Wealth, GDP, and Macroeconomics

Session 2: Wealth and GDP – Concepts and applications

• This session covers the circular flow of income, GDP, GNP, national income, disposable income, real vs. nominal GDP, and price change measurements like CPI and deflator.

Mercantilism and Wealth

• Mercantilism held that wealth was fixed and finite so the only way to prosper was to hoard gold and implement tariffs on products from abroad.
• According to mercantilist theory, nations should export goods while importing nothing, which led to retaliatory tariffs and the choking of international trade.

Adam Smith and Free Trade

• Adam Smith argued that free trade and open markets, both domestically and internationally, would lead to greater prosperity.
• Allowing individuals to freely produce and exchange goods, driven by self-interest, surpasses the benefits of strict government control.

Introduction to Macroeconomics

• Macroeconomics studies the aggregate behavior of the economy.
• Economists are concerned with production levels and growth rate, unemployment rate, and inflation rate.
• Economic policies should be based on these variables, known as macroeconomic data.

Circular Flow of Income

• The circular flow of income is a simplified model that explains the aggregate behavior of the economy and transactions.
• The model includes transactions between households, businesses, the public sector (government), and the external sector although we deal with a "closed economy" for this course.
• Transactions result in two types of intersectoral flows: real flows of goods, services, or factors of production, and monetary flows for physical units or money transfers without physical exchange.
• These occur in markets such as factors of production, goods and services, and financial markets.

Circular Flow: Households and Businesses

• Focus is on transactions between households and businesses in a closed economy without government.
• Transactions occur in markets for goods/services and markets for factors of production.
• Transactions create real flows of goods, services, or factors of production plus money flows for payments of goods, salaries, rent, dividends, etc.

The Role of Households

• In markets for factors of production, households own factors like labor, land, and physical capital, and sell or rent these to businesses, creating a real flow.
• Households receive income from businesses like salaries, rent, interest, and dividends, generating a money flow.
• In the Goods and Services Market, households spend their income, which is private consumption (C) within the economy.

The Role of Businesses

• Businesses buy or rent factors of production in the markets of land, labor, and physical capital, and this generates a real flow from households to businesses.
• Businesses pay income to households, creating a money flow.
• In the goods and services market, businesses are producers/suppliers selling goods and services to households.
• Businesses receive payments from households for goods and services, indicated by the GDP, creating a money flow.

Key Lesson: Income and Spending

• Within an economy, income must equal spending; every transaction involves a buyer and a seller. Euros spent are income for a seller.
• Aggregate production, or GDP, measures total income and spending within the economy.

Circular Flow with the Government

• Transactions now include businesses, households, and the government in a closed economy.
• These happen in goods and services and factors of production.
• The government receives taxes (t) from households and makes transfers (tr payments with no physical exchange) to households, such as pensions, scholarships, and subsidies.
• Net taxes, T=(t-tr), is the money flow from households to the government. T=(t-tr).
• The government buys goods and services from businesses (G), generating a real flow.

Circular Flow with Government: Key Insights

• Within the economy, income must equal spending. In any transaction, money spent by a buyer becomes income for a seller.
• The government acts as another buyer but is also allocating rent.
• Aggregate production (GDP) measures total income of economic agents, including the government.
• Aggregate production (GDP) measures total spending in goods and services by households, businesses, and the government.

Circular Flow with Government and Financial Markets

• The model shows transactions between households, businesses, and the government within three markets: goods and services, factors of production, and financial markets.
• Financial markets generate money flows into the economy.
• This comes from savings classified as private savings (S) and public savings (T-G).
• Savings go to businesses/government through loans and stock to finance investment (I).

Defining Savings

• Public savings are defined as (T-G), where T is net taxes and G is government spending.
• Private savings are defined as S = GNDI – C, where GNDI is Gross National Disposable Income.
• GNDI is the total available income or production (GDP) minus net taxes where GNDI = GDP-T.
• Gross National Savings (GNS/SN) are defined as national savings where GNS = S + (T-G).

Key Lesson: Savings and Investment

• Savings have to equal investment.
• Private savings (S) and government savings (T-G) equals to National Savings (SN).
• National Savings (SN) funds Investment (I).
• GNS = SN = S + (T-G) = I

Government Financing Capacity

• Government capacity or need for financing is evaluated.
• If (T-G) > 0, the government has financing capacity (government has a budget superavit), so I(investment) > S (private savings).
• If (T-G) < 0, there is need for financing (government has a deficit), I(investment) < S (private savings.

Importance of GDP

• Gross Domestic Product (GDP) measures the aggregate production of goods and services within an economy.
• GDP provides information about the size of an economy, its growth over time, and allows growth comparisons among economies.
• GDP per capita measures welfare in the economy where GDP is divided by the country's population, equivalent to the GDP average per person, used as a proxy for the average standard of living.
• A greater GDP enables a country to increase its development in education and healthcare.

