Chapter 10: �Measuring a Nation’s Income(Mankiw)

Why Macroeconomics?

• In economics, we have two main subfields:
• Microeconomics and Macroeconomics
• Macroeconomics was created to:
1. Measure the “health” of the whole economy
2. Give government policy tools
• In general, countries have 3 macroeconomic goals:
1. Promote economic growth
2. Limit Unemployment
3. Keep prices stable

Gross Domestic Product

• GDP measures:
1. Total income of everyone in the economy
2. Total expenditure on goods and services in an economy
• An example: The Triangle (Raleigh/Durham/Chapel Hill) had a GDP of $83,288,000,000 in 2017.
• With a population of ~2,200,000 in 2017, that translates to an average of $37,858.18 per person.

Gross Domestic Product

• We usually say that income = expenditure.
• Every $ you make, you will either save or spend.
• Going back to our example:
1. If the average GDP per person is the triangle is $37,858.18…
2. This means on average each person has an income of approximately $18,929.09
3. Obviously, this may seem low since it includes students, children, retired population, etc.

Circular-Flow Diagram

• Recall from Chapter 1, the Circular-Flow Diagram:

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• Simple macroeconomy depiction
• The only difference from Chapter 1�is the addition of “(=GDP)”
• This graph omits:
1. The government (taxes)
2. Financial system (banks)
3. Foreign markets (trades)

More about GDP

• “Textbook Definition”: GDP is the market value of all final goods and services produced within a country in a given period of time.
1. Market value – the “MSRP” price, the price you see, all measured in local currency. Things like mowing your lawn, driving, doing dishes are excluded (no market value).
2. All final goods – Legally produced & sold items that are intended for the end user. Intermediate goods on the other hand are not included in the GDP.
3. Goods & services – tangible items such as boba, iphone, lip balm. Examples of intangible services include internet service, legal counsel, and Netflix.
4. Within a country – production inside a country’s borders, irrespective of if a citizen or a foreigner produced the final good.
5. Given period of time – usually within a year.

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Example of GDPs

North Korea – $40,000,000,000

North Dakota – $52,089,000,000

Example of GDPs

North Carolina – $449,754,000,000

U.S. has the highest GDP followed by:

1. China
2. Japan
3. Germany
4. India
5. United Kingdom (pre Brexit)

Let’s break down GDP

Consumption

• Total spending by households on goods and services.
• Key distinction for housing:
1. For renters, consumption includes rent payments
2. For homeowners, consumption includes the rental value of the house (but not the purchase price nor the mortgage payment).
• Have you heard of phrases such as “strength of the American consumer?”

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% of consumption on total GDP

Investment

• Total spending on goods that will be used in the future to produce… more goods
• Examples:
1. Business capital: business structures, equipment, patents
2. Residential capital: apartment building, an individual’s own home
3. Inventory: goods produced but not yet sold.
• We are not talking about stocks, bonds, CDs, when it comes to “investment”.

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Government

• All spending on goods and services by the government (local, state, and federal)
• So, what have they purchased?
• Weapons – explosives, missiles, aircrafts, ships…
• Tractors
• Live Animals
• Research and Development
• Studies (i.e. air quality analysis)
• Furniture (i.e. Ben Carson in 2018 under HUD)

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• Transfer payments such as social security or unemployment benefits are excluded.

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We heard about HUD’s $31,000 dining set

Net Exports

• Net exports are defined as: exports – imports.
1. Exports are foreign spending on domestic goods and services
2. Imports are the portions of consumption, investment, and government spending that are spent on goods and services produced abroad.
• For example, the U.S. exports American cars, technology, weapons, soybeans, clothes, and much more.
• U.S. also imports foreign cars, foods, clothing, electronics, and you guessed it – much more.

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Justin Bieber – one of Canada’s�exports to the U.S.

Practice – Does it affect GDP?

• In each of the following cases, determine if GDP is affected (if at all) and specifically think about which component changes (C, I, G, NX)
1. Michelle purchases “merch” from “MrBeast”, a famous North Carolinian Youtuber.
2. Tommy spends $50,000 on 50 laptops to use in his entertainment business. The laptops were made in China.
3. Your car broke down and you decided to purchase a used car.
4. Michael Scott Paper Company produced $2 million worth of paper. Consumers purchased $1.3 million worth, the city of Scranton purchased $0.2 million worth, and there was a surplus of $.5 million worth of paper.

