GDP: Measuring Total Production and Income Chapter 19

1. ECN 3100 TOPIK 6: PENDAPATAN NEGARA GDP: Measuring TotalProduction and IncomeChapter 19

2. GDP: Measuring Total Production and Income • Microeconomics The study of how households and businesses make choices, how they interact in markets, and how the government attempts to influence their choices. • Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. • Business cycle Alternating periods of economic expansion and economic recession.

3. Expansion The period of a business cycle during which total production and total employment are increasing. • Recession The period of a business cycle during which total production and total employment are decreasing. • Economic growth The ability of an economy to produce increasing quantities of goods and services. • Inflation rate The percentage increase in the price level from one year to the next.

4. Measuring Total Production: Gross Domestic Product Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time. • GDP IS MEASURED USING MARKET VALUES, NOT QUANTITIES • GDP INCLUDES ONLY THE MARKET VALUE OF FINAL GOODS - Final good or service A good or service purchased by a final user. • GDP INCLUDES ONLY CURRENT PRODUCTION that take place during the indicated time period.

5. GDP did not include i) Intermediate Goods and Services If include intermediate goods and services, we would be double counting. Eg. Freightliner produce truck as a final good but did not produce tire for its trucks. The value of the tire would be counted once when it was sold to Freightliner and a second time when Freightliner sold truck that was installed on to the truck. ii) Transfer paymentsPayments by the government to individuals for which the government does not receive a good or service in return. Eg: payment to retired

6. MALAYSIA: GDP (1970 – 2001)

7. Calculating GDP

8. GDP = Value of eye examinations + value of pizzas + value of textbooks = $5,000 + $800 + $2,000 = $7,800 (assumption: paper is an intermediate goods and its value did not included in GDP)

9. Production, Income, and the Circular Flow Diagram Figure 19-1 • Firms sell goods and service to three groups: households, firms and government. • To produce goods and services, firms use factor of production: labor, capital, natural resources and entrepreneurship. • Households supply factors of production to firms in exchange for income: wages, interest, profit and rent. • Firms make payment of wages and interest to households in exchange for hiring using factors of production. • Households use their income to purchase goods and services, pay taxes and saving. • Firms and government borrow the funds that flow from households into the financial system. • GDP measure the total incomer received by households • GDP measure the total value of expenditures on final goods and services or total value of income.

10. 19 - 1 The Circular Flow andthe Measurement of GDP Circular Flow Diagram The Flow of spending in the economy GDP = total income GDP = total expenditures

11. Components of GDP • PERSONAL CONSUMPTION EXPENDITURES, OR “CONSUMPTION” • Consumption (C) Spending by households on goods and services, not including spending on new houses. 2. GROSS PRIVATE DOMESTIC INVESTMENT, OR “INVESTMENT” • Investment (I) • a)Business Fixed Investment -spending by firms on new factories, office buildings, machinery, and inventories • b) Residential investment - spending by households on new houses. • c) Changes in business inventories.

12. 3. GOVERNMENT CONSUMPTION AND GROSS INVESTMENT, OR “GOVERNMENT PURCHASES” • Government purchases (G) Spending by federal, state, and local governments on goods and services. 4. NET EXPORTS OF GOODS AND SERVICES, OR “NET EXPORTS” (NX) - Net exports Exports minus imports. An Equation for GDP and Some Actual Values

13. 19 - 2 Components of GDP in 2004 An Equation for GDP and Some Actual Values

14. The table provides a more detailed breakdown and shows several interesting points: • Consumer spending on services is greater than the sum of spending on durable and nondurable goods. • Business fixed investment is the largest component of investment. • Purchases by state and local governments are greater than purchases by the federal government. • Imports are greater than exports, so net exports are negative.

15. Measuring GDP by the Value Added Method 19 – 1 Calculating Value Added Value added The market value a firm adds to a product.

16. Does GDP Measure What We Want It to Measure? Shortcomings in GDP as a Measure of Total Production (does not include two types of production) • HOUSEHOLD PRODUCTION - Household production Goods and services people produce for themselves. ii) THE UNDERGROUND ECONOMY - Underground economy Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

17. Does GDP Measure What We Want It to Measure? • Shortcomings of GDP as a Measure of Well-Being • THE VALUE OF LEISURE IS NOT INCLUDED IN GDP • GDP IS NOT ADJUSTED FOR POLLUTION OR OTHER NEGATIVE EFFECTS OF PRODUCTION • GDP IS NOT ADJUSTED FOR CHANGES IN CRIME AND OTHER SOCIAL PROBLEMS

18. Real GDP versus Nominal GDP • Calculating Real GDP • Real GDP The value of final goods and services evaluated at base year prices. • Nominal GDP The value of final goods and services evaluated at current year prices.

19. 19 - 2 • Calculating Real GDP

20. Real GDP for 2005 (base year=2000) GDPreal = value eye examination + value pizzas + value textbooks = $4000 + $880 + $1,800 = $6,680 GDPnominal(2005) = value eye examination + value pizzas + value textbooks = $5000 + $800 + $2,000 = $7,800 qtty (2005) * price (2000) qtty (2005) * price (2005)

21. 19 - 3 Nominal GDP and Real GDP, 1990-2004 • Comparing Real GDP and Nominal GDP

22. Nominal GDP vs Real GDP Nominal GDPvalues the production of goods and services at current prices. Real GDPvalues the production of goods and services at constant prices.

23. The GDP Deflator • GDP deflator A measure of the price level, calculated by dividing nominal GDP by real GDP, and multiplying by 100. • To track increases in price level over time. Price level A measure of the average prices of goods and services in the economy.

24. Eg.: GDP Deflator X 100 X 100 Price level increased = 109 – 106 106 X 100 = 2.8%

25. Other Measures of Total Production and Total Income • Gross National Product (GNP) • Net National Product (NNP) • National Income • Personal Income • Disposable Personal Income

26. Gross National Product the value of final goods and services produced by residents of a country, even if production takes place outside of the country. Net National Product GNP minus depreciation (the value of worn-out machinery, equipment and building).

27. National Income total income earned by nation’s residents in the production of goods and services. Personal Income income that household and noncorporate business received, includes payments received by households from government and interest on government bonds. excludes retained earnings – income that corporation have earned but have not paid to their owners.

28. Disposable Personal Income is equal to personal income minus personal tax payments

29. GDP • GDP is the best single measure of the economic well-being of a society. • GDP per persontells us the income and expenditure of the average person in the economy. • Higher GDP per person indicates a higher standard of living. • GDP is not a perfect measure of the happiness or quality of life, however. • Some things that contribute to well-being are not included in GDP. • - The value of leisure. • - The value of a clean environment. • - The value of almost all activity that takes place outside • of markets, such as the value of the time parents spend with • their children and the value of volunteer work.