The Product of a Nation Measuring Economic How do we measure the ’s Aggregates and the Circular performance? Flow of Income Francois Quesnay (1758) The Product of a Nation First to measure economic activity as a flow, The Circular Flow of Income and The circular flow of Expenditure through different sectors of the economy Limitations of National Income Accounting output and income Accounting for Price Changes National income accounting system

© 2003 South-Western/Thomson Learning 1 2

National Income Accounts How to Measure GDP

Gross domestic product GDP can be measured Measures the of all final by total spending on U.S. or and services produced during a year by by total income received from production resources • located in the United States, • regardless of who owns them Expenditure approach Adds up the aggregate expenditure on all National income accounts final produced during that year One person’s spending is another person’s income Double entry bookkeeping system Income approach Aggregate output is recorded on one side Adds up the aggregate income earned income created by that spending on the during the year other side

3 4 How to Measure GDP GDP: Expenditure Approach GDP includes only final goods and services Divide aggregate expenditure into Sold to the final, or ultimate, user its four components Ignores secondhand value of used goods • These goods were counted in GDP when they were produced

Intermediate goods and services Investment purchased for additional processing and resale Government Purchases Excluded to avoid the problem of double counting Net • Counting added-value more than once

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Consumption Investment

Consists of purchases of final goods Gross private domestic investment and services by Consists of Largest spending category • spending on new goods Accounting on average for about two- • additions to inventories thirds of U.S. GDP That is, spending that is not used for Three components current consumption • Services Categories • Durable Goods: Goods that are expected • Physical capital: new buildings and new to last at least three years machinery purchased by firms • Nondurable Goods • New residential construction • Inventories

7 8 Inventories Investment

Consists of stocks of goods in process Excludes stocks of finished goods Deal with unexpected changes in the purchases of durable supply of their resources goods demand for their products Net changes in inventories Purchases of existing buildings and Net increase in inventories • Counts as investment machines • Current production not used for current consumption Net decrease in inventories Purchases of financial assets • Counts as negative investment, or disinvestment, • Sale of output already credited to a prior year’s • Like Stocks and bonds GDP • Simply an indication of ownership 9 10

Government Purchases Net Exports Government consumption and Equal the value of U.S. exports minus gross investment the value of U.S. of goods and services Spending by all levels of government Include merchandise trade and services A little less than one-fifth of U.S. GDP The value of U.S. imports has exceeded the value of our exports nearly every year since Excludes transfer payments the 1960s an outright grant from government to : Produce in domestic, but not the recipient consume in domestic Æ Add to GDP Not true purchases by government : Consume in domestic, but not Ex: Social security, welfare benefits, produce in domestic, ÆSubtract from unemployment insurance GDP

11 12 GDP: Expenditure Approach GDP: Income Approach Nation’s aggregate expenditure equals the Sum incomes arising from that sum of productions Consumption, C In double-entry bookkeeping: Investment, I Value of aggregate output equals the aggregate income paid for resources Government Purchases, G used to produce that output Wages Net Exports, (Exports, X, minus Imports, I) Interest Rent C + I + G + (X – M) = Aggregate Expenditures = GDP Profit arising from production

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GDP : Income Approach Computation of Value Added for a New Desk Aggregate income equals the sum of all

the income earned by resource suppliers Value added= selling Cost of price minus the amount Sale Intermediate Value paid for inputs Stage of Value Goods Added Production (1) (2) (3) Aggregate expenditure = GDP = Value added represents Logger $ 20 $ 20 aggregate income income to resource Miller 50 $ 20 30 suppliers. Manufacturer 120 50 70 Retailer 200 120 80

Avoid double counting either by Market Value of Final Good $200 including only the market value of the final goods and services, or calculating the value added at each stage of Sum of the value added = market value of the final good production Value added for all final goods and services equals GDP based on the income approach 15 16 Measuring Economic The Circular Flow Model Aggregates and the Circular stream flows clockwise Income from firms to Flow of Income households: Lower half of the circle Spending from households to firms – the upper half of the The Product of a Nation circle. The Circular Flow of Income and For each flow of money Expenditure there is an equal and opposite flow of goods or Limitations of National Income Accounting resources. Accounting for Price Changes

© 2003 South-Western/Thomson Learning 17 18

The Circular Flow The Circular Flow

At 1, firms make production decisions. Production of aggregate Aggregate income output, or GDP, gives rise to an total income from producing GDP equal amount of aggregate income.

