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Lecture 5

ECON 102 Lecture 5: ECON 102 - Chapter 5 Notes

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ECON 102
Karl Pinno

Thursday, October 6, 2016 ECON 102 Chapter 5: Measuring a Nation’s Income Definitions: Microeconomics - the study of how individuals and how firms make decisions and how they interact in markets Macroeconomics - the study of economy-wide phenomena, including inflation, unemployment, and economic growth Gross Domestic Product (GDP) - measures the total income of a nation; the most closely watched economic statistic because it is the best measure of a society’s economic well-being The Economy’s Income and Expenditure GDP measures two things at once: 1. the total income of everyone in the economy 2. the total expenditure on the economy’s output of goods and services. • The reason that GDP can perform the trick of measuring both total income and total expenditure is that these two things are really the same. • For an economy as a whole, income must equal expenditure. Why is this true? An economy’s income is the same as its expenditure because every transaction has two parties: a buyer and a seller. Every dollar of spending by some buyer is a dollar of income for some seller. service, and Karen is a buyer. Doug earns $100, and Karen spends $100. Thus, the transactionller of a contributes equally to the economy’s income and to its expenditure. GDP, whether measured as total income or total expenditure, rises by $100. The Circular-Flow Diagram • Households buy goods and services from firms, and firms use their revenue from sales to pay wages to workers, rent to landowners, and profit to firm owners. GDP = the total amount spent by households in the market for goods and services • = the total wages, rent, and profit paid by firms in the markets for the factors of production 1 Thursday, October 6, 2016 The Measurement of Gross Domestic Product GDP: the market value of all final goods and services within a country in a given period of time “GDP is the Market Value…” • GDP adds together many different kinds of products into a single measure of the value of economic activity • uses market prices, because they measure the amount people are willing to pay for different goods, therefore they reflect the value of those goods • e.g If the price of an apple is twice the price of an orange, then an apple contributes twice as much to GDP as does an orange “…Of All…” • It includes all items produced in the economy and sold legally in markets • also includes the market value of the housing services provided by the economy’s stock of housing (Rent = tenant’s expenditure & landlord’s income) • If people are property owners and not tenants, then the government includes this in total GDP by estimating its rental value • Note: There are some products, however, that GDP excludes because measuring them is so difficult • e.g. items produced and sold illicitly, such as illegal drugs OR items produced and consumed at home, and therefore, never enter the marketplace (vegetables you buy at the grocery store are part of GDP, whereas vegetables you grow in your garden are not) • These exclusions from GDP can at times lead to paradoxical results. For example, when Karen pays Doug to mow her lawn, that transaction is part of GDP. If Karen were to marry Doug, the situation would change. Even though Doug may continue to mow Karen’s lawn, the value of the mowing is now left out of GDP because Doug’s service is no longer sold in a market. Thus, when Karen and Doug marry, GDP falls. “…Final…” • GDP includes only the value of final goods • the reason is that the value of intermediate goods is already included in the prices of the final goods • an important exception to this principle arises when an intermediate good is produced and is added to a firm’s inventory of goods to be used or sold at a later date • In this case, the intermediate good is taken to be “final” for the moment, and its value as inventory investment is added to GDP. “…Goods and Services…” GDP includes both tangible goods (food, clothing, cars) and intangible services • (haircuts, housecleaning, dentist visits) 2 Thursday, October 6, 2016 “…Produced…” • GDP includes goods and services currently produced • Does not include transactions involving items produced in the past • e.g. when Ford produced and sells a new car, the value of the car is included in GDP. When one person sells a used a car to another person, the value of the used car is not included in GDP “…Within a Country…” • GDP measures the value of production within the geographic confines of a country Items are included in a nation’s GDP if they are produced domestically, regardless • of the nationality of the producer “…In a Given Period of Time” • GDP measures the value of production that takes place within a specific interval of time (usually that interval is a year or a quarter) GDP measures the economy’s flow of income and expenditure during that interval • Other Measures of Income • Gross National Product • Net National Product • National Income Personal Income • • Disposable Personal Income The Components of GDP Y = C + I + G + NX Consumption: spending by households in goods and services with the exception of purchases of new housing Investment: spending in capital-equipment, inventories, and structures, including household spending on new housing • purchase of goods that will be used in the future to produce more goods and services • As mentioned earlier in this chapter, the treatment of inventory accumulation is noteworthy. When IBM produces a computer and, instead of selling it, adds it to its inventory, IBM is assumed to have “purchased” the computer for itself. That is, the national income accountants treat the computer as part of IBM’s investment spending. Notice that GDP accounting uses the word investment differently from how the term might be used in everyday conversation. 3 Thursday, October 6, 2016 Government Purchases: spending in goods and services by local, territorial, provincial, and federal governments •When the government pays the salary of a Canadian Forces general, that salary is part of government purchases. But what happens when the government pays a Canada Pension Plan benefit to one of the elderly? Such government spending is calle
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