EC 202 January 31, 2011 1) National Income -- GDP 1 ...
EC 202 January 31, 2011 1) National Income -- GDP 1) Macroeconomics studies the overall economy and its aggregate performance. a) Considers overall economic activity and how it is influenced by employment, aggregate output and demand for goods and services, business cycles, government monetary (money supply) and fiscal (direct spending) policy, savings and investment. b) Focuses on behavior of economy as a whole 2) The Major Macroeconomic Issues a) Living standards and Economic growth i ) Living Standards ⇒ The degree to which people have access to goods and services that make their lives easier, healthier, safer, and more enjoyable ii ) Economic Growth ⇒ A process of steady increases in the quantity and quality of the goods and services the economy can produce iii ) Note: Economic growth (Producing and consuming more goods and services) does not necessarily mean improvement in the quality-of-life (1) Value of a healthy ecosystem not considered in GDP (2) Value of leisure time not considered in GDP (3) Business firms and politicians often focus on short-term profits and immediate consequences as opposed to taking a long-term (intergenerational) view. b) Productivity ⇒ Measure of national economic performance i ) Current and accurate information on the overall economy is necessary for economists, business and financial organizations, policymakers, etc. to determine the economy’s performance and evaluate the future implications of various policy decisions ii ) Gross Domestic Product (GDP) (1) Measure of the nation’s aggregate output (2) Market value of the final goods and services produced in a country during a given time period (3) GDP = Consumer Spending + Private Investment in New Plant and Equipment + Government Purchases + Net Exports (i.e., Exports – Imports) (4) GDP = C + I + G + NX c) Recessions and expansions
January 31, 2011 Page 2 i ) Business Cycles ⇒ Periodic alterations in economic activity (1) Downturns, know as recessions (2) Upturns, know as expansions ii ) Production Possibility Curve can be used to illustrate iii ) Average length of a business cycle has been 5 years and 7 months (i.e., recession to expansion to recession) d) Employment and Unemployment i ) Employment ⇒ Number of people currently employed in the economy ii ) Unemployment ⇒ Number of people actively looking for work but not currently employed e) Inflation i ) Aggregate price level ⇒ Overall price level for final goods and services in the economy ii ) Inflation ⇒ Rising aggregate price level iii ) Deflation ⇒ Falling aggregate price level f) Economic interdependence among nations i ) Movement of goods, services, and assets across national borders (i.e., trade) ii ) Exchange rate ⇒ value of one national currency in terms of the other iii ) Trade balance ⇒ Value of goods and services sold to other countries and value of goods and services purchased from other countries iv ) Capital Flows ⇒ International movements of financial assets 3) Measuring national economic performance i ) Current and accurate information on the overall economy is necessary for economists, business and financial organizations, policymakers, etc. to determine the economy’s performance and evaluate the future implications of various policy decisions ii ) Gross Domestic Product (GDP) (1) Measure of the nation’s aggregate output (2) Market value of the final goods and services produced in a country during a given time period (3) GDP is used as a measure of the size of the economy and can also be used to compare the economic performance with other countries
January 31, 2011 Page 3 Nominal GDP (1960 through 2008)
GDP 2010 (Nominal) ($ million)
January 31, 2011 Page 4 iii ) Market prices of goods and services are used to value national income (GDP) iv ) GDP per capita Country
GDP Per Capita (2010 Nominal $)
Luxembourg Norway Qatar Switzerland Denmark Australia Sweden United Arab Emirates United States Netherlands
$104,390 84,543 74,422 67,074 55,113 54,869 47,667 47,406 47,132 46,418
