III THE DATA OF MACROECONOMICS

1. III THE DATA OF MACROECONOMICS CHAPTER 5 MEASURING A NATION’S INCOME

2. 5 Measuring a Nation’s Income

3. Microeconomics and Macroeconomics • Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets • Macroeconomics is the study of the economy as a whole • Its goal is to explain the economic changes that affect many households, firms, and markets at once CHAPTER 5 MEASURING A NATION’S INCOME

4. Macroeconomics • Macroeconomics answers questions like the following: • Why is average income high in some countries and low in others? • Why do prices rise rapidly in some time periods while they are more stable in others? • Why do production and employment expand in some years and contract in others? CHAPTER 5 MEASURING A NATION’S INCOME

5. Total Income • When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning • We can temporarily boost our standard of living by borrowing from others. • But in the long run we can’t depend on others; our standard of living depends heavily on our own total income CHAPTER 5 MEASURING A NATION’S INCOME

6. Income = Expenditure • We could measure either total income or total expenditure • the result would be the same either way • For an economy as a whole, income must equal expenditure because: • Every transaction has a buyer and a seller. • Every dollar of spending by some buyer is a dollar of income for some seller. CHAPTER 5 MEASURING A NATION’S INCOME

7. But what about saving? • Q: People typically save part of what they earn. How then is income equal to expenditure for the economy as a whole? • A: What people save tends to be loaned to businesses who then spend what they borrowed. CHAPTER 5 MEASURING A NATION’S INCOME

8. International Trade • We buy foreign-made goods and foreigners buy goods made by us • Q: In that case, how can our total income be equal to our total expenditure? • A: Very good point! It is better to say that total income equals the total expenditure on domestically produced goods (GDP) CHAPTER 5 MEASURING A NATION’S INCOME

9. Gross Domestic Product • Gross Domestic Product (GDP) is one measure of a country’s total income • There are other measures • GDP is the total market value of all final goods and services produced within a country in a given period of time. • For example, the GDP of the United States was more than fourteen trillion dollars in 2008 • $ 14,264.60 billion, according to the U.S. Department of Commerce CHAPTER 5 MEASURING A NATION’S INCOME

10. GDP is the Market Value … • In GDP, all output is valued at market prices. • The market value of all sandwiches produced is both the total expenditure of the buyers of those sandwiches and the total income of the makers of those sandwiches • As our goal is to measure total income, it therefore makes sense to measure the market values of the various produced goods and add them up CHAPTER 5 MEASURING A NATION’S INCOME

11. … Of All Final Goods … • GDP records only the value of final goods, not intermediate goods • Intermediate goods are those goods that disappear inside other goods that are produced for sale • Final goods are goods that are not intermed iate goods • This way, the value of intermediate goods is counted only once, not twice or thrice. CHAPTER 5 MEASURING A NATION’S INCOME

12. … Of All Final Goods … • Intermediate goods are sold by their producers to producers of other goods • Examples: milk sold by a dairy to an ice-cream company, grapes sold by a vineyard to a winemaker, printer paper sold to Kinko’s • Final goods are goods that are sold to the final users of those goods • Examples: milk you buy at the supermarket, table grapes you buy at the farmer’s market, printer paper you buy for your computer printer • All goods made this year but not sold by year’s end are regarded as final goods (inventories) CHAPTER 5 MEASURING A NATION’S INCOME

13. … Of All Final Goods … • Suppose a dairy farmer sells milk worth $50,000 to an ice-cream company. • The farmer does not buy anything from any other firm. • The total income of the dairy farmer and her employees is, therefore, $50,000 • The ice-cream company uses the milk to produce ice-cream which it sells for $75,000. • The ice-cream company does not buy anything from any firm other than the dairy. • Therefore, the total income of the owners and employees of the ice-cream firm is $25,000. • Therefore, the total income of this country is $75,000 • This is accurately measured by the value of the ice-cream (the final good) alone • Had we also counted milk, the intermediate good, we would have calculated total income to be $125,000, which would have been an exaggeration. CHAPTER 5 MEASURING A NATION’S INCOME

14. … and Services … • GDP includes both • tangible goods (food, clothing, cars) and • intangible services (haircuts, housecleaning, doctor visits, legal consultations). • Trade in assets does not affect GDP. • Such trade does not require new productive activity, it is merely the transfer of ownership of an asset from one person to another CHAPTER 5 MEASURING A NATION’S INCOME

15. … Produced Within a Country … • GDP measures the value of all production within the geographic boundaries of a country. • The citizenship of the owners of the resources used in production is not the key issue • Production by foreigners living in a country is counted in the country’s GDP • Production by a country’s citizens working in other countries is not counted CHAPTER 5 MEASURING A NATION’S INCOME

16. … In a given period of time • GDP measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). • GDP includes goods and services currently produced, not transactions involving goods produced in the past. • Transactions involving used cars or buildings that were constructed in the past are not counted CHAPTER 5 MEASURING A NATION’S INCOME

17. What’s not counted in GDP? • GDP includes all items produced in the economy and sold legally in markets. • It excludes items produced and sold illicitly, such as illegal drugs. • GDP excludes most items that are produced and consumed at home and that never enter the marketplace. CHAPTER 5 MEASURING A NATION’S INCOME

