Methods of Measuring the National Income - PowerPoint

Document Sample
Methods of Measuring the National Income - PowerPoint Powered By Docstoc
					     ECON2301 - Principles of
        Macroeconomics

         Instructor: Patrick M. Crowley

    Lecture 8 – Measuring the Economy’s
                Performance

1
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




                                         2
The Simple Circular Flow
   Two observations
    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.

   Understanding these two observations lies
    behind how we construct our nation’s accounts.
   Every market-based economy in the world
    constructs it’s national accounts in a similar
    manner.
                                                              3
Figure 8-1 The Circular Flow
of Income and Product




                               4
The Simple Circular Flow (cont'd)
   Product Markets
       Transactions in which households buy goods




                                                     5
The Simple Circular Flow (cont'd)
   Factor Markets
       Transactions in which businesses buy resources




                                                         6
The Simple Circular Flow (cont'd)
   Total Income
       Wages, rent, interest, profits




                                         7
The Simple Circular Flow (cont'd)
                              Question
                                  Why must total
                                   income be identical
                                   to the dollar value of
                                   total output?
                              Answer
                                  Every transaction
                                   simultaneously
                                   involves an
                                   expenditure and
                                   a receipt.

                                                        8
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)
   National income accounting identity:
    Value of (new) production ≡ total income ≡ total expenditures


                                                                    9
National Income Accounting (cont'd)
Defn: 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 in a given
 period of time
   Observations
       Has to go through a market
       Final, not intermediate goods
       Goods produced abroad not counted in GDP
                                                   10
National Income Accounting (cont'd)

   Stress on final output
       What is a final good?
           Wheat?
           Steel?
           Oil?
           Bread?
           Automobile?
           Gasoline?
National Income Accounting (cont'd)
   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




                                                            12
Table 8-1 Sales Value and Value Added at
Each Stage of Donut Production




                                           13
National Income Accounting (cont'd)
   Exclusion of financial transactions, transfer
    payments, and secondhand goods
       Numerous transactions occur that have nothing to do
        with final goods and services being produced.

   Note we exclude anything produced abroad as our
    factors of production didn’t get paid any income for
    producing it
   But we include all US exports as even though we
    don’t consume these, our factors of production get
    paid for producing them
   We exclude any work that doesn’t go through a legal       14
    market (e.g. charity work, homemaker work in the
    house, black market activities)
International Example: Greece Pays a Price for
Broadening Its GDP Definition

 Greece’s government recently announced that its
  official tabulation of GDP would include
  production in black market industries.
 Consequently, GDP rose by about 25% for every
  year since 2000, which reduces the amount of EU
  payments Greece is eligible for by almost $600
  million annually.
 Why is it harder now to compare Greek GDP to
  the levels of other nations?
National Income Accounting (cont'd)
   GDP’s limitations
       Excludes non-market production
       It is not necessarily a good measure of the well-being
        of a nation.

   GDP is a measure of the value of production in
    terms of market prices, and an indicator of
    economic activity.
   GDP is not a measure of a nation’s overall
    welfare.
                                                                 16
Two Main Methods
of Measuring GDP
   From national income accounting identity, we
    can either value our production (output) in terms
    of spending (expenditure approach) or in terms of
    income (income approach)
   Expenditure approach
       Computing GDP by adding up the dollar value at
        current market prices of all final goods and services
        purchased

   Expenditure approach is simpler than income
    approach, but considered less accurate
                                                                17
Two Main Methods
of Measuring GDP (cont'd)




             Expenditure Approach   18
Two Main Methods
of Measuring GDP (cont'd)


               Income Approach




                                 19
Two Main Methods
of Measuring GDP (cont'd)
   Deriving GDP by the expenditure approach

       Consumption Expenditure (C)
           Durable Consumer Goods
               Life span of more than three years
           Nondurable Consumer Goods
               Goods that are used up in three years
           Services
               e.g. doctors, dentists, lawyers, real estate
                agents, private tuition                        20
Two Main Methods
of Measuring GDP (cont'd)
    Gross Private Domestic Investment (I)
        The creation of capital goods, such as factories and
         machines, that can yield production and hence consumption
         in the future
            Also included: changes in business inventories and
             repairs made to machines, new buildings
        Capital Goods
            Life span of more than three years – used to
             make/produce something else
        Fixed Investment
            Purchases by business of newly produced producer
             durables or capital goods
                                                                        21
        Inventory Investment
            Changes in stocks of finished goods and goods in process
Two Main Methods
of Measuring GDP (cont'd)
   Deriving GDP by the
    expenditure approach
       Government Expenditures (G)
           State, local, and federal current and capital spending
           Valued at cost
   Deriving GDP by the
    expenditure approach
       Net Exports (Foreign Expenditures)