China’s per capita income is $4,323 i ) Three methods to calculate GDP (1) Expenditure method ⇒ (a) Adding up the total amount spent on final goods and services and subtracting the amount spent on imported goods and services from exported goods and services (b) GDP = Consumer Spending + Private Investment in New Plant and Equipment + Government Purchases + Net Exports (i.e., GDP = C+I+G+NX) • Consumer Spending 1. Consumer durables ⇒ Long-term goods such as cars, furniture, appliances 2. Consumer nondurables ⇒ Short-term goods such as food and clothing 3. Services ⇒ Financial, legal, and educational services, and other common services such as athletic club membership, lawn care, barbers and hair stylists, etc. • Private Investment 1. Business fixed investment ⇒ New capital goods such as factories, machinery, office buildings 2. Residential investment ⇒ New homes and apartments constructed in current year
January 31, 2011 Page 5 3. Inventory investment ⇒ Addition of unsold goods to a company’s inventory • Government Purchases 1. Purchases of final goods and services by federal, state, and local governments 2. Does not include transfer payments (e.g., unemployment insurance) or interest paid on government debt • Net Exports 1. Exports are domestically produced final goods and services that are sold abroad 2. Imports are purchases by domestic buyers of goods and services produced abroad (c) Note: When using the expenditure method, the market values of intermediate goods and services are not included in GDP • Goods used up in the production of final goods and services 1. Example -- tires on a new auto 2. Value of Tires (Intermediate good) included in market value of Auto (Final product) E xam ple Q u estio n : •
A tir e m a n u fa c tu r e r p r o d u c e s $ 2 0 0 ,0 0 0 w o r th o f tir e s. $ 15 0 ,0 0 0 w o r th is so ld to a m ajo r c ar c o m p a n y fo r u se o n n ew c a r s. T h e o th e r $ 5 0 ,0 0 0 w o r th is s o ld d ir ec tly to c u sto m er s fo r fin a l u se.
H o w m u c h is c o n tr ib u ted to G D P ?
(2) Income method ⇒ (a) Adding total labor and capital income (b) Labor income includes, before taxes, includes wages, salaries and the income of the self-employed. (Represents about 75% of GDP) (c) Capital income consists of payments to the owners of physical capital (factories, machines, and office buildings) and intangible capital (e.g., patents, copyrights) (Represents about 25% of GDP)
January 31, 2011 Page 6 E xam ple Q u estio n : F o r th e fo llo w in g in c o m e c o m po n en ts: • E m plo yee c o m pen satio n ⇒ $ 8 0 0 0 • C o r po r ate pr o fits ⇒ $ 15 0 0 • N et in ter est ⇒ $ 6 0 0 • P r o p r ieto r ’s in c o m e ⇒ $ 10 0 0 • R en ta l In c o m e ⇒ $ 8 0 W H A T A R E T H E F O LLO W IN G V A LU E S ? 1. T o ta l in c o m e fo r o w n er s o f c a p ita l? 2 . T o ta l in c o m e fo r la b o r ? 3 . U sin g th e in c o m e m eth o d , G D P?
(3) Value-added method ⇒ (a) Aggregating the value added by each firm in each stage of the production process (b) Market value of firm’s product minus the cost of inputs • Value added represents that portion of the value of the final good or service that the firm creates in its stage of the production process • Summing the value added by all firms in the economy yields the final value of goods and services (i.e., GDP)
V ALUE -A DDED M ETHOD Company Farmer Grain Mill Dave’s Bread
Revenue Cost of Inputs Value added $0.50 $1.20 $2.00
$0.00 $0.50 $1.20
$0.50 $0.70 $0.80
Total Cost $0.50 $1.20 $2.00
(c) Many European countries use a value-added tax to acquire revenue (As opposed to income tax in U.S.)
V ALUE -A DDED M ETHOD Company
Revenue
Farmer Grain Mill Dave’s Bread
$0.50 $1.25 $2.12
Cost of Inputs $0.00 $0.55 $1.32
W ITH
Value added $0.50 $0.70 $0.80
T AX 10% Tax $.05 $.07 $.08
Total Cost $.55 $1.32 $2.20
January 31, 2011 Page 7
4) Nominal GDP and Real GDP a) Nominal GDP i ) Current dollar value of production (1) Quantities of final goods produced are valued at current year prices (2) Cannot be used to make comparisons between years because prices change overtime b) Real GDP i ) Value of production tied to base year prices (1) Quantities of final goods produced are valued at base year price (2) Allows comparison of GDP over many years E xam ple Q u estio n : Given the following information:
What is the value of Real GDP in 2007 using 2006 as the base year?