18. Real Versus Nominal GDP • Nominal GDP values the production of goods and services at current prices. • Real GDP values the production of goods and services at constant prices. CHAPTER 5 MEASURING A NATION’S INCOME

19. CHAPTER 5 MEASURING A NATION’S INCOME

20. Real and Nominal GDP of USA CHAPTER 5 MEASURING A NATION’S INCOME

21. The GDP Deflator • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. • It tells us what part of the rise in nominal GDP is attributable to a rise in prices rather than a rise in the quantities produced. CHAPTER 5 MEASURING A NATION’S INCOME

22. The GDP Deflator • The GDP deflator is calculated as follows: CHAPTER 5 MEASURING A NATION’S INCOME

23. Example: 2009 • US Nominal GDP was $14,119.0 billion • US Real GDP was $12,880.6 billion (chained 2005 dollars) • US GDP Deflator = (14,119.0/12,880.6) × 100 = 109.6 • This means that, roughly, final goods and services were on average 9.6% pricier in 2009 compared with 2005 CHAPTER 5 MEASURING A NATION’S INCOME

24. Converting Nominal GDP to Real GDP • Nominal GDP is converted to real GDP as follows: CHAPTER 5 MEASURING A NATION’S INCOME

25. Table 2 GDP Deflator CHAPTER 5 MEASURING A NATION’S INCOME

26. Components of GDP • We need to pay attention not only to the value of all final goods and services made in a country (GDP), we also need to watch where the demand is coming from • That way, when there’s a recession, we’ll know which sector needs the most attention • GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports CHAPTER 5 MEASURING A NATION’S INCOME

27. Components of GDP • GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports • Q: Why do we subtract imports? • A: GDP is the market value of all final “Made in USA” goods. But consumption, investment, and government spending all include foreign goods. Therefore, to make the two sides of the equation the same, we must take out all imported goods CHAPTER 5 MEASURING A NATION’S INCOME

28. The Components Of GDP • Consumption (C): • The spending by households on goods and services, with the exception of purchases of new housing. • Investment (I): • The spending on capital equipment, inventories, and structures, including new housing. CHAPTER 5 MEASURING A NATION’S INCOME

29. The Components Of GDP • Government Purchases (G): • The spending on goods and services by local, state, and federal governments. • Does not include transfer payments because they are not made in exchange for currently produced goods or services. • Net Exports (NX): • Exports minus imports. CHAPTER 5 MEASURING A NATION’S INCOME

30. Table 1 GDP and Its Components (2004) CHAPTER 5 MEASURING A NATION’S INCOME

31. Government Purchases 15% Net Exports -5 % Investment 16% Consumption 70% GDP and Its Components (2004) CHAPTER 5 MEASURING A NATION’S INCOME

32. CHAPTER 5 MEASURING A NATION’S INCOME

33. CHAPTER 5 MEASURING A NATION’S INCOME

34. CHAPTER 5 MEASURING A NATION’S INCOME

35. U.S. Exports and Imports, as a percentage of real GDP CHAPTER 5 MEASURING A NATION’S INCOME

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37. Growth rates CHAPTER 5 MEASURING A NATION’S INCOME

38. http://research.stlouisfed.org/fred2/series/GDPCA CHAPTER 5 MEASURING A NATION’S INCOME

39. Where to find US data • Bureau of Economic Analysis, U.S. Department of Commerce: http://bea.gov • Federal Reserve Bank of St. Louis: http://research.stlouisfed.org/fred2/categories/18 CHAPTER 5 MEASURING A NATION’S INCOME

40. International Comparisons • When the GDP numbers for various countries’ are being compared, the same currency units must be used • There are two ways of converting from national countries to a common currency, such as the US dollar • Use market exchange rates • Use a common set of prices (PPP) CHAPTER 5 MEASURING A NATION’S INCOME

41. GDP per capita, in US dollars Source: World Economic Outlook 2008 database, IMF CHAPTER 5 MEASURING A NATION’S INCOME

42. GDP And Economic Well-being • 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. CHAPTER 5 MEASURING A NATION’S INCOME

43. Table 3 GDP, Life Expectancy, and Literacy CHAPTER 5 MEASURING A NATION’S INCOME

44. GDP And Economic Well-being • 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. CHAPTER 5 MEASURING A NATION’S INCOME

45. Robert Kennedy on GDP • [Gross Domestic Product] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans. CHAPTER 5 MEASURING A NATION’S INCOME

46. Any questions? CHAPTER 5 MEASURING A NATION’S INCOME

47. Summary • Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy. • Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services. CHAPTER 5 MEASURING A NATION’S INCOME

48. Summary • GDP is the market value of all final goods and services produced within a country in a given period of time. • GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports. CHAPTER 5 MEASURING A NATION’S INCOME

49. Summary • Nominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services. • The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy. CHAPTER 5 MEASURING A NATION’S INCOME

50. Summary • GDP is a good measure of economic well-being because people prefer higher to lower incomes. • It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, aren’t measured by GDP. CHAPTER 5 MEASURING A NATION’S INCOME