Chapter 5.docx

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14 Apr 2012
Chapter 5: Measuring a Nation’s Income
Microeconomics: study of how households and firms make decisions and how they interact in
Macroeconomics: study of the economy as a whole, including inflation, unemployment, and
economic growth
o Explain economic changes that affect many households, firms, and markets
Gross domestic product (GDP): measures the total income of a nation
o Single measure of a society’s economic well-being
The Economy’s Income and Expenditure
People with higher income= higher standards of living
GDP measures two things
o Total income of everyone in the economy
o Total expenditure on the economy’s output of goods and services
For an economy as a whole, income must equal expenditure
o Every transaction has two parties, a buyer and a seller
o Transaction contributes equally to the economy’s income and to its expenditure
Circular flow diagram: describes all the transactions between household and firms in a simple
o Households buy goods and services from firms
o Expenditures flow through the markets for goods and services
o Firms use money they receive to pay worker’s wages
o Income flows through the markets for the factors of production
To compute GDP add up all expenditures, or add up all the income
Harder with real economy lots of different things that wouldn’t make this work
o Eg. Most people don’t spend all their income, they save it or pay taxes
The Measure of Gross Domestic Product
Gross domestic product (GDP): market value of all final goods and services produced within a
country in a given period of time
GDP is the Market Value…
Market prices measure the amount people are willing to pay for different goods, they reflect the
value of those goods
Eg. If the price of an apple is twice as much as an orange, then an apple contributes twice as
much GDP as does an orange
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…Of All…
GDP tries to be comprehensive, includes all items produced in the economy and sold legally in
Includes market value of housing services
o Rental housing, rent equals both the tenant’s expenditure and the landlords’ income
GDP is based on the assumption that the owner in effect, pays rent to himself, so the rent is
included both in his expenditure and in his income
GDP excludes
o Illegal drugs
o Things that aren’t in the market, eg. Vegetables that you grow at home
Ex Karen and Doug. Karen mows Doug’s lawn for money. If they get married, that changes, no
longer in the market, so not calculated in GDP, GDP falls
o Underestimates the actual productivity of economy
Intermediate good: good before it is sold on the market per se. eg.
Final good: finished product
GDP only includes final goods
o Value of intermediate good included in prices of final ood
Exception, when intermediate good is added to firm’s inventory of goods to be used or sold at a
later date
o Inventory investment
…Goods and Services…
Tangible and intangible
GDP only goods and services that are currently produced
o Not items purchased in the past
Eg, value of a sale of used car not included in GDP calculation
…Within a Country…
GDP value of production within the geographic confines of a country
Eg, when a Canadian owns a factory in Haiti, productions of factory part of Haiti GDP
…In a Given Period of Time…
Interval of a year of a quarter (three months)
When GDP quarter, presented ‘at an annual rate’
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