Posted by Muhammad Atif Saeed | Thursday, 29 December 2011 |
Posted in
Economics,
Macro Economics
I. Basics
Money is a part of everyone's life, and we all want it, but do you know how it gains value and how it is created? Check out the following link for more:
The following page will prime you for the topics discussed in this chapter:
What Is Money?
What Are the Functions of Money?Money has three basic functions.
- It acts a medium of exchange. If money did not exist, we would have much more complicated lives. If you wished buy bananas, you would need a barter arrangement where another party valued something you had and could also provide you with bananas. Anything can serve as money (ie. Coins, cigarettes, shells) as long as someone else will accept it as a medium of exchange.
- Money is a way to store value. Although many things (land, gold, etc.) can serve as a store of value, money has one large advantage in the sense that it can quickly be converted into other goods. One problem with using money as a way to store value is that some forms of money do not pay interest. Another problem is that inflation destroys the value of money over time.
- Money is also used as a unit of account. The values and costs of goods, services, and assets can be expressed as a unit of money. Prices expressed as money are used to help consumers make choices among numerous goods and services.
What is the Money Supply?
The supply of money is the amount of money available in a country; it is measured in many ways. The two most frequent ways to measure money are referred to as M1 and M2.
M1 is the narrowest definition of the money supply. It includes:
- cash (currency) in circulation
- checking accounts (demand deposits) - both non-interest earning and interest-earning
- travelers' checks
M2 includes:
- all components of M1
- money market mutual funds
- deposits in savings accounts
- time deposit of less than 100K at depository institutions (banks, credit unions, savings and loans)
Using Commodities as Money
Problems that arise when using commodities include requiring a double coincidence of wants (does the person you want food from want your cigarettes?) and the difficulties in making price comparisons.
| Within the context of our discussion, "Money" means anything that can be used in exchange for goods or services. It is not referring to currency (in the form of coins, dollar bills, debit cards, etc.) that modern societies use every day to purchase goods and services. |
Posted by Muhammad Atif Saeed | |
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Macro Economics
Classical vs. Keynesian Economics
Under classical economic theory, an economy will always move towards equilibrium at full capacity and full employment. Aggregate demand will adjust to full potential GDP, assisted by flexible wages and prices. Desired savings are kept equal to desired investment by responses to interest rate changes.
British economist John Maynard Keynes took the viewpoint that spending induces businesses to supply goods and services. If consumers become pessimistic about their futures and cut down on their spending, then business will reduce their production. He rejected the classical viewpoint that unemployment would be resolved by flexible wage rates; instead, wages are viewed as being "sticky" when downward pressures exist. Business will produce only the quantities of goods and services that government, consumers, investors and foreigners are expected to buy. If the planned expenditures are less than what would be associated with production at full employment, then output will be less than the economy's full potential.
The Four Components of the Keynesian ModelThere are four components of planned aggregate expenditures in the Keynesian model: consumption, investment, government spending and net exports. Some basic assumptions about the Keynesian model should be noted. When the economy is operating at full employment capacity, then only the natural rate of unemployment is extant. Wages and prices are not flexible until full employment occurs; at that point, increases in demand will only cause prices to go higher.
- Consumption - Keynes believed that consumption expenditures are mainly influenced by the level of income. As income increases, consumption will increase but not by as much as the increase in income. The relation between consumption and income is known as the consumption function.
- Investment - This category includes spending on fixed assets such as machinery, and changes in inventories of raw materials and final goods. Keynes believed that in the short run, investment spending is not a function of income.
- Government - As with investment, planned government expenditures are not a function of income.
- Net Exports - Exports remain constant and imports increase as aggregate income rises, so net exports (exports minus imports) will tend to go down as aggregate income goes up.
Formula 4.3
Aggregate Demand = C + I + G + (X - M)
In the Keynesian model, equilibrium is achieved when the value of current production equals planned aggregate expenditures. At that point, there is no incentive for firms to alter their production plans. If expenditures exceed the value of output, business inventories will be drawn down. Firms will need to expand production in order to replenish inventories and meet the higher level of demand. If demand exceeds production, business inventories will rise and production will be cut back until inventories are at normal levels.
Note that equilibrium can occur at levels of output which are below the level of output consistent with full employment.
Figure 4.3: Aggregate Expenditures
In the graph above, AE0 represents aggregate expenditures that would occur at different price levels. The 45 degree line, AE=GDP, represents the points where equilibrium occurs. Equilibrium occurs at point (P0,Q0), where output is less than can be achieved at QF, the output associated with full employment.
Ideally, planned aggregate expenditures will shift to a line such as AE1. At that point, full employment is achieved.
From a Keynesian view, market economies are viewed as being inherently unstable: they are prone to booms and busts. Changes in demand, magnified by multiplier effects, tend to cause wild swings in the economy. Fluctuations in private business investment are the largest cause of the economy swinging to different levels of output.
