Chapter

Measuring a Nation’s Income

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The Economy’s Income and Expenditure

• Gross Domestic Product (GDP)– Measures the total income of everyone in the

economy– Measures the total expenditure on the

economy’s output of goods and services• For an economy as a whole

– Income must equal expenditure• Circular-flow diagram – assumptions:

• All goods and services – bought by households• Households - -spend all of their income

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Figure

The circular-flow diagram

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Households buy goods and services from firms, and firms use their revenue from sales to pay wages to workers, rent to landowners, and profit to firm owners. GDP equals the total amount spent by households in the market for goods and services. It also equals the total wages, rent, and profit paid by firms in the markets for the factors of production.

Measurement of Gross Domestic Product

• Gross domestic product (GDP)– Market value of all final goods and services– Produced within a country – In a given period of time

• “GDP is the market value…”– Market prices - reflect the value of the goods

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Measurement of Gross Domestic Product

• “… of all…”– All items produced in the economy

• And sold legally in markets

– Excludes items that are:• Produced and sold illicitly, or• Produced and consumed at home

• “… final…”– Value of intermediate goods is already

included in the prices of the final goods

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Measurement of Gross Domestic Product

• “… within a country…”– Goods and services produced domestically,

regardless of the nationality of the producer• “… in a given period of time”

– A year or a quarter

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The Components of GDP

• Y = C + I + G + NX– Identity– Y = GDP– C = consumption– I = investment– G = government purchases– NX = net exports

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The Components of GDP

• Consumption – Spending by households– On goods and services– Exception: purchases of new housing

• Investment– Spending on capital equipment, inventories,

and structures– Including household purchases of new housing– Inventory accumulation

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The Components of GDP

• Government purchases– Government consumption expenditure and

gross investment– Spending on goods and services – By local, state, and federal governments– Does not include transfer payments

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The Components of GDP

• Net exports = Exports - Imports– Exports

• Spending on domestically produced goods by foreigners

– Imports• Spending on foreign goods by domestic residents

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• 2007, GDP of the United States = $14 trillion• GDP per person = $45,838

– Consumption = $32,225 per person– Investment = $7,061 per person– Government purchases = $8,912 per person– Net exports = –$2,360 per person

The components of U.S. GDP

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Real Versus Nominal GDP

• Total spending rises from one year to the next– Economy - producing a larger output of goods

and services– And/or goods and services are being sold at

higher prices• Nominal GDP

– Production of goods and services– Valued at current prices

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Real Versus Nominal GDP

• Real GDP– Production of goods and services– Valued at constant (or base year) prices– Designate one year as base year– Not affected by changes in prices

• For the base year– Nominal GDP = Real GDP

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Table

Real and Nominal GDP

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Prices and Quantities

Year Price of hot dogs

Quantity of hot dogs

Price of hamburgers

Quantity of hamburgers

200820092010

$1$2$3

100150200

$2$3$4

50100150

Calculating Nominal GDP

200820092010

($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200($2 per hot dog × 150 hot dogs) + ($3 per hamburger × 100 hamburgers) = $600($3 per hot dog × 200 hot dogs) + ($4 per hamburger × 150 hamburgers) = $1,200

Calculating Real GDP (base year 2008)

200820092010

($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200($1 per hot dog × 150 hot dogs) + ($2 per hamburger × 100 hamburgers) = $350($1 per hot dog × 200 hot dogs) + ($2 per hamburger × 150 hamburgers) = $500

Calculating the GDP Deflator

200820092010

($200 / $200) × 100 = 100($600 / $350) × 100 = 171($1,200 / $500) × 100 = 240

This table shows how to calculate real GDP, nominal GDP, and the GDP deflator for a hypothetical economy that produces only hot dogs and hamburgers.

Real Versus Nominal GDP

• The GDP deflator (all goods and services)– Measure of the price level for all goods and

services – inflation at the national level– Ratio of nominal GDP to real GDP times 100– =100 for the base year– Measures the current level of prices relative to

the level of prices in the base year• Inflation

– Economy’s overall price level is rising

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Real Versus Nominal GDP

• Inflation rate– Percentage change in some measure of the

price level from one period to the next

• The GDP deflator– Can be used to take inflation out of nominal

GDP (“deflate” nominal GDP)

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1001 year in deflator GDP

1 year in deflator GDP-2 year in deflator GDP2 year in Inflation

• The GDP data– Real GDP grows over time– Growth is not steady

• Recession– Real GDP declines– Lower income– Rising unemployment– Falling profits– Increased bankruptcies

Real GDP over recent history

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GNP Growth is Not Steady

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Figure

Real GDP in the United States

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This figure shows quarterly data on real GDP for the U.S. economy since 1965. Recessions—periods of falling real GDP—are marked with the shaded vertical bars.

The Business Cycle – Another Look

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Business Cycle - Phases

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GDP - Good Measure of Economic Well-being?

• GDP – “single measure of the economic well-being of a society”?– Measures both economy’s total income and

total expenditure– Larger GDP correlated with

• Good life• Better healthcare• Better educational systems

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• Rich countries - Higher GDP per person– Better

• Life expectancy• Literacy• Internet usage

• Poor countries - Lower GDP per person– Worse

• Life expectancy• Literacy• Internet usage

International differences in GDPand the quality of life

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GDP - Good Measure of Economic Well-being?

• Does not consider how income is distributed (GINI coefficient)

• A low Gini coefficient indicates a more equal distribution,

– 0 corresponding to complete equality, – higher Gini coefficients => more unequal

» 1 corresponding to complete inequality. When used as a measure of income inequality,

» most unequal society will be one in which a single person receives 100% of the total income and the remaining people receive none (G = 1−1/N);

» and the most equal society will be one in which every person receives the same income (G = 0).

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Relative Income Distribution Rankings• U.S., Gini coefficient of 0.450, ranks near the extreme

end of the inequality scale

– comparable income inequality: Cameroon, Madagascar, Rwanda, Uganda, Ecuador.

• China, significantly more equal than the U.S. with a Gini coefficient of 0.415

• http://www.theatlantic.com/international/archive/2011/09/map-us-ranks-near-bottom-on-income-inequality/245315/

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Equality of Distribution of Income

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GDP - Good Measure of Economic Well-being?

• GDP – not a perfect measure of well-being– Besides equality/inequality of distribution of

income– Also doesn’t include value of

• Leisure• Quality of the environment• Almost all activity that takes place outside

markets (some legal, some not!)

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Table

GDP and the quality of life

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Country Real GDP perperson (2005)

Life expectancy

Adult literacy(% of population)

Internet usage(% of population)

United StatesJapan GermanyRussia Mexico Brazil China Indonesia India Pakistan Bangladesh Nigeria

$41,890 31,26729,46110,84510,7518,4026,7573,8433,4522,3702,0531,128

78 years 8279657672727064656347

99%9999999289919061504769

63 %67451518199737

0.34

The table shows GDP per person and three other measures of the quality of life for twelve major countries.