Disposable income (DI) is the income 2. Not all income is available remaining after for household, governments collect taxes. taxes are subtracted transfers added 3. Some of these tax are returned to the income stream as transfer payments. Net taxes (NT) 4. By subtracting taxes and Taxes minus transfer payments adding transfers, we obtain disposable income to the GDP = Aggregate income = DI + NT households

19 20 The Circular Flow Expenditure Half of the Circular Flow

Households, with DI in hand, must decide Disposable income splits at 5 Î how much to consume (C) and to save (S) DI = C + S. DI=C+S Consumption spending remains in the circular flow. Firms produced the output, they wait and Saving flows to financial see how much consumers want to spend markets.

If any output go unsold, suppliers will be stuck with it in the form of unplanned While the primary borrowers are firms and governments, in reality, additions to inventories financial markets are connected to all four economic decision-makers.

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Circular Flow Circular Flow

Some spending goes for imports, M. Firms in our simplified model pay This flows to foreign producers Î A resource suppliers an amount equal leakage from the circular flow at 8. to the entire value of output, Nothing left for investment.

Firms and households must Exports enters the circular flow at point 9. borrow to investments

6 investment spending enters the circular flow Æ The net impact on aggregate aggregate spending = C + I. expenditures= exports - imports, (or net exports)

Governments also borrow to finance deficits. These purchases, Aggregate spending flows into firms at 10. G, enter the spending stream in 7. (Aggregate expenditure).

23 24 Circular Flow of Income and Expenditure Leakages Equal Injections

Upper half of the circular flow: expenditure half Expenditure=income leads to focuses on the components that make up DI + NT = C + I + G + (X – M) aggregate expenditure • Consumption, C Since DI=C+S Æ • Investment, I • Government Purchases, G C + S + NT = C + I + G + (X – M) • Net Exports, X - M Subtracting C and adding M to both sides Æ S + NT + M = I + G + X C + I + G + (X – M)=aggregate expenditure Thus, the leakages (S, NT, and M) must =market value of aggregate output= GDP equal the injections (I, G, and X) into the circular flow Lower half of the circular flow: aggregate income=DI+ NT

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Planned versus Actual Investment Measuring Economic Planned Investment The amount firms plan to invest before Aggregates and the Circular knowing how much they sell Actual Investment Flow of Income Includes both • planned investment and • unplanned changes in inventories Unplanned increases in inventories cause The Product of a Nation firms to decrease production next time The Circular Flow of Income and If there are no unplanned changes in Expenditure inventories will GDP be at an Limitations of National Income Accounting equilibrium level planned investment =actual investment Accounting for Price Changes

© 2003 South-Western/Thomson Learning 27 28 Limitations of National Income Accounting Limitations

For some economic activity, income Some production is not included in GDP must be imputed (estimated), GDP includes only products sold in markets No market exchange! Ignores “do-it-yourself” household Imputed rental income production • homeowners receive from home ownership • If householders are largely self-sufficient Æwill understate GDP Imputed dollar amount for wages paid in Ignores the underground economy kind, such as employers’ payments for employees’ medical insurance • Unreported because – it’s illegal Imputed dollar amount for food produced by – evade taxes farm families for their own consumption • Federal study suggests the equivalent of 7.5% of GDP or about $750 billion in 2001

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Leisure, Quality and Variety GDP Ignores Depreciation(折舊) Some capital wears out or becomes Workdays is much shorter now obsolete Increase in leisure time

People also retire at earlier age and live Net production: longer after retirement Subtracting this depreciation from GDP Î quality of life has increased

Quality and variety of products available Depreciation measures the value of have also improved because of the capital stock that is used up or technological advances and competition becomes obsolete in the production process GDP does not reflect these improvements 31 32 Net Domestic Product GDP Does Not Reflect All Costs

Net domestic product: Some production and consumption =GDP minus depreciation degrades the quality of our environment

Two definitions of investment Negative externalities such as pollution Gross investment measures the value are largely ignored in GDP accounting investment during a year • Used in computing GDP GDP also ignores the depletion of Net investment =gross investment-depreciation • If net investment is negative Æthe capital stock natural resources Î ignores the natural declines capital stock • If it is zero Î capital stock remains constant • If positiveÆ the capital stock grows • Used in computing net domestic product

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GDP and Economic Welfare Measuring Economic Aggregates and the Circular In computing GDP, the market value of output is the measure of value Flow of Income

No information about its composition, some economists question whether GDP The Product of a Nation is a good measure of the nation’s The Circular Flow of Income and economic welfare Expenditure Limitations of National Income Accounting Accounting for Price Changes

© 2003 South-Western/Thomson Learning 35 36 Accounting for Price Changes Accounting for Price Changes

GDP measures the value of output in Since average price level changes over current dollars, time, current-dollar comparisons across years can be misleading the dollar values when the output is produced Called nominal GDP Specifically, nominal GDP increase over time because Output increases Allows for comparisons among Prices increase income or expenditure components Both of these occur in a particular year

