Lecture 2 measuring a nation s income

LECTURE 2
Measuring a Nation’s Income


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class
• Attendance check is compulsory and
constitutes 10% to the final grade
• Please have your smartphones on silent mode
• Students must do homework before the
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Assessment for the subject will be on the basis of:
• Class Participation Required 10%
• Group assignment(s) Required 10%
• Midterm: 20%, small test: 10%
• To pass this subject students must achieve:
• 50% or more in the final examination, AND an
overall mark of 50% or more (For students
entering Cohort 2016-2020 or earlier)
• An overall mark of 50% or more. (For students
entering Cohort 2017-2021 or after)


Lecture Objectives
• Consider why an economy’s total income
equals its total expenditure.
• Learn how gross domestic (GDP) is defined
and calculated and its four components.
• Distinguish between real GDP and nominal
GDP.
• Consider whether GDP is a good measure of
economic well-being.



The Economy’s Income and Expenditure
• Gross Domestic Product (GDP)

- Measures the total income of everyone in the
economy
- Measures the total expenditure on the

economy’s output of goods and services

• For an economy as a whole
- Income must equal expenditure

• Circular-flow diagram - assumptions:
• All goods and services - bought by households
• Households - -spend all of their income

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Figure 1
The circular-flow diagram
Households buy goods
and services from firms,
and firms use their
revenue from sales to
pay wages to workers,
rent to landowners, and
profit to firm owners.
GDP equals the total
amount spent by
households in the
market for goods and
services. It also equals
the total wages, rent,
and profit paid by firms
in the markets for the
factors of production.

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Measurement of Gross Domestic Product
• Gross domestic product (GDP)

- Market value of all final goods and service
- Produced within a country
- In a given period of time

• “GDP is the market value…”
Market prices - reflect the value of the goods

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Measurement of Gross Domestic Product

•

“… of all…”

- All items produced in the economy
• And sold legally in markets

- Excludes most items
• Produced and sold illicitly
• Produced and consumed at home

•

“… final…”
- Value of intermediate goods is already
included in the prices of the final goods
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Measurement of Gross Domestic Product
•

“… goods and services…”
- Tangible goods & intangible services

•

“… produced…”
- Goods and services currently produced

• “… within a country…”
- Goods and services produced domestically,
regardless of the nationality of the producer

• “… in a given period of time”
- A year or a quarter
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- When Tim buys a new refrigerator, the

transaction contributes to which component of
the GDP?
- The construction of a highway?
- A new pair of Gucci shoes produced in China?
- A new pair of Gucci shoes produced by Chinese
people living in Italy?


The Components of GDP
• Y = C + I + G + NX
Identity
- Y = GDP
- C = consumption
- I = investment
- G = government purchases
- NX = net exports

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The Components of GDP
• Consumption
- Spending by households
- On goods and services
- Exception: purchases of new housing

• Investment
- Spending on capital equipment, inventories,
and structures
- Including household purchases of new

housing
- Inventory accumulation
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The Components of GDP
• Government purchases
- Government consumption expenditure and
gross investment
- Spending on goods and services
- By local, state, and federal governments
- Does not include
transfer payment


The Components of GDP
• Net exports = Exports - Imports
- Exports
• Spending on domestically produced goods by
foreigners

- Imports
• Spending on foreign goods by domestic residents

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The components of U.S. GDP

• 2010, GDP of the United States = $14 trillion
• GDP per person = $45,838
- Consumption = $32,225 per person
- Investment = $7,061 per person
- Government purchases = $8,912 per person
- Net exports = -$2,360 per person

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Table

1

GDP and its components

Gross domestic product, Y
Consumption, C
Investment, I
Government purchases, G
Net exports, NX

Total
(in billions of dollars)

Per person
(in dollars)

Percent
of total

$13,843
9,732
2,132
2,691
-712

$45,838
32,225
7,061
8,912
-2,360

100%
70
15
19
-5

This table shows total GDP for the U.S. economy in 2010 and the breakdown of GDP
among its four components.
When reading this table, recall the identity Y = C + I + G + NX.

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Real Versus Nominal GDP
• Total spending rises from one year to the next
- Economy - producing a larger output of goods
and services

- And/or goods and services are being sold at
higher prices

• Nominal GDP
- Production of goods and services
- Valued at current prices
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Real Versus Nominal GDP
• Real GDP
- Production of goods and services
- Valued at constant prices
- Designate one year as base year
- Not affected by changes in prices

• For the base year
- Nominal GDP = Real GDP

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Table

2

Real and Nominal GDP
Prices and Quantities
Year

Price of
hot dogs

Quantity of
hot dogs

Price of
hamburgers

Quantity of
hamburgers

2008
2009
2010

$1
$2
$3

100
150
200

$2
$3
$4

50
100

150

Calculating Nominal GDP
2008
2009
2010

($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200
($2 per hot dog × 150 hot dogs) + ($3 per hamburger × 100 hamburgers) = $600
($3 per hot dog × 200 hot dogs) + ($4 per hamburger × 150 hamburgers) = $1,200
Calculating Real GDP (base year 2008)

2008
2009
2010

($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200
($1 per hot dog × 150 hot dogs) + ($2 per hamburger × 100 hamburgers) = $350
($1 per hot dog × 200 hot dogs) + ($2 per hamburger × 150 hamburgers) = $500
Calculating the GDP Deflator

2008
2009
2010

($200 / $200) × 100 = 100
($600 / $350) × 100 = 171
($1,200 / $500) × 100 = 240

This table shows how to calculate real GDP, nominal GDP,

and the GDP deflator for a hypothetical economy that
produces only hot dogs and hamburgers.

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Real Versus Nominal GDP
• The GDP deflator
- Measure of the price level
- Ratio of nominal GDP to real GDP times 100
- =100 for the base year
- Measures the current level of prices relative to
the level of prices in the base year

• Inflation
- Economy’s overall price level is rising
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