Lesson 3, Topic 1
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Measuring the State of the Economy

Abdulaziz July 22, 2020
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  • Gross domestic product (GDP)
    • The market value of the final goods and services produced in an economy over a certain period.
  • Production measure of GDP
    • The number of goods produced in the economy.
  • Expenditure measure
    • The total purchases in the economy.
  • Income measure
    • All the income earned in the economy.
  • All three approaches give identical measures of GDP.

Production = Expenditure = Income

Economy of Eden

  • The economy of Eden only produces apples
  • To make apples, you need land, a tractor, and someone to pick the apples
  • GDP=Income=Expenditure=$3

Each year, Eden produces 3 apples, and apples sell for $1 each

The landowner makes $1 per year, the worker of the tractor gets $1 per year, and the worker makes $1 per year

The workers, the landowner, and the owner of the tractor all purchase 1 apple per year, for $1 each

  • When calculating income, we need to distinguish between “profits” and “economic profits”
  • Profits
    • Normal competitive return on inputs.
  • Economic profits
    • Above-normal returns associated with prices that exceed those that prevail under perfect competition.

The Expenditure Approach to GDP

The national income accounting identity states:

Y = C + I + G + NX

Y = GDP (in dollars)
C = consumption
I = investment
G = government purchases
NX = net exports = exports – imports

Other important identities

  • C+I+G+(X-M)=Y (Expenditure=GDP)
  • C+S+T=Y (Income=GDP)
  • I=S+(G-T)+(M-X)
  • Savings/Investment Equation
  • Net exports (trade balance) for the United States is negative.
  • The recent trade deficit indicates that the United States is borrowing goods from the rest of the world.
  • As the trade balance has turned negative, consumption has increased as a share of GDP recently.

The Income Approach to GDP

  • The income approach
    • Measures the sum of all income earned in the economy.
  • Capital
    • Inputs into production other than labor that are not used up in the production process.
    • Firms increase capital through investment.
  • Depreciation
    • The deterioration of the capital stock due to wear and tear.

GDP – depreciation = net domestic product.

  • Total shares of GDP to inputs:
    • Share of GDP to Labor: two-thirds
    • Share of GDP to Capital: one-third.
    • Labor’s share of GDP has remained approximately constant over time.

The Production Approach to GDP

  • There is no “double counting” in GDP; only the final sale of goods and services count.
  • Value added
    • The amount each producer contributes to GDP.
    • The revenue generated by each producer minus the value of intermediate products.
  • Only new production of goods and services counts toward GDP.

What Is Included in GDP and What’s Not?

  • Only goods and services that are transacted through markets are included in GDP.
  • GDP does not include:
    • Government transfer payments to individuals.
      • Social Security, Medicare, unemployment insurance
    • A measure of the health of a nation’s people.
    • Changes in environmental resources.