Chapter 21

Tracking the U.S. Economy

© 2009 South-Western/ Cengage Learning

The Product of a Nation• 17th and 18th century

– Mercantilism • Economic prosperity: stock of precious metals

• 1758– Circular flow of output and income

• National income accounting system

•2

National Income Accounts

• GDP– Market value– All final goods and services– Produced during a year– By resources located in US

• One person’s spending– Another person’s income

•3

National Income Accounts

• Expenditure approach– Spending on all final goods and services

• Income approach – Earnings by those who produce all output

• Final goods and services• Intermediate goods and services

– Additional processing– Resale

•4

GDP: Expenditure Approach

• Consumption, C– Personal consumption expenditures– Households

• Services• Nondurable goods• Durable goods

– 2/3rds of GDP

•5

GDP: Expenditure Approach• Investment, I

– Gross private domestic investment• New capital goods

– Physical capital– New residential construction

• Net additions to inventories– Current production not used for current consumption– Inventories

» Goods in process» Finished goods

– 1/6th of GDP

•6

GDP: Expenditure Approach

• Government purchases, G– Government consumption and gross investment

• Goods and services• Not included:

– Transfer payments

– 1/5th of GDP

•7

GDP: Expenditure Approach• Net exports, X-M

– Exports (X) minus imports (M)• Physical items• Invisibles (intangibles)

– Negative• Imports > Exports

– 2% of GDP for last decade– 5-6% of GDP recently

C+I+G+(X-M)=Aggregate expenditure=GDP

•8

GDP: Income Approach• Aggregate income

– Sum of income from production• Earned by resource suppliers

– Wages– Interest– Rent– Profit

Aggregate expenditure = GDP = Aggregate income

•9

GDP: Income Approach• Avoid double counting

– Market value of final good, OR– Sum of value added

• Each stage of production

• Value added– Selling price minus payments for inputs– Income earned

•10

Exhibit 1Computation of value added for a new desk

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Stage ofProduction

(1)Sale

Value

(2)Cost of

IntermediateGoods

(3)Value

Added

LoggerMillerManufacturerRetailer

$20 50120200

-$20 50 120

$20 30 70 80

Market value of final good $200

The value added at each stage of production is the sale price at that stage minus the cost of intermediate goods, or column (1) minus column (2).

The value added at each stage sum to the market value of the final good.

Circular Flow: Income and Expenditure

• Assumptions• Capital – doesn’t wear out• Firms – pay out all profits

• Income flow– GDP = Aggregate income– Net taxes, NT

• Taxes - Transfer payments

– Disposable income, DI• DI = GDP - NT

• GDP=DI+NT•12

Exhibit 2Circular flow of income and expenditure

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1: GDP=aggregate income

2: Taxes leak

3: Transfer payments enter

Net taxes: NT = taxes – transfers

4: Disposable income flows to households

DI = aggregate income – NT

5: Households spend or save DI

Consumption enters

Savings leak

6: Investment enter

7: Government purchases enter

8: Imports leak

9: Exports enter

10: Consumption + Investment + Government purchases + Net export = Aggregate expenditure

Circular Flow: Income and Expenditure• Expenditure flow

– DI = C + S• Consumption, C • Savings, S – to financial markets

– Investments, I (borrowed)• Firms – on capital• Households – residential construction

– Government spending, G– Net exports = X-M

• C+I+G+(X-M) = GDP •14

Leakages = Injections

• C+I+G+(X-M)=DI+NT• C+I+G+(X-M)=C+S+NT• I+G+X=S+NT+M• Injections

– I, G, X

• Leakages– S, NT, M

•15

Limitations: National Income Accounting

• Some production – not included in GDP• Do-it-yourself production• Underground economy

• Leisure, quality, and variety• Net domestic product

• GDP minus depreciation• Net investment = I - depreciation

• GDP – doesn’t reflect all costs• Negative externalities• Depletion of natural resources

•16

Accounting for Price Changes

• Nominal GDP– Prices in same year

• Price index– In base year = 100– (Price in current year / Price in base year)*100

•17

Exhibit 3Hypothetical example of a price index, base year 2006

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Year

(1)Price of Bread

in Current Year

(2)Price of Bread in Base Year

(3)Price index=(1)/(2)×100

200620072008

$1.251.301.40

$1.251.251.25

100104112

The price index equals the price in the current year divided by the price in the base year, all multiplied by 100.

Accounting for Price Changes

• Consumer price index, CPI– Market basket– (Cost of basket in current year / Cost in base

year)*100– Overstates inflation, 1% per year

• Quality bias• Substitution• Discount stores• Widely used products

•19

Exhibit 4Hypothetical market basket used to develop the consumer price index

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Product

(1)Quantity in

market basket

(2)Prices in

base year

(3)Cost of

Basket in base year

=(1)×(2)

(4)Prices in

current year

(5)Cost of

Basket incurrent year

=(1)×(4)

TwinkiesFuel oilCable TV

365 packages500 gallons12 months

$0.89/package1.00/gallon

30.00/month

$324.85 500.00 360.00

$0.79 1.50

30.00

$288.35 750.00 360.00

$1,184.85 $1,398.35

The cost of a market basket in the current year, shown at the bottom of column (5), sums the quantities of each item in the basket, shown in column (1), times the price of each item in the current year, shown in column (4)

Accounting for Price Changes

• GDP price index– Production– (Nominal GDP/Real GDP)*100– Before 1995

• Fixed-weighted system; base year 1987

– Chain-weighted system; base year 2000

•21

Exhibit 5US gross domestic product in nominal dollars and chained (2000) dollars

22

National Income Accounts

• National income– Earned by American-owned resources

• Personal income– Received by individuals

• Disposable income– Personal income minus taxes

– Spend or save

23

Exhibit 6Deriving net domestic product and national income in 2006 (in trillions of dollars)

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Gross domestic product (GDP)Minus depreciationNet domestic product

Plus net earnings of American resources abroad

National income

$13.19 -1.61 11.58

+ 0.08$11.66

Exhibit 7Deriving personal income and disposable income in 2006 (in trillions of dollars)

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National incomeIncome received but not earned minus income earned but not received

Personal incomeMinus personal taxes and nontax charges

Disposable income

$11.66

-0.68 10.98

-1.35 $9.63

National Income Accounts

• Employee compensation• Proprietors’ income• Corporate profits• Net interest• Rental income of persons

26

Exhibit 8Expenditure and income statement for the US economy in 2006 (in trillions of dollars)

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Aggregate Expenditure

Consumption (C) Gross investment (I)Government purchases (G)Net exports (X-M) GDP

$9.22 2.21 2.52 -0.76$13.19

cc

Aggregate Income

DepreciationNet taxes on productionCompensation of employeesProprietors’ incomeCorporate profitsNet interestRental income of persons GDP

$1.61 0.92 7.45 1.01 1.55 0.60 0.05$13.19