Monetarists believe that fluctuations in the money supply are the chief source of fluctuations in real economic output and that the major cause of inflation is excessive growth in the money supply.
According to the monetarist view, economies will usually operate at full employment. Aggregate demand is mainly influenced by changes in the money supply. Fluctuations in aggregate demand will be diminished if growth in the money supply is kept at a steady rate.Monetarists concur with the Keynesian viewpoint that wages are "sticky" when downward pressures exist
Posted by Muhammad Atif Saeed | |
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In the short-run, an unanticipated decrease in aggregate demand will lead to an excess supply of resources, which will lead to a decline in resource prices. Unemployment will increase, prices will go down and output will be reduced. Over a longer period of time, lower resource costs will cause a shift to the right in aggregate supply. The economy will move to producing a level of output consistent with full employment (as was the case before the decrease in aggregate demand), but at a lower price level.
An unanticipated increase in aggregate demand will, in the short-run, lead to an output level that is greater than what is consistent with full employment. This occurs because price levels are different that what was anticipated by resource providers. There will be less unemployment than the "natural rate" of unemployment. There will be upward pressure on resource prices and interest rates, which will, over the long-run, result in a decrease in aggregate demand. Resource providers will make adjustments to the new price levels and output will decline to what is consistent with full employment. A new market equilibrium will occur at a higher price level. So in the long-run, inflation (higher prices) will be the major effect of the increase in aggregate demand.
In the short-run, an unanticipated decrease in SAS will lower the availability of resources. This will lead to an increase in resource prices, which will in turn cause the aggregate supply curve of goods and services to shift up and to the left. A reduced level of output will be produced at higher prices. If the cause of the unanticipated decrease in SAS is temporary, then there should be no changes in prices or output over the long-run. If the cause is more important, then the long-run supply curve will shift to the left. The economy would produce a lower level output at higher prices.
An unanticipated increase in aggregate supply will, in the short-run, lead to a shift to the right in SAS. Output and income will expand beyond what is consistent with full employment at a lower price level. If what produced the increase in aggregate supply is only temporary, the SAS curve will return to normal levels and prices and output will be as before. If what produced the change is permanent, then both SAS and LAS will shift to the right. There will be a greater amount of output, at lower prices.
Self-Correcting MechanismsThree aspects of a market economy that help to stabilize the economy and lessen the impact of economic shocks include:
1.Changes in Resource Prices - If the economy is operating at less than full employment, there will be downward pressure on prices for labor and other resources. That effect will stimulate short-run aggregate supply. If the economy is operating above full employment, prices for labor and other resources will get bid up, and short-run aggregate supply will be reduced.
2. Change in Real Interest Rates - During recessions, business demand for capital funding declines, causing a lowering of real interest rates. The lower interest rates in turn stimulate consumers to buy large items and cost of business investment projects are reduced, which stimulates business investment spending. Economic booms lead to higher interest rates, thereby lowering demand for consumer durable goods and funding for business investment projects. Therefore, interest rate movements work to stabilize aggregate demand.
3.Relative Stability of Consumption - The permanent income hypotheses states that household consumption is mainly a function of expected long-range (permanent) income. Since long-run income has more of an impact on spending than temporary changes in current income, consumption spending stays relatively the same across business cycles. During economic boom times, consumers will increase their savings; during a recession, temporary declines in income will induce households to draw on their savings so as to maintain a level of consumption in line with their expected long-run incomes.
Posted by Muhammad Atif Saeed | |
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The Aggregate Supply Curve
The aggregate supply curve shows the relationship between a nation's overall price level, and the quantity of goods and services produces by that nation's suppliers. The curve is upward sloping in the short run and vertical, or close to vertical, in the long run.
Net investment, technology changes that yield productivity improvements, and positive institutional changes can increase both short-run and long-run aggregate supply. Institutional changes, such as the provision of public goods at low cost, increase economic efficiency and cause aggregate supply curves to shift to the right.
Some changes can alter short-run aggregate supply (SAS), while long-run aggregate supply (LAS) remains the same. Examples include:
- Supply Shocks - Supply shocks are sudden surprise events that increase or decrease output on a temporary basis. Examples include unusually bad or good weather or the impact from surprise military actions.
- Resource Price Changes - These, too, can alter SAS. Unless the price changes reflect differences in long-term supply, the LAS is not affected.
- Changes in Expectations for Inflation - If suppliers expect goods to sell at much higher prices in the future, their willingness to sell in the current time period will be reduced and the SAS will shift to the left.
The Aggregate Demand CurveThe aggregate demand curve shows, at various price levels, the quantity of goods and services produced domestically that consumers, businesses, governments and foreigners (net exports) are willing to purchase during the period of concern. The curve slopes downward to the right, indicating that as price levels decrease (increase), more (less) goods and services are demanded.
