lecture personal income by renata.vivien

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									GDP and the Standard
of Living
                       CHAPTER   14
CHAPTER CHECKLIST

When you have completed your study of this
chapter, you will be able to

1   Define GDP and explain why the value of production,
    income, and expenditure are the same for an economy.
2   Describe how economic statisticians measure GDP an
    distinguish between nominal GDP and real GDP.

3   Describe and explain the limitations of real GDP as a
    measure of the standard of living.
14.1 GDP, INCOME, AND EXPENDITURE

<GDP Defined
  Gross domestic product or GDP
  The market value of all the final goods and services
  produced within a country in a given time period.
  Value Produced
     • Use market prices to value production.
14.1 GDP, INCOME, AND EXPENDITURE

  What Produced
  Final good or service is a good or service that is
  produced for its final user and not as a component of
  another good or service.
  Intermediate good or service is a good or service
  that is produced by one firm, bought by another firm,
  and used as a component of a final good or service.
  GDP includes only those items that are traded in
  markets.
14.1 GDP, INCOME, AND EXPENDITURE

  Where Produced
    • Within a country
  When Produced
    • During a given time period.
14.1 GDP, INCOME, AND EXPENDITURE

<Circular Flows in the U.S. Economy
  Consumption expenditure is the expenditure by
  households on consumption goods and services.
  Investment is the purchase of new capital goods
  (tools, instruments, machines, buildings, and other
  constructions) and additions to inventories.
14.1 GDP, INCOME, AND EXPENDITURE

  Government expenditure on goods and services
  is the expenditure by all levels of government on goods
  and services.
  Net exports of goods and services is the value of
  exports of goods and services minus the value of
  imports of goods and services.
14.1 GDP, INCOME, AND EXPENDITURE

  Exports of goods and services are the items that
  firms in in the United States produce and sell to the rest
  of the world.
  Imports of goods and services are the items that
  households, firms, and governments in the United
  States buy from the rest of the world.
14.1 GDP, INCOME, AND EXPENDITURE

  Total expenditure is the total amount received by
  producers of final goods and services.
  Consumption expenditure: C
  Investment: I
  Government expenditure on goods and services: G
  Net exports: NX
            Total expenditure = C + I + G + NX
14.1 GDP, INCOME, AND EXPENDITURE

  Income
  • Labor earns wages.
  • Capital earns interest.
  • Land earns rent.
  • Entrepreneurship earns profits.
  Households receive these incomes.
14.1 GDP, INCOME, AND EXPENDITURE

<Expenditure Equals Income
  Because firms pay out everything they receive as
  incomes to the factors of production, total expenditure
  equals total income.
  That is:
                     Y = C + I + G + NX
  The value of production equals income equals
  expenditure.
 14.1 GDP, INCOME, AND EXPENDITURE

Figure 14.1
shows the
circular flow
of income
and
expenditure.
The table
shows the
U.S. data
for 2007.
14.2 MEASURING U.S. GDP
<The Expenditure Approach
  Measures GDP by using data on consumption
  expenditure, investment, government expenditure on
  goods and services, and net exports.
  Table 14.1 on the next slide shows the calculation for
  2007.
14.2 MEASURING U.S. GDP

 Expenditures Not in GDP
  Used Goods
  Expenditure on used goods is not part of GDP because
  these goods were part of GDP in the period in which
  they were produced and during which time they were
  new goods.
  Financial Assets
  When households buy financial assets such as bonds
  and stocks, they are making loans, not buying goods
  and services.
14.2 MEASURING U.S. GDP

<The Income Approach
  Measures GDP by summing the incomes that firms pay
  households for the factors of production they hire.
  The U.S. National Income and Product Account divide
  incomes into two big categories:
     • Wages
     • Interest, rent, and profits
14.2 MEASURING U.S. GDP

  Wages
    Wages, called compensation of employees in the
    national accounts, is the payment for labor services.
    It includes net wages and salaries plus fringe
    benefits paid by employers such health care
    insurance, social security contributions, and pension
    fund contributions.
14.2 MEASURING U.S. GDP

  Interest, Rent, and Profit
  Interest, rent, and profit, called net operating surplus in
  the national account, is the sum of the incomes earned
  by capital, land, and entrepreneurship.
  Interest is the income households receive on loans they
  make minus the interest they pay on their borrowing.
  Rent includes payments for the use of land and other
  rented inputs.
  Profit includes the profits of corporations and small
  businesses.
14.2 MEASURING U.S. GDP
14.2 MEASURING U.S. GDP

  Net domestic product at factor cost is the sum of
  wages, interest, rent, and profit.


