Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 8 Measuring the Economy’s Performance

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.

Chapter 8

Measuring the Economy’s Performance


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Chapter Outline

• The Simple Circular Flow• National Income Accounting• Two Main Methods of Measuring GDP• Other Components of National Income

Accounting• Distinguishing Between Nominal and Real

Values• Comparing GDP Throughout the World


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Figure 8-1 The Circular Flow of Income and Product


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The Simple Circular Flow (cont'd)

• Product Markets

– Transactions in which households buy goods


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• Factor Markets

– Transactions in which businesses buy resources


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• Question

– Why must total income be identical to the dollar value of total output?

• Answer

– Every transaction simultaneously involves an expenditure and a receipt.


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The Simple Circular Flow

The concept of the circular flow of income involves two principles:

1. In every economic exchange, the seller receives exactly the same amount that the buyer spends.

2. Goods and services flow in one direction and money payments flow in the other.


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National Income Accounting

• National Income Accounting– A measurement system used to estimate

national income and its components

• Total Income– The yearly amount earned by the nation’s

resources (factors of production)

– Equals Total Spending (why?)


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National Income Accounting (cont'd)

• Gross Domestic Product (GDP)– The total market value of all final goods and

services produced by factors of production located within a nation’s borders


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• Stress on final output

– What is a final good?• Wheat?

• Steel?

• Oil?

• Bread?

• Automobile?

• Gasoline?

– Hint: Some are intermediate goods.


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• Intermediate Goods– Goods used up entirely in the production of final

goods

• Value Added– The dollar value of an industry’s sales minus the

value of intermediate goods (for example, raw materials and parts) used in production

– Value Added (not $ sales) is your contribution to the economy


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Table 8-1 Sales Value and Value Added at Each Stage of Donut Production


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Cost Breakdown for a pair of Nike shoes from Indonesia (1995)

Cost TotalProduction labourMaterialsRent, equipmentSupplier's operating profitDutiesShippingCost to Nike

$2.75$9.00$3.00$1.75$3.00$0.50

$20.00

Research and developmentPromotion and advertisingSales, distribution, admin.Nike's operating profitCost to retailer

$0.25$4.00$5.00$6.23

$35.50

Retailer's rentPersonnelOtherRetailer's operating profitCost to consumer

$9.00$9.50$7.00$9.00

$70.00

www-personal.umich.edu/~lormand/poli/nike/nike101-8.htm


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Transactions that have nothing to do with final goods and services being produced:

• Financial transactions (stocks, bonds, loans)

• Transfer Payments (social security tax/benefit, unemployment benefits)

• Secondhand Goods

• Pure gifts


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Two Main Methods of Measuring GDP (cont'd)

Presenting the Expenditure Approach

– Where• C = consumption expenditures

• I = investment expenditures

• G = government expenditures

• X = net exports (exports – imports)

GDP = C + I + G + X


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Two Main Methods of Measuring GDP (cont'd)

Deriving GDP by the Income Approach

• Gross Domestic Income (GDI)

– Wages: salaries and labor income

– Rent: farms, houses, stores

– Interest: savings accounts

– Profits: sole proprietorships, partnerships, corporations


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Figure 8-3 Gross Domestic Product and Gross Domestic Income, 2009 (in billions of 2009 dollars per year)

Sources: U.S. Department of Commerce and author’s estimates.


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Distinguishing Between Nominal and Real Values

• Nominal Values

– Measurements in terms of the actual market prices at which goods are sold; expressed in current dollars, also called money values

• Real Values– Measurements after adjustments have been

made for changes in the average of prices between years; expressed in constant dollars

– This price-corrected GDP is the real GDP.


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*Price index: measured by the GDP deflator

Real GDP = x 100Nominal GDP

Price index*

Example: Correcting GDP for Price Index Changes

• Correcting GDP for price index changes

– Nominal (current) dollars GDP

– Real (constant) dollars GDP


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Table 8-3 Correcting GDP for Price Index Changes


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Per capita real GDP =Real GDP

Population

Distinguishing Between Nominal and Real Values (cont'd)

• Per capita GDP

– Adjusting for population growth


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Source: U.S. Department of Commerce

Figure 8-4 Nominal and Real GDP


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Table 8-4 Comparing GDP Internationally


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• GDP’s limitations

– Excludes non-market production

– It is not necessarily a good measure of the well-being of a nation.

– Does money buy happiness?

– OK, can you tell me which country do you want to live in?


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Myth #8: Money is everything

• Money is everything up to a point• Get a real job and you are there

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Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 8 Measuring the Economy’s Performance