Factors that can shift an aggregate demand curve include:
- Real Interest Rate Changes - Such changes will impact capital goods decisions made by individual consumers and by businesses. Lower real interest rates will lower the costs of major products such as cars, large appliances and houses; they will increase business capital project spending because long-term costs of investment projects are reduced. The aggregate demand curve will shift down and to the right. Higher real interest rates will make capital goods relatively more expensive and cause the aggregate demand curve to shift up and to the left.
- Changes in Expectations - If businesses and households are more optimistic about the future of the economy, they are more likely to buy large items and make new investments; this will increase aggregate demand.
- The Wealth Effect - If real household wealth increases (decreases), then aggregate demand will increase (decrease)
- Changes in Income of Foreigners - If the income of foreigners increases (decreases), then aggregate demand for domestically-produced goods and services should increase (decrease).
- Changes in Currency Exchange Rates - From the viewpoint of the U.S., if the value of the U.S. dollar falls (rises), foreign goods will become more (less) expensive, while goods produced in the U.S. will become cheaper (more expensive) to foreigners. The net result will be an increase (decrease) in aggregate demand.
- Inflation Expectation Changes - If consumers expect inflation to go up in the future, they will tend to buy now causing aggregate demand to increase. If consumers' expectations shift so that they expect prices to decline in the future, t aggregate demand will decline and the aggregate demand curve will shift up and to the left.
Posted by Muhammad Atif Saeed | |
Posted in
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Macro Economics
Inflation
Inflation is defined as an increase in the overall price level. Please note that inflation does not apply to the price level of just one good, but rather to how prices are doing overall. A consumer facing inflation that occurs at the rate of 10% per year will able to buy 10% less goods at the end of the year if his or her income stays the same. Inflation can also be defined as a decline in the real purchasing power of the applicable currency.
Consumer Price Index (CPI)The CPI represents prices paid by consumers (or households). Prices for a basket of goods are compiled for a certain base period. Price data for the same basket of goods is then collected on a monthly basis. This data is used to compare the prices for a particular month with the prices from a different time period.
Example:The inflation rate is computed by subtracting the CPI of last year's prices from the CPI value for this year, dividing that difference by last year's CPI value and then multiplying by 100.
So if the value of the price index for the current year is equal to 165, and last year's value was 150, the rate would be calculated as:
Inflation rate = (165 - 150) X100= 10
150
CPI Sources of BiasThe CPI is not a perfect measure of inflation. Sources of bias include:
·Quality adjustments - quality of many goods (e.g., cars, computers, and televisions) goes up every year. Although the Bureau of Labor Statistics is now making adjustments for quality improvements, some price increases may reflect quality adjustments that are still counted entirely as inflation.
·New goods - new goods may be introduced that will be hard to compare to older substitutes.
·Substitution - if the price goes up for one good, consumers may substitute another good that provides similar utility. A common example is beef vs. pork. If the price goes up, and the price of pork stays the same, consumers might easily switch to pork. Although the CPI will go higher due to the price increase in beef, many consumers may not be worse off. Also, when prices go up, consumers may effectively not pay the higher prices by switching to discount stores. The CPI surveys do not check to see if consumers are substituting discount or outlet stores.
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The creation of "full employment" is a common economic policy goal. However, full employment does not imply zero unemployment. A dynamic economy will always have some unemployment; this is not necessarily harmful. Types of unemployment are often broken down as follows:
Structural Unemployment - Changes occur in market economies such that demand increases for some jobs skills while other job skills become outmoded and are no longer in demand. For example, the invention of the automobile increased demand for automobile mechanics and decreased demand for farriers (people who shoe horses).
·Frictional Unemployment - This type of unemployment occurs because of workers who are voluntarily between jobs. Some are looking for better jobs. Due to a lack of perfect information, it takes times to search for the better job. Others may be moving to a different geographical location for personal reasons and time must be spent searching for a new position.
·Cyclical Unemployment - This occurs due to downturns in overall business activity.
As previously noted, full employment does not equate to zero unemployment. Some unemployment is normal in a market economy and is actually expected as part of an efficient labor market. Full employment is defined as the level of employment that occurs when unemployment is normal, taking into account structural and frictional factors.
The natural rate of unemployment is that amount of unemployment that occurs naturally due to imperfect information and job shopping. It is the rate of unemployment that is expected when an economy is operating at full capacity. At this time in the U.S., the natural rate of unemployment is considered to be about 5%.
Look Out!
The concepts of "full employment" and "natural rate of unemployment" are used extensively in macroeconomics - make sure you understand these concepts! |
Posted by Muhammad Atif Saeed | |
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The civilian labor force is defined as those who have jobs or are seeking a job, are at least 16 years old and are not serving in the military. A person who does not have a job, is available for work and is actively seeking work is considered to be unemployed.
