GDP And Economic Well-being PDF

0 In this chapter, look for the answers to these questions:  What is Gross Domestic Product (GDP)?  How is GDP related to a nation’s total income and spending?  What are the components of GDP?  How is GDP corrected for inflation?  Does GDP measure society’s well-being?...

0 In this chapter, look for the answers to these questions:  What is Gross Domestic Product (GDP)?  How is GDP related to a nation’s total income and spending?  What are the components of GDP?  How is GDP corrected for inflation?  Does GDP measure society’s well-being? 1  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. 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 of expenditure by a buyer is a dollar of income for the seller. 3  The Circular-Flow Diagram  is a simple depiction of the macroeconomy.  illustrates GDP as spending, revenue, factor payments, and income.  First, some 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) 4 FIGURE 1: The Circular-Flow Diagram Households:  own the factors of production, sell/rent them to firms for income  buy and consume g&s Firms Households 5 FIGURE 1: The Circular-Flow Diagram Firms Households Firms:  buy/hire factors of production, use them to produce g&s  sell g&s 6 FIGURE 1: 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) 7  What This Diagram Omits  The government collects taxes purchases 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 8 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: GDP measures all goods using the same units (e.g., dollars in the U.S.), rather than “adding apples to oranges.” Things that don’t have a market value are excluded, e.g., housework you do for yourself. 9 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 are intended for the end user. Intermediate goods are used as components or ingredients in the production of other goods. GDP only includes final goods, as they already embody the value of the intermediate goods used in their production. 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 tangible goods (like DVDs, mountain bikes, beer) and intangible services (dry cleaning, concerts, cell phone service). 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 includes currently produced goods, not goods produced in the past. 12 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. 13 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). 14  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 15  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. 16  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. 17  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. These payments represent transfers of income, not purchases of g&s. 18  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 19 ACTIVE LEARNING 1: GDP and its components In each of the following cases, determine how much GDP and each of its components is affected (if at all). A. Shilpa spends Rs.200 to buy her husband dinner at the finest restaurant in Boston. B. Sarah spends RS.1800 on a new laptop to use in her publishing business. The laptop was built in China. C. Jane spends Rs.1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. D. General Motors builds Rs.500 million worth of cars, but consumers only buy Rs.470 million worth of them. 20 ACTIVE LEARNING 1: Answers A. Shilpa spends Rs.200 to buy her husband dinner at the finest restaurant in Boston. Consumption and GDP rise by Rs.200. B. Sarah spends Rs.1800 on a new laptop to use in her publishing business. The laptop was built in China. Investment rises by Rs.1800, net exports fall by Rs.1800, GDP is unchanged. 21 ACTIVE LEARNING 1: Answers C. Jane spends Rs.1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer. Current GDP and investment do not change, because the computer was built last year. D. General Motors builds Rs.500 million worth of cars, but consumers only buy Rs.470 million of them. Consumption rises by Rs.470 million, inventory investment rises by Rs.30 million, and GDP rises by Rs.500 million. 22  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. 23  EXAMPLE: Pizza Latte Year P Q P Q 2022 Rs.10 400 Rs.2.00 1000 2023 Rs.11 500 Rs.2.50 1100 2024 Rs.12 600 Rs.3.00 1200 Compute nominal GDP in each year: Increase: 2022:Rs.10 x 400 + Rs.2 x 1000 = Rs.6,000 37.5% 2023:Rs.11 x 500 + Rs.2.50 x 1100 = Rs.8,250 30.9% 2024:Rs.12 x 600 + Rs.3 x 1200 = Rs.10,800 24  EXAMPLE: Pizza Latte year P (Rs) Q P (Rs) Q 2022 10 400 2.00 1000 2023 11 500 2.50 1100 2024 12 600 3.00 1200 Compute real GDP in each year, using 2022 as the base year: Increase: 2022:Rs.10 x 400 + Rs.2 x 1000 = Rs.6,000 20.0% 2023:Rs.10 x 500 + Rs.2 x 1100 = Rs.7,200 16.7% 2024:Rs.10 x 600 + Rs.2 x 1200 = Rs.8,400 25 EXAMPLE: Nominal Real year GDP GDP 2022 Rs.6000 Rs.6000 2023 Rs.8250 Rs.7200 2024 Rs.10,800 Rs.8400 In each year,  nominal GDP is measured using the (then) current prices.  real GDP is measured using constant prices from the base year (2022 in this example). 26 EXAMPLE: Nominal Real year GDP GDP 2022 6000 6000 37.5% 20.0% 2023 8250 7200 30.9% 16.7% 2024 10,800 8400  The change in nominal GDP reflects both prices and quantities.  The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation. 27  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. 28 EXAMPLE: Nominal Real GDP year GDP GDP Deflator 2022 6000 6000 100.0 14.6% 2023 8250 7200 114.6 2024 10,800 8400 128.6 12.2% Compute the GDP deflator in each year: 2022: 100 x (6000/6000) = 100.0 2023: 100 x (8250/7200) = 114.6 2024: 100 x (10,800/8400) = 128.6 29 ACTIVE LEARNING 2: Computing GDP 2022 (base yr) 2023 2024 P Q P Q P Q good A 30 900 31 1,000 36 1050 good B 100 192 102 200 100 205 Use the above data to solve these problems: A. Compute nominal GDP in 2022. B. Compute real GDP in 2023. C. Compute the GDP deflator in 2024. 30 ACTIVE LEARNING 2: Answers 2022 (base yr) 2023 2024 P Q P Q P Q good A 30 900 31 1,000 36 1050 good B 100 192 102 200 100 205 A. Compute nominal GDP in 2022. 30 x 900 + 100 x 192 = 46,200 B. Compute real GDP in 2023. 30 x 1000 + 100 x 200 = 50,000 31 ACTIVE LEARNING 2: Answers 2022 (base yr) 2023 2024 P Q P Q P Q good A 30 900 31 1,000 36 1050 good B 100 192 102 200 100 205 C. Compute the GDP deflator in 2024. Nom GDP = 36 x 1050 + 100 x 205 = 58,300 Real GDP = 30 x 1050 + 100 x 205 = 52,000 GDP deflator = 100 x (Nom GDP)/(Real GDP) = 100 x (58,300)/(52,000) = 112.1 32  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.  Robert Kennedy issued a very eloquent yet harsh criticism of GDP: 33 Gross Domestic Product… “… does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.” - Senator Robert Kennedy, 1968  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 35  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. 36 CHAPTER SUMMARY  Gross Domestic Product (GDP) measures a country’s total income and expenditure.  The four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports.  Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year, and is corrected for inflation.  GDP is the main indicator of a country’s economic well-being, even though it is not perfect. 37