E xam ple Q u estio n : Given the following data for an economy, compute the value of GDP. • • • • • • • • • • •
Consumption expenditures ⇒ $50 Imports ⇒ $40 Government purchases of goods and services ⇒ $20 Construction of new homes and apartments ⇒ $30 Sales of existing homes and apartments ⇒ $40 Exports ⇒ $50 Government payments to retires ⇒ $10 Household purchases of durables goods ⇒ $20 Beginning-of-year inventory ⇒ $10 End-of-year inventory ⇒ $20 Business fixed investment ⇒ $30
GDP = _________________________________________
January 31, 2011 Page 2 i ) Business Cycles ⇒ Periodic alterations in economic activity (1) Downturns, know as recessions (2) Upturns, know as expansions ii ) Production Possibility Curve can be used to illustrate iii ) Average length of a business cycle has been 5 years and 7 months (i.e., recession to expansion to recession) d) Employment and Unemployment i ) Employment ⇒ Number of people currently employed in the economy ii ) Unemployment ⇒ Number of people actively looking for work but not currently employed e) Inflation i ) Aggregate price level ⇒ Overall price level for final goods and services in the economy ii ) Inflation ⇒ Rising aggregate price level iii ) Deflation ⇒ Falling aggregate price level f) Economic interdependence among nations i ) Movement of goods, services, and assets across national borders (i.e., trade) ii ) Exchange rate ⇒ value of one national currency in terms of the other iii ) Trade balance ⇒ Value of goods and services sold to other countries and value of goods and services purchased from other countries iv ) Capital Flows ⇒ International movements of financial assets 3) Measuring national economic performance i ) Current and accurate information on the overall economy is necessary for economists, business and financial organizations, policymakers, etc. to determine the economy’s performance and evaluate the future implications of various policy decisions ii ) Gross Domestic Product (GDP) (1) Measure of the nation’s aggregate output (2) Market value of the final goods and services produced in a country during a given time period (3) GDP is used as a measure of the size of the economy and can also be used to compare the economic performance with other countries
January 31, 2011 Page 3 Nominal GDP (1960 through 2008)
GDP 2010 (Nominal) ($ million)
January 31, 2011 Page 4 iii ) Market prices of goods and services are used to value national income (GDP) iv ) GDP per capita Country
GDP Per Capita (2010 Nominal $)
Luxembourg Norway Qatar Switzerland Denmark Australia Sweden United Arab Emirates United States Netherlands
$104,390 84,543 74,422 67,074 55,113 54,869 47,667 47,406 47,132 46,418
China’s per capita income is $4,323 i ) Three methods to calculate GDP (1) Expenditure method ⇒ (a) Adding up the total amount spent on final goods and services and subtracting the amount spent on imported goods and services from exported goods and services (b) GDP = Consumer Spending + Private Investment in New Plant and Equipment + Government Purchases + Net Exports (i.e., GDP = C+I+G+NX) • Consumer Spending 1. Consumer durables ⇒ Long-term goods such as cars, furniture, appliances 2. Consumer nondurables ⇒ Short-term goods such as food and clothing 3. Services ⇒ Financial, legal, and educational services, and other common services such as athletic club membership, lawn care, barbers and hair stylists, etc. • Private Investment 1. Business fixed investment ⇒ New capital goods such as factories, machinery, office buildings 2. Residential investment ⇒ New homes and apartments constructed in current year
January 31, 2011 Page 5 3. Inventory investment ⇒ Addition of unsold goods to a company’s inventory • Government Purchases 1. Purchases of final goods and services by federal, state, and local governments 2. Does not include transfer payments (e.g., unemployment insurance) or interest paid on government debt • Net Exports 1. Exports are domestically produced final goods and services that are sold abroad 2. Imports are purchases by domestic buyers of goods and services produced abroad (c) Note: When using the expenditure method, the market values of intermediate goods and services are not included in GDP • Goods used up in the production of final goods and services 1. Example -- tires on a new auto 2. Value of Tires (Intermediate good) included in market value of Auto (Final product) E xam ple Q u estio n : •
A tir e m a n u fa c tu r e r p r o d u c e s $ 2 0 0 ,0 0 0 w o r th o f tir e s. $ 15 0 ,0 0 0 w o r th is so ld to a m ajo r c ar c o m p a n y fo r u se o n n ew c a r s. T h e o th e r $ 5 0 ,0 0 0 w o r th is s o ld d ir ec tly to c u sto m er s fo r fin a l u se.