    Net exports (NX) = Total exports – Total imports
                                                                     22
Two Main Methods
of Measuring GDP (cont'd)
   Presenting the expenditure approach
       Where
           C   = consumption expenditures
           I   = investment expenditures
           G   = government expenditures
           X   = exports
           M   =   imports




                    GDP = C + I + G + X-M
                                             23
Figure 8-2
GDP and Its Components




                         24
Two Main Methods
of Measuring GDP (cont'd)
   Depreciation and net domestic product
       Deducting for depreciation (capital consumption
        allowance)
           Reduction in the value of capital goods over a one-year
            period due to physical wear and tear, and also to
            obsolescence




                         NDP = GDP – Depreciation
                                                                      25
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.
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.
Other Components of
National Income Accounting
   National Income (NI)
       The total of all factor payments to resource owners

   Personal Income (PI)
       The amount of income that households actually
        receive before they pay personal income taxes

   Disposable Personal Income (DPI)
       Personal income after personal income taxes have
        been paid


                                                              28
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

   Constant Dollars
       Dollars expressed in terms of real purchasing power
                                                                 29
Example: Correcting GDP
for Price Index Changes
   Correcting GDP for price index changes
       Nominal (current) dollars GDP
       Real (constant) dollars GDP




                           Nominal GDP
                Real GDP =               x 100
                            Price level*
                    *Price level: measured by the GDP deflator

                                                                 30
Table 8-3 Correcting GDP for Price
Index Changes
Distinguishing Between Nominal
and Real Values (cont'd)
   Per capita GDP
       Adjusting for population growth




                                     Real GDP
               Per capita real GDP =
                                     Population



                                                  32
Figure 8-4 Nominal and Real GDP




          Source: U.S. Department of Commerce
Comparing GDP throughout the world
   Foreign Exchange Rate
       The price of one currency in terms
        of another

   Foreign exchange rate
           $1.25 = 1 euro, or $1 = 0.80 euros
           French per capita income = 23,168.80 euros
           French per capita income in terms of dollars equals
            23,168.80 euros x $1.25 = $28,961

   Purchasing Power Parity
       Adjustments in exchange rate conversions that takes
        into account differences in the true cost of living       34
        across countries
Table 8-4 Comparing GDP
Internationally
International Example: Purchasing Power Parity
Comparisons of World Incomes

 The International Monetary Fund accepted the
  purchasing power parity approach a few years
  ago.
 It started presenting the statistics on each
  country’s GDP relative to others and based on the
  purchasing power parity relative to the dollar.
 Why is China’s per capita GDP higher based on
  purchasing power parity?
Issues and Applications: The Art of Estimating
GDP often Requires Touch-Ups
   The Bureau of Economic Analysis gives an advance
    estimate of quarterly GDP.
   The estimate receives considerable attention from the news
    media.
   Nevertheless, the estimate is updated at least two times.
   How different is the final result?




                                                                 37
Figure 8-5 Effects of Revisions
in GDP Estimates on Measured
GDP Growth Rates




                                  38
Issues and Applications: QoQ or YoY?

Purple plot is   20.0
real GDP
change on        15.0

QoQ basis,       10.0
and blue line
is real GDP       5.0

change on
                  0.0
YoY basis.               1947   1954   1961   1968   1975   1982   1989   1996   2003

Which is more     -5.0

volatile?
                 -10.0

                                                                                        39
                 -15.0
Summary
   The circular flow of income and output
   National income accounting identity
   Gross domestic product (GDP)
   Expenditure vs income method
   Distinguishing between nominal GDP and real GDP
   Limitations of GDP
   Foreign exchange rates
   Purchasing power parity
   International comparisons of GDP
   Revisions and different ways of measuring growth


                                                       40

				
DOCUMENT INFO
Description: Methods of Measuring the National Income document sample