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Quiz, week #2

Measuring macro outcomes

My expectations are that it will take a page or more to answer the two questions below

 

1. Are people worse off when the price level rises as fast as their income?  Why do people often feel worse off in such circumstances?

2. Identify two groups that benefit from deflation and two that lose.

 

Chapter 5

 

1. NATIONAL-INCOME ACCOUNTING

 

    

 

This chapter introduces national-income accounting.  The data generated by national-income accounting is used to track the economy’s performance.  This chapter provides a framework on which future chapters will build.  The three questions that are to be kept in mind while reviewing the chapter are:

           

1.  How much income is being produced?  What is it being used for?

2.  How much income is being generated in the marketplace?

3.  What’s happening  to prices and wages?

 

 

OUTLINE

 

I.          Introduction

A.   Government only wants to tackle problems that it can measure.

B.   The Great Depression resulted in a commitment to national income accounting.

1.   Definition:     National-Income Accounting – The measurement of aggregate economic activity, particularly national income and its components.

2.   Developed by Simon Kuznets and the U.S. Department of Commerce, it answers questions such as:

• How much output is being produced?  What is it being used for?

• How much income is being generated in the marketplace?

• What’s happening to prices and wages?

 

II.         Measures of Output

A.   Gross Domestic Product (GDP)  (Figure 5.1a and b, Table 5.1)

1.   Definition:     Gross Domestic Product (GDP) – The total dollar value of final output produced within a nation’s borders in a given time period.

2.   The use of prices to value market output allows us to summarize output activity and compare outputs of one period with that of another.

3.   GDP vs. GNP

• GNP refers to output produced by American-owned factors regardless of location.

• GDP refers to output produced within America’s borders.

• GDP is geographically focused, including all output produced within a nation’s borders regardless of whose factors of production are used to produce it.

• For example, Apple’s output in Singapore ends up in Singapore’s GDP; the cars produced at Honda’s Ohio plant are counted in US GDP.

4.   International Comparisons

• The geographic focus of GDP facilitates international comparisons of economic activity.

• The World View in chapter 2 illustrates a comparison of GDP values.

5.   GDP per Capita

• Definition:     GDP per Capita - Total GDP divided by total population: average GDP.

• GDP per capita is commonly used as a measure of a country’s standard of living.

• Disparities in per capita GDP mean that people in low-income countries have little access to telephones, televisions, paved roads, schools, and healthcare.

• World View:  “Global Inequalities”

Over 1.3 billion people live in nations the World Bank calls “low-income”.   The average income in low-income nations is only $1,500.  Behind statistical comparisons of GDP per capita lie very tangible differences in the way people live.  Low GDP per capita implies a lot of deprivation.

• Measures of per capita GDP tell us nothing about the way GDP is actually distributed or used; they are only a statistical average.

B.   Measurement Problems

1.  Non-market activities

• GDP measures exclude most goods and services produced that are not sold in the market.  For example, the homemaker who cleans, washes, gardens, shops and cooks produce goods of value, but they are not exchanged in the market and are thus not included in GDP.

• Exclusion of non-market activities causes problems when comparing living standards.  As homemakers have entered the workforce and pay for housekeeping service, current GDP figures might exaggerate increases in GDP because some services are now provided through the market.

2.  Unreported income

• The GDP statistics also fail to capture market activities that are not reported to tax or census authorities.

• The “ underground economy” is motivated by tax avoidance or the desire to conceal illegal activities.

• IRS estimates that two-thirds of the “underground” income comes from legitimate services.

• In The News: “A Lot Going On Under the Table”

GDP statistics include only the value of reported market transactions.  Several statistics that estimate the size of the “underground” economy are listed.  Since many transactions are not included in the official GDP, it likely is significantly understated.

C.   Value Added  (Table 5.2)

1.   Not all reported market transactions get included at full value in GDP statistics.  If it did, the same output would be counted repeatedly.

2.   The production of most goods and services involves a series of stages.

3.   To accurately measure GDP we must distinguish intermediate goods from final goods.

4.   Definition:     Intermediate Goods – Good or services purchased for use as input in the production of final goods or services.

