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Principle of Macroeconomics

Dr. Ou Hu

Webpage: www.as.ysu.edu/~ohu

Office Hours:11:00-12:00, Monday through Friday and by appointment

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Principles of Macroeconomics

• Macroeconomics – study the behaviors of the overall economy

• Macroeconomic Goals– Sustainable economic growth– Full employment – Stable price

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Gross Domestic Product, GDP: A Definition

– A nation’s gross domestic product (GDP)

• Total value of all final goods and services produced for the market during a given period within the nation’s borders.

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Gross Domestic Product, GDP: A Definition

• …of all final…– When measuring production, we only count goods and

services that are sold to their final users.• Avoids over-counting intermediate products when measuring

GDP.– Value of all intermediate products is automatically included in

value of final products they are used to create.

– Examples: tires, glass, flour, etc.

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Gross Domestic Product, GDP: A Definition

• …goods and services…– Goods: cars, furniture, computers, beer, etc.– Services: medical, financial, educational, etc.

• …produced…– In order to contribute to GDP, something must be

produced.

Q: should stocks or bonds be included in the calculation

of GDP?

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Gross Domestic Product, GDP: A Definition

• …for the market…– GDP does not include all final goods and services produced in the

economy• Includes only the ones produced for the market—that is, with the

intention of being sold.• Example: ‘Do it yourself’ activities

• …during a given period…– GDP measures production during some specific period of time

• Only goods produced during that period are counted. how about old houses? And how about the services provided by the

realtors?• GDP is actually measured for each quarter, and reported as an annual

rate.

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Gross Domestic Product, GDP: A Definition

• …within the nation’s borders– U.S. GDP measures output produced within U.S.

borders.• Regardless of whether it was produced by Americans

– Incomes Americans earned abroad are not counted.– However, foreigners producing goods or services within the

country are included:

Chinese Acrobats, Toyota, Andrea Bocelli

– GDP vs.GNP• GNP=GDP+net income receipts

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The Expenditure Approach to GDP

• Expenditure approach divides output into four categories according to which group in the economy purchases it as final users– Consumption goods and services (C)—purchased by households

– Private investment goods and services (I)—purchased by businesses

– Government goods and services (G)—purchased by government agencies

– Net exports (NX)—purchased by foreigners

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The Expenditure Approach to GDP

• When we add up the purchases of all four groups we get GDP

GDP = C + I + G + NX

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Consumption Spending

• Consumption is the part of GDP purchased by households as final users– Almost everything households buy during the year is included as

part of consumption spending when we calculate GDP

– One exception is construction of new homes• Counted as private investment

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Private Investment

• Private investment has three components– Business Fixed Investment

• Factories, office buildings, machinery, and software • Are regarded as final goods, and firms that buy them as final users of

those goods

– Residential Investment• Residential housing is an important part of a nation’s capital stock• House will continue to provide services into the future

– Changes in Business Inventories• Why do we count the change in firms’ inventories as part of investment

in measuring GDP?– When goods are produced but not sold during the year, they end up in a

firm’s inventory stock– Part of the nation’s capital stock– Will provide services in the future, when they are finally sold and used

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Government Purchases

• Purchases by state, local, and federal government are included.

• Government purchases include – Goods

• Fighter jets, police cars, school buildings, spy satellites, etc.– Services

• Such as those performed by police, legislators, and military personnel

• Government is considered to be a purchaser even if it actually produces the goods or services itself

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Government Purchases

• Transfer payments represent money redistributed from one group of citizens (taxpayers) to another (poor, unemployed, elderly).

– While transfers are included in government budgets as outlays they are not purchases of currently produced goods and services.

• Not result in production of new goods and services• Not included in government purchases or in GDP

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Net Exports

• Not only do we spend on domestic goods and services, but we also spend on those from the rest of the world. So does the rest of the world.

– Add all the U.S. exports (sold to foreigners) in the measure of GDP– Deduct all the U.S. imports (bought from foreigners) during the

year, leaving us with just output produced in United States

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Other Approaches to GDP: The Value-Added Approach

• Value added – Firm’s contribution to a product or– Revenue it receives for its output

• Minus cost of all the intermediate goods that it buys

• GDP is sum of values added by all firms in economy.

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Other Approaches to GDP: The Factor Payments Approach

• In any year, value added by a firm is equal to total factor payments made by that firm.

• Thus, GDP = total factor payments made by all firms in the economy

• factor payments like wages, salaries, rent, interest and profit– GDP is measured by adding up all of the income

• Gives us an important insight into the macroeconomy– Total output of economy (GDP) = total income earned in the

economy

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Measuring GDP: A Summary

• Different ways to calculate GDP– Expenditure Approach

• GDP = C + I + G + NX– Value-Added Approach

• GDP = Sum of value added by all firms– Factor Payments Approach

• GDP = Wages and Salaries + interest + rent + profit

Therefore, Total output = Total income

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Problems With GDP

• Changes in Quality• Underground Economy• Non-market Production• Not a perfect measure of economic well-being

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Change in Quality

– While BEA includes impact of quality changes for many goods and services (such as automobiles and computers)

• Does not have the resources to estimate quality changes for millions of different goods and services

By ignoring these quality improvements, GDP probably understates true growth from year to year.

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The Underground Economy

• Some production is hidden from government authorities– Either because it is illegal

• Drugs, prostitution, most gambling– Or because those engaged in it are avoiding taxes

• Production in these hidden markets cannot be measured accurately

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Non-Market Production

• GDP does not include non-market production– Goods and services that are produced, but not sold in the market

• Whenever a non-market transaction becomes a market transaction GDP will rise even though total production has remained the same

• So, we must we must exercise caution in interpreting changes in GDP.

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Not a perfect measure of economic well-being

• No value measured on leisure

• “Bad” things can raise GDP.

Disasters, wars, etc.

• Externality – ecological cost