Do Now.

1. Do Now. • In December 1975 the government of Portugal—a provisional government in the process of establishing a democracy—feared that it was facing an economic crisis. Business owners, alarmed by the rise of leftist political parties, issued dire warnings about plunging production. Newspapers speculated that the economy had shrunk 10 to 15% since the 1974 revolution that had overthrown the country’s long-standing dictatorship. • In the face of these reports of economic collapse, some Portuguese were pronouncing democracy itself a failure. Others declared that capitalism was the culprit, demanding that the government seize control of the nation’s factories and force them to produce more. But how bad was the situation, really? Speculate on why Portugal was having so many problems.

2. AP Macroeconomics MR. Graham Unit Three Measurement of Economic Performance

3. Module 10: The Circular Flow and Gross Domestic Product 3

4. National Income Accounting Measures the flows of income and expenditures in the economy over time. Serves the same purpose for the economy as a whole as does the income statement of a firm. The most simplified representation of the macroeconomy and national income accounting is the Circular-Flow Model.

5. The Circular-Flow Diagram The model involves the following principles: There are two groups of decision-makers in a private economy: households and businesses 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

6. The Circular-Flow Diagram Product Markets Households are on the demand side, purchasing goods and services. Businesses are on the supply side, offering products for sale. Interaction of this demand and supply determines the price of each product.

7. Product Markets Businesses provide final goods and services to households… The Circular-Flow Diagram

8. The Circular-Flow Diagram • Product Markets • …who in turn pay for them with money.

9. The Circular-Flow Diagram Factor Markets Households are on the supply side, providing resources directly (workers) or indirectly (ownership of corporations, land, etc.) Businesses are on the demand side, purchasing resources in order to produce goods and services. Interaction of this supply and demand determines the price of each resource, which in turn is income for the owner of that resource.

10. Factor Markets Households “sell” resources to businesses… The Circular-Flow Diagram

11. Factor Markets …who in turn pay for them with wages, rent, interest, and profits (i.e. Total Income). The Circular-Flow Diagram

12. The Circular-Flow Diagram

13. Question Why must the total dollar value of income and output money be identical to each other? Answer Every transaction simultaneously involves expenditure and receipt. The Circular-Flow Diagram If $ value of output is greater than $ value of input, difference is profit. “Profit”—for both households and firms—is always the residual item that completes the circular flow.

14. (Expanded) Circular-Flow Diagram

15. Gross Domestic Product (GDP) The most commonly presented statistic of national income accounting is the GDP. Represents the total market value of all final goods and services produced within a country in one year. The GDP at the end of FY12 = $15.85 trillion.

16. Gross Domestic Product (GDP) Represents the total market value… We compute the value of production, not just production. Simply Adding Production Adding the Value of Production

17. Gross Domestic Product (GDP) …of all final goods and services… It avoids double or multiple counting by eliminating any intermediate goods (goods used up entirely in the production of final goods). • At each stage, value is added to the final product, the bottle of ketchup; we only count the final price ($3)

18. Gross Domestic Product (GDP) …produced within a country… If a good was produced in America, it doesn’t matter where it was consumed, or where the actual company was headquartered. Ex: General Motors has a factory producing trucks in South Africa. The value of these trucks is counted in South Africa’s GDP.

19. Gross Domestic Product (GDP) …in one year. GDP sums the dollar value of what has been produced in the economy over the year, not what was actually sold. Ex: A Honda Civic produced in Kentucky in 2012, but not sold until January 2013, is counted in 2012 production and 2012 GDP.

20. Gross Domestic Product (GDP) 3 Ways for Calculating GDP Survey firms and add up the total value of their production of final goods and services. Sum the total factor income earned by households from firms in the economy. Add up aggregate spending on domestically produced final goods and services in the economy.