5.   Two ways to calculate GDP.

• Compute the value of the final output.

• Count only the value added at each stage of production.

• Definition:     Value Added – The increase in the market value of a product that takes place at each stage of the production process.

D.  Real vs. Nominal GDP (Tables 5.3 ad 5.4)

1.   Changes in GDP brought about by changes in the price level can give a distorted view of economic activity.

2.   Distinguishing increases in quantity from increases in prices is done by distinguishing between real GDP and nominal GDP.

• Definition:     Nominal GDP – The value of final output produced in a given period, measured in the prices of that period (current prices).

•    Definition:     Real GDP– The value of final output produced in a given period, adjusted for changing prices.

• The distinction between nominal and real GDP is important whenever the price level changes.

• Definition:     Base Period – The time period used for comparative analysis; the basis for indexing (e.g., of price changes).

•        Formula

 

3.   Inflation tends to obscure actual declines in real output.

4.   Definition:     Inflation – An increase in the average level of prices of goods and services.

5.   Chain-Weighted Price Adjustments

• Chain-weighted indices use a moving average of price levels in consecutive years as an inflation adjustment.

E.   Net Domestic Product

1.   Changes in real GDP tell us how much the economy’s output is growing.

2.   Growth at the expense of future output occurs unless factors of production are replaced.

3.   Next year, we won’t be able to produce as much output unless we replace factors of production we use this year.

4.   Definition:     Production Possibilities – The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology.

5.   Value of capital used in producing goods and services is called depreciation and is estimated by U.S. Department of Commerce.

6.   Definition:     Depreciation – The consumption of capital in the production process; the wearing out of plant and equipment.

7.   Definition:     Net domestic product (NDP) = GDP- depreciation.

8.   Some of each year’s output will consist of newly produced plant and equipment or investment goods.

9.   Definition:     Investment – Expenditures on (production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories.

10.   Distinction between GDP and NDP is mirrored in the difference between gross investment and net investment.

• Definition:     Gross Investment  - Total investment expenditure in a given time period.

• Definition:     Net investment  - Gross investment less depreciation.

11.   The stock of capital – the total collection of plant and equipment – will not grow unless gross investment exceeds depreciation.

 

III.        The Uses of Output

A.   The GDP accounts also tell us what mix of output has been selected, that is, society’ s answer to the question of WHAT to produce.

B.   Consumption

1.   The major uses of total output conform to the four sets of market participants.

2.   Goods and services used by households are called consumption goods.

3.   Consumer spending claims over two-thirds of our annual output.  (See Figure 2.3 in chapter 2)

C.   Investment

1.   Investment goods are the plant, machinery, and equipment that we produce.

2.   Investment spending claims approximately 15% of total output.

D.   Government Spending

1.   Third major user of GDP is the public sector.

2.   Resources purchased by the government sector are unavailable for consumption or investment purposes.

3.   Claims approximately one-fifth of total output.

E.   Net Exports

1.   Definition:     Exports – Goods and services sold to foreign buyers.

2.   Definition:     Imports – Goods and services purchased from foreign sources.

3.   We export some goods; thus, GDP will be larger than the sum of our own consumption, investment, and government purchases.

4.   We import some goods and services which are not calculated as part of America’s GDP since they were not produced within our borders.

5.   Exports are added to GDP and imports are subtracted.  Exports - imports = net exports.

6.   Definition:     Net Exports – The value of exports minus the value of imports.

7.   The value of GDP can be computed by adding up expenditures of market participants.

8.     Formula

 

Where      C = Consumption expenditure

I = investment expenditure

G = government expenditure

X = exports

M = imports

 

IV.       Measures of Income  (Table 5.5, and Figure 5.2)

A.   GDP accounts have two sides: one is expenditure (demand), the other is income (supply).

B.   The total value of market incomes must equal the total value of final output, or GDP.

C.   National Income

1.   By charting the flow of income through the economy, we see FOR WHOM the output is produced.

2.   Depreciation

• Depreciation charges reduce GDP to the level of NDP  (Net Domestic Product) before any income is available to current factors of production.