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Real GDP Price Indexes

Real GDP refers to GDP adjusted for An index number: changes in prices Î measures the compares the value of some variable in a changes which occurred in output particular year to its value in a base year values in other years are expressed relative to the base-year price This process of adjusting nominal GDP for price changes is called deflating GDP Price index: or real GDP Dividing each year’s price by the price in the base year and multiplying by 100

39 40 A Price Index (base year = 2000) Price Indexes

The price index for 2001 is $1.30 / $1.25*100 = 104, The price index for 2001 is $1.40 / $1.25*100 = 112, Price index permits comparisons between any two years

Price of Bread Price of Bread in Current Year in Base Year Price Index Year (1) (2) (3) = (1)/(2)x100 Ex: what happened to the price level between 2001 and 2002? 2000 $1.25 $1.25 100 Ans: 112 / 104=107.7, you would find 2001 1.30 1.25 104 that the price level rose by 7.7% 2002 1.40 1.25 112

Thus, the index is 4% higher in 2001 than in the base year, and 12% higher in 2002 than in the base year.

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Consumer Price Index Develop CPI in Hypothetical Market The consumer price index, CPI, measures changes in the cost of buying a “market basket” of goods and services Quantity in Price in Cost of Basket purchased by a typical family Good or Market Basket Base Year in Base Year (1) (2) (3 ) = (1) x (2)

Federal government uses 1982 – 1984 Twinkies 365 packages $0.84/pkg. $ 324.85 as the base period: Fuel Oil 500 gallons 1.00/gallon 500.00 Calculating the CPI for a market basket of Cable TV 12 months 30.00/month 360.00 400 goods and services in eight categories $1,184.85

A simplified version of the process is presented as follows.

43 44 Develop CPI in Hypothetical Market Problems with the CPI

In column (4), not all prices have changed by the same percent since the base CPI tends to overstate inflation year. The cost of purchasing this same market basket in the current year is Quality bias: $1,398.35 • CPI assumes the quality of the market basket remains constant over time CPI holds constant the kind and amount of goods and Prices in Cost of Basket services in the market basket, Good or Current Year in Base Year • Slow to incorporate consumer responses to changes in Service (4) (5) = (1) x (4) relative prices • Does not allow households to shift away from relatively Twinkies $ 0.79 $ 288.35 cost goods Failed to keep up with the consumer shift toward Fuel Oil 1.50 750.00 discount stores Cable TV 30.00 360.00 $1,398.35 Researchers conclude the CPI has overestimated inflation by about 1 percent per Price index for the current year= ($1,398.35 / $1,184.85)*100=118 Between the base year and the current year, the “cost of living” increased by 18%. year

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Impact of These Problems GDP Price Index

Overstating the inflation rate causes a number of Measures the average level of problems prices of goods and services Changes in the index determine changes in tax brackets Changes in the index determine changes in payments included in GDP • Wage agreements that include cost-of-living allowance GDP price index = (nominal GDP / (COLA) • Social Security benefits real GDP) x 100 • Welfare payments Nominal GDP is the dollar value of • About 30% of federal outlays are tied CPI this year’s GDP measured in this-year – 1% overstatement cost the federal $180 billion per year prices Distorts other measures of the economy. Real GDP is the dollar value of this • Based on CPI, real wage fell 2% between 1980 and 2000. year’s GDP measured in base year • If the CPI overstates inflation by 1% per year, the real wage increased by 20% prices

47 48 GDP Price Index GDP Price Index

A measure of real GDP is constructed as the As the base year is close to the weighted sum of goods and services year in question, this yields an accurate measure of real GDP The question is what weights (price) to use Between World War II and 1995, the Bureau of Economic Analysis (BEA) used prices of a In early 1996, the BEA switched particular base year, most recently, 1987, to estimate real GDP from a fixed-price weighting In this case, the quantity of each output in a system to a chain-weighted system particular year was valued by using the 1987 real GDP adjusts the weights in price calculating a price index more or less continuously from year to year

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U.S. GDP in Current Dollars and Chained GDP Price Index (1996) Dollars To provide the reference point, BEA measures U.S. real GDP and its components in chained 1996 dollars

To summarize Current-dollar (nominal) GDP growth reflects growth in real GDP and in the price level Chained-dollar GDP growth reflects only growth in output

51 52 課堂報告 Homework

請解釋何謂Disposable income 15. Calculate the GDP by income 請解釋何謂Net tax approach 請解釋何謂 transfer payment 15.Calculate GDP by expenditure 請解釋何謂Net domestic product approach 請解釋gross investment和net investment的差別 請解釋何謂consumer price index

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