Chapter 25: Measuring the Aggregate Economy

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsCalculate GDP using the expenditures and value added approachesDistinguish real from nominal conceptsCalculate aggregate income and explain how it relates to aggregate productionDescribe the limitations of using GDP and national income accountingAggregate AccountingAggregate accounting (or national income accounting) is a set of rules and definitions for measuring economic activity in the economy as a wholeAggregate accounting is a way of measuring total, or aggregate production, expenditures, and incomeGross domestic product (GDP) is the total market value of all final goods and services produced in an economy in a one-year periodThe Components of GDPGDP is divided into four expenditure categories:Consumption (C) is spending by households on goods and servicesInvestment (I) is spending for the purpose of additional productionGovernment spending (G) is goods and services that government buysNet exports is spending on exports (X) minus spending on imports (M)GDP = Consumption + Investment + Government spending + Net exportsGDP = C + I + G + (X-M)GDP Measures Final OutputGDP does not measure total transactions in the economyIt counts final output, but not intermediate goodsFinal output is goods and services purchased for final useIntermediate products are used as an input in the production of some other productCounting the sale of both final and intermediate goods would result in double countingTwo Ways of Eliminating Intermediate GoodsCalculate only final outputA firm would report how much it sold to consumers and how much it sold to producers (intermediate goods)Follow the value added approachValue added is the increase in value that a firm contributes to a product or serviceIt is calculated by subtracting intermediate goods (the cost of materials that a firm uses to produce a good or service) from the value of its salesGross and Net ConceptsNet domestic product is GDP adjusted for depreciation,Depreciation is the amount of capital used up in producing that year’s GDPNDP measures output available for purchaseNDP = C + I + G + (X-M) – depreciationNet Investment is gross investment minus depreciationNational and Domestic ConceptsGDP is the total value of all final goods and services produced in an economy in a one-year periodGDP is output produced within a country’s bordersGross National Product (GNP) is the aggregate final output of citizens and businesses of an economy in one yearGNP is output produced by a country’s citizensGNP = GDP + Net foreign factor incomeNet foreign factor income is the income from foreign domestic factor sources minus foreign factor income earned domesticallyCalculating Aggregate IncomeAggregate income is the total income earned by citizens and businesses in a country in a yearAggregate income consists of:Employee compensationRentInterestProfitsAggregate income = Employee compensation + Rents + Interest + Profits Equality of Aggregate Income and Aggregate ProductionWhenever a good or service is produced (output), somebody receives an income for producing itAggregate Income ≡ Aggregate ProductionProfit is a residual that makes the income side equal the expenditures sideThis aggregate identity allows us to calculate GDP either by adding up all values of final outputs (C, I, G, net exports) or by adding up the values of all earnings or incomeAs globalization has expanded, net exports have become increasingly importantReal GDP, Nominal GDP and Price IndicesNominal GDP is GDP calculated at current pricesThe GDP deflator is a price indexReal GDP = Nominal GDPGDP deflatorX 100GDP deflator = Nominal GDPReal GDPX 100Real GDP is nominal GDP adjusted for inflationOther Real and Nominal Distinctions Nominal interest rate is the rate you pay or receive to borrow or lend moneyReal interest rate is the nominal interest rate adjusted for inflationReal interest rate = Nominal interest rate – Inflation rateOther Real and Nominal DistinctionsReal wealth is the value of the productive capacity of the assets of an economy measured by the goods and services it can produce now and in the future Nominal wealth is the value of these assets measured in current pricesAsset price inflation is a rise in the price of assets unrelated to increases in their productive capacitySome Limitations of Aggregate AccountingGDP measures economic activity, not welfareGDP does not measure happiness, nor does it measure economic welfareMeasurement problems existMeasurements of inflation can involve significant measurement errorsSubcategories are often interdependentFor example, the line between consumption and investment may be unclearSome Limitations of Aggregate AccountingMeasurement is necessary, and the GDP measurements and categories have made it possible to think and talk about the aggregate economyThe genuine progress indicator (GPI) makes a variety of adjustments to GDP to better measure the progress of society rather than just economic activityThe GPI includes social goals such as pollution reduction, education, and healthChapter Summary Aggregate accounting is a set of rules and definitions for measuring economic activity in the aggregate economyGDP is the total market value of all final goods and services produced in an economy in one yearAggregate income = Compensation of employees + Rent + Interest + ProfitAggregate income equals aggregate production because whenever a good is produced, somebody receives income for producing it, and profit is key to that equalityGDP = C + I + G + (X - M)Chapter Summary To compare income over time, we must adjust for price-level changes and obtain “real” measuresReal interest rate = Nominal interest rate – InflationGDP has its problems:It is difficult to compare across countriesGDP does not measure economic welfareIt does not include transactions in the underground economy