CHAPTER
23
Measuring a Nation’s Income
Economics
PRINCIPLES OF
N. Gregory Mankiw
© 2009 South-Western, a part of Cengage Learning, all rights reserved
Micro vs. Macro
▪ Microeconomics:
The study of how individual households and firms
make decisions, interact with one another in
markets.
▪ Macroeconomics:
The study of the economy as a whole.
▪ We begin our study of macroeconomics with the
country’s total income and expenditure.
MEASURING A NATION’S INCOME !2
Income and Expenditure
▪ Gross Domestic Product (GDP) measures
total income of everyone in the economy.
▪ GDP also measures total expenditure on the
economy’s output of g&s.
For the economy as a whole,
income equals expenditure
because every dollar a buyer spends
is a dollar of income for the seller.
MEASURING A NATION’S INCOME !3
The Circular-Flow Diagram
▪ a simple depiction of the macroeconomy
▪ illustrates GDP as spending, revenue,
factor payments, and income
▪ Preliminaries:
▪ Factors of production are inputs like labor,
land, capital, and natural resources.
▪ Factor payments are payments to the factors
of production (e.g., wages, rent).
MEASURING A NATION’S INCOME !4
The Circular-Flow Diagram
Households:
▪ own the factors of production,
sell/rent them to firms for income
▪ buy and consume goods & services
Firms Households
Firms:
▪ buy/hire factors of production,
use them to produce goods
and services
▪ sell goods & services
MEASURING A NATION’S INCOME !5
The Circular-Flow Diagram
Revenue (=GDP) Spending (=GDP)
Markets for
G&S Goods &
G&S
sold Services bought
Firms Households
Factors of Labor, land,
production Markets for capital
Factors of
Wages, rent, Production Income (=GDP)
profit (=GDP)
MEASURING A NATION’S INCOME !6
What This Diagram Omits
▪ The government
▪ collects taxes, buys g&s
▪ The financial system
▪ matches savers’ supply of funds with
borrowers’ demand for loans
▪ The foreign sector
▪ trades g&s, financial assets, and currencies
with the country’s residents
MEASURING A NATION’S INCOME !7
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
Goods are valued at their market prices, so:
▪ All goods measured in the same units
(e.g., dollars in the U.S.)
▪ Things that don’t have a market value are
excluded, e.g., housework you do for yourself.
MEASURING A NATION’S INCOME !8
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
Final goods: intended for the end user
Intermediate goods: used as components
or ingredients in the production of other goods
GDP only includes final goods – they already
embody the value of the intermediate goods
used in their production.
MEASURING A NATION’S INCOME !9
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes tangible goods
(like DVDs, mountain bikes, beer)
and intangible services
(dry cleaning, concerts, cell phone service).
MEASURING A NATION’S INCOME !10
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes currently produced goods,
not goods produced in the past.
MEASURING A NATION’S INCOME !11
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
GDP measures the value of production that occurs
within a country’s borders, whether done by its own
citizens or by foreigners located there.
MEASURING A NATION’S INCOME !12
Gross Domestic Product (GDP) Is…
…the market value of all final goods &
services produced within a country
in a given period of time.
Usually a year or a quarter (3 months)
MEASURING A NATION’S INCOME !13
The Components of GDP
▪ Recall: GDP is total spending.
▪ Four components:
▪ Consumption (C)
▪ Investment (I)
▪ Government Purchases (G)
▪ Net Exports (NX)
▪ These components add up to GDP (denoted Y):
Y = C + I + G + NX
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Consumption (C)
▪ is total spending by households on g&s.
▪ Note on housing costs:
▪ For renters, consumption includes rent
payments.
▪ For homeowners, consumption includes the
imputed rental value of the house, but not the
purchase price or mortgage payments.
MEASURING A NATION’S INCOME !15
Investment (I)
▪ is total spending on goods that will be used in the
future to produce more goods.
▪ includes spending on
▪ capital equipment (e.g., machines, tools)
▪ structures (factories, office buildings, houses)
▪ inventories (goods produced but not yet sold)
Note: “Investment” does not
mean the purchase of financial
assets like stocks and bonds.
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Government Purchases (G)
▪ is all spending on the g&s purchased by govt
at the federal, state, and local levels.
▪ G excludes transfer payments, such as
Social Security or unemployment insurance
benefits.
They are not purchases of g&s.
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Net Exports (NX)
▪ NX = exports – imports
▪ Exports represent foreign spending on the
economy’s g&s.
▪ Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
▪ Adding up all the components of GDP gives:
Y = C + I + G + NX
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Real versus Nominal GDP
▪ Inflation can distort economic variables like GDP,
so we have two versions of GDP:
One is corrected for inflation, the other is not.
▪ Nominal GDP values output using current prices.
It is not corrected for inflation.
▪ Real GDP values output using the prices of
a base year. Real GDP is corrected for inflation.
MEASURING A NATION’S INCOME !19
Nominal and Real GDP in the U.S.,
1965-2007
Real GDP
(base year
2000)
Nominal
GDP
!20
The GDP Deflator
▪ The GDP deflator is a measure of the overall
level of prices.
▪ Definition:
nominal GDP
GDP deflator = 100 x
real GDP
▪ One way to measure the economy’s inflation
rate is to compute the percentage increase in
the GDP deflator from one year to the next.
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GDP and Economic Well-Being
▪ Real GDP per capita is the main indicator of
the average person’s standard of living.
▪ But GDP is not a perfect measure of
well-being.
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GDP Does Not Value:
▪ the quality of the environment
▪ leisure time
▪ non-market activity, such as the child care
a parent provides his or her child at home
▪ an equitable distribution of income
MEASURING A NATION’S INCOME !23
Then Why Do We Care About GDP?
▪ Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.
▪ Many indicators of the quality of life are positively
correlated with GDP. For example…
MEASURING A NATION’S INCOME !24
