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The Simple Circular Flow

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National Income (NI) 7,872.0. Minus corporate taxes, Social Security ... long-run trends in real GDP. They have not done as well. predicting recessions. ... – PowerPoint PPT presentation

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Title: The Simple Circular Flow


1
The Simple Circular Flow
2
The Simple Circular Flow
3
The Simple Circular Flow
4
The Simple Circular Flow
5
The Simple Circular Flow
Figure 8.1
6
The Simple Circular Flow
  • Two observations
  • In every economic exchange, the seller receives
    exactly the same amount that the buyer spends.
  • Goods and services flow in one direction and
    money payments flow in the other.

7
The Simple Circular Flow
  • Profits explained
  • Question
  • Why is profit a cost of production?
  • Answer
  • Profits are the return entrepreneurs receive for
    the risk they incur when organizing productive
    activities

8
The Simple Circular Flow
  • Product Markets
  • Transactions in which households buy goods

9
The Simple Circular Flow
  • Final Goods and Services
  • Goods and services that are at their final stage
    of production and will not be transformed into
    yet other goods or services

10
The Simple Circular Flow
  • Factor Markets
  • Transactions in which businesses buy resources

11
The Simple Circular Flow
  • Total Income
  • The yearly amount earned by the nations factors
    of production

12
The Simple Circular Flow
  • Question
  • Why must total income be identical to the dollar
    value of total output?
  • Answer
  • Every transaction simultaneously involves an
    expenditure and a receipt

13
National Income Accounting
  • Gross Domestic Product (GDP)
  • The total market value of all final goods and
    services produced by factors of production
    located within a nations borders

14
National Income Accounting
  • Observations
  • GDP measures the dollar value of final output
  • GDP measures the dollar value of final goods and
    services produced per year by factors of
    production located within a nations borders

15
Two Main Methods of Measuring GDP
  • Expenditure Approach
  • A way of computing national income by adding up
    the dollar value at current market prices of all
    final goods and services

16
Two Main Methods of Measuring GDP
Expenditure Approach
17
Two Main Methods of Measuring GDP
  • Income Approach
  • A way of measuring national income by adding up
    income received by all factors of production

18
Two Main Methods of Measuring GDP
Income Approach
19
Two Main Methods of Measuring GDP
  • Deriving GDP by the expenditure approach
  • Consumption Expenditure (C)
  • Durables
  • Life span of more than three years
  • Nondurables
  • Life span of less than three years
  • Services
  • Intangible commodities

20
Two Main Methods of Measuring GDP
  • Deriving GDP by the expenditure approach
  • Gross Private Domestic Investment (I)
  • The creation of capital goods, such as factories
    and machines, that can yield production and hence
    consumption in the future

21
Two Main Methods of Measuring GDP
  • Deriving GDP by the expenditure approach
  • Gross Private Domestic Investment (I)
  • Fixed investment
  • Inventory investment
  • New residential structures

22
Two Main Methods of Measuring GDP
  • Deriving GDP by the expenditure approach
  • Government Expenditures (G)
  • State, local, and federal
  • Valued at cost

23
Two Main Methods of Measuring GDP
  • Deriving GDP by the expenditure approach
  • Net Exports (Foreign Expenditures)

24
Two Main Methods of Measuring GDP
  • Mathematical representation using the
    expenditure approach

25
GDP and Its Components
Figure 8-3
26
Two Main Methods of Measuring GDP
  • Deriving GDP by the income approach

27
Deriving GDP by the Income Approach
  • Gross Domestic Income (GDI)
  • The sum of all incomewages, interest, rent, and
    profitspaid to the four factors of production

28
Two Main Methods of Measuring GDP
  • Gross Domestic Income (GDI)
  • Wages
  • Interest
  • Rent
  • Profits

29
Gross Domestic Product and Gross Domestic
Income, 2000 (in billions of 2000 dollars per
year)
Figure 8-4
Source U.S. Department of Commerce. First
quarter preliminary data annualized.
30
Gross Domestic Product and Gross Domestic
Income, 2000 (in billions of 2000 dollars per
year)
Expenditure Point of ViewProduct
Flow Expenditures by Different Sectors
Household sector Personal consumption
expenses 6,661.5 Government sector Purchase
of goods and services 1,734.6 Business sector
Gross private domestic investment (including
depreciation) 1,727.0 Foreign sector Net
exports of goods and services -273.6 Gross
Domestic Product 9,849.5
31
Gross Domestic Product and Gross Domestic
Income, 2000 (in billions of 2000 dollars per
year)
Income Point of ViewCost Flow Domestic Income
(at factor cost)
Wages All wages, salaries, and supplemental
employee compensation 5,678.4 Rent All rental
income of individuals plus implicit rent on
owner-occupied dwellings 155.4 Interest Net
interest paid by business 490.2 Profit
Proprietorial income 701.3 Corporate profits
before taxes deducted 952.0 Non-income expense
items Indirect business taxes and other
adjustments 762.1 Depreciation 1,215.4
Statistical discrepancy -105.3 Gross Domestic
Income 9,849.5
32
Other Components of National Income Accounting
  • National Income (NI)
  • The total of all factor payments to resource
    owners
  • Personal Income (PI)
  • The amount of income that households actually
    receive before they pay personal income taxes

