Measuring a Nation’s Income

Measuring a Nation’s Income

Microeconomics
Microeconomics is the study of how individual
households and firms make decisions and how
they interact with one another in markets.
Macroeconomics
Macroeconomics is the study of the economy
as a whole.
Its goal is to explain the economic changes that
affect many households, firms, and markets at
once.
Measuring a Nation’s Income
Macroeconomics answers questions like the
following:
Why is average income high in some countries
and low in others?
Why do prices rise rapidly in some time
periods while they are more stable in others?
Why do production and employment expand in
some years and contract in others?
THE ECONOMY’S INCOME AND
EXPENDITURE
When judging whether the economy is doing
well or poorly, it is natural to look at the total
income that everyone in the economy is
earning.
THE ECONOMY’S INCOME AND
EXPENDITURE
For an economy as a whole, income must
equal expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a
dollar of income for some seller.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure
of the income and expenditures of an
economy.
It is the total market value of all final goods
and services produced within a country in a
given period of time.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
The equality of income and expenditure can
be illustrated with the circular-flow diagram.
 MARKETS
Revenue FOR Spending
GOODS AND SERVICES
•Firms sell Goods and
Goods
•Households buy services
and services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars

Copyright © 2004 South-Western

THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
GDP is the market value of all final goods and
services produced within a country in a given
period of time.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
“GDP is the Market Value . . .”
Output is valued at market prices.
“. . . Of All Final . . .”
It records only the value of final goods, not
intermediate goods (the value is counted only
once).
“. . . Goods and Services . . . “
It includes both tangible goods (food, clothing,
cars) and intangible services (haircuts,
housecleaning, doctor visits).
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
“. . . Produced . . .”
It includes goods and services currently
produced, not transactions involving goods
produced in the past.
“ . . . Within a Country . . .”
It measures the value of production within the
geographic confines of a country.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
“. . . In a Given Period of Time.”
It measures the value of production that takes
place within a specific interval of time, usually
a year or a quarter (three months).
THE COMPONENTS OF GDP
GDP includes all items produced in the
economy and sold legally in markets.
THE COMPONENTS OF GDP
What Is Not Counted in GDP?
GDP excludes most items that are produced
and consumed at home and that never enter
the marketplace.
It excludes items produced and sold illicitly,
such as illegal drugs.
THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)

Y = C + I + G + NX
THE COMPONENTS OF GDP
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of
new housing.
Investment (I):
The spending on capital equipment,
inventories, and structures, including new
housing.
THE COMPONENTS OF GDP
Government Purchases (G):
The spending on goods and services by local,
state, and federal governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
Net Exports (NX):
Exports minus imports.
Copyright©2004 South-Western
REAL VERSUS NOMINAL GDP
Nominal GDP values the production of goods
and services at current prices.
Real GDP values the production of goods and
services at constant prices.
REAL VERSUS NOMINAL GDP
An accurate view of the economy requires
adjusting nominal to real GDP by using the
GDP deflator.
Copyright©2004 South-Western
The GDP Deflator
The GDP deflator is a measure of the price
level calculated as the ratio of nominal GDP
to real GDP times 100.
It tells us the rise in nominal GDP that is
attributable to a rise in prices rather than a
rise in the quantities produced.
The GDP Deflator
The GDP deflator is calculated as follows:

N o m in al G D P
G D P d eflato r =  100
R eal G D P
The GDP Deflator
Converting Nominal GDP to Real GDP
Nominal GDP is converted to real GDP as
follows:
N o m in al G D P2 0 X X
R eal G D P 2 0 X X   100
G D P d eflato r2 0 X X
 Billions of
1996 Dollars
$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000
1970 1975 1980 1985 1990 1995 2000

Copyright © 2004 South-Western

 Billions of
1996 Dollars
$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000
1970 1975 1980 1985 1990 1995 2000

Copyright © 2004 South-Western

 Billions of
1996 Dollars
$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000
1970 1975 1980 1985 1990 1995 2000

Copyright © 2004 South-Western

GDP AND ECONOMIC WELL-BEING
GDP is the best single measure of the
economic well-being of a society.
GDP per person tells us the income and
expenditure of the average person in the
economy.
GDP AND ECONOMIC WELL-BEING
Higher GDP per person indicates a higher
standard of living.
GDP is not a perfect measure of the
happiness or quality of life, however.
GDP AND ECONOMIC
WELL-BEING
Some things that contribute to well-being are
not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place
outside of markets, such as the value of the
time parents spend with their children and the
value of volunteer work.
Copyright©2004 South-Western
Summary
Because every transaction has a buyer and a
seller, the total expenditure in the economy
must equal the total income in the economy.
Gross Domestic Product (GDP) measures an
economy’s total expenditure on newly
produced goods and services and the total
income earned from the production of these
goods and services.
Summary
GDP is the market value of all final goods and
services produced within a country in a given
period of time.
GDP is divided among four components of
expenditure: consumption, investment,
government purchases, and net exports.
Summary
Nominal GDP uses current prices to value the
economy’s production. Real GDP uses
constant base-year prices to value the
economy’s production of goods and services.
The GDP deflator—calculated from the ratio
of nominal to real GDP—measures the level of
prices in the economy.
Summary
GDP is a good measure of economic well-
being because people prefer higher to lower
incomes.
It is not a perfect measure of well-being
because some things, such as leisure time
and a clean environment, aren’t measured by
GDP.