  Net domestic product at factor cost is not GDP.
  We need to make two adjustments to arrive at GDP:
    • One from factor cost to market prices
    • One from net product to gross product
14.2 MEASURING U.S. GDP

  From Factor Cost to Market Price
  The expenditure approach values goods at market
  prices; the income approach values them at factor cost.
  Indirect taxes (such as sales taxes) make market prices
  exceed factor cost.
  Subsidies (payments by government to firms) make
  factor cost exceed market prices.
  To convert the value at factor cost to the value at
  market prices, we must:
     • Add indirect taxes and subtract subsidies
14.2 MEASURING U.S. GDP
14.2 MEASURING U.S. GDP
  From Gross to Net
  The expenditure approach measures gross product; the
  income approach measures net product.
  Gross profit is a firm’s profit before subtracting the
  depreciation of capital.
  Net profit is a firm’s profit after subtracting the
  depreciation of capital.
  Depreciation is the decrease in the value of capital
  that results from its use and from obsolescence.
14.2 MEASURING U.S. GDP

  Income includes net profit, so the income approach
  gives a net measure.
  Expenditure includes investment. Because some new
  capital is purchased to replace depreciated capital, the
  expenditure approach gives a gross measure.
  To get gross domestic product from the income
  approach, we must add depreciation to total income.
  After making these two adjustments the income
  approach almost gives the same estimate of GDP as
  the expenditure approach.
14.2 MEASURING U.S. GDP
14.2 MEASURING U.S. GDP

 Statistical Discrepancy
  The income approach and the expenditure approach do
  not deliver exactly the same estimate of GDP—there is
  a statistical discrepancy.
  Statistical discrepancy is the discrepancy between
  the expenditure approach and income approach
  estimates of GDP, calculated as the GDP expenditure
  total minus the GDP income total.
14.2 MEASURING U.S. GDP
14.2 MEASURING U.S. GDP

<GDP and Related Measures of Production
 and Income
  Gross national product or GNP is the market value
  of all the final goods and services produced anywhere in
  the world in a given time period by the factors of
  production supplied by residents of the country.
  U.S. GNP = U.S. GDP + Net factor income from abroad
14.2 MEASURING U.S. GDP

 Disposable Personal Income
 Consumption expenditure is one of the largest
 components of aggregate expenditure and one of the
 main influences on it is disposable personal income.

 Disposable personal income is the income received
 by households minus personal income taxes paid.
14.2 MEASURING U.S. GDP


Figure 14.2 shows the
relationship between
GDP, GNP, and
disposable personal
income.
14.2 MEASURING U.S. GDP

<Real GDP and Nominal GDP
  Real GDP is the value of the final goods and services
  produced in a given year expressed in the prices of the
  base year.
  Nominal GDP is the value of the final goods and
  services produced in a given year expressed in the
  prices of that same year.
  The method of calculating real GDP changed in recent
  years. Here we describe the essence of the calculation.
  The appendix gives the technical details.
14.2 MEASURING U.S. GDP

<Calculating Real GDP
  The goal of calculating real GDP is to measure the
  extent to which total production has increased
  Real GDP removes the influence of price changes from
  the nominal GDP numbers.
  To focus on the principles and keep the numbers easy
  to work with, we’ll calculate real GDP for an economy
  that produces only one consumption good, one capital
  good, and one government service.
14.2 MEASURING U.S. GDP

  Table 14.3 shows the calculation with 2000 (base year)
  and 2008.
  To find the total expenditure in 2000 multiply the
  quantity of each item produced in 2000 by its price in
  2000.
  Then sum the expenditures to find nominal GDP in
  2000.
  The next slide shows the data.
Nominal
GDP in
2000 is
$100
million.

Because
2000 is the
base year,
real GDP
in 2000 is
also $100
million.
14.2 MEASURING U.S. GDP

  In part (b) of Table 14.3, we calculate nominal GDP in
  2008.
  Again, we calculate nominal GDP by multiplying the
  quantity of each item produced by its price and then
  sum the expenditures to find nominal GDP in 2008.
Nominal
GDP in
2000 is
$100
million.

Nominal
GDP in
2008 is
$300
million.
14.2 MEASURING U.S. GDP

Nominal GDP in 2000 is $100 million and in 2008 it is $300
million.

Nominal GDP in 2008 is three times its value in 2000.
But by how much has the quantity of final goods and
services produced increased?
14.2 MEASURING U.S. GDP

  The increase in real GDP will tell by how much the
  quantity of good and services has increased.
  Real GDP in 2008 is what the total expenditure would
  have been in 2008 if prices had remained the same as
  they were in 2000.
  To calculate real GDP in 2008 multiply the quantities
  produced in 2008 by the price in 2000 and the sum
  these expenditures to find real GDP in 2008.
  Part (c) of Table 14.3 shows the details.
Real GDP
in 2000 is
$100
million.

Real GDP
in 2008 is
$160
million—
only 1.6
times real
GDP in
2000.
14.3 THE USE AND LIMITATIONS OF REAL GDP

We use estimates of real GDP for two main purposes:
     • To compare the standard of living over time
     • To compare the standard of living among countries


<The Standard of Living Over Time
   To compare living standards we calculate real GDP per
   person—real GDP divided by the population.
   Table 14.4 shows two calculations
14.3 THE USE AND LIMITATIONS OF REAL GDP

 In 1967, real GDP in the United States was $3,485 billion
 and the population of the United States was 198.7
 million.

