Measuring the Economy: GDP, GNI, Investment

Key Macroeconomic Concepts Explained

Core Definitions

Net Taxes (T): Taxes – (government transfer income and interest payments)

Inventories (INV): Goods produced but not yet sold.

The Basic Macroeconomic Equation

The basic equation of macroeconomics represents total spending in the economy:

GDP = C + I + G + (X-M)

Where:

• C = Consumption
• I = Investment
• G = Government Spending
• X = Exports
• M = Imports

Understanding GDP and Related Measures

Concepts Related to GDP

• Final Sales of Domestic Product: GDP – change in inventories.
• Gross Domestic Purchases: GDP – (X-M).
• Gross National Income (GNI): Formerly known as Gross National Product (GNP). Takes an ownership approach instead of a geographic approach to define the production of a nation. Example: how to count the value of production by a Japanese-owned auto plant in the USA.

GDP vs. GNI

GDP uses a geographic approach, which is often preferred when focusing on jobs. The USA switched to using GDP in 1997.

Limitations of GDP as a Welfare Measure

Economic growth is defined as an increase in real GDP. However, interpreting an increase in real per capita GDP as necessarily meaning people are "better off" or have a higher quality of life is problematic due to several factors:

1. Environmental Impact: Pollution (air, water, carbon pollution, toxic wastes, nuclear waste) is ignored in GDP.
2. Resource Depletion: Depletion of natural resources is ignored by GDP, neglecting the well-being of future generations.
3. Working Conditions: Health and safety in working conditions are ignored by GDP.
4. Leisure Time: The value of leisure time is ignored by GDP.
5. Type of Production: Some production increases GDP but doesn’t improve people's lives (e.g., building nuclear bombs).

Propensities and Their Geometric Meaning

Geometric interpretations of the propensities related to consumption (C) and saving (S):

1. Marginal Propensity to Consume (MPC): Slope of the Consumption (C) curve.
2. Marginal Propensity to Save (MPS): Slope of the Saving (S) curve.
3. Average Propensity to Consume (APC): Slope of the line from the origin to a point on the C curve.
4. Average Propensity to Save (APS): Slope of the line from the origin to a point on the S curve.

Fixed Investment Spending

Definition and Significance

Fixed investment spending (If) is a component of total spending. It tends to fluctuate significantly and can influence economic cycles.

Factors Affecting Fixed Investment

(If) depends on a variety of factors:

1. Profits
2. Interest rates (financing costs)
3. Tax laws/incentives
4. Oil prices (investment for energy conservation to reduce energy costs)
5. Compliance with government regulations requires investment spending (e.g., pollution controls, consumer protection laws like air bags, and worker health and safety regulations)
6. Measures of use of existing business structures and equipment: industrial capacity utilization, vacancy rates (e.g., real estate, apartment buildings, shopping centers, office buildings)
7. Business confidence
8. Corporate debt
9. Price of physical capital (e.g., machinery or airplanes)