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Slide 8-1
The Simple Circular Flow
Slide 8-2
The Simple Circular Flow
Slide 8-3
The Simple Circular Flow
Slide 8-4
The Simple Circular Flow
Slide 8-5
The Simple Circular Flow
Figure 8.1
Slide 8-6
The Simple Circular Flow
Two observations
– In every economic exchange, the seller receives exactly the same amount that the buyer spends.
– Goods and services flow in one direction and money payments flow in the other.
Slide 8-7
The Simple Circular Flow
Profits explained
– Question• Why is profit a cost of production?
– Answer• Profits are the return entrepreneurs receive
for the risk they incur when organizing productive activities
Slide 8-8
The Simple Circular Flow
Product Markets
– Transactions in which households buy goods
Slide 8-9
The Simple Circular Flow
Final Goods and Services
– Goods and services that are at their final stage of production and will not be transformed into yet other goods or services
Slide 8-10
The Simple Circular Flow
Factor Markets
– Transactions in which businesses buy resources
Slide 8-11
The Simple Circular Flow
Total Income
– The yearly amount earned by the nation’s factors of production
Slide 8-12
The Simple Circular Flow
Question– Why must total income
be identical to the dollar value of total output?
Answer– Every transaction
simultaneously involves an expenditure and a receipt
Slide 8-13
National Income Accounting
Gross Domestic Product (GDP)
– The total market value of all final goods and services produced by factors of production located within a nation’s borders
Slide 8-14
National Income Accounting
Observations
– GDP measures the dollar value of final output
– GDP measures the dollar value of final goods and services produced per year by factors of production located within a nation’s borders
Slide 8-15
Two Main Methodsof Measuring GDP
Expenditure Approach
– A way of computing national income by adding up the dollar value at current market prices of all final goods and services
Slide 8-16
Two Main Methodsof Measuring GDP
Expenditure Approach
Slide 8-17
Two Main Methods of Measuring GDP
Income Approach
– A way of measuring national income by adding up income received by all factors of production
Slide 8-18
Two Main Methodsof Measuring GDP
Income Approach
Slide 8-19
Two Main Methodsof Measuring GDP
Deriving GDP by the expenditure approach– Consumption Expenditure (C)
• Durables– Life span of more than three years
• Nondurables– Life span of less than three years
• Services– Intangible commodities
Slide 8-20
Two Main Methodsof Measuring GDP
Deriving GDP by the expenditure approach– Gross Private Domestic Investment (I)
• The creation of capital goods, such as factories and machines, that can yield production and hence consumption in the future
Slide 8-21
Two Main Methodsof Measuring GDP
Deriving GDP by the expenditure approach– Gross Private Domestic Investment (I)
• Fixed investment• Inventory investment• New residential structures
Slide 8-22
Two Main Methodsof Measuring GDP
Deriving GDP by the expenditure approach– Government Expenditures (G)
• State, local, and federal• Valued at cost
Slide 8-23
Two Main Methodsof Measuring GDP
Deriving GDP by the expenditure approach– Net Exports (Foreign Expenditures)
Net exports (X) = total exports - total imports
Slide 8-24
Two Main Methodsof Measuring GDP
Mathematical representation using the expenditure approach
GDP = C + I + G + X
Slide 8-25
GDP and Its Components
Figure 8-3
Slide 8-26
Two Main Methodsof Measuring GDP
Deriving GDP by the income approach
Slide 8-27
Deriving GDP by the Income Approach
Gross Domestic Income (GDI)– The sum of all income—wages, interest,
rent, and profits—paid to the four factors of production
Slide 8-28
Two Main Methodsof Measuring GDP
Gross Domestic Income (GDI)– Wages
– Interest
– Rent
– Profits
Slide 8-29
Gross Domestic Product and Gross Domestic Income, 2000
(in billions of 2000 dollars per year)
Figure 8-4 Source: U.S. Department of Commerce. First quarter preliminary data annualized.
