CHAPTER 2

1. CHAPTER 2 The Measurement of Income, Prices, and Unemployment It has been said that figures rule the world; maybe. I am quite sure that it is figures which show us whether it is being ruled well of badly -Johann Wolfgang Goethe, 1830

2. Flows and Stocks • Investment and the Capital Stock: K = K-1 + I • Capital stock = capital stock last year + investment • Saving and Wealth W = W-1 + S

3. Current Account and net International Investment Position • net international investment position (NIIP) measures the net stock of outstanding loans between a country and the rest of the world NIIP = NIIP-1 + CA • Public Debt and the Deficit Dg = Dg-1 + DEF

5. National Income Accounting • Purpose: measure the flow of output; it measures the performance of the economy for purposes of public policy • Created in the aftermath of the Great Depression, during WWII to determine the capacity of US industry to help fight the war

6. Gross Domestic Product • GDP is the most important measure of economic output • GDP is defined as the total value of all final goods and services produced by the domestic economy in one year • Includes: • Currently produced goods and services • Goods sold on the market • Excludes goods that are resold in the current period • Genuine Progress Indicator

7. GDP and GNP • GNP=total value of all goods and services produced by the nation’s citizens • GNP = GDP + NFP • NFP (Net Foreign Product) = factor payments to domestic residents abroad minus factor payments to foreigners earned domestically

8. Output Approach: GDP = C + I + G + NX Value-added Approach: GDP = Wages + Profits + Rents + Interest + Indirect Business Taxes Measuring GDP

9. Figure 2-2 The Contribution of One Loaf of Bread to Consumption Expenditures and Income Created

10. Consumption ( C ) durable goods nondurable goods services Investment (I) Inventory investment Fixed investment producer goods new construction Government (G) R = tax revenue F = transfer payments T = net taxes = R - F Net Exports (NX) exports Imports Types of Expenditures

11. Y = C+S+T E= C+I+G+(NX) Y=E C+S+T= C+I+G+(NX) S+T= I+G+(NX) Saving and taxes (income not consumed equals that part of expenditures that is not consumed Leakages=withdrawals from expenditures (income not consumed) S,T, IM Injections=expenditures not consumed) I,G, EX Flow in equations

12. Figure 2-3 Introduction of Saving and Investment to the Circular Flow Diagram

13. Figure 2-4 Introduction of Taxation, Government Spending, and the Foreign Sector to the Circular Flow Diagram

14. Consumption as a Percentage of GDP

15. Investment as a Percentage of GDP

16. Government Spending as a Percentage of GDP

17. Exports and Importsas a Percentage of GDP

18. Types of Income • Compensation • Corporate Profits • Proprietor Profits • Interest • Rents

19. Employee Compensation as a Percentage of National Income

20. Corporate Profits, Proprietorships, and Interest as a Percentage of National Income

21. Other Measures of Economic Output • Net national product (NNP) = GNP - depreciation • National Income (NI) = NNP - indirect taxes + business transfer payments (gifts, etc)

22. Personal Income (PI) = NI • - contributions to social insurance (FICA) • - corporate profits minus dividends • + personal interest income from the government and consumers • + government transfer payments (e.g., unemployment insurance, relief, benefits to veterans) • Disposable Income (Yd) = NI - personal taxes

23. GDP over time

24. Figure 2-5 Nominal GDP, Real GDP, and the Implicit GDP Deflactor, 1900-98

26. Figure 2-6 The U.S. Ratio of Actual to Natural Real GDP (Y/YN) and the Unemployment Rate, 1956-98

27. Relation Between Unemployment and the Business Cycle • Okun’s law: for every 2 percent increase in GDP, unemployment falls by 1 percent

28. Unemployment Rate