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Measuring a Nations Income
Chapter 23
N. Gregory Mankiw
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Measuring a Nations Income
Microeconomics Microeconomics is the study of how individual
households and firms make decisions and how
they interact with one another in markets. Macroeconomics
Macroeconomics is the study of the economy as awhole.
Its goal is to explain the economic changes thataffect many households, firms, and markets atonce.
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Measuring a Nations Income
Macroeconomics answers questions like the
following:
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 insome years and contract in others?
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THE ECONOMYS INCOME AND
EXPENDITURE
When judging whether the economy is doingwell or poorly, it is natural to look at the totalincome that everyone in the economy is
earning. For an economy as a whole, income must
equal expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollarof income for some seller.
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure of
the income and expenditures 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.
The equality of income and expenditure can
be illustrated with the circular-flow diagram.
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Figure 1 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 of
production
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
Copyright 2004 South-Western
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
GDP is the market value of all final goods and
services produced within a country in a given
period of time.
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
GDP is the Market Value . . .
Output is valued at market prices.
. . . Of All Final . . .
It records only the value of final goods, not
intermediate goods (the value is counted only once).
. . . Goods and Services . . .
It includes both tangible goods (food, clothing, cars)and intangible services (haircuts, housecleaning,
doctor visits).
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
. . . Produced . . .
It includes goods and services currently produced,
not transactions involving goods produced in the
past.
. . . Within a Country . . .
It measures the value of production within the
geographic confines of a country.
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THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
. . . In a Given Period of Time.
It measures the value of production that takes
place within a specific interval of time, usually a
year or a quarter (three months).
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THE COMPONENTS OF GDP
GDP includes all items produced in the
economy and sold legallyin markets.
What Is Not Counted in GDP? GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
It excludes items produced and sold illicitly, suchas illegal drugs.
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THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
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THE COMPONENTS OF GDP
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of new
housing.
Investment(I):
The spending on capital equipment, inventories,
and structures, including new housing.
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THE COMPONENTS OF GDP
Government Purchases (G):
The spending on goods and services by local,
state, and federal governments.
Does notinclude transfer payments because they
are not made in exchange for currently produced
goods or services.
Net Exports (NX): Exports minus imports.
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Table 1 GDP and Its Components
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GDP and Its Components (2001)
Consumption69%
Government Purchases
18%Net Exports
-3 %Investment
16%
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REAL VERSUS NOMINAL GDP
Nominal GDP values the production of goods
and services at current prices.
Real GDP values the production of goods and
services at constant 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
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Table 2 Real and Nominal GDP
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Table 2 Real and Nominal GDP
Copyright2004 South-Western
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GDP Deflator
The GDP deflatoris a measure of the price
level calculated 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.
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The GDP Deflator
GDP deflator =Nominal GDP
Real GDP
100
Real GDP
Nominal GDP
GDP deflator20XX
20XX
20XX
100
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Table 2 Real and Nominal GDP
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GDP AND ECONOMIC WELL-BEING
GDP is the best single measure of theeconomic well-being of a society.
GDP per persontells us the income and
expenditure of the average person in theeconomy.
Higher GDP per person indicates a higher
standard of living. GDP is not a perfect measure of the happiness
or quality of life, however.
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GDP AND ECONOMIC WELL-BEING
Some things that contribute to well-being are
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 and the value ofvolunteer work.
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T bl 3 GDP Lif E t d Lit
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Table 3 GDP, Life Expectancy, and Literacy
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Summary
Because every transaction has a buyer and a
seller, 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 thesegoods and services.
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Summary
GDP is the market value of all final goods and
services 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 the
economys 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-
being because 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.
Semester Genap 2013 30Principles of Economics