Slide 8-1 The Simple Circular Flow. Slide 8-2 The Simple Circular Flow.

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The Simple Circular Flow

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Figure 8.1

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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.

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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

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Product Markets

– Transactions in which households buy goods

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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

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Factor Markets

– Transactions in which businesses buy resources

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Total Income

– The yearly amount earned by the nation’s factors of production

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Question– Why must total income

be identical to the dollar value of total output?

Answer– Every transaction

simultaneously involves an expenditure and a receipt

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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

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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

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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

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Expenditure Approach

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Two Main Methods of Measuring GDP

Income Approach

– A way of measuring national income by adding up income received by all factors of production

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Income Approach

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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

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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

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Deriving GDP by the expenditure approach– Gross Private Domestic Investment (I)

• Fixed investment• Inventory investment• New residential structures

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Deriving GDP by the expenditure approach– Government Expenditures (G)

• State, local, and federal• Valued at cost

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Deriving GDP by the expenditure approach– Net Exports (Foreign Expenditures)

Net exports (X) = total exports - total imports

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Mathematical representation using the expenditure approach

GDP = C + I + G + X

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GDP and Its Components

Figure 8-3

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Deriving GDP by the income approach

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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

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Gross Domestic Income (GDI)– Wages

– Interest

– Rent

– Profits

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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.

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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



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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



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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

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Other Components of National Income Accounting

Disposable Personal Income (DPI)

– Personal income after personal income taxes have been paid

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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

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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

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Real Values

– Measurements after adjustments have been made for changes in the average of prices between years; expressed in constant dollars

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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*

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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

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Example

– Base Year = 1992

– Price Index = 100

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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

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1993

– Price Index = 102.2

Real 1993 GDP = = 100 = $6,206.8 billion$6,343.3

102.2

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1987

– Price Index = 82.7

Real 1993 GDP = = 100 = $5,489.6 billion$4,539.9

82.7

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Nominal and Real GDP

Figure 8-5 Source: U.S. Department of Commerce

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Per capita GDP

– Adjusting for population growth

Per capita real GDP =real GDP

population

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Question

– Is real per capita GDP a good indicator of social well-being?

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Some issues

– The distribution of output

– Changes in leisure time

– Increased traffic congestion

– Air pollution

– Crime

– Housework

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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?

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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

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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

Slide 8-1 The Simple Circular Flow. Slide 8-2 The Simple Circular Flow.

Documents

Transcript of Slide 8-1 The Simple Circular Flow. Slide 8-2 The Simple Circular Flow.