MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT

The Language of Macroeconomics:The National Income Accounts

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. PowerPoint by Beth IngramUniversity of Iowa

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Key Concepts

Gross Domestic Product (GDP) Gross National Income Real and Nominal Measures National Income Accounts GDP and Human Welfare

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Gross Domestic Product

Total market value of final goods and services produced in a country during a given period

Need to know How much was produced (quantity) What the production was worth (price)

Why do we need to know the price?

Price provides a common unit in which to value quantities Important when you have more than one type

of good

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Example -- Company X

Production in 2002 200 washers at $500 100 dryers at $400

Production in 2004 200 washers at $600 100 dryers at $450

Nominal Production = 200 x $500 + 100 x $400

= $140,000

Nominal Production = 200 x $600 + 100 x $450

= $165,000

Problem: dollar value of output higher, but real output the same

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Nominal GDP vs. Real GDP

Important Distinction

Nominal GDP: measure output in current prices = py Real GDP (y): accounts for price change

---measure output in constant prices ---use prices from a base year ---is an index

Difference between Nominal GDP and Real GDP is the change in prices Nominal GDP/Real GDP = GDP Deflator => tells

change in prices => price index (py)/p = y

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By how much has production increased between 2002 and 2005? (using 2002 as base year for prices)

Production in 2002 200 washers at $500 100 dryers at $400

Production in 2005 300 washers at $600 100 dryers at $450

Real Production (2005) = 300 x $500 + 100 x $400 = $190,000Real Production (2002) = 200 x $500 + 100 x $400 = $140,000Growth Rate = ($190,000-$140,000)/$140,000 = 35.71%

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By how much has production increased between 2002 and 2005? (using 2005 as base year for prices)

Production in 2002 200 washers at $500 100 dryers at $400

Production in 2005 300 washers at $600 100 dryers at $450

Real Production (2005) = 300 x $600 + 100 x $450 = $225,000Real Production (2002) = 200 x $600 + 100 x $450 = $165,000Growth Rate = ($225,000-$165,000)/$165,000 = 36.36%

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Chain Weighted Prices

Problems with fixed prices Different growth rates dependent on which

base year for price is used Fixed price assumes fixed fundamental value

society places on good Chain weighting as “averaging” of prices

Chain-weighted growth of 36.03%

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GDP Annual Percent Growth

Indonesia, Real and Nominal GDP growth

Nominal GDP growth Real GDP GrowthSource: EcoWin

90 91 92 93 94 95 96 97 98 99 00 01 02

Percent

-20

-10

0

10

20

30

40

50

60

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A Closer Look at GDP

GDP = (1) total market value of (2) final goods and services produced in a (3) country during a (4) given period (1) Total market value

Prices reflect value placed on good/service by society

Ignores non-market economic activity (2) Final goods & services

No intermediate goods…avoid double counting (3) In a country/region…domestically produced (4) Given period

No used sales counted Services rendered on used sales is counted

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GDP as Value-Added Measure (Bread Example)

Company Revenues – Cost of purchased inputs = Value added

ABC Grain $0.50 $0.00 $0.50

General Flour $1.20 $0.50 $0.70

Hot’n’Fresh $2.00 $1.20 $0.80

Total $2.00

GDP equals final goods sold = $2.00

Or

GDP equals valued added = $0.50 + $0.70 + $0.80 = $2.00

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Measures of Output

product (output) approach: The market value of the final goods and services produced in a country during a given period

expenditure approach: how much households, firms, government, and foreigners spend on GDP

Income approach: the income generated from making GDP Payments to labor and capital

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Three Measures GDP are Equal

= =

Market Market value of value of

final final goods goods

and and servicesservices

Production Expenditure Income

InvestmentInvestment

ConsumptionConsumption

GovernmentGovernment

purchasespurchases

Net exportsNet exports

Capital Capital IncomeIncome

Labor IncomeLabor Income

= =

Market Market value of value of

final final goods goods

and and servicesservices

Production Expenditure Income

InvestmentInvestment

ConsumptionConsumption

GovernmentGovernment

purchasespurchases

Net exportsNet exports

Capital Capital IncomeIncome

Labor IncomeLabor Income

Product Expenditure Income

= =

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Product Approach: Sectors as a % of GDP (2001)

0

10

20

30

40

50

60

70

80

Low Income Middle Income High Income

Agriculture Industry Service

U.S.

