Lecture+1.Ch5

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Macroeconomics 1B

Lecture 1*

Measuring A Nation’s Income

*Mankiw, N. Gregory and Mark P. Taylor. 2014. Macroeconomics. UK: Cengage Learning EMEA, Ch5

Understand◦ Why an economy’s total income equals its total

expenditure◦ How GDP is defined and measured◦ The components of GDP◦ The distinction between real GDP and nominal

GDP◦ Whether GDP is a good measure of economic well-

being

Purpose of Lecture

The study of how society manages its

scarce resources

Economics

For an economy as a whole income equals expenditure because:◦ Every transaction has a buyer and a seller.

Every rand of spending by some buyer is a dollar of income for some seller

The Economy’s Income and Expenditure

The Circular-Flow Diagram

The Economy’s Income and Expenditure

Gross Domestic Product (GDP) Is the market value of all final goods and services

produced within a country in a given period of time

The Measurement of Gross Domestic Product

“GDP is the Market Value…”◦ A monetary measure

The Measurement of Gross Domestic Product

Three Types of GDPGross value added at factor cost+ other taxes on production*- other subsidies on production**Gross value added at basic prices+ taxes on production#- subsidies on production##GDP at market prices

The Measurement of Gross Domestic Product

*Taxes on factors of production: property, capital and payroll taxes, etc.**Subsidies on factors of production: job creation and training subsidies, etc.#Taxes on products: general sales taxes, VAT, fuel levy, duties and taxes on imports, etc.##Subsidies paid on agricultural commodities, transportation services and energy, etc.

“…Of All Final…”◦ Avoid double counting

Intermediate goods versus Final goods Value added

The Measurement of Gross Domestic Product

“…Goods and Services…” It includes both

tangible goods: food, clothing, cars and intangible goods: haircuts, house cleaning, doctor visits

The Measurement of Gross Domestic Product

“…Produced…”◦ It includes goods and services produced in the

period we’re considering, not transactions involving goods produced in the past.

◦ E.g. do not include second hand goods, i.e, used cars, used houses, second hand cellphone etc.

◦ No unilateral transfers between individual or form government.

The Measurement of Gross Domestic Product

“…Within a Country…”◦ It measures the value of production within the

geographic confines of a country. Ownership is not important.

“…In a Given Period of Time.”◦ It measures the value of production that takes

place within a specific interval of time, usually a year or a quarter. GDP is a flow & not a stock.

The Measurement of Gross Domestic Product

Expenditure Approach◦ Money spent on final goods and services

Income Approach◦ Incomes of the factors of production

Production Approach◦ Sum of the value added during each phase of the

production process

Three Approaches to GDP

GDP (Y) is the sum of the following:◦ Consumption (C)◦ Investment (I)◦ Government Purchases (G)◦ Net exports (NX)

Y = C + I + G + NX

The Components of GDP: The Expenditure Approach

Consumption:◦ The spending by households on goods and services,

with the exception of purchases of new housingSpending includes:◦ Durable goods (with over 3 years of life span)

Cars, washing machines, fridges, ovens◦ Non-durable goods (with no more than 3 years life

span Food and clothing

◦ Services (intangible items) Haircuts and medical care

The Components of GDP: The Expenditure Approach

Investment◦ The spending on capital equipment, inventories,

and structures, including new housing

The Components of GDP: The Expenditure Approach

Government Purchases◦ The spending on goods and services and gross

investment in highways, bridges, and so on.

◦ Does not include transfer payments because they are not made in exchange for currently produced goods and services

The Components of GDP: The Expenditure Approach

Net exports◦ Exports minus imports

◦ Exports The purchase of domestically-produced goods and

services by foreign residents, firms and governments◦ Imports

The purchase of foreign-produced goods and services by domestic residents, firms and governments

The Components of GDP: The Expenditure Approach

 From GDP to GNP GNP (gross national product) is the total income earned by a country’s

nationals. It is equal to GDP + Factor income of domestic residents from abroad less the Factor income accruing to foreigners employed domestically.

From GNP to NNP Total income of a nation’s residents minus losses from depreciation (i.e.

consumption of fixed capital or the replacement cost of fixed capital)

From NNP to NI National Income (NI) differs from NNP in that it is calculated by subtracting

indirect business taxes & adding business subsidies.

From NI to PI personal income (PI) is the measure of income received by households, i.e.

NI plus transfer payments (social security benefits, unemployment benefits, welfare benefits, disability benefits) less payroll taxes (social security contributions), corporate profit taxes & undistributed corporate profits)

From PI to DI disposable income (DI) is PI less personal taxes (personal income, personal

property & inheritance taxes)

Compensation of Employees◦ Wages and salaries paid to employees◦ Employers’ contributions to social security and employee benefit plans◦ Monetary value of fringe benefits, tips, and paid vacations

Proprietors’ Income◦ All forms of income earned by self-employed individuals

Corporate profits◦ All the income earned by stockholders of corporations

Rental Income (of persons)◦ Income received by individuals for the use of their nonmonetary assets (land,

houses, offices).

