The Measurement of Income and Prices Chapter 2 Instructor: MELTEM INCE

1. The Measurement of Income and Prices Chapter2 Instructor: MELTEM INCE

2. Types of Investment (I) • Inventory Investment is the change in the stock of raw materials, parts, and finished products held by businesses. • Fixed Investmentincludes all final goods (mainly structures and equipment) purchased by businesses not intended for resale.

3. Relation of Investment and Saving • Personal Saving (S) is that part of personal income that is not consumed or paid out in taxes • Also referred to as Private Saving • Algebraically: S = (Y-T) - C (where T = Net Taxes) • Funds from savings are channeled to firms in two basis ways: • Households buy bonds and stocksissued by firms • Households deposit savingsin banks and other financial institutions that in turn lend money to firms • Firms use the money channeled from savings to buy investment goods

4. Net Exports and Net Foreign Investment • Exports are goods produced within one country and shipped to another • Importsare goods consumed within one country but produced in another country • Net Exports (NX) are equal to the excess of exports over imports • Net Foreign Investment (NFI)is equal to U.S. purchases of foreign financial assets minus foreign purchases of U.S. financial assets • Interesting connection: NX = NFI

5. The Government Sector • Government Purchases (G) is the value of goods and services purchased by the government at the federal, state and local levels • Transfer Payments (F) are payments from the government to households that do not require the recipient to provide a service in return • Examples: Social Security, Medicare, and Food Stamps • Government Spending= G + F • The Government pays for its spending by collecting Taxes (R) or by borrowing and/or printing money • Net Taxes (T) = R – F • Budget Surplus= T – G

7. Deriving the “Magic” Equation • The income accounting identity states that an economy’s income must equal its expenditures: Y ≡ E • Now, use the fact that household incomemust equal household outlays(and recall that T = R - F): Y + F= C + S + R • Equating (1) and (2) yields the “Magic Equation” C + S + T = C + I + G + NX  S + T = I + G + NX

8. Interpreting the “Magic Equation” Recall the “Magic Equation:” S + T=I + G + NX • Leakages (S + T) describe the portion of total income that is not available for consumption • Injections (I + G + NX) is a term for non-consumption expenditures T – G =I + NX - S The left side is government budget deficit. If it is negative, then the government is running a deficit.

9. Measurig National Output • Gross National Product (GNP) : The market value of all the final goods and services produced within a country during a given time period-usually a year; equal to the sum of all values added in the economy. • Potential GNP ( Y*) : The real gross national product the economy could produce if its productive resources were full employed at their normal intensity of use. Also called full-employment GNP, full-employment national income.

10. Measurig National Output Final Goods and Services :Many goods areproduced in the economy are not classified as finalgoods, but instead as intermediate goods. Intermediate goods are produced by one firm foruse in further processing by another firm or toproduce final goods. For example; weat is anintermediate good for bread. So that is the valueadded to produce final goods and services.

11. Measurig National Output Value added: During some stage of production isthe difference between the value of goods as they leave a stage of product,on and the cost of the goods as they entered that stage. Value added is the value of firm’s production – all the inputs value which gets from other firms. Sum of value added = wage + rent + profit +interest.

12. Example Production levelMarket Valuecost of intermediate goodValue Added Wheat 1000 TL - 1000 TL Flour 2600 TL 1000 TL 1600 TL Entrepreneurship 4000 TL 2600 TL 1400 TL Bread 5000 TL 4000 TL 1000 TL 12600 TL 7600 TL 5000 TL As you’ve seen, the market value of bread (final good)5000 TL. also includes the market values of wheat, flourand entreprenurship services. In that reason; GNP is sumof the market value of all the final goods and services = sum of allvalues added.

13. Nominal GDP, Real GDP, and the GDP Deflator • Nominal GDP is the value of gross domestic product in current (actual) prices. • Real GDP is the measure of gross domestic product using prices of an arbitrarily chosen base year. • The GDP deflatoris a price index that measures the aggregate economy’s price level. • Algebraically: GDP Def = Nominal GDP / Real GDP * 100 • The percentage change in the GDP deflator gives a measure of the economy’s inflation rate.

14. The Expenditure Approach Expenditure approach a method of computing GDP that measures theamount spent on all final goods during a given period. Expenditurecategories: • personal consumption expenditures ( C): household spending on consumer goods. • Gross private domestic investment (I ) : spending by firms and households on new capital , i.e. plant, equipment, inventory etc. • Government consumption and gross investment (G ): expenditures by state and local governments for final goods and services. • Net exports (EX-IM) : net spending by the rest of the world, or exports minus imports. GDP = C + I + G + (EX - IM)

15. The Income Approach A method of computing GDP that measures the income –wages, rents, ineterst, and profits- received by all factors of production in producing final goods. Personal income is the income received by households before paying personal income taxes. The amount of income that households have to spend or save is called “disposable personal income” or after-tax income. It is equal to personal income minus personal taxes.

16. GNP - GDP • The difference between GDP and GNP is; GDP is the market value of all the final goods and services that are produced by that nation’s production factors but GNP also includes the market value of all the final goods and services that are produced by foreigners. On the other hand; GDP measures the output located in that country. • Ex: only goods and services that are produced within a “country” as part of that country’s GDP. Toyota, a Japanese firm, produces automobiles if in Turkey, and the value of this production is part of Turkey’s GDP, not part of Japan’s GDP.

17. Growth Rate • We use estimates of real GDP to calculate teh economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next. Economic growth rate = Real GDP(t) -Real GDP(t-1) X 100 Real GDP (t-1)

18. National Income The value of a nation’s total production of goods and services is called its “national product”. Hence when we study national product we are also studying national income. National Income =Total consumption expenditure+ Total savings

20. National Income National income is the total amount earnedby the factors of production in the economy;it is equal to NNP except for a statisticaldiscrepancy. GNP – depreciation = Net NP Net NP – Ti = National Income

22. The Consumer Price Index (CPI) A price index measures the price level at a given period relative to the base period.The Consumer Prices Index (CPI) covers price of commodities commonly bought by households. Changes in the value of the CPI are meant to measure changes in the typical household’s “cost of living”. Government statisticians periodically survey a group of households to discover how they spend their incomes.

23. I= 800 G-T= 400 S= 1000 NX=? G - T = S - (I + NX) 400 = 1000 – 800 – NX NX = - 200 GDP Def = Nominal GDP / Real GDP * 100 GDP Def = 10,608/10,400 = 1.02