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Measuring a Nation’s IncomeMicroeconomics is the study of how

individual households and firms make decisions and how they interact with one another in markets.

Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at the same time.

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Measuring a Nation’s IncomeMacroeconomics answers questions like the following:

Why is average income high in some countries and low in others?

Why is inflation high in some countries and low in others? Why was inflation in Turkey above 40% in most of 1980s and 1990s?

Why do production and employment grow in some years and contract in others?

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The Economy’s Income And Expenditure When judging whether the economy is

doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.

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The Economy’s Income And Expenditure For an economy as a whole, total income

must equal total expenditure because: Every transaction has a buyer and a seller. Every dollar of spending (expenditure) by some

buyer is a dollar of income for some seller.

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The Measurement Of Gross Domestic Product

The equality of income and expenditure can be illustrated with the circular-flow diagram.

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Figure 1 The Circular-Flow Diagram

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods 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

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The Measurement Of Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and expenditures of an economy.

GDP is the total market value of all final goods and services produced within a country in a given period of time.

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The Measurement Of Gross Domestic Product “GDP is the Market Value . . .”

Output is valued at market prices.

“. . . Of All. . .” Includes all items produced in the economy and legally

sold in markets. (underground economy in Turkey?)

“. . . Final . . .” It records only the value of final goods, not intermediate

goods (the value is counted only once).

“. . . Goods and Services . . .” It includes both tangible goods (food, clothing, cars) and

intangible services (haircuts, housecleaning, doctor visits).

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The Measurement Of Gross Domestic Product “. . . Produced . . .”

It includes goods and services currently produced, not transactions involving goods produced in the past. When a used car is sold, GDP does not increase.

“ . . . Within a Country . . .” It measures the value of production within the

geographic confines of a country. “. . . In a Given Period of Time.”

It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

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The Components Of GDP GDP includes all items produced in the

economy and sold legally in markets. What Is Not Counted in GDP?

GDP excludes most items that are produced and consumed at home and that never enter the marketplace.

It excludes items produced and sold illicitly, such as illegal drugs. Or the underground, unrecorded transactions & activities.

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The Components Of GDPGDP (Y) is the sum of the following:

Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX

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The Components Of GDP Consumption (C):

• The spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):• The spending on capital equipment,

inventories, and structures, including new housing.

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The Components Of GDP Government Purchases (G):

The spending on goods and services by central government, municipalities and other government agencies. Roads, schools, hospitals, wages of govt. employees, etc.

Does not include transfer payments because they are not made in exchange for currently produced goods or services. Ex: Social security, child support, education support, etc.

Net Exports (NX): Exports minus imports.

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Table 1: US 2004 GDP and Its Components

© 2007 Thomson South-Western

US GDP and Its Components (2004)

Consumption 70%

Government Purchases

19% Net Exports -5 %

Investment16%

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REAL VERSUS NOMINAL GDP Nominal GDP values the production of

goods and services at current prices. Real GDP values the production of goods

and services at constant prices.

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REAL VERSUS NOMINAL GDP An accurate view of the economy requires

adjusting nominal to real GDP by using the GDP deflator.

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Table 2 Real and Nominal GDP

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Table 2 Real and Nominal GDP

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Table 2 Real and Nominal GDP

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The GDP Deflator The GDP deflator is a measure of the price

level calculated as the ratio of nominal GDP to real GDP times 100.

It tells us what portion of the increase in nominal GDP that is because of inflation rather than an increase in the quantities produced.

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The GDP Deflator

The GDP deflator is calculated as follows:

G D P d efla to r =N o m in a l G D P

R eal G D P 1 0 0

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The GDP Deflator

Nominal GDP is converted to real GDP as follows:

R eal G D PN o m in a l G D P

G D P d efla to r2 0 X X2 0 X X

2 0 X X

1 0 0

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Table 2 Real and Nominal GDP

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Inflation based on GDP Deflator 2005-2006 inflation: 71% 2006 – 2007 inflation: ~40%

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Real GDP in TurkeyReal GDP (1000 YTL, 1987 prices)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

years

© 2007 Thomson South-Western

Figure 2 Real GDP in the United States

Billions of

2000 Dollars

$10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000

1970 1975 1980 1985 1990 20001995 2005

2,000

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Is GDP a Good Measure of Economic Well-being?

GDP is the best single measure of the economic well-being of a society.

GDP per person tells us the income and expenditure of the average person in the economy.

Higher GDP per person indicates a higher standard of living.

GDP is not a perfect measure of the happiness or quality of life, however.

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GDP and Economic Well-being Some things that contribute to well-being

are not included in GDP. Income distribution. GINI index measures

distribution. The value of leisure. The value of a clean environment. The value of almost all activity that takes place

outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

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Table 3 GDP and the Quality of Life