Slide 8-30
Expenditure Point of View—Product FlowExpenditures by Different Sectors:
Household sector Personal consumption expenses $6,661.5
Government sector Purchase of goods and services 1,734.6
Business sector Gross private domestic investment (including depreciation) 1,727.0
Foreign sector Net exports of goods and services -273.6
Gross Domestic Product $9,849.5
Gross Domestic Product and Gross Domestic Income, 2000
(in billions of 2000 dollars per year)
Slide 8-31
Income Point of View—Cost FlowDomestic Income (at factor cost):
Wages All wages, salaries, and supplemental employee compensation $5,678.4
Rent All rental income of individuals plus implicit rent on owner-occupied dwellings 155.4
Interest Net interest paid by business 490.2
Profit Proprietorial income 701.3 Corporate profits before taxes deducted 952.0
Non-income expense items Indirect business taxes and other adjustments 762.1 Depreciation 1,215.4 Statistical discrepancy -105.3
Gross Domestic Income $9,849.5
Gross Domestic Product and Gross Domestic Income, 2000
(in billions of 2000 dollars per year)
Slide 8-32
Other Components of National Income Accounting
National Income (NI)
– The total of all factor payments to resource owners
Personal Income (PI)
– The amount of income that households actually receive before they pay personal income taxes
Slide 8-33
Other Components of National Income Accounting
Disposable Personal Income (DPI)
– Personal income after personal income taxes have been paid
Slide 8-34
Billions of Dollars
Gross domestic product (GDP) 9,849.5Minus depreciation -1,215.4
Net domestic product (NDP) 8,634.1 Minus indirect business taxes -762.1
and other adjustmentsNational Income (NI) 7,872.0 Minus corporate taxes, Social Security
contributions, corporate retained earnings -1,236.5 Plus government and business transfer payments +1,606.8
Personal Income (PI) 8,242.3Minus personal income tax and non-tax payments -1,253.2
Disposable personal income (DPI) 6,989.1
Source: U.S. Department of Commerce
Going from GDP to Disposable Income, 2000
Slide 8-35
Distinguishing Between Nominal and Real Values
Nominal Values
– Measurements in terms of the actual market prices at which goods are sold; expressed in current dollars
Slide 8-36
Distinguishing Between Nominal and Real Values
Real Values
– Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars
Slide 8-37
Distinguishing Between Nominal and Real Values
Correcting GDP for price index changes
– Nominal (current) dollars GDP
– Real (constant) dollars GDP
*Price level: measured by the GDP deflator
Real GDP = = 100nominal GDP
price level*
Slide 8-38
1990 5,803.2 86.8 6,683.51991 5,986.2 89.8 6,669.21992 6,318.9 91.7 6,891.11993 6,642.3 94.2 7,054.11994 7,054.3 96.1 7,337.81995 7,400.5 98.2 7,537.11996 7,813.2 100.0 7,813.21997 8,300.9 101.7 8,165.11998 8,759.9 102.9 8,516.31999 9,254.6 104.4 8,867.02000 9,849.5 106.4 9,256.2
(1) (2) (3) (4) = [(2)/(3)]x 100
Nominal GDP Real GDP(billions of (billions of dollars
dollars Price Level Index per yearYear per year) (base year 1992 = 100) in constant 1992 dollars)
Correcting GDP for Price Changes
Source: U.S. Department of Commerce, Bureau of Economic Analysis
Slide 8-39
Distinguishing Between Nominal and Real Values
Example
– Base Year = 1992
– Price Index = 100
Slide 8-40
Distinguishing Between Nominal and Real Values
Real GDP = nominal GDPin the base year
Real 1992 GDP = = 100nominal GDP
price index
Real 1992 GDP = = 100 = $6,020.2 billion$6,020.2
100
Slide 8-41
Distinguishing Between Nominal and Real Values
1993
– Price Index = 102.2
Real 1993 GDP = = 100 = $6,206.8 billion$6,343.3
102.2
Slide 8-42
Distinguishing Between Nominal and Real Values
1987
– Price Index = 82.7
Real 1993 GDP = = 100 = $5,489.6 billion$4,539.9
82.7
Slide 8-43
Nominal and Real GDP
Figure 8-5 Source: U.S. Department of Commerce
Slide 8-44
Distinguishing Between Nominal and Real Values
Per capita GDP
– Adjusting for population growth
Per capita real GDP =real GDP
population
Slide 8-45
Distinguishing Between Nominal and Real Values
Question
– Is real per capita GDP a good indicator of social well-being?
Slide 8-46
Distinguishing Between Nominal and Real Values
Some issues
– The distribution of output
– Changes in leisure time
– Increased traffic congestion
– Air pollution
– Crime
– Housework
Slide 8-47
Forecasting economists have done a relatively good job predicting long-run trends in real GDP.
They have not done as well predicting recessions.
Issues and Applications:How Well Do Economists Predict GDP?
Slide 8-48
Forecasted Growth Actual Growth Start of Recession Date of Forecast over the Next Year (%) in Real GDP (%)
December 1969 December 1969 1.5 -.6
November 1973 December 1973 1.5 -1.8
January 1980 December 1979 -.7 -.3
July 1990 December 1989 2.1 -.1
July 1991 December 1990 2.2 .7
Economic Forecasts:Missing the Mark
Source: Business Week, September 30, 1992, p. 92
Slide 8-49
How Well Do Economists Predict GDP?
Difficulties in predicting downturns
– Trying to develop computer models for a changing multi-trillion dollar economy
– Globalization
– Data sources and methodology