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Macroeconomics ECO 403

LESSON 04

THE DATA OF MACROECONOMICS

THE CIRCULAR FLOW

Income (S)

Labor

Households

Firms

Goods (bread)

Expenditure ($)

"Expenditure = Income" Why?

In every transaction,

the buyer's expenditure becomes the seller's income.

Thus, the sum of all expenditure equals

the sum of all income

Rules for computing GDP

1) To compute the total value of different goods and services, the national income

accounts use market prices.

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Macroeconomics ECO 403

Thus, if

$0.50

$1.00

GDP = [P (A) × Q (A)] + [P (O) × Q (O)]

= ($0.50 × 4) + ($1.00 × 3)

GDP = $5.00

2) Used goods are not included in the calculation of GDP.

3) Treatment of inventories depends on if the goods are stored or if they spoil.

4) Intermediate goods are not counted in GDP only the value of final goods.

Value added of a firm equals the value of the firm's output less the value of the intermediate

goods the firm purchases.

Example

· A farmer grows a bushel of wheat and sells it to a miller for $1.00

· The miller turns the wheat into flour and sells it to a baker for $3.00

· The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00

· The engineer eats the bread

· Compute

value added at each stage of production

GDP

· The value of the final goods already includes the value of the intermediate goods, so

including intermediate goods in GDP would be double-counting.

· Thus,

Expenditure = Income = Sum of value added

5) Some goods are not sold in the marketplace and therefore don't have market prices. We

must use their imputed value as an estimate of their value. For example, home ownership and

government services.

· Apt Rent will be included in GDP.

Your expenditure and landlord's income

· How about people who own houses?

They pay themselves their rent.

· How about services of police officers, firefighters and senators?

All public goods and services

· These are all included in GDP.

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Macroeconomics ECO 403

Nominal vs Real GDP

· The value of final goods and services measured at current prices is called nominal

GDP.

It can change over time either because there is a change in the amount (real value) of

goods and services or a change in the prices of those goods and services.

Hence, nominal GDP

Y=P×y

where P is the price level & y is real output

Real GDP or,

y = Y/P

is the value of goods and services measured using a constant set of prices?

This distinction between real and nominal can also be applied to other monetary

values, like wages. Nominal (or money) wages can be denoted by (W) and

decomposed into a real value (w) and a price variable (P). Hence,

W = nominal wage = P x w

w = real wage = W/P

This conversion from nominal to real units allows us to eliminate the problems created by

having a measuring stick (dollar value) that essentially changes length over time, as the price

level changes.

Apple & Orange Economy

Let's see how real GDP is computed in our apple and orange economy.

For example, if we wanted to compare output in 2002 and output in 2003, we would obtain

base-year prices, such as 2002 prices.

· Real GDP in 2002 would be:

[2002 P (A) × 2002 Q (A)] + [2002 P(O) × 2002 Q(O)]

Real GDP in 2003 would be:

[(2002 P (A) × 2003 Q (A)] + [(2002 P (O) × 2003 Q (O)]

Real GDP in 2004 would be:

[(2002 P (A) × 2004 Q (A)] + [(2002 P (O) × 2004 Q (O)]