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Income Approach

Global Rule of Thumb: 70% of income goes to labor, 30% of income goes to capital

U.S. example

1993-2003: Functional Distribution of Income

wages, salaries, benefits, 65.2%

Proprietors Income, 8.1%

Rental Income, 1.8%

Corporate Profits, 10.2%

Interest, 6.0%

Other, 8.8%

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Expenditure (Demand) Approach

Consumption by individuals (C) Consumption and investment by government (G)

Does not include transfer payments Investment by the private sector (I)

Generally presented in two subcategories(1) Gross Capital Formation

(2) Change in Inventories

Net Exports (NX)…exports-imports

Y = C + G + I + NXY = C + G + I + NX

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Expenditure (Demand) Approach

Expenditure approach often used to see what forms of spending are driving economic growth

Calculate contributions to growth

t

t

t ComponenteExpenditurofRateGrowthGDP

ComponenteExpenditur

1

1

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Expenditure (Demand) Approach

Contribution to Growth

-4%

-2%

0%

2%

4%

6%

8%

U.S. GDP Growth RateContribution from Private & Public Consumption, Housing Investment

Source: BEA

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Expenditure (Demand) Approach

U.S. Consumption as a % of GDP

65%

70%

75%

80%

85%

90%

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

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World GDP

2004 Dollar Size of the World GDP

$0.00

$5,000.00

$10,000.00

$15,000.00

$20,000.00

$25,000.00

$30,000.00

$35,000.00

$40,000.00

$45,000.00

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World GDP

Value of Economy ($ Billions)

$0.00

$2,000.00

$4,000.00

$6,000.00

$8,000.00

$10,000.00

$12,000.00

$14,000.00

Dollar Value PPP Dollar Value

China U.S.

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GDP Per Capita

GDP Per Capita (Thousands PPP $)

$0.00

$5,000.00

$10,000.00

$15,000.00

$20,000.00

$25,000.00

$30,000.00

$35,000.00

$40,000.00

$45,000.00

China U.S.

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GDP and GNI

GDP Output produced within a geographic location (US,

Italy, etc.) GNI (Gross National Income)

Also called GNP (Gross National Product) Output produced by citizens of a geographic region Value must be remitted back to country

GNI = GDP + NFP (Net Factor Payments) NFP = payments to domestically owned factors (labor

and capital) located abroad minus payments to foreign factors located domestically

Payments: (1) net dividends, interest, rent flows abroad (2) net wage flows abroad

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Example

Joe Canadien, citizen of Canada, works in US and sends wages back to Canada

US GDP includes Joe’s wages Canadian GNI includes Joe’s wages

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GDP: Two Questions

Does GDP correctly measure production?

Is GDP a good proxy for welfare?

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GDP Measurement Problems

Underground economic activity Illegal activities Tax avoidance

Non-market transactions Homemaking Leisure

Negative consequences of production pollution

2-27 Does Increased GDP = Improved Human Welfare?

IndicatorAll developing

countries

GDP per person 3,530 1,170 25,860(U.S. dollars)

Life expectancy at 64.5 51.7 78.0birth (years)

Infant mortality rate 61 100 6(per 1,000 live births)

Under-5 mortality rate 89 159 6(per 1,000 live births)

Doctors 78 30 252(per 100,000 people)

Incidence of HIV/Aids 1.3 4.3 0.3(% in 15-49 age group)

Undernourished 18 38 Negligiblepeople (%)

Primary enrollment 85.7 60.4 99.9rate (as % of age group)

Secondary enrollment 60.4 31.2 96.2rate (as % of age group)

Adult literacy rate (%) 72.9 51.7 98.6

Least developed countries

Industrialized countries

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Does Increased GDP = Improved Human Welfare? Is more output better? Human Development Index

Table from UNDP website Animated comparisons HDI calculator Note that as countries get richer, income per

capita plays smaller role

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Summary

Need for consistent set of data Real and Nominal Variables GDP and GNI Value added = Income = Total Expenditure GDP a rough proxy for human welfare

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