Net Interest◦ The interest income received by households and government minus the interest

they paid out

The Income Approach: National Income*

*Reading 1: Principles of Macroeconomics

GDP = National Income◦ - Income earned from the rest of the world◦ +Income earned by the rest of the world◦ +Indirect business taxes◦ +Capital consumption allowance (depreciation)◦ +Statistical discrepancy

The Income Approach: Making Some Adjustments*

*Reading 1: Principles of Macroeconomics

The Production ApproachStages of Production

Sales Value

Firm A: Sheep Farm

R0 – R120

Firm B: Wool processor

R120 – R180

Firm C: Suit Manufacturer

R180 – R220

Firm D: Clothing wholesaler

R220 -R270

Firm E: Retail Clothier

R270- R350

Total Sales Value R1140

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.4.

The Production ApproachStages of Production

Sales Value Value Added

Firm A: Sheep Farm

R0 – R120 R120

Firm B: Wool processor

R120 – R180 R60

Firm C: Suit Manufacturer

R180 – R220 40

Firm D: Clothing wholesaler

R220 -R270 R50

Firm E: Retail Clothier

R270- R350 R80

Total Sales Value R1140

Value Added R350

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.4.

Net Domestic Product (NDP)◦ NDP = GDP – Capital Consumption Allowance (Deprcn)

Personal Income◦ Personal income = National Income

- Undistributed corporate profits - Social insurance taxes - Corporate profit taxes +Transfer payments

Disposable Income ◦ Disposable Income = Personal Income – Personal Taxes

Other National Income Accounting Measurements

Nominal GDP◦ Values the production of goods and services at

current prices Real GDP

◦ Values the production of goods and services at constant prices

An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator

Real GDP, Nominal GDP and GDP Deflator

The GDP Deflator

◦ It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced

Converting Nominal GDP to Real GDP

Real GDP, Nominal GDP and GDP Deflator

G D P d efla to r =N o m in a l G D P

R ea l G D P 1 0 0

R eal G D PN o m in a l G D P

G D P d efla to r2 0 X X2 0 X X

2 0 X X

1 0 0

Year (1)Units of Output

(2)Price of Pizza per Unit

(3)Unadjusted or Nominal GDP,

(4)GDP Deflator(Year 1 = 100)

(5)Adjusted or Real GDP

1 5 10 50 100 50

2 7 20 140 200 70

3 8 25 200 250 80

4 10 30 ? ? ?

Real GDP, Nominal GDP and GDP Deflator

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.5.

Year (1)Units of Output

(2)Price of Pizza per Unit

(3)Unadjusted or Nominal GDP, (1)x(2)

(4)GDP deflator,(Year 1 = 100)

(5)Adjusted or Real GDP

1 5 10 50 100 50

2 7 20 140 200 70

3 8 25 200 250 80

4 10 30 300 ? ?

Real GDP, Nominal GDP and GDP Deflator

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.5.

Year (1)Units of Output

(2)Price of Pizza per Unit

(3)Unadjusted or Nominal GDP, (1)x(2)

(4)GDP deflator,(Year 1 = 100)

(5)Adjusted or Real GDP,(1)x base year price

1 5 10 50 100 50

2 7 20 140 200 70

3 8 25 200 250 80

4 10 30 300 ? 100

Real GDP, Nominal GDP and GDP Deflator

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.5.

Note: Also (5) = ((3)/(4))x100

Year (1)Units of Output

(2)Price of Pizza per Unit

(3)Unadjusted or Nominal GDP, (1)x(2)

(4)GDP deflator,((3)/(5))x100(Year 1 = 100)

(5)Adjusted or Real GDP, (1)x base year price

1 5 10 50 100 50

2 7 20 140 200 70

3 8 25 200 250 80

4 10 30 300 300 100

Real GDP, Nominal GDP and GDP Deflator

van Rensburg, J. J., C. R. McConnell and S. L. Brue. 2011. Macroeconomis. New York: McGraw Hill, Table 15.5.

Note: Also (5) = ((3)/(4))x100

Higher GDP per person indicates a higher standard of living

GDP is not a perfect measure of the happiness or quality of life, however.

GDP and Economic Well-Being

The value of leisure

GDP Excludes:

The value of a clean environment

GDP Excludes:

The value of non-market activities

GDP Excludes:

Underground activities

GDP Excludes:

Legal

Illegal

Second Hand Sales

GDP Excludes:

Financial Transactions◦ Stock market transactions

GDP Excludes:

Transfer Payments ◦ Public transfer payments

GDP Excludes:

Transfer Payments◦ Private transfer payments

GDP Excludes:

Measuring the cost of living◦ Reading: Mankiw, Ch6

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