Transcript as % of GDP

Chapter 2
The Measurement
of Income,
Prices, and
Unemployment
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The Measurement of Income, prices
and Unemployment
Why we care about income?
• the key to understand the changes in unemployment is the
changes in actual real GDP.
• The growth rate of standards of living is measured by
productivity, which requires understanding of real GDP.
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The circular flow of income and
expenditures
• The circular flow of income and expenditure model is a simple
representation of the macro economy
• Assume that households spend all their income, no savings and
no government
• There are two types of transactions between households and
firms. Note:
• Firms sell goods and services paid by households (consumption
expenditures)
• Households must work to earn income to pay for their
consumption (income)
Income and consumption are equal
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Figure 2-1 The Circular Flow of Income
and Consumption Expenditures
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The circular flow of income and
expenditures
• Income (Y) = labor services
= consumption expenditures (C)
= product
• Each of the four elements in the figure is a flow magnitude.
– The value of output produced by firms equals the value of expenditures
by participants in the economy
– The value of output produced by firms equals the total income generated
in the economy
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What GDP is and what GDP is not
• GDP (Y) is the value of all final goods and services that are
currently produced and sold (but not resold) through the
market during the current time period
• The GDP of a country is often referred to as the country’s
output and/or income
• There are 3 major rules for including items in the
total final product.
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What GDP is and what GDP is not
1. Currently produced: a good must be currently produced, i.e.,
exclude all used items. It also excludes any transaction in
which money is transferred without any accompanying good or
a service; transfer payments (gifts from one person to another,
gifts from the government to persons; social security, medical
care and unemployment benefits), it also excludes capital gains
accruing to persons as the price of their assets change.
2. Sold in the market. Goods must be sold in the market and
valued at market prices. The value of personal time spent in
activities that are not sold in the market are excluded (self
consumption). Pollution cost allowances are excluded.
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What GDP is and what GDP is not
3. But not resold. A good must not be resold in the current time
period. i.e., the good must be a final product not an
intermediate product.
Intermediate goods, Final goods and Value added.
• Intermediate good, is resold by its purchaser either in its present
form or in an altered form.
• Final good, is sold to a final user rather than being resold.
• Value added, is the value of firms output minus the value of the
intermediate goods. It includes wages, rent, interest profit (it is
equal to final product).
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Table 2-1 What’s In and What’s Out of
GDP
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What GDP is and what GDP is not
What is the domestic in GDP?
• GDP includes all final goods and services produced within the
country regardless of whether they are sold in the country or
exported. Imported goods are excluded.
• Gross national product GNP.
• It is GDP plus factor payments to citizens from abroad and
subtracting payments to factor income to the rest of the world.
GNP = GDP + Factor payments from the rest of the world
– Factor payments to the rest of the world.
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What GDP is and what GDP is not
What’s the Gross in GDP
• GDP includes depreciation or part of the fixed capital stock
used up due to obsolescence and physical wear (consumption of
fixed capital.
Net Domestic Product (NDP).
= GDP - Depreciation.
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Components of Expenditure
•
Types of investment. Final goods that business firms keep for
themselves are called private investments or capital formation.
They add to nation’s stock of income-yielding assets. There
are two types of private investments.
• Inventory Investment is the change in the stock of raw
materials, parts and finished products held by businesses.
– Any goods that are unsold automatically are counted as part of
unplanned inventory investment.
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• Fixed Investment includes all final goods (mainly structures
and equipment) purchased by businesses not intended for resale.
– Houses and condominiums owned by households are also counted as
fixed investment.
Relation of Investment and Saving
• Personal Saving (S) is that part of personal income that is not
consumed or paid out in taxes
– Also referred to as Private Saving
– Algebraically: S = (Y-T) - C (where T = Net Taxes)
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• Funds from savings are channeled to firms in two basis ways:
– Households buy bonds and stocks issued by firms
– Households deposit savings in banks and other financial institutions that
in turn lend money to firms
• Firms use the money channeled from savings to buy investment
goods
• Saving is a leakage from the income used for consumption
expenditures. This leakage must be balanced by an injection on
non-consumption spending in the form of private investment.
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Figure 2-2 Introduction of Saving and
Investment to the Circular Flow Diagram
Leakage
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Injection
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Net Exports and Net Foreign
Investment
•
Exports are goods produced within one country and shipped to
another. Exports creates income in the country, but not part of the
consumption and investment spending of residents
• Imports are goods consumed within one country but produced in
another country. Imports are expenditures of residents for goods
ui8/and services produced abroad and thus do not create domestic
income
• If income created from exports is greater than income spent on
imports, the net effect is a higher level of domestic production and
income. Thus, net exports is a component of a final product and
GDP
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Net Exports and Net Foreign
Investment
• Another name of net exports is net foreign investment, since net
foreign investment (net exports) creates claims on foreigners. If
Japanese exports to USA is greater than its imports from USA,
US payments of the net exports will enable Japan to buy US
assets including bank accounts in USA.
• Net Exports (NX) are equal to the excess of exports over
imports
• Net Foreign Investment (NFI) is equal to purchases of foreign
financial assets minus foreign purchases of financial assets
Interesting connection: NX = NFI !
