Lesson 1, Topic 1
In Progress

# Measuring the State of the Economy

##### Abdulaziz July 22, 2020
• Gross domestic product (GDP)
• The market value of the final goods and services produced in an economy over a certain period.
• Production measure of GDP
• The number of goods produced in the economy.
• Expenditure measure
• The total purchases in the economy.
• Income measure
• All the income earned in the economy.
• All three approaches give identical measures of GDP.

Thus:
Production = Expenditure = Income

## Economy of Eden

• The economy of Eden only produces apples
• To make apples, you need land, a tractor, and someone to pick the apples
• GDP=Income=Expenditure=\$3

Production
Each year, Eden produces 3 apples, and apples sell for \$1 each

Income
The landowner makes \$1 per year, the worker of the tractor gets \$1 per year, and the worker makes \$1 per year

Expenditure
The workers, the landowner, and the owner of the tractor all purchase 1 apple per year, for \$1 each

• When calculating income, we need to distinguish between “profits” and “economic profits”
• Profits
• Normal competitive return on inputs.
• Economic profits
• Above-normal returns associated with prices that exceed those that prevail under perfect competition.

## The Expenditure Approach to GDP

The national income accounting identity states:

Y = C + I + G + NX

Where
Y = GDP (in dollars)
C = consumption
I = investment
G = government purchases
NX = net exports = exports – imports

#### Other important identities

• C+I+G+(X-M)=Y (Expenditure=GDP)
• C+S+T=Y (Income=GDP)
• I=S+(G-T)+(M-X)
• Savings/Investment Equation
• Net exports (trade balance) for the United States is negative.
• The recent trade deficit indicates that the United States is borrowing goods from the rest of the world.
• As the trade balance has turned negative, consumption has increased as a share of GDP recently.

## The Income Approach to GDP

• The income approach
• Measures the sum of all income earned in the economy.
• Capital
• Inputs into production other than labor that are not used up in the production process.
• Firms increase capital through investment.
• Depreciation
• The deterioration of the capital stock due to wear and tear.

GDP – depreciation = net domestic product.

• Total shares of GDP to inputs:
• Share of GDP to Labor: two-thirds
• Share of GDP to Capital: one-third.
• Labor’s share of GDP has remained approximately constant over time.

## The Production Approach to GDP

• There is no “double counting” in GDP; only the final sale of goods and services count.