Economic Well Being

Agec 217, Summer 2007

Economic Well Being

• Macroeconomics

The study of the economy as a whole

Circular Flow Diagram (Mankiw)

Copyright © 2004 South-Western

Spending

Goods andservicesbought

Revenue

Goodsand services

sold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sell

goods and services•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

Economic Well Being

Macroeconomic Indicators• Employment and Unemployment• Income• Wealth• Inflation• Stock market indices• Interest rates• Retirement solvency• Output (GDP)

Economic Well Being

Economic Well Being

• Gross Domestic Product (GDP)

– The market value of all final goods and services produced within a country in a given period of time• Final goods (intermediate goods not included)• Produced within borders, by citizens or foreigners• Time period: typically one year

GDP

• Gross Domestic Product = C + I + G + NX

C ConsumptionI InvestmentG Government SpendingNX Net Exports

Net Exports = Exports - Imports

GDP

• Per capita GDP– Gross Domestic Product per person in a country

• Nominal GDP– Uses prices in the year of the measurement

• Real GDP– Uses prices for a “base” year to enable year to

year comparisons

GDP Values (US, 2001)

Total in Trillions of

Dollars

Percent of Total

Consumption (C) $7.0 69%

Investment (I) $1.6 16%

Government Purchases (G) $1.9 18%

Net Exports (NX) -$0.3 -3%

Total $10.1 100%

Historical GDP

GDP Measured

• Assume a diet of Pizza and Soda

– 2005: 500 pizza slices and 300 sodas• Prices: pizza = $1.00 and soda = $0.50

– 2006: 550 pizza slices and 330 sodas• Prices: pizza = $1.10 and soda = $1.00

GDP Measured

• Nominal GDP’s

– 2005• 500 * $1.00 + 300 * $0.50 = $650

– 2006• 550 * $1.10 + 330 * $1.00 = $935

– Percent change = 44% growth

GDP Measured

• Real GDP’s (Base year = 2005)

– 2005• 500 * $1.00 + 300 * $0.50 = $650

– 2006• 550 * $1.00 + 330 * $0.50 = $715

– Percent change = 10% growth

GDP Measured

• GDP Deflator (measure of inflation) for base year(Inflation: the percent increase in price level)– Calculation

• Nominal GDP / Real GDP * 100

– 2005 (2005 base)• GDP Deflator = ($650 / $650) * 100 = 100

– 2006 (2005 base)• GDP Deflator = ($935 / $715) * 100 = 131

GDP Measured

• Using the deflator

– Calulation• Nominal GDP / GDP Deflator * 100 = Real GDP

– 2006• ($935 /131) * 100= $715

GDP

• Recession: Two quarters of declining real GDP

• Depression: A severe or long recession

GDP• Recession: Negative % change in real GDP for

two consecutive quarters

% Change GDP =

(Current Period GDP – Previous Period GDP) *100--------------------------------------------------------

Previous Previous GDP

GDP rationale

• Real GDP per capita is a measure of income and buying power in an economy. It measures our ability to produce the items we need and desire.

• Recessions as measured by GDP often arrive with stock market drops beforehand and higher unemployment afterwards.

Critiques of GDP

• Household Income and GDP

Critiques of GDP

• Consumer Confidence Index (Conference Board): Is it predictive of actual conditions?– 1. Current business conditions. – 2. Business conditions for the next six months. – 3. Current employment conditions. – 4. Employment conditions for the next six months. – 5. Total family income for the next six months.

• Frogs in water

Critiques of GDP

• Human Development Index

– Life Expectancy– Education (literacy and enrollment)– GDP

http://en.wikipedia.org/wiki/Human_Development_Index

Critiques of GDP

• Human Development Index

Critiques of GDP

• What we spend money on is not always positive (car accident).

• GDP does not include how much time we spend on labor

• Some of production has environmental impacts, for which the costs are not always measured

Summary

• GDP is comparatively easy to measure and consistently used to determine a country’s overall economic health as it has links to many measures of well being. However, GDP may not capture all aspects of well being that are important to a nation’s citizens.