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The Simple Circular Flow

The Simple Circular Flow . The Simple Circular Flow . The Simple Circular Flow . The Simple Circular Flow . The Simple Circular Flow . Figure 8.1. The Simple Circular Flow. Two observations In every economic exchange, the seller receives exactly the same amount that the buyer spends.

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The Simple Circular Flow

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  1. The Simple Circular Flow

  2. The Simple Circular Flow

  3. The Simple Circular Flow

  4. The Simple Circular Flow

  5. The Simple Circular Flow Figure 8.1

  6. The Simple Circular Flow • Two observations • In every economic exchange, the seller receives exactly the same amount that the buyer spends. • Goods and services flow in one direction and money payments flow in the other.

  7. The Simple Circular Flow • Profits explained • Question • Why is profit a cost of production? • Answer • Profits are the return entrepreneurs receive for the risk they incur when organizing productive activities

  8. The Simple Circular Flow • Product Markets • Transactions in which households buy goods

  9. The Simple Circular Flow • Final Goods and Services • Goods and services that are at their final stage of production and will not be transformed into yet other goods or services

  10. The Simple Circular Flow • Factor Markets • Transactions in which businesses buy resources

  11. The Simple Circular Flow • Total Income • The yearly amount earned by the nation’s factors of production

  12. The Simple Circular Flow • Question • Why must total income be identical to the dollar value of total output? • Answer • Every transaction simultaneously involves an expenditure and a receipt

  13. National Income Accounting • 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

  14. National Income Accounting • Observations • GDP measures the dollar value of final output • GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders

  15. Two Main Methodsof Measuring GDP • Expenditure Approach • A way of computing national income by adding up the dollar value at current market prices of all final goods and services

  16. Two Main Methodsof Measuring GDP Expenditure Approach

  17. Two Main Methods of Measuring GDP • Income Approach • A way of measuring national income by adding up income received by all factors of production

  18. Two Main Methodsof Measuring GDP Income Approach

  19. Two Main Methodsof Measuring GDP • Deriving GDP by the expenditure approach • Consumption Expenditure (C) • Durables • Life span of more than three years • Nondurables • Life span of less than three years • Services • Intangible commodities

  20. Two Main Methodsof Measuring GDP • Deriving GDP by the expenditure approach • 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

  21. Two Main Methodsof Measuring GDP • Deriving GDP by the expenditure approach • Gross Private Domestic Investment (I) • Fixed investment • Inventory investment • New residential structures

  22. Two Main Methodsof Measuring GDP • Deriving GDP by the expenditure approach • Government Expenditures (G) • State, local, and federal • Valued at cost

  23. Net exports (X) = total exports - total imports Two Main Methodsof Measuring GDP • Deriving GDP by the expenditure approach • Net Exports (Foreign Expenditures)

  24. GDP = C + I + G + X Two Main Methodsof Measuring GDP • Mathematical representation using the expenditure approach

  25. GDP and Its Components Figure 8-3

  26. Two Main Methodsof Measuring GDP • Deriving GDP by the income approach

  27. Deriving GDP by the Income Approach • Gross Domestic Income (GDI) • The sum of all income—wages, interest, rent, and profits—paid to the four factors of production

  28. Two Main Methodsof Measuring GDP • Gross Domestic Income (GDI) • Wages • Interest • Rent • Profits

  29. Gross Domestic Product and Gross Domestic Income, 2000(in billions of 2000 dollars per year) Figure 8-4 Source: U.S. Department of Commerce. First quarter preliminary data annualized.

  30. Gross Domestic Product and Gross Domestic Income, 2000(in billions of 2000 dollars per year) Expenditure Point of View—Product Flow Expenditures by Different Sectors: Household sector Personal consumption expenses $6,661.5 Government sector Purchase of goods and services 1,734.6 Business sector Gross private domestic investment (including depreciation) 1,727.0 Foreign sector Net exports of goods and services -273.6 Gross Domestic Product $9,849.5