21. Calculating GDP 3 2 1

22. Sum the total factor income earned by households from firms in the economy. Adding up all components of national income, including wages, interest, rent, and profits. “Income Approach” Calculating GDP

23. Calculating GDP 2

24. Add up aggregate spending on domestically produced final goods and services in economy. Adding up the dollar value of all final goods and services purchased by consumers, businesses, government, and buyers from outside the country. “Expenditure Approach” Calculating GDP

25. Calculating GDP 3

26. GDP = C + I + G + X Consumption (C): Households’ purchases of final goods and services during the year Durable Consumer Goods Nondurable Consumer Goods Services The Components of GDP

27. GDP = C + I + G + X Gross Private Domestic Investment (I): Domestic spending on: additions to inventories, new capital goods (factories, machines) The Components of GDP

28. GDP = C + I + G + X Government Expenditures (G): consumption and investment for all government branches State, local, and federal Includes all direct purchases of resources (i.e. labor) The Components of GDP

29. GDP = C + I + G + X Net Exports (X): the value of exports less the value of imports The Components of GDP Net exports (X) = Total exports – Total imports

30. Presenting the expenditure approach Where C = consumption expenditures I = investment expenditures G = government expenditures X = net exports The Components of GDP GDP = C + I + G + X

31. Answer the following… • Define GDP • List some things that are included in the calculation of GDP • List some things that are not • Explain why national income accounting is important • What are the 3 methods for calculating GDP?

32. Comparing the Methods (1 and 2)

33. Comparing the Methods (2 and 3) GDP and National Income, 2011

34. Comparing the Methods (2 and 3) GDP and National Income, 2011

35. Exclusions from the GDP calculation… Intermediate goods and services Inputs Used goods Transfer Payments Financial assets (i.e. stocks and bonds) Foreign-produced goods and services GDP: What’s In and What’s Out?

36. A painter purchases new brushes for his business? The services of an accountant? A purchase of a used automobile? A Social Security check paid to a retired worker? The sale of a new home? An increase in business inventories? The government’s purchase of a new fighter jet? Unemployment paid to a laid-off worker? Should it be counted?

37. Do Now: • http://www.reffonomics.com/textbook2/macroeconomics2/introtomacro/gdp.swf • http://www.youtube.com/watch?v=lBDT2w5Wl84 • http://www.learner.org/series/econusa/unit15/

38. Module 11: Interpreting Real Gross Domestic Product 38

39. What GDP Tells Us • Provides us with a scale against which to compare our current economy with • economic performance of other years • economic performance of other countries • Be careful…part of the increase in the value of GDP over time represents increases in the prices of goods and services rather than an increase in output.

40. Calculating Nominal GDP • Nominal GDP: GDP calculated at existing prices. • Has the value of sales increased from year 1 to year 2? • What is the Nominal GDP growth rate? Year 2 Year 1 Growth Rate = - 1 8-40

41. Calculating Real GDP • Real GDP: Nominal GDP adjusted for inflation. • Does this increase in the dollar value of GDP overstate the real growth in the economy? • How much would GDP have gone up if prices had not changed (i.e. “Year 1” prices)? 8-41

42. Calculating Real GDP Nominal GDP Price Index* Real GDP = x 100 *Price Index: measured by the GDP deflator 8-42

43. Real GDP • Between 1997 and 2007, Venezuela’s GDP grew by an average of 28% annually—is Venezuela experiencing an economic miracle? 7-43

44. Economic Growth • Typically measured by Real GDP growth rate: Year 2 Year 1 2010: $13,180 billion 2012: $13,660 billion Growth Rate = - 1 8-44

45. Other things equal, a country with a larger population will have higher GDP simply because there are more people working. Per capita real GDP Adjusting for population growth Real GDP Population Per capita real GDP = Per Capita Real GDP 8-45

46. Comparing GDP Internationally • Purchasing Power Parity: Adjustment in exchange rate conversions that takes into account differences in the true cost of living across countries

47. Links • http://www.reffonomics.com/textbook2/macroeconomics2/inflation/realnominal.swf

48. Do Now. What is the difference between real GDP and nominal GDP Define labor force Define unemployment What is the current unemployment rate? What is a “healthy” unemployment rate for a country to have? • http://www.youtube.com/watch?v=lBDT2w5Wl84 • http://www.learner.org/series/econusa/unit15/

49. Module 12: The Meaning and Calculation of Unemployment 49

50. The Unemployment Rate • It is another important variable, in addition to GDP and inflation, on which macroeconomics focuses. 7-50