayers to recipients , but not to production in the economy

Second-Hand Goods are excluded :

Second hands goods are not calculated in the current year’s GDP. This is so they are not counted more than once

—> EX: Used cars, used bikes, used clothing

Goods produced but not Sold :

• This in included in GDP as part of inventory Changes or a good component of investment

• Sold to US = consumption spending

• Sold to foreign customer = export spending

—> EX : if a bicycle your selling remains unsold in the current year, it’s treated as increase in inventories as part of investment spending

What does the labor force consist of ?

• over 16 years of age

• Not students

• Not retired

• Not in prison

• Not in hospitals

• Not in military force

• People actively seeking work or working

• College students employed if they have a job

• College students not considered unemployed if they are without work

How is unemployment measured ?

• By using a household Current population survey conducted on telephone

What does the unemployment rate ignore?

• Someone working fewer hours than desired/ below their skill level

• People without homes or phones are more likely to be unemployed but arent counted

• Ignores discouraged workers—> Someone given up to look for work

GDP : The Expenditure Approach

• Total spending in an economy on goods and services

• Consumption, investment, government spending, net exports

• Expenditure GDP= C + I + G + ( X - M )

GDP : As Final Output

• Total value of final goods and services PRODUCED

• Intermediate goods excluded

• Σ( Pi x Qi )

GDP : Sources as income

• Production side of GDP

• Calculates GDP based on who earns money from PRODUCTION (income earned in an economy)

• Wages, Interest, Net Factor Income from Abroad, Capital Consumption Allowance , Statistical Discrepancy

• Income GDP = W + i + profit - NFIA + CCA + SD

GDP Expenditures = GDP as Sources of Income

• Everything spent by consumers businesses, and the government turns to income for workers, businesses, and the government

• Every dollar spent in the economy ( Expenditures ) becomes someones income ( sources of income)

GDP : Uses of Income

• Consumptions Side of GDP

• Total of income earned is spent or saved

• Consumption Spending, Saving, Taxes, and Import Spending

• Use of Income GDP = C + S + T + M

What can be used to Illustrate GDP?

Circular Flow Model

What is Circular Flow Model?

• Assumes only 2 sectors of economy are households and firms

• Shows interaction between households and firms in 2 markets ( Product Markets and Resource Markets )

%Δ Nominal GDP = ( Nominal GDP other year - Nominal GDP base year / Nominal GDP base year ) x 100

Nominal GDP base year = Real GDP base year

• this is to determine how much output really increased form one year to the other

• So we have to look at real GDP for both years

To calculate the Real GDP on the other year we must do…

Σ( Base year prices x Output in the other years prices ( Q ) )

% Δ Real GDP = (Calculated Real GDP in other year - Base year) / Base year X 100

GDP Price Deflator Equation :

GDP Price Deflator t = ( Nominal GDP t / Real GDPt ) X 100

Real GDP - Base Year Approach

• Used until 1995

• BEA Used to calculate this way but sometimes can cause problems

Real GDP - Chain-Type Growth Rate

• BEA developed new way to measure Real GDP

• MODERN AND MORE ACCURATE WAY to Calculate real GDP

• Uses information from both

Chain - Type growth rate ( NEW WAY)

• THEN :

  —> Chain - Type Real GDP 2 = g x Real GDP 1

Chain - Real GDP Price Deflator

Chain - Type Real GDP Price Deflator t = ( Nominal GDP t / Chain - Type Real GDP t ) X 100

Chain - Type of Real GDP vs Base Year Approach

• Measure of Real GDP = Chain - Type provides Lower estimate of Real GDP than Base Year Approach

• Rate of inflation (GDP Price Deflator) = Chain - Type provides higher estimate of the rate of inflation compared to Base Year approach

Per Capita GDP

• Per Capita = GDP / Population

• Average Income Per Person in a Country

• Countries with higher Per Capita GDP also have higher standards of living ( doesn’t always mean this though)

• Doesn’t really acknowledge the distribution of wealth. It just shows the average. People with more money might oull up the per capita GDP

Factors of why GDP may not be accurate indicator of Social Welfare:

• Defensive expenditures —→ people spend to protect themselves from perceived threats to their health and safety

• Value of Leisure —→ benefits people get from free time when they aren’t working. Workers are not producing anything while consuming leisure time. Higher the GDP= less value of leisure

• Population Differences —→ when comparing countries , one has to be careful. Countries could have high GDP due to population but the standard of living may not always be high (per capita GDP will be smaller )

• Distribution of Income —→ Higher per capita GDP may disguise the great inequalities in income. Two countries might have same Per capita GDP but standards of living can be completely different. Doesn’t really tell us about the distribution of an economy which is important factor of determining quality of life

• Cultural Differences—→ differences in cultures between countries make comparisons based on per capita GDP difficult. Countries where more goods are produced in the home (non-market transactions) then that country will have lower GDP since its not counted in the GDP. Countries have differences in whats legal and illegal. Also cultures differ in how they value leisure. Countries with higher divorce rates = higher GDP

• Price and exchange rates —→ Changes in price/exchange rates can affect relative positions of countries that are being compared using per Capita GDP

• Quality changes —→ GDP stats doesn’t always capture quality changes in the products included. Chnages how much value people get for their money

• Wars and natural disasters—→ Changes GDP in way that doesn’t reflect change in happiness.

“GDP takes no account of increasing inequality, pollution or damage to peoples health and the environment. It treats crime, divorce, and other elements of social progress as economic gains”

Gini Coefficient

• Measures income inequality in a country

• Shows how evenly or unevenly income is distributed among people

• Higher number means more inequality in a country

Gini Coefficient Equation :

Gini = (5000- A(area under lorenz curve ) / 5000

Lorenz Curve

• graph where percent of total income earned ( y- axis)

• And the percent of Population is plotted ( x - axis)