components

librarians. Government purchases averaged a bit less

than one-fifih of U.S. GDP during the last decade'

r Government purchases, and therefore GDP' exclude

transfer payments' such as Social Securily' welfare

benefits, and unemployment insurance' Such pay-

ments are not true purchases by the government or

true earnings bY the reciPients' The final spending component, net exports'

reflects international trade in goods and services' Goods, oT merchandise traded, include physical items

such as bananas and DVD players (stuffyou can put

in a box). Services, or so- cal1ed inuisibles, include intangible items, such as European tours and online customer service from India. Foreign Pur- chases of U.S. goods and services are counted as part of U.S. GDP. But U.S. purchases of foreign goods and services are subtracted from U'S. GDP. lrli:t expoli.$ equal the value of U.S. exPorts of

rl*f :'ihe ldntlct':i

by resource suppliers in the economy' Thus' we can

say that

Aggregate expenditure : GDP : Aggregate income

A prod.uct usually goes through several stages involving different firms on its way to the consumer'

a woodJn desk, for example, starts as raw timber' which is typically cut by one firm, milied by another'

made into a aest< by a third, and retailed by a fourth'

We avoid double counting either by including only

the market value of the desk when it is sold to the

ffiffiF Se*cd #ffi t$?c 6ms*swe &PPr*ateh The expenditure aPProach sums, or aggregates, sPending

on production. The income approach sums, or aggregates'

income arising from that Pro- duction. Again, double-entry bookkeeping ensures that the value of aggregate outPut

equals the aggregate income paid for resources used to Pro- duce that output: the wages, interest, rent, and Profit aris-

ing from Production.The Price of a HersheY bar reflects the income earned bY resource suppliers along the way' Aggregait int';t:'le equals the sum of all the income earned

GDP based on the income approach' For example' sup-

pose you buy a wooden desk for $zoo' This final mar-

let vatue gets added directly into GDP' Consider the history of it,at desk. Suppose the treethal-gave its life

for your studies was cut into a iog and sold to a miller

for -$zo,

who converted the log to lumber that sold for

$5o to a desk maker, who made the desk and sold it

for $rzo to a retailer, who sold it to you for $zoo' Column (I) of Exhibit r lists the selling price at

each stage of production' If all these transactions were add-*ed .,p, ttt" total of $39o wouid exceed the

$zoo market value of the desk' To avoid double count-

ing, we inciude oniy the value added at each stage'

lisied in column (3) as the difference between the pur-

ch"r" pric" ana ihe seliing price at that stage' Again'

:r,;.1:'i,ri I Computation of Value Added lor a New Desk

fina1 user ot bY summmg the value added at each stage of Production. The vaiue added bY each fi,rm equals that firm's seliing price minus Payments for inputs from other firms. The value added at each stage is the income earned by resource suPPli-

ers at that stage. The ualue added at all staqes sums to the market value of the fnal good., and the ualue added

for all final goods sums to

(31

Value Added

(3)={1}-(2}

$20

30

-A gg: * gatt IixP* l :r<i i i ir"r'q: With the expenditure approach, the nati0n's ngsregate

expexdittre sums consurnption, invesiment, gavernment

Burchases, aad net exPorts'

C + I + G + (X -Ml : Aggregateexpenditure : GDP C : Consumption / : lnvestment 6 = Government Purchases

(X' M)= Netexports = Exporls -'lmports

goods and services minus ihe valr-,e of U.S. imports of goods and services U'S'

imports have exceeded U'S exports nearly every year since the r96os, meaning U'S' net exports have

teen negative. During the last decade'-net exports

"rr"r"g"J a negative 2 percent of GDP, but this has

becorie u ,,"gitiu" 5 or 5 percent of GDP in recent years.

r:*t eHP*ii;* ch* ,;*iile *{ a *r:i.in:i1's cxp{,'$s :::in*n the v;llt';;: *l its imp'"rris iit-rp'r'ee?te c!-ii'.:frlil"rit e i:r,e.ll *Fr,:t':dilig +rr i!ir*i g**{is ;}nd s*rvi**s i* an n-ic{}:t{,:fi rlr' ei *r! :: g a g ive* p*;'i,:*i, rrsi:*llY * Y*ar

