Economic Today Measuring the Economy’s Performance
Introduction
Underground economy: value of final goods/services not counted in official production measures.
~6% of U.S. production.
⅓ in some countries.
To measure underground activities → must first understand official measure of total production (GDP).
8.1 The Simple Circular Flow
Principles:
In every transaction: seller’s receipts = buyer’s expenditure.
Goods/services flow one way; money flows opposite.
Profits as costs: returns to entrepreneurs for risk-taking.
Markets:
Product markets: households buy goods.
Factor markets: businesses buy resources.
Total income: yearly earnings from factors of production (wages, rent, interest, profits).
Final goods/services: at last production stage; not inputs for further production.
Why total output = total income? Every expenditure is someone else’s income.
8.2 National Income Accounting
Definition: System to measure national income + components.
Gross Domestic Product (GDP): total market value of all final goods/services produced within a nation’s borders in one year.
Key points:
Measures dollar value of final output.
Excludes:
Intermediate goods (use value-added method).
Financial transactions (stocks, bonds, transfers).
Secondhand sales.
Household + underground production.
GDP limitations:
Excludes nonmarket production.
Not a measure of well-being.
Examples:
Free internet services (e.g., MOOCs) not in GDP.
Some propose an “economic dashboard” to supplement GDP.
8.3 Two Main Methods of Measuring GDP
Expenditure Approach
GDP = C + I + G + X
C: Consumption (durable goods, nondurables, services).
I: Investment (capital goods, inventories, repairs).
G: Government spending (valued at cost).
X: Net exports (exports – imports).
Gross National Product (GNP): production by nation’s residents (anywhere) – excludes foreign-owned production inside borders.
Net Domestic Product (NDP): GDP – depreciation.
Income Approach
GDP = Gross Domestic Income (wages + rent + interest + profits) + indirect business taxes + depreciation.
Gross Domestic Income (GDI) = total income paid to four factors of production.
8.4 Other Components of National Income Accounting
National Income (NI): total factor payments to resource owners.
Personal Income (PI): income actually received by households before taxes.
Disposable Personal Income (DPI): PI – personal taxes; income available for spending or saving.
8.5 Nominal vs Real GDP
Nominal GDP: measured at current market prices (“money values”).
Real GDP: adjusted for price level changes; expressed in constant dollars.
Constant dollars: dollars with purchasing power adjusted for inflation.
Foreign exchange rate: value of one currency vs another (affects GDP comparisons).
Purchasing Power Parity (PPP): adjusts exchange rates for cost of living differences across countries.
Issues and Applications
Underground economy:
10% of GDP in U.S. & Japan.
25% in Romania, Turkey.
Environmental adjustments: Some argue GDP should account for natural resource depletion or pollution.
Summary of Learning Objectives
Circular flow: expenditures = income; goods flow one way, money the other.
GDP: total market value of final goods/services within borders; excludes nonmarket activity; not a welfare measure.
Measurement methods:
Expenditure approach: GDP = C + I + G + X.
Income approach: sum of wages, rent, interest, profits (+ taxes & depreciation).
National income components: NI, PI, DPI.
Nominal vs real GDP: nominal = current prices; real = constant dollars, adjusted for inflation.