 Real GDP per person = $3,485 billion ÷ 198.7 million
 Real GDP per person = $17,536

 In most years, real GDP per person increases, but
 sometimes it doesn’t change.
14.3 THE USE AND LIMITATIONS OF REAL GDP

Long-Term Trend
Figure 14.3 shows
the long-term trend
in U.S. real GDP per
person.
Real GDP per person
doubled in the 36
years from 1967 to
2002.
14.3 THE USE AND LIMITATIONS OF REAL GDP

  Short-Term Fluctuations
  Fluctuations in the pace of expansion of real GDP is
  called the business cycle.
  The business cycle is a periodic irregular up-and down
  movement of total production and other measure of
  economic activity.
  The four stages of a business cycle are expansion,
  peak, recession, and trough.
14.3 THE USE AND LIMITATIONS OF REAL GDP


The shaded periods
show the
recessions—
periods of falling
production that
lasts for at least six
months.
14.3 THE USE AND LIMITATIONS OF REAL GDP

<Standard of Living Across Countries
  To compare living standards across countries, we must
  convert real GDP into a common currency and common
  set of prices, called purchasing power parity.
<Goods and Services Omitted from GDP
     •   Household production
     •   Underground production
     •   Leisure time
     •   Environment quality
14.3 THE USE AND LIMITATIONS OF REAL GDP

  Household Production
    • Real GDP omits household production, it
      underestimates the value of the production of
      many people, most of them women.
  Underground Production
    • Hidden from government to avoid taxes and
      regulations or illegal.
    • Because underground economic activity is
      unreported, it is omitted from GDP.
14.3 THE USE AND LIMITATIONS OF REAL GDP

  Leisure Time
     • Our working time is valued as part of GDP, but our
       leisure time is not.
  Environment Quality
    • Pollution is not subtracted from GDP.
    • We do not count the deteriorating atmosphere as a
      negative part of GDP.
    • If our standard of living is adversely affected by
      pollution, our GDP measure does not show this
      fact.
14.3 THE USE AND LIMITATIONS OF REAL GDP

<Other Influences on the Standard of Living
  Health and Life Expectancy
    • Good health and a long life do not show up directly
      in real GDP.
  Political Freedom and Social Justice
     • A country might have a very large real GDP per
       person but have limited political freedom and
       social justice.
     • A lower standard of living than one that had the
       same amount of real GDP but in which everyone
       enjoyed political freedom.
APPENDIX: MEASURING REAL GDP

<The Problem with Base-Year Prices
  We’ll calculate real GDP in 2008 using 2000 as the
  base year and found that real GDP in 2008 was 1.6
  percent greater than in 2000—an increase of 60%.
  But if we had used 2008 prices rather than 2000, real
  GDP would have increased from $150 million (2008
  dollars) in 2000 to $300 million in 2008—an increase of
  100%.
  So did real GDP increase by 60% or 100%?
APPENDIX: MEASURING REAL GDP

  The BEA method uses the prices of both years.
  The three steps in the method are
  • Value production in the prices of adjacent years.
  • Find the average of the two percentage changes.
  • Link (chain) back to the base year.
APPENDIX: MEASURING REAL GDP

<Value Production in the Prices of Adjacent
 Years
  Let’s take as the two adjacent years 2008 and its
  preceding year 2007.
  Value the quantities produced in 2007 and 2008 at both
  the prices of 2007 and the prices of 2008.
  Table A14.1 shows the calculations.
APPENDIX: MEASURING REAL GDP

  The table gives
     • Value of production in 2007 at 2007 prices is $145.
     • Value of production in 2008 at 2007 prices is $160.

     • Value of production in 2007 at 2008 prices is $158.
     • Value of production in 2008 at 2008 prices is $172.


  The next step is the find the percentage increases using
  2007 prices and 2008 prices and then average these
  two percentages.
APPENDIX: MEASURING REAL GDP

<Find the Average of Two Percentage Changes
  Table A14.1 sets out the calculation:
     • Value of production in 2007 at 2007 prices is $145.
     • Value of production in 2008 at 2007 prices is $160.
  Using 2007 prices, production increased by 10.3%.
     • Value of production in 2007 at 2008 prices is $158.
     • Value of production in 2008 at 2008 prices is $172.
  Using 2008 prices, production increased by 8.9%.
  The average percentage increase in production is 9.6%.
APPENDIX: MEASURING REAL GDP
APPENDIX: MEASURING REAL GDP

<Link (Chain) Back to the Base Year
  Starting in the base year, apply the calculated average
  percentage increase each year to obtain the chained-
  dollar real GDP.
  Figure A14.1 illustrates the calculation with assumed
  data.

								
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