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Measuring Economic Aggregates and the Circular Flow of Income The Product of a Nation Measuring Economic How do we measure the economy’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 output and income Expenditure through different sectors of the economy Limitations of National Income Accounting 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 market value of all final goods by total spending on U.S. production 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 goods and services 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 Consumption were produced Intermediate goods and services Investment purchased for additional processing and resale Government Purchases Excluded to avoid the problem of double counting Net Exports • Counting added-value more than once 5 6 Consumption Investment Consists of purchases of final goods Gross private domestic investment and services by households Consists of Largest spending category • spending on new capital 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 Household 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. imports 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 Export: Produce in domestic, but not the recipient consume in domestic Æ Add to GDP Not true purchases by government Import: 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 13 14 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 Money 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. 21 22 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 finance 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 25 26 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 29 30 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
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