H o w m u c h is c o n tr ib u ted to G D P ?
(2) Income method ⇒ (a) Adding total labor and capital income (b) Labor income includes, before taxes, includes wages, salaries and the income of the self-employed. (Represents about 75% of GDP) (c) Capital income consists of payments to the owners of physical capital (factories, machines, and office buildings) and intangible capital (e.g., patents, copyrights) (Represents about 25% of GDP)
January 31, 2011 Page 6 E xam ple Q u estio n : F o r th e fo llo w in g in c o m e c o m po n en ts: • E m plo yee c o m pen satio n ⇒ $ 8 0 0 0 • C o r po r ate pr o fits ⇒ $ 15 0 0 • N et in ter est ⇒ $ 6 0 0 • P r o p r ieto r ’s in c o m e ⇒ $ 10 0 0 • R en ta l In c o m e ⇒ $ 8 0 W H A T A R E T H E F O LLO W IN G V A LU E S ? 1. T o ta l in c o m e fo r o w n er s o f c a p ita l? 2 . T o ta l in c o m e fo r la b o r ? 3 . U sin g th e in c o m e m eth o d , G D P?
(3) Value-added method ⇒ (a) Aggregating the value added by each firm in each stage of the production process (b) Market value of firm’s product minus the cost of inputs • Value added represents that portion of the value of the final good or service that the firm creates in its stage of the production process • Summing the value added by all firms in the economy yields the final value of goods and services (i.e., GDP)
V ALUE -A DDED M ETHOD Company Farmer Grain Mill Dave’s Bread
Revenue Cost of Inputs Value added $0.50 $1.20 $2.00
$0.00 $0.50 $1.20
$0.50 $0.70 $0.80
Total Cost $0.50 $1.20 $2.00
(c) Many European countries use a value-added tax to acquire revenue (As opposed to income tax in U.S.)
V ALUE -A DDED M ETHOD Company
Revenue
Farmer Grain Mill Dave’s Bread
$0.50 $1.25 $2.12
Cost of Inputs $0.00 $0.55 $1.32
W ITH
Value added $0.50 $0.70 $0.80
T AX 10% Tax $.05 $.07 $.08
Total Cost $.55 $1.32 $2.20
January 31, 2011 Page 7
4) Nominal GDP and Real GDP a) Nominal GDP i ) Current dollar value of production (1) Quantities of final goods produced are valued at current year prices (2) Cannot be used to make comparisons between years because prices change overtime b) Real GDP i ) Value of production tied to base year prices (1) Quantities of final goods produced are valued at base year price (2) Allows comparison of GDP over many years E xam ple Q u estio n : Given the following information:
What is the value of Real GDP in 2007 using 2006 as the base year?
E xam ple Q u estio n : Given the following data for an economy, compute the value of GDP. • • • • • • • • • • •
Consumption expenditures ⇒ $50 Imports ⇒ $40 Government purchases of goods and services ⇒ $20 Construction of new homes and apartments ⇒ $30 Sales of existing homes and apartments ⇒ $40 Exports ⇒ $50 Government payments to retires ⇒ $10 Household purchases of durables goods ⇒ $20 Beginning-of-year inventory ⇒ $10 End-of-year inventory ⇒ $20 Business fixed investment ⇒ $30
GDP = _________________________________________