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The Government Sector
• Government Purchases (G) is the value of goods and services
purchased by the government.
• Transfer Payments (F) are payments from the government to
households that do not require the recipient to provide a service in
return
– Examples: Social Security, Medicare and Food Stamps
• Government Spending = G + F
• The Government pays for its spending by collecting
Taxes (R) or by borrowing and/or printing money
• Net Taxes (T) = R – F
• Budget Surplus = T – G
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Global Ecolnomic Crisis and GDP
• How long did the crisis last?
– Business Cycle Peak: 2007:Q4
– Business Cycle Trough: 2009:Q2
• How did the components of GDP behave over this time?
–
–
–
–
Real consumption by 0.8%
Real government spending by 6.6%
NX became significantly less negative
But real investment by 31.7%!
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Deriving the “Magic” Equation and
the Twin Deficits
• The income accounting identity states that an economy’s income
must equal its expenditures: (spending)
Y≡E
Y = C + I + G + NX
(1)
• Now, use the fact that household income must equal household
outlays (and recall that T = R - F): (Income allocation)
Y+F=C+S+R
(2)
Y=C+S+T
• Equating (1) and (2) yields the “Magic Equation”
C + S + T = C + I + G + NX
 S + T = I + G + NX
• The technical name of this equation is “the leakages-injection)
identity”.
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Interpreting the “Magic Equation”
• Recall the “Magic Equation:” S + T = I + G + NX
• Leakages (S + T) describe the portion of total income that is not
available for consumption
•
Injections (I + G + NX) is a term for non-consumption
expenditures
• The “Magic Equation” shows how leakages and injections are
connected by definition!
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“Magic Equation” Application:
Twin Deficits
Recall the “Magic Equation:” S + T = I + G + NX
• Rearranging (1) yields  T - G = (I + NX) – S
(1)
– If T - G < 0  possibly NX < 0
– This suggests that a budget deficit and trade deficit might be
observed at the same time!
– Note that the “magic equation” only suggests the possible
connections that may be observed in these variables.
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Interpreting the “Magic Equation”
•
•
•
The government budget and the twin deficits
Rearrange eq. 4 to show the uses of a government budget
surplus
T – G = (I + NX) – S
If T>G, there are 3 ways that a government budget surplus can
be used
1. A budget surplus allows private savings to decline without
a need for a decline of total investment (I+NX).
2. A budget surplus can stimulate domestic investment (I)
3. a budget surplus can boost foreign investment (NX) or if
NX is negative, reduce borrowing from foreigners.
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• If T<G, the government is running a deficit, there are 3
implications
• Budget deficit could make (I) smaller.
• Budget deficit requires that (S) must rise to avoid any
downward pressure on total investment (I+NX).
• If S does not increase, to avoid a decline in (I+NX), there must
be more borrowing from foreigners and a decline in lending to
foreigners.
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The “Magic Equation” in Recent
Years (as % of GDP)
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Where does household income come
from? income leakages and the circular flow
• Expenditures on GDP (C+I+G+Nx) create income.
• Income is to be spent on another round of expenditure.
• Household receive only part of the GDP, the rest is leaks out in
the form of tax and savings.
• The most important portion of domestic income is
compensations to employees.
Different types of income (see the following figure)
• US GDP data for Q3 2010
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• Summarize the steps by which income travels from business
firms to households.
1. Net Domestic Product = GDP – depreciation
• Now you may notice that gross or net depends on whether
depreciation is included or excluded
1. Domestic income = NDP – indirect business taxes
2. Personal income = DI – undistributed profits – corporate taxes
+ transfer payments
3. Personal disposable income = personal income – personal
income taxes
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Nominal GDP, Real GDP and the
GDP Deflator
• Nominal GDP is the value of gross domestic product in current
(actual) prices.
• Real GDP is the measure of gross domestic product using prices
of an arbitrarily chosen base year.
• The GDP deflator is a price index that measures the aggregate
economy’s price level.
– Algebraically: GDP Def = Nominal GDP / Real GDP * 100
– The percentage change in the GDP deflator gives a measure of the
economy’s inflation rate.
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Figure 2-4 Nominal GDP, Real GDP,
and the GDP Deflator, 1900–2010
Source:
Appendi
x Table
A-1. See
explanat
ion in
Appendi
x C-4.
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Measuring Unemployment
• The unemployed are those who either are on temporary layoff or have
taken specific action to look for work
• The total labor force is total of the civilian employed, the armed forces
and the unemployed
• The actual unemployment rate (U) is defined below:
• Each month 1,500 census workers interview a random sample of 60,000
households to estimate unemployment
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Flaws in the Definition of
Unemployment
• U is not a measure of social distress
– Much worse for the head of a household to be unemployed
compared to a 16-year old teenage
– Other common situations:
• College graduates looking for first jobs
• Women reentering the labor market after maternity leave
• People who voluntarily quit jobs and are now looking again
• U misses “forced part time workers”
• U misses “discouraged workers” who are not actively seeking jobs
and therefore are not in the labor force
– See chart on next slide!
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Millions Impacted by Recessions
but Not Counted as Unemployed
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