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Chapter 15: Measuring a Nation’s income

The gross domestic product measures the total income of a nation. GDP is the most closely watched economic statistic because it is thought to be the best single measure of a society’s economic well-being.

The Economy’s Income and Expenditure

If you were to judge how a person is doing economically, you might first look at her or his income. A person with a high income can more easily afford life’s necessities and luxuries. The same logic applies to a nation’s overall economy. When judging whether the economy is doing well or poorly, it is natural to look at the national income that everyone in the economy is earning. That is the task of gross domestic product.

Why not total asset? Assets are only relevant for the income you can derive from it.

GDP measures two things at once: the total income of everyone in the economy and the total expenditure on the economy’s output of goods and services. For any economy as a whole, income must equal expenditure. Why is this true? An economy’s income is the same as its expenditure because every transaction has two parties: a buyer and seller. Every dollar of spending by some buyer is a dollar of income for some seller.

Because every transaction has a buyer and a seller, the total expenditures in the economy must equal the total income in the economy. The equality of income and expenditure can be illustrated with the circular-flow diagram.

It is transactions between households and firms in a simple economy. Money continuously flows from households to firms and then back to households. GDP measures this flow of money. We can compute it for this economy in one of two ways: * By adding up the total expenditure by households or

* By adding up the total income (wages, rent and profit) paid by firms.

Question? What two things does GDP measure? How can it measure two things at one?

The Measurement of Gross Domestic Product

Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time.

* “GDP is the market value…”
The price people are paying for it. Output is valued at market prices. * “… of All …”
All items sold legally, housing, things you do/produce at home in a social sphere. * “… Final…”
It records only the value of final goods, not intermediate goods (the value is counted only once). There is inventory exception. For example when an intermediate good is produced and, rather than being used, is added to a firm’s inventory of goods for use or sale at a later date (…) * “… Goods and services…”

It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). * “…Produced …”
GDP includes goods and services currently produced. It does not include transactions involving items produced in the past (GM selling cars >< you selling cars) * “… Within a Country …”
It measures the value of production within the geographical border. * “… In a Given Period of Time…”
It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

Question: Which contributes more to GDP – the p° of a pound of hamburger or the p° of a pound of caviar? Why?

Problems with GDP

* Ignores all nonmarket forms of p° (market forms of transaction) * Ignores illegal (black market) p° (illegal activities) * Ignores underlying social change
* Ignores economic value added.

The Components of GDP

GDP is divided among 4 components of expenditure: consumption, investment, government purchases, and net exports.

* Consumption: spending by households on goods and services, with the expectation of purchases of new housing * Investment: spending on capital equipment, inventories and structures, including household purchases of new housing * Government Purchases: spending on...
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