GDP The Circular-Flow Diagram The Circular Flow

GDPIntroduction & The ExpenditureApproachThe Circular-Flow DiagramThe Circular FlowWages, rents,interest, profitsHouseholdImportsTaxesSavingsFactor servicesGoodsGovernmentFinancial marketsPersonal consumptionOther countriesGovernmentSpendingInvestmentFirms(production)ExportsMcGraw-Hill/Irwin© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.1

The National Accounts‣Households earn income via the factormarkets from wages, interest on bonds,dividends on stocks, and rent on land.An Expanded Circular-Flow Diagram: The Flows of Money Through theEconomyIncome from the FactorMarketIncome received byHouseholds• Wages• Rent• Interest• ProfitFactors ofProduction• Labor• Land• Financial Capital• Physical Capital2

The National Accounts‣Via the financial markets, privatesavings is channeled to firms forinvestment spending (I).An Expanded Circular-Flow Diagram: The Flows of Money Through theEconomyInvestment Spending• Spending on productive physical capitaland changes to inventories– Inventories seen as contributing to thefuture sales of the firm• Spending on additional inventory adds toInvestment spending• Drawing down inventories is counted as fall inInvestment spending3

The National Accounts‣ Government purchases of goods andservices (G) is paid for by tax receipts as wellas by government borrowing.An Expanded Circular-Flow Diagram: The Flows of Money Through theEconomyThe National Accounts• Exports (X) generate an inflow of funds intothe country from the rest of the world• imports (IM) lead to an outflow of funds tothe rest of the world. Foreigners can alsobuy stocks and bonds in the U.S. financialmarkets.4

An Expanded Circular-Flow Diagram: The Flows of Money Through theEconomyGDP=C+I+G+(X-IM)• C• I• G• X• IM• Consumer spending• Investment• Government• Exports• ImportsWhat Is GDP?• GDP is the nation’s expenditures onall FINAL goods and servicesproduced during the year at marketprices.Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-35

The Flow Not Stock• With GDP we are measuring a Flowor a movement NOT a Stock– The store of wealth is a stock concept.How• An adult male ofaverage sizenormally hasMuch about 6 quarts is(5.6 liters) ofablood.• This is an stockStockconcept.ConceptA Stock ConceptGDP is a flow conceptIncome ArmMeasuringThe In MacroeconomicssameGDPwayisyoursimilarto blood taking Expenditurespressure your blood is thepressure. same on Equalsboth armsIncomeExpenditure Arm6

How GDP Is Measured?Income (wages, salary, rent, interest, profits)FirmsHouseholdsExpenditures by Consumers, Investors, Government, and Net ExportsCopyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-6How GDP Is Measured?Income (wages, salary, rent, interest, profits)FirmsSame AsHouseholdsExpenditures by Consumers, Investors, Government, and Net ExportsCopyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-7How GDP Is Measured?Income (wages, salary, rent, interest, profits)Value of what isproducedFirmsSame AsHouseholdsValue of what isspentExpenditures by Consumers, Investors, Government, and Net ExportsCopyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-87

How GDP Is Measured?Income (wages, salary, rent, interest, profits)Flow of IncomeApproachValue of what isproducedFirmsSame AsHouseholdsExpendituresApproachValue of what isspentExpenditures by Consumers, Investors, Government, and Net ExportsCopyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-9How GDP Is Measured?Income (wages, salary, rent, interest, profits)Flow of IncomeApproachValue of what isproducedFirmsSame AsHouseholdsExpendituresApproachValue of what isspentExpenditures by Consumers, Investors, Government, and Net Exports(GDP = C + I + G + Xn )• ConsumptionThe Components of GDP,– Durable goods …………$ 820– Nondurable goods …….. 2,010 2000 (in $ billions)– Services ……………….. 3,929– Total C …………………………….$6,759• Investment– Plant & Equipment …….$ 1,361– Residential Housing …… 416– Inventory change ………. 57– Total I ……………………………….1,834• Government Purchases– Federal ………………….$ 595– State and Local …………. .1,148– Total G ……………………………..$1,743• Net Exports (Xn)– Exports ………………….$ 1,099– Imports …………………..- 1,466– Xn …………………………………$ - 370• GDP …… …………………………$9,966Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-48

• Consumption– Durable goods …………$ 820– Nondurable goods …….. 2,010– Services ……………….. 3,929– Total C …………………………….$6,759• Investment– Plant & Equipment …….$ 1,361– Residential Housing …… 416– Inventory change ………. 57– Total I ……………………………….1,834• Government Purchases– Federal ………………….$ 595– State and Local …………. .1,148– Total G ……………………………..$1,743• Net Exports (Xn)– Exports ………………….$ 1,099– Imports …………………..- 1,466– Xn …………………………………$ - 370• GDP …… …………………………$9,966The Components ofGDP, 2000 (in $billions)GDP = C + I + G + XnGDP =6,759+1,834+1,743+(-370)GDP = 9,966Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.9-5Income ArmGDP is a flow conceptIn MacroeconomicsExpendituresEqualsIncomeExpenditure ArmWhat’s measured on theincome side?Income receivedby Households• Wages• Rent• Interest• ProfitFactors ofProduction• Labor• Land• Financial Capital• Physical Capital9