Practice – Does it affect GDP?

• Michelle purchases “merch” from “MrBeast”, a famous North Carolinian Youtuber.
• Consumption and GDP goes up
• Tommy spends $50,000 on 50 laptops to use in his entertainment business. The laptops were made in China.
• Investment rises by $50,000. Net exports fall by 50,000. GDP does not change
• Your car broke down and you decided to purchase a used car.
• Current GDP and consumption does not change.
• Michael Scott Paper Company produced $2 million worth of paper. Consumers purchased $1.3 million worth, the city of Scranton purchased $0.2 million worth, and there was a surplus of $.5 million worth of paper.
• Consumption goes up by $1.3 million, Investment goes up by $.5 million, Government goes up by $.2 million. GDP rises by $2 million.

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Real versus Nominal GDP

• Have you heard of inflation?
• i.e. $100 in 1900 is not worth the same amount today.
• Adjusting for inflation would mean that $100 in 1900 would be equal to $3110 in 2020.
• Nominal GDP: not corrected for inflation, values at current prices.
• Real GDP: corrected for inflation using a particular year as the “base year”
• During the base year, nominal GDP = Real GDP.
• i.e. $100 in 1900 is worth $100 in 1900.

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Example

Compute the nominal GDP in each year:

• 2017: $10 x 400 + $2.00 x 1000 = $6,000
• 2018: $11 x 500 + $2.50 x 1100 = $8,250
• 2019: $12 x 600 + $3.00 x 1200 = $10,800

Increase:

Example

Compute the real GDP in each year, using 2017 as the base year:

• 2017: $10 x 400 + $2 x 1000 = $6,000
• 2018: $10 x 500 + $2 x 1100 = $7,200
• 2019: $10 x 600 + $2 x 1200 = $8,400

Example

• When calculating GDP:
• Nominal GDP is measured using the then-current prices.
• Real GDP is measured using the prices from the base year.
• The change in real GDP is the amount that GDP would change if we had zero inflation (prices constant). In other words, real GDP is corrected for inflation.

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Nominal & Real GDP from our example

Real GDP vs Nominal GDP, base = 1990

Notice that the nominal GDP has a higher slope due to the fact that it includes inflation!

GDP Deflator

Example

Compute the GDP deflator:

100

2017: 100 x (6000/6000) = 100

114.6

2018: 100 x (8250/7200) = 114.6

128.6

2019: 100 x (10,800/8400) = 128.6

Practice

Given the chart below, compute the following:

• Nominal GDP in 2010
• Real GDP in 2011
• GDP deflator in 2012

1. $30 x 900 + $100 x 192 = $46,200

2. $30 x 1000 + $100 x 200 = $50,000

3. Nom GDP = $36 x 1050 + $100 x 205 = $58,300

Real GDP = $30 x 1050 + $100 x 205 = $52,000

GDP deflator = 100 x (Nom GDP)/(Real GDP)

= 100 x ($58,300)/($52,000) = 112.1

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GDP and Welfare

• Real GDP per capita: Real GDP divided by the number of people in the country.
• U.S. has ~330 million people. Real GDP ~ 20 trillion. Real GDP per capita: ~$60,600
• China has ~1.4 billion people. Real GDP ~12.5 trillion. Real GDP per capita: ~$8,930
• However, GDP does not account for:
1. Living cost differences
2. Quality of environment
3. Leisure time
4. Distribution of income
• Big picture wise, a larger GDP allows a country to have a higher standard of living.

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GDP and Life Expectancy

GDP and Average Schooling

GDP and Overall Life Satisfaction

Summary

• Gross Domestic Product (GDP) measures a country’s total income and expenditure.
• The four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports.
• Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year and is corrected for inflation.
• GDP is the main indicator of a country’s economic well-being, even though it is not perfect.

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Questions this chapter addressed

• What is Gross Domestic Product (GDP)?
• How is GDP related to a nation’s total income and spending?
• What are the components of GDP?
• How is GDP corrected for inflation?
• Does GDP measure society’s well-being?
• What is GDP per capita / real GDP?