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Lecture 2

Lecture 2 Spring 2014.pdf

6 Pages

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ECON 1132
Andrew Petersen

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Ec. 132.03 Harold Petersen Principles of Economics-Macro January 16, 2014 Lecture 2: Measurement of Output and Income. Your text refers to GDP as one of the great inventions of the past century. The late Hugo Chavez of Venezuela once referred to GDP as a capitalist plot. In 2008 President Sarzoky of France appointed a commission to consider alternatives to GDP as a measure of well being. So what is GDP and why was it invented? It is an effort to measure total output of an economic system. Economists build models to try to explain what moves output up or down and we need measurement to test the models. We want to see what policy actions best promote both growth and stability. But to see what works we need measurement. Today we will take a close look at how we measure output and income. Economics is concerned with how we use our resources to produce goods and services to satisfy wants. In macro we look at the total volume of economic activity--at total output and income, at employment for the system as a whole, and at the general price level. We visualize a circular flow of resources from households to business firms and a flow of goods and services back to households. Then we also have a flow of money as people get paid for working and in turn spend the money, or at least most of it, on goods and services. consumption expenditures $ $ goods & services Households Business Firms resources $ wages, int., profit $ How do we measure total output and income? We measure output by the flow of expenditures on goods and services (the upper loop) and income by the flow of income from production (the lower loop). We start with a concept called gross domestic product, or GDP, which is the money value of all goods and services produced within a year. We look at it from the expenditure side, or the flow-of product side as your text calls it on 2 p.95 (p. 397 hardcover), and from the earnings side, or as your text calls it the flow-of-cost approach. To see how these two approaches differ but lead to the same total, let’s look at the numbers for 2007. My approach here will be very similar to what you find in the text on p. 96 (p. 398 hardcover), except that I will show everything as a percentage of GDP. Expenditure Approach Earnings Approach Consumption 70 Wages, Sal., Benefits 56 +Gross Investment 16 +Corporate Profits 11 +Gov’t Purchases 19 +Proprietors’ Income 8 +Net Exports -5 +Rental Income 1 = GDP 100 +Net Interest 5 - Depreciation 12 +Depreciation 12 = NDP 88 +Production Taxes, etc. 7 = GDP 100 Addendum: Corporate Profits 11 -Corp. Profit Taxes 3 Exports 12 -Dividends 6 -Imports 17 =Retained Earn. 2 =Net Exports -5 Total spending is broken down into consumption, gross investment, government purchases, and net exports. Consumption represents spending by consumers on goods and services to satisfy immediate wants. Gross investment is spending by firms on new plant and equipment, by households on new housing, and as measured also includes additions to inventories--stocks of goods produced but not yet sold. Investment is intended to measure what we put away for the future. Government purchases is spending on goods and services at all levels of government, including such items as school supplies, fire engines, salaries of government workers, and tanks and missiles. It does not include transfer payments, such as unemployment checks or social security checks. Net exports is what we sell abroad minus what we purchase from abroad. By final products we mean those sold for final use, rather than for further processing prior to sale, such as automobiles to consumers, but not the steel and the glass and the rubber as sold to the auto producers. We focus on final products to avoid double counting. If you buy a Buick for $32,000, that $32,000 includes the glass and the steel and the tires as sold to G.M. for processing into the car. 3 Think of total output as consisting of what we produce for immediate satisfaction of wants (consumption) plus what we put away for the future (investment). Government purchases are a mix which in reality includes both. Viewed in this light—production for immediate wants plus what we put away for the future, we might argue that GDP overstates our total output. It includes in gross investment our total output of new machines, even though many of these machines are merely replacing others which are wearing out. We account for this by subtracting an allowance for depreciation (or capital consumption) and calling the remainder net domestic product. With depreciation at 12% of the total, NDP in the above numbers would be 88% of the total. Now let's look at the lower loop--the earnings from production, as allocated to the resources. We take the numbers, for the most part, from the financial statements of business firms. Again look at the numbers for 2007 (above): By far the largest component is wages, and much of the rest is interest and profit. What we would like to measure here, is how much of the income is paid to labor for its contribution and how much to capital. The numbers are taken for the most part from financial statements of business firms, and in some cases wages and profits are very clear. For smaller, unincorporated businesses, however, what flows through to the bottom line as profit, recorded here as proprietors' income, is in fact a combination of labor income, for the owners' time spent at work, and in part a return on capital invested. One further part of the net receipts of business --production taxes--is simply left alone as an item in itself. The U.N. statisticians, in agreeing on rules of measurement following World War II, decided that certain tax receipts, turned directly over to government, such as those from sales taxes and excise taxes, could not reasonably be allocated between wages, rent, and profit. If we think of wages and benefits as labor income and profits, interest, and rent as capital income, then we find that labor income is about ¾ of the total (76% of the sum of wages and benefits, corporate profits, interest, and rent). The remaining 1/4 might be thought of as property income. Now turn to disposable income . We want a measure of how much income households have available, after taxes, for spending or saving. Thus from GDP we subtract depreciation and all taxes--social security taxes, corporate income taxes, personal taxes, and production taxes. We also subtract corporate retained earnings--that part of corporate net income not paid out to stockholders, and finally, we add back in transfer payments. Transfer payments include income received by households not as wages or profits but rather as 4 transfers from others, largely through the tax system. As measured it includes social security checks, unemployment compensation, and welfare payments. Disposable
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