  31. Gross Domestic Product and Gross Domestic Income, 2000(in billions of 2000 dollars per year) Income Point of View—Cost Flow Domestic Income (at factor cost): Wages All wages, salaries, and supplemental employee compensation $5,678.4 Rent All rental income of individuals plus implicit rent on owner-occupied dwellings 155.4 Interest Net interest paid by business 490.2 Profit Proprietorial income 701.3 Corporate profits before taxes deducted 952.0 Non-income expense items Indirect business taxes and other adjustments 762.1 Depreciation 1,215.4 Statistical discrepancy -105.3 Gross Domestic Income $9,849.5

  32. 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

  33. Other Components of National Income Accounting • Disposable Personal Income (DPI) • Personal income after personal income taxes have been paid

  34. Going from GDP to Disposable Income, 2000 Billions of Dollars Gross domestic product (GDP) 9,849.5 Minus depreciation -1,215.4 Net domestic product (NDP) 8,634.1 Minus indirect business taxes -762.1 and other adjustments National Income (NI) 7,872.0 Minus corporate taxes, Social Security contributions, corporate retained earnings -1,236.5 Plus government and business transfer payments +1,606.8 Personal Income (PI) 8,242.3 Minus personal income tax and non-tax payments -1,253.2 Disposable personal income (DPI) 6,989.1 Source: U.S. Department of Commerce

  35. 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

  36. Distinguishing Between Nominal and Real Values • Real Values • Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars

  37. Real GDP = nominal GDP price level* = 100 *Price level: measured by the GDP deflator Distinguishing Between Nominal and Real Values • Correcting GDP for price index changes • Nominal (current) dollars GDP • Real (constant) dollars GDP

  38. Correcting GDP for Price Changes (1) (2) (3) (4) = [(2)/(3)] x 100 Nominal GDP Real GDP (billions of (billions of dollars dollars Price Level Index per year Year per year) (base year 1992 = 100) in constant 1992 dollars) 1990 5,803.2 86.8 6,683.5 1991 5,986.2 89.8 6,669.2 1992 6,318.9 91.7 6,891.1 1993 6,642.3 94.2 7,054.1 1994 7,054.3 96.1 7,337.8 1995 7,400.5 98.2 7,537.1 1996 7,813.2 100.0 7,813.2 1997 8,300.9 101.7 8,165.1 1998 8,759.9 102.9 8,516.3 1999 9,254.6 104.4 8,867.0 2000 9,849.5 106.4 9,256.2 Source: U.S. Department of Commerce, Bureau of Economic Analysis

  39. Distinguishing Between Nominal and Real Values • Example • Base Year = 1992 • Price Index = 100

  40. nominal GDP price index = 100 Real 1992 GDP = $6,020.2 100 = 100 = $6,020.2 billion Real 1992 GDP = Distinguishing Between Nominal and Real Values Real GDP = nominal GDPin the base year

  41. $6,343.3 102.2 = 100 = $6,206.8 billion Real 1993 GDP = Distinguishing Between Nominal and Real Values • 1993 • Price Index = 102.2

  42. $4,539.9 82.7 = 100 = $5,489.6 billion Real 1993 GDP = Distinguishing Between Nominal and Real Values • 1987 • Price Index = 82.7

  43. Nominal and Real GDP Figure 8-5 Source: U.S. Department of Commerce

  44. real GDP population Per capita real GDP = Distinguishing Between Nominal and Real Values • Per capita GDP • Adjusting for population growth

  45. Distinguishing Between Nominal and Real Values • Question • Is real per capita GDP a good indicator of social well-being?

  46. Distinguishing Between Nominal and Real Values • Some issues • The distribution of output • Changes in leisure time • Increased traffic congestion • Air pollution • Crime • Housework

  47. Issues and Applications:How Well Do Economists Predict GDP? • Forecasting economists have done a relatively good job predicting long-run trends in real GDP. • They have not done as well predicting recessions.

  48. Economic Forecasts:Missing the Mark Forecasted Growth Actual Growth Start of Recession Date of Forecast over the Next Year (%) in Real GDP (%) December 1969 December 1969 1.5 -.6 November 1973 December 1973 1.5 -1.8 January 1980 December 1979 -.7 -.3 July 1990 December 1989 2.1 -.1 July 1991 December 1990 2.2 .7 Source: Business Week, September 30, 1992, p. 92

  49. How Well Do Economists Predict GDP? • Difficulties in predicting downturns • Trying to develop computer models for a changing multi-trillion dollar economy • Globalization • Data sources and methodology

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