aggregiit* itrer:i:r:e e {i *ai*ir"lgs r:l iese ur** *i:pgti!ers i* i:r'i *r:*:t**:r7 ci.rinq a givr:r: 1:*ri*C, ilsx*iiy a Tesr va]ue a<1derl a! *ach ittfi** *f ;:r*ciu:= iia!!, t** s*[liirg ;:ri;:r: *i a 6:r+#u'rt rrlnils th{i *sst *f inlsrt}1*iiiai* 6o**s Pl;rcl:aseil f r*t* *ther firri:;

r Stage of i Production

(1) l2l Sale Cost of Value lntermediate

Goods

$ 20 \--\...- bo --.-.- \$ zo--\

120 -\_\=-t-r 50 200 \ t20

Market value of final good

Logger

Miller

Manufacturer

Betailer

70

80

$200

1o.2 lr,i\il.'l : i'llrllin:llliiiais tf rt/i:lliiltli;'-:tl''t:llrr':'

--'i -:;iue added at each stage equals the income earnedby --'"i,-:: r-irho supply their resources at that sta.ge.For exam-

:-: -.:-le $ao in value added by the retailer consists :: .:-come to resource suppiiers at that stage, from .:,: ;ai.esperson to the janitor who cleans ::-: >hcwroom to the trucker who : ::'" -:es "free delivery" of Your r::,:::. The value added at a1l :::::s totals $zoo, which is :.: -*: :"ne f,nal market value of -'::

-esk and the total income i.-:-:i by all resource suPP1iers i"":a--i:ne way.

.: reinforce your understanding of the equality :: -:-::rne and spending, let's return to something -:::;;ced in the first chapter, the circular-flow _- _ i --

- _ -=-.

retain no earnings), we can say that GDP equals aggre- gate income. The circular flow is a continuous pro- cess, but the iogic of the model is clearest if we begin

at juncture (l) in Exhibit z, where U'S' firms make

ii I

production decisions. After all, production must occur before output can be

sold and income earned. As Henry Ford explained, "lt is not the emploYer who PaYs the wages-the emPloYer

only handies the moneY. It is the Product that PaYs wages."

Households supply their labor, capital, nat- ural resources, and entrepreneurial ability to make prod.ucts that sell to pay wages, interest, rent, and profit. Production of aggregate output, or GDP, gives rise to an equal amount of aggregate income'

Thus, at juncture (I), aggregate output equals aggegate income. But not all that income is available

to spend. At juncture (z), governments coilect taxes' Some of these tax dollars return as transfer payments

i,

tl

t,

I

I

:

I i

l#2 ilir*re3me' r3*wf *rf 3ffirr:e:?* .ib

:" :'" ; Ixpr*::#"tt *t:'* *-... -:*dei in Exhibit 2 out- ,-:.:; :he cire ular flow of -.r::r::3 and spending in ':*.. ::cnomy for not only -:;=tcclds and firtns, as *.= :1: case in Chapter r, : *: :5'/ernments and the :::i ii the world. The main irr:irr: iows clockwise around --: ::::re, first as income from :j-:: : :: households (in the :;;=: :-alf of the circle), and

'-.:.::, 1; spending from house- : : :. =ack to firms (in the .-::.:: ialf of the circle). For i;:,-- i.:r,, of money, there is ",.... =:---. and opPosite flow of ::..,: -::s or resources. Here we : .,::- :he money.

'{n{tl*"le tr-*aXf CIf tfu* eira*xlar Ffrsruv -- --:-: process of develop- ..- = ' :-::ular flow of income .,- : =:=::ding, we must make r': -- : :-:=plifrTing assumPtions. ::='::::=:i-r., by asSuming that :.: .:.:a, :apital does not wear .:*' -.. no capital deprecia- : - - .::: rhat firms pay out ali :* : :, -. :: irm owners (i.e., firms

Iixi:il:ii, ::. Circular Flow ol lncome and Expenditure

6& 6& Households

b.H o

6:t, iixg l{41r., -r9.:lx,eIXr

+ \9 "fi:''"t:." r:q

,a ::. .;.. r .a

\ !. 10

,,,$:'

"^- i

^n$ i'' .rd .6\/ .,e

lqE :'- .. I :rL.-

\. o--%

\

The value added at each stage equals

the ineorne earned bY those who

supply their resources at that stage.

m Government

r "F?

lj: l;t,

#::.r

L. iil !:r

rilri

i:. .

ii: ;:l

::.

C1-{AP'I'ER 7 lritcki;tq; lhl iJ.ll. Lri:orlcrn:'r 103