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Chapter #5 ECN.doc

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ECN 204
Christopher Gore

Chapter #5 - Equality of income and expenditure is with the circular-flow diagram - Households buy goods and services from firms; these expenditures flow through the markets for goods and services - The firms in turn use the money they receive from sales to pay workers’ wages, landowners’ rent, and firm owners’ profit; this income flows through the markets for the factors of production - money flows from households to firms and then back to households - We can compute GDP for this economy in one of two ways: by adding up the total expenditure by households or by adding up the total income (wages, rent, and profit) paid by firms - Because all expenditure in the economy ends up as someone’s income, GDP is the same regardless of how we compute it Gross national product (GNP) - is the total income earned by a nation’s permanent residents (called nationals) regardless of where they were located when the income was earned. - For example, when a British citizen works temporally in Canada, his production is part of Canada’s GDP because it was earned within the geographic boundaries of Canada. It is not part of Canada’s GNP, however, because he is a British citizen. The value of his production is part of Britain’s GNP. Net national product (NNP) - is the total income of a nation’s residents (GNP) minus losses from depreciation. - Depreciation is called the “capital consumption allowance.” National income - is the total income earned by a nation’s residents in the production of goods and services. - It differs from net national product by excluding indirect business taxes (sales taxes) and including business subsidies. NNP and national income also differ because of a “statistical discrepancy” that arises from problems in data collection. Personal income - is the income that households and non-corporate businesses receive Disposable personal income - is the income that households and non-corporate businesses have left after satisfying all their obligations to the government. - It equals personal income minus personal taxes and certain nontax payments (such as traffic tickets) GDP – is the market value of all final goods and services produced within a country in a given period of time - Market value – GDP adds together many different kings of products into a single measure of the value of economic activity. - Of All – includes all the produced goods and services in the economy and sold legally in market. However, some goods are not accounted because it is difficult to measure them. GDP excludes most items produces and sold illegally, products those are produced and consumed at home and never enter the market place (Vegetables that grow in your garden). Paradoxical results; Karen pays Bob to mow her lawn = GDP rises, but if they were married = GDP falls. This can be seen as an underestimation of true amount of productive activity taking place in the economy. - Final – (intermediate goods); paper --------> (final goods); cards: the value of intermediate goods is already included in the price of the final goods. However, an important exception is when an intermediate replaces the final good when it is sold to another company for a period of time but it is later adjusted accordingly. - Goods and Services – includes both tangible and intangible goods and services - Produced – includes goods and services that are currently produces. When GM produces a new car and sells it = GDP rises. However, if a car owner sells a used car, it is not part of the GDP. - Within a country – when a Canadian citizen works temporarily in China, his production is part of China’s GDP. The items are included in a nation’s GDP if they are produced domestically, no matter of the producer’s nationality - In a given period of time – GDP measures the economic flow during the interval  4 months, 6 months, 1 year THE COMPONENTS OF GDP  Four components: • Consumption (C) • Investment (I) • Government Purchases (G) • Net Exports (NX)  These components add up to GDP (denoted Y): Y = C + I + G + NX The equation is an identity—an equation that must be true by the way the variables in the equation are defined - each dollar of expenditure included in GDP is placed into one of the four components of GDP - total of the four components must be equal to GDP Consumption  It is total spending by households on g&s.  Examples: Cars, cloths, food, concerts, haircuts  There is an exception on housing costs: • For renters, consumption includes rent payments. • For homeowners, consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments. Investment  It is total spending on goods that will be used in the future to produce more goods.  It includes spending on • capital equipment (e.g., machines, tools) • structures (factories, office buildings, houses) • inventories (goods produced but not yet sold)  It is the sum of purchases of capital equipment, inventories, and structures Government Purchases  Include spending on goods and services by local, territorial, provincial, and federal governments.  It includes the salaries of government
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