ECONOMICS TOPIC 7 LESSON 1

ECONOMICS TOPIC 7 LESSON 1

Economic Performance and Challenges

ESSENTIAL QUESTION

Why should we care how the economy is doing?

OBJECTIVES

Explain how gross domestic product (GDP) is calculated.

Interpret GDP data.

Identify factors that influence GDP.

Describe other output and income measures.

Economic Measures

Economists have developed many tools to monitor the nation’s economic performance.

Economists use a system called national income accounting to monitor the U.S. economy. They collect and organize macroeconomic statistics on production, income, investment, and savings.

What is GDP?

 gross domestic product (GDP), which is the dollar value of all final goods and services produced within a country’s borders in a given year.

What is GDP?

 Dollar value refers to the total cash value of the sales of all goods and services produced in a country’s households, firms, and government in a calendar year.

What is GDP?

 Final goods and services are products in the form sold to consumers. They differ from intermediate goods, which are products used in the production of final goods.

What is GDP?

Produced within a country’s borders is especially important to remember. Because we are trying to find the country’s gross domestic product, we can look only at the goods and services produced within that country. 

What is GDP?

In a given year takes into account when a good was produced. Suppose your neighbor sells you his used car. When the car was originally made, it was counted in the GDP of that year. Thus, it would be inaccurate to count it toward GDP again this year when it was resold.

Multiple Choice

Why are imports not included in gross domestic product?

• They are heavily taxed.

• They are durable goods.

• They are not final goods and services.

• They are produced outside the country.

CALCULATING GDP

The Expenditure Approach

First, bear in mind that consumer goods include two kinds of goods. They are durable goods—those that last for a relatively long time, such as refrigerators and DVD players—and nondurable goods—those that last a short period of time, such as food, light bulbs, and sneakers.

CALCULATING GDP

The Expenditure Approach

First, economists estimate the annual expenditures, or amounts spent, on four categories of final goods and services:

1. consumer goods and services
2. business goods and services
3. government goods and services
4. net exports

CALCULATING GDP

The Expenditure Approach

Net exports are found by adding up exports—goods produced in the country but purchased in other countries—and then subtracting imports. Imports, of course, were produced in another country.

CALCULATING GDP

The Expenditure Approach

After finding the value of those four categories, economists add them together to arrive at the total expenditures on goods and services produced during the year. This total equals GDP. Figure 7.1

Open Ended

Analyze Charts How would the country’s GDP change if the economy produced trucks that were purchased for $25,000 each instead of $20,000 each?

CALCULATING GDP

The Income Approach

The second method to calculate GDP, known as the income approach, This method calculates GDP by adding up all the incomes in the economy. The rationale for this approach is that when a firm sells a product or service, the selling price minus the dollar value of goods and services purchased from other firms represents income for the firm’s owners and employees.

Open Ended

Analyze Charts How would cutting workers affect GDP?

Two Measures of GDP

Calculating Nominal GDP

We calculated nominal GDP—that is, GDP measured in current prices. Because it is based on current prices, this type of GDP is also called “current GDP.” To calculate nominal GDP, we simply use the current year’s prices to calculate the value of the current year’s output. 

Two Measures of GDP

Calculating Real GDP

The data in revealS a problem with nominal GDP. The GDP of Year 2 is higher than that of Year 1 even though the output of cars and trucks in the two years is the same. The difference is due to an increase in prices. To correct for this distortion, economists determine real GDP, which is GDP expressed in constant, or unchanging, prices.

Open Ended

Analyze Charts What is the difference between nominal and real GDP for Year 2?

Multiple Choice

What problem is solved by using real GDP?

• misrepresentations of output

• distortions caused by changes in prices over time

• the difficulty in determining current average prices

• differences between the expenditure and income approach

What GDP Doesn’t Measure

Nonmarket Activities

GDP does not measure goods and services that people make or do themselves, such as caring for children, mowing the lawn, cooking dinner, or washing the car.

What GDP Doesn’t Measure

The Underground Economy

A large amount of production and income is never recorded or reported to the government. For instance, transactions on the black market—the market for illegal goods—are not counted.

What GDP Doesn’t Measure

Negative Externalities

Unintended economic side effects, or externalities, have a monetary value that often is not reflected in GDP. For example, a power plant that emits smoke and dust is polluting the air. That negative result is not subtracted from GDP.

What GDP Doesn’t Measure

Quality of Life

we should remember that additional goods and services do not necessarily make people any happier. some things that are not counted in GDP contribute to most people’s quality of life, such as pleasant surroundings, ample leisure time, and personal safety.

Multiple Choice

Which is an example of a nonmarket activity?

• buying a car

• cleaning your house

• baby-sitting for less than minimum wage

• going to a movie with someone who buys your ticket

Other Economic Measures

While gross domestic product is the primary measure of income and output, economists also look at other measures to focus on specific parts of the economy. tHE Figure shows how GDP is used to determine five other economic measures.

Other Economic Measures

The first is gross national product (GNP), the annual income earned by a nation’s firms and citizens. 

GNP does not account for depreciation, or the loss of the value of capital equipment that results from normal wear and tear.

Other Economic Measures

the cost of replacing this physical capital slightly reduces the value of what we produce. GNP minus the cost of depreciation of capital equipment is called net national product (NNP). NNP measures the net output for one year, or the output made after the adjustment for depreciation.

Other Economic Measures

Once they have calculated NNP, government economists adjust their figures to account for minor discrepancies between different sources of data. After making these minor adjustments to NNP, they get another measure, called national income (NI).

Other Economic Measures

From NI, we can find out how much pretax income businesses actually pay to U.S. households. This is found by subtracting the profits that firms reinvest in the business and the income taxes and Social Security taxes they pay out. What remains is called personal income (PI).

Other Economic Measures

Finally, we want to know how much money people actually have to spend after they pay their taxes, a figure called disposable personal income (DPI). To find DPI, we take personal income and subtract individual income and Social Security taxes.

Multiple Choice

What is disposable personal income?

• how much people earn in a year

• how much people pay in income taxes

• how much people spend on durable goods

• how much people have to spend after paying their taxes

Factors That Affect GDP

Aggregate Supply

Think of aggregate supply as a supply curve for the whole economy. First, economists add up the total supply of goods and services produced for sale in the economy—in other words, GDP.

Factors That Affect GDP

Aggregate Supply

They calculate the price level, the average of all prices in the economy. They determine aggregate supply, the total amount of goods and services in the economy available at all possible price levels..

Factors That Affect GDP

Aggregate Demand

Aggregate demand is the amount of goods and services in the economy that will be purchased at all possible price levels. As price levels in the economy move up and down, individuals and businesses change how much they buy—in the opposite direction that aggregate supply changes...

Factors That Affect GDP

Aggregate Supply/Aggregate Demand Equilibrium

When we put together the aggregate supply (AS) and aggregate demand (AD) curves, we can find the AS/AD equilibrium in the economy as a whole. Look at Figure 7.7. The intersection of the AS and AD curves indicates an equilibrium price level of P1 and an equilibrium real GDP of Q1

Multiple Choice

Which of the following is not included in aggregate demand?

• an increase in supply

• government spending

• foreigners’ demand for export goods

• business spending on capital investment

Open Ended

Why should we care how the economy is doing?