33
Other Components of National Income Accounting
  • Disposable Personal Income (DPI)
  • Personal income after personal income taxes have
    been paid

34
Going from GDP to Disposable Income, 2000
Billions of Dollars
Gross domestic product (GDP) 9,849.5 Minus
depreciation -1,215.4 Net domestic product
(NDP) 8,634.1 Minus indirect business
taxes -762.1 and other adjustments National
Income (NI) 7,872.0 Minus corporate taxes,
Social Security contributions, corporate
retained earnings -1,236.5 Plus government
and business transfer payments 1,606.8 Personal
Income (PI) 8,242.3 Minus personal income tax
and non-tax payments -1,253.2 Disposable
personal income (DPI) 6,989.1
Source U.S. Department of Commerce
35
Distinguishing Between Nominal and Real Values
  • Nominal Values
  • Measurements in terms of the actual market prices
    at which goods are sold expressed in current
    dollars

36
Distinguishing Between Nominal and Real Values
  • Real Values
  • Measurements after adjustments have been made for
    changes in the average of prices between years
    expressed in constant dollars

37
Distinguishing Between Nominal and Real Values
  • Correcting GDP for price index changes
  • Nominal (current) dollars GDP
  • Real (constant) dollars GDP

38
Correcting GDP for Price Changes
(1) (2) (3) (4) (2)/(3) x 100 Nominal
GDP Real GDP (billions of (billions of
dollars dollars Price Level Index per
year Year per year) (base year 1992 100) in
constant 1992 dollars)
1990 5,803.2 86.8 6,683.5 1991 5,986.2 89.8 6,66
9.2 1992 6,318.9 91.7 6,891.1 1993 6,642.3 94.2
7,054.1 1994 7,054.3 96.1 7,337.8 1995 7,400.5 9
8.2 7,537.1 1996 7,813.2 100.0 7,813.2 1997 8,30
0.9 101.7 8,165.1 1998 8,759.9 102.9 8,516.3 199
9 9,254.6 104.4 8,867.0 2000 9,849.5 106.4
9,256.2
Source U.S. Department of Commerce, Bureau of
Economic Analysis
39
Distinguishing Between Nominal and Real Values
  • Example
  • Base Year 1992
  • Price Index 100

40
Distinguishing Between Nominal and Real Values
  • Real GDP nominal GDP in the base year

41
Distinguishing Between Nominal and Real Values
  • 1993
  • Price Index 102.2

42
Distinguishing Between Nominal and Real Values
  • 1987
  • Price Index 82.7

43
Nominal and Real GDP
Figure 8-5
Source U.S. Department of Commerce
44
Distinguishing Between Nominal and Real Values
  • Per capita GDP
  • Adjusting for population growth

45
Distinguishing Between Nominal and Real Values
  • Question
  • Is real per capita GDP a good indicator of
    social well-being?

46
Distinguishing Between Nominal and Real Values
  • Some issues
  • The distribution of output
  • Changes in leisure time
  • Increased traffic congestion
  • Air pollution
  • Crime
  • Housework

47
Issues and Applications How Well Do Economists
Predict GDP?
  • Forecasting economists have done a relatively
    good job predicting long-run trends in real GDP.
  • They have not done as well predicting recessions.

48
Economic Forecasts Missing the Mark
Forecasted Growth Actual Growth Start of
Recession Date of Forecast over the Next Year
() in Real GDP ()
December 1969 December 1969 1.5 -.6 November
1973 December 1973 1.5 -1.8 January 1980 December
1979 -.7 -.3 July 1990 December 1989 2.1 -.1 July
1991 December 1990 2.2 .7
Source Business Week, September 30, 1992, p. 92
49
How Well Do Economists Predict GDP?
  • Difficulties in predicting downturns
  • Trying to develop computer models for a changing
    multi-trillion dollar economy
  • Globalization
  • Data sources and methodology
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