GDP: Definition

• GDP is the value of all final goods and services produced within a country in a specific period at current market prices.
• Market Price value (Price and quantity) provides a standard measurement, units cannot be added, and some services, like healthcare/defense, are measured by the cost of factors of production.

GDP Scope

• GDP includes all goods and services except what's exchanged in the underground, informal, or illegal economy.
• GDP includes services (healthcare, education, and trade) and goods sold to final consumers.
• GDP distinguishes between consumption (C) and capital goods (K) and between fixed capital (FK) and inventories (Is).

GDP Exclusions

• GDP excludes intermediate goods used to produce other goods/services that disappear in the production process- including these goods would count them more than once.

GDP Qualification

• GDP is domestic if goods/services are produced with factors of production owned by nationals or international owners.
• GDP is per unit of time, including goods/services produced within the period.

GDP Inclusions

• GDP includes final goods and services produced domestically, including capital goods.
• GDP includes new buildings, structures, and raw materials produced, but not yet used during the period.

GDP Exclusions

• GDP does not include intermediate goods/services in production, factors of production in production, goods of a previous periods, financial assets like stocks, or goods and services produced internationally.

GDP vs. GNP

• GDP measures the total value of final goods and services produced within a country, regardless of who made them (nationals or foreigners).
• GNP measures the total value of final products and services produced by a country's residents, regardless of location.

Methods of GDP Calculation

• There are three methods of calculating GDP: production (supply), income, and spending (demand).
• The Production method adds the total market price value of final goods/services.
• The Income method adds all income/rent earned by factors involved in the production of final goods/services.
• The Spending method adds all spending on final goods/services, including imported goods.

GDP Calculation: Production

• To determine the Nominal GDP, add market Price Value, the alternative approach is to sum up all added value.
• Added value is the production value minus the value of raw materials as well as intermediate goods that were inputs.

GDP by Total Sum of Final Goods

• The final good market price value (Burger) already covers the value of the intermediate good.
• Adding the beef price would count it twice

GDP as Value Added in the Economy

• Total value should equal Farmer's added value + McDonald's added value.

GDP Calculation: Income Approach

• GDP is determined by adding all payments businesses make to owners of the factors of production.
• Payments include salaries, interest, rent, and dividends.
• Additionally, profits not distributed by businesses are included (which go to owners of physical capital).

Components from the Income Approach

• Includes salaries that are compensation for work, gross operating surplus that is profits and capital compensation, lastly, net taxes on production and imports.

GDP Calculation: Spending

• GDP is calculated by adding expenses by those buying final goods and services produced domestically.
• Expenses are classified under private consumption (C) which is, total expenses, government spending (G), and total expenses in goods and service by the government

Spending: What does it include?

• Private consumption (C) includes expenses in foreign goods and excludes new housing.
• Government spending (G) includes expenses in foreign goods but not transfers.

Spending: What else does it include?

• Considers gross investment/fixed capital investment as expenses in capital goods that will be used in the future.
• Includes new housing purchases, expenses in foreign goods, and those produced as not sold.

Exports and Imports

• It covers Exports(X) which are expenses of foreign residents and Import(M) which consist of expenses of national residents.
• To obtain accurate results of expenses you add X, exports, and subtract M, imports, as part of C, I, G spent on foreign goods.

Formula for finding GDP

• The following can be expressed in to GDP= C + L + G +(X - M)
• This results PIB + M, that is total supply, in the form of C + I + G + X

Main GDP Components from Demand Side

• Consumption 77%, Private 56%, Government21%
• Investment 21% which is Gross Capital
• Exports and Imports are 2%

Gross Investment Components

• Gross investment has two components; Investment, wich is a result of purchase of capital, and is expressed as
• Purchases is NET invested in IN FIXED CAptial, which Is Purchases of capital that incorporate into the production which results in Capital increasing
• This is the difference between Kfp versus Kpp, capital stock at the end, versus initial.

Gross Investment Components Part 2

• Considers DEPRECIATION expenses as replacement for deteriorated capital or obsolete laptops.
• IN INVENTORIES, considers good inventories, and inventories, which Is calculated from the difference, end of period, from beginning of period.

GDP: Production/Supply

• Includes addition of all of the final goods and services, as well as added value that is produced
• If added value, the GDP is a sum of (9.000 less the 4.200), from the price of goods.

Nominal value

• GDP is given in terms of euros, which calculates Nominal GDO or CURRENT price, for a specific year.
• Year is used to measure prices, and year is used to measure quantity produced.

Nominal GDP

• Considers quantities produced at (t-1) at the same year

Problems arising from nominal value

Increase due to: - Greater production - prices increasing - increases in both price and quantity

Nominal vs.Real

• Real GDP measures value of all goods,with prices from a base year
• Real GDP at year, considers constant prices measured from base year, to find what constant prices were during (t-1)

What happens after comparing nominal GDP from (t-1) to (t)?

• Change in GDP is linked to a greater production of goods while given that the year has Constant Prices.
• Choosing 1987 as the base year, showed that GDP has increased in 75% between 2007 and 2008.
• It rises to 43% to between between 2008 and 2009