ECON203 Principles of Macroeconomics Week 4 Topic : Related Measures & GDP uses and limitations
Introduction to Macroeconomics Unit 5. Circular Flow and GDP Measuring a Nation’s Product and...
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Transcript of Introduction to Macroeconomics Unit 5. Circular Flow and GDP Measuring a Nation’s Product and...
Introduction to Macroeconomics
Unit 5
Circular Flow and GDPMeasuring a Nation’s Product and Income
Macroeconomics = The study of the nation’s economy as a whole.
Focuses on a few key issues:1. Gross Domestic
Product (GDP)2. Inflation3. Unemployment4. Economic Growth
Macroeconomics
Every day people go to work, where they produce or sell goods/services, and return home with a paycheck
They use their income to purchase all of the things necessary to conduct a modern life
We have investigated the specifics that determine how individual producers or firms decide how much to produce/consume Now we step back and look at the entire economy as a whole
In order to understand the relationship between production of goods/services and income for the consumers for an entire economy, we must return to the circular flow diagram
Production and Income
The important point to remember is that production generates income Firms pay for
inputs, generating income for workers, land owners, other firms, etc
Any profit is income for the owners of the firm
Production and Income
Example: Your taxes pay for a school district to hire principals, teachers, and other staff
Your taxes also pay for the school to rent buildings or property, and to pay interest on any money borrowed The income
These individuals provide education for the students in the district The production
Circular Flow
How do we measure the production of an entire economy? GDP = the total market value of all final goods and services
produced in an economy in a given year “Total market value” = take the quantity of each good produced
and multiply it by the $ value of each “Final goods and services” = goods that are sold to final
consumers, as opposed to goods that are used in the production process Example: the steel used to manufacture cars.
Steel = intermediate good, car = final good “In a given year” = we do not keep a running total of all goods
produced by an economy…why? Allows us to measure growth of an economy
Measuring Production
How is GDP affected by price and quantity? If the price of goods and services increases, GDP will
increase, even if the quantity produced stys the same If the quantity produced increases, GDP will increase,
even if price stays the same And vise-versa
So…if only the prices increase, is this economy growing? Is it a stronger economy?
Economists apply the Reality Principle to GDP Consider real GDP
GDP
Reality Principle = what matters to people is the real value of money or income – its purchasing power – not its the face value
Real GDP = a measure of GDP that accounts for changes in the price of goods
Nominal GDP = a measure of GDP using current prices only (i.e. does not account for price changes from year to year)
Real GDP
Example: Consider the computers produced by an economy In year 1: 10 computers sold at $1,000 each In year 2: 12 computers sold at $1,100 each
Nominal GDP for year 1 and 2 is? $10,000; $13,200 Is this economic growth?
To calculate real GDP we simply use the year 1 prices for both years Real GDP for year 1 and 2 is?
$10,000; $12,000 The real GDP has grown by a factor of 1.2
Real GDP
Economic growth = sustained increased in the real production of an economy over a period of time
Real GDP & Economic Growth
There are four main components to GDP:1. Consumption of Expenditures; Purchases by
consumers2. Private Investment expenditures; purchases
by firms3. Government purchases; Purchases by
federal, state, and local government4. Net exports; net purchases by the foreign
sector, or domestic exports minus domestic imports
Components of GDP
Consumption Expenditures = Purchasers by consumers of currently produced goods and services, either domestic or foreign
Examples: TV sets, DVD players, cars, clothing, hair-styling services, movie tickets, food, and all other consumer items
Can be sub-divided into 3 categories: Durable goods (last for a long time – cars) Non-Durable Goods (last a short time – food) Services (fastest growing category)
Overall, consumption expenditures account for a large % of GDP (%67 – USA)
1. Consumption Expenditures
1. Consumption Expenditures
Private investment expenditures = Purchases of newly produced goods and services by firms
There are three components to private investment expenditures:
1. Spending on new equipment and facilities within a year
2. Spending on a newly produced home3. An increase in inventories
2. Private Investment Expenditures
Gross investment = the total of all NEW investments within the year
BUT, in order to determine the true investment by the private sector, we also have to consider the deterioration of previous investments (machines, facilities, etc)
Depreciation = the wear and tear of capital as it is used in production Example: a mold used to shape a plastic product cracks and
must be replaced The net investment = total investment – depreciation Net investment (not gross investment) is used to calculate
GDP
2. Private Investment Expenditures
Government purchases = purchases of newly produced goods and services by all levels of government Example: increase in wages associated with hiring more
government workers This component does NOT include transfers. Why?
This is money that is simply moved around It does not represent production when we are discussing
the entire economy However, transfers do make up large % of a
governments annual budget, and contribute to deficit
3. Government Purchases
For open economies, or economies that trade with other nations, exports and imports must be factored into GDP
Net exports = total exports – total imports If a good/service is not produced in a nation’s
economy, then it can not be included in the GDP Therefore we must subtract imports
Net exports can be negative if more goods/services are imported into a country then exported
4. Net Exports
4. Net Exports