•   

NDP = GDP – depreciation

  Formula

 

• Once depreciation charges are subtracted from GDP, we are left with Net Domestic Product.  To this we add net foreign factor income to calculate national income.

• Definition:     National Income (NI) – Total income earned by current factors of production: NDP plus foreign factor income

D.   Personal Income  (Table 5.6)

1.   Corporate taxes, indirect business taxes and retained earnings are subtracted from national income before determining consumer income.

2.   Social security tax is then removed giving the personal income before the payment of personal taxes.

3.   Households receive income in the form of transfer payments.

4.   Definition:     Personal Income (PI) – Income received by households before payment of personal taxes.

 

 

Personal income  = National income - (corporate taxes + retained earnings + Social Security taxes) + (transfer payments + capital income)

  

E.   Disposable income (Table 5.6)

1.  

Disposable Income = personal income – personal taxes

  Definition:     Disposable Income (DI) – After-tax income of households; personal income less personal taxes.

2.   Formula

           

3.   Households end up with roughly 70% of revenue generated from GDP.

4.  

Disposable income = consumption + saving

  All disposable income is either consumed or saved.

5.   Formula

 

6.   Definition:     Saving – That part of disposable income not spent on current consumption; disposable income less consumption.

 

V. The Flow of Income

A.   The dollar value of output will always equal the dollar value of income.

B.   Total income (GDP) ends up distributed the following way:

1.   To households, in the form of disposable income.

2.   To businesses, in the form of retained earnings and depreciation allowances.

3.   To government, in the form of taxes.

C.   Income and Expenditure  (Figure 5.3) - Flow of income that starts with GDP ultimately returns to the market in the form of new consumption (C), investment (I), and government purchases (G).

 

VI. The Economy Tomorrow:  The Quality of Life

0. Do the GDP accounts – either the expenditure side or the income side – tell us anything we really want to know about the quality of life?

0. Intangibles –< /span> Economic measures do not capture the completeness of the way in which we view the world or the totality of what makes our lives satisfying.  For example a clear day, a sense of accomplishment or even a smile can do more for a person’s well-being than movement in the GDP account, but cannot be measured.

C. Index of Well-Being – Researchers at Fordham University have devised an alternative index of well-being called the Index of Social Health.

      D.  In the News: “Material Wealth vs. Social Health”< /b>

According to the “Index of Social Health” the nation’s social performance has been declining, even as economic variables have shown improvement.  The conclusion is that national-income accounts emphasize material well being but are incomplete as a gauge of societal welfare.

Summary

· Inflation is an increase in the average price level. Typically it’s measured by changes in a price index such as the Consumer Price Index (CPI). LO1

· At the micro level, inflation redistributes income by altering relative prices, income, and wealth. Because not all prices rise at the same rate and because not all people buy (and sell) the same goods or hold the same assets, inflation doesn’t affect everyone equally. Some individuals actually gain from inflation, whereas others suffer a loss of real income or wealth. LO2

· At the macro level, inflation threatens to reduce total output because it increases uncertainties about the future and thereby inhibits consumption and production decisions. Fear of rising prices can also stimulate spending, forcing the government to take restraining action that threatens full employment. Rising prices also encourage speculation and hoarding, which detract from productive activity. LO2

· Fully anticipated inflation reduces the anxieties and real losses associated with rising prices. However, few people can foresee actual price patterns or make all the necessary adjustments in their market activity. LO1

· The U.S. goal of price stability is defined as an inflation rate of less than 3 percent per year. This goal recognizes potential conflicts between zero inflation and full employment as well as the difficulties of measuring quality improvements and new products. LO3

· From 1800 to 1945, prices both rose and fell, leaving the average price level unchanged. Since then, prices have risen nearly every year but at widely different rates. LO3

· Inflation is caused by either excessive demand (demand-pull inflation) or structural changes in supply (cost-push inflation). LO1

· Cost-of-living adjustments (COLAs) and adjustable-rate mortgages (ARMs) help protect real incomes from inflation. Universal indexing, however, wouldn’t eliminate inflationary redistributions of income and wealth. LO2

· Worldwide inflation rates have diminished in recent years. Experience with inflation and changing patterns of asset ownership are creating political pressure for greater price stability. LO3