Key labor market indicators include: - The Labor Force Participation Rate - This rate is calculated by dividing the number of people in the civilian labor force by the total civilian population of those 16 years old or older.
- The Unemployment Rate - This is computed by dividing the number of unemployed by the number of people in the civilian labor force. That number is multiplied by 100 and expressed as a percentage. Part-time workers are considered to be employed.
- The Employment/Population Ratio - This ratio is calculated by dividing the number of job-holding civilians who are at least 16 years old by the total number of people in the civilian population within the same age group. This ratio will tend to go higher during economic booms and lower during recessions.
There are several issues with calculating the unemployment rate. The handling of discouraged workers is one point of contention. This phrase describes workers who are without a job but are not actively seeking a job because they have gotten discouraged about their job search. Such people would not be officially counted as unemployed, although this is a point of contention. Another area of dispute has to do with the inclusion of part-time workers as employed. Some believe that they should not be counted as employed, especially those who would prefer to work full-time. Due to definitional disputes with the unemployment rate, many economists prefer to use the employment/population ratio, which uses numbers that are easily measured and are well defined.
Generally unemployment is higher during a recession. Employment usually does not pick up until after the economy is coming out of a recession; it is usually regarded as a "lagging indicator" for the health of the economy.
GDP, Real Wages and Aggregate Hours WorkedWe cannot simply look at the number of people with jobs when examining the total quantity of labor in an economy. Some workers only have part-time jobs, while others work more than the standard work-week. Aggregate hours, which is the total number of hours worked by all employees, is a better measure of the quantity of labor.
The number of aggregate hours worked should increase with GDP. Data pertaining to aggregate hours in the United States is maintained by the U.S. Department of Labor Bureau of Labor Statistics.
Changes in real wage rates can be calculate by dividing nominal wages by the GDP deflator. Data for real wages in the United States is also maintained by the Bureau of Labor Statistics.
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I. The Business Cycle
Phases of the Business CycleEconomies usually have long-term secular trends, such as a certain rate of expansion for the labor force and/or the general population. One feature of market economies is that economic activity sometimes rises above the long-term trend line, while at other times it falls below.
Figure 4.2
A business peak, or boom, occurs when unemployment is low, incomes are high and businesses are operating at full capacity. When aggregate economic conditions began to slow, the business cycle is said to be in a contraction, or recessionary phase. Sales begin to fall, and unemployment starts to rise. The low point of the contraction phase is called the recessionary trough. The business cycle begins the expansionary phase after the low point is reached and business conditions began to improve. Business sales improve, and the unemployment rate begins to decline. Another boom will follow, and the cycle will begin anew.
Conditions during the low point are referred to as a recession. Many economists define a recession as being a decline in Gross Domestic Product over two or more quarters. Severe recessions (both in length of time and severity of the contraction) are referred to as depressions.
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I. Economic Rent
Economic Differences of Small and Large IncomesThese differences are best explained by the concept of marginal revenue product, which we discussed earlier in the chapter. Remember that marginal revenue product of a resource is defined as the increase in a firm's total revenue attributable to employing one more unit of that resource. The increase in output due to adding one more resource unit is called the marginal product. The relationship between additional resources and output implies that skilled laborers are three times as productive as unskilled labor, and therefore, firms are willing to pay skilled laborers three times as much as unskilled labor.
Keeping this in mind, workers with large incomes are associated with a high marginal revenue product, while those with small incomes are associated with a low marginal revenue product. For example, a star baseball pitcher (skilled labor) will have a high marginal revenue product, while a dishwasher (unskilled labor) will have a low marginal revenue product. Very few people are qualified to pitch in Major League Baseball, while there are many people qualified to wash dishes.
Economic Rent and Opportunity CostsEconomic rent is the difference between what an owner of a factor of production (such as land, capital or labor) receives and the opportunity cost for that owner.
Let's suppose the factor of production is labor. In this example, the laborer receives $20/per hour for their job, and the minimum salary they'd be willing to work for (opportunity cost) is $16/per hour. This $4/hour difference is the laborer's economic rent. In the case of the superstar baseball pitcher, most of the salary earned may be economic rent. Most of a wages of a dishwasher is opportunity cost, since these types of jobs pay minimum wage.If the factor of production is a plot of land, the supply curve would be perfectly vertical, since there is no way for the landowner to supply additional land. In this case, all money received is economic rent.
The size of economic rent received by a owner of a factor of production is determined by the elasticity of supply for that particular good or service.
- If the elasticity of supply is neither elastic nor inelastic, the supply curve will slope upward and the supplier's income would be split between economic rent and opportunity cost.
- If the elasticity of supply is inelastic, the supply curve would be perfectly vertical and the supplier's entire income would be comprised of economic rent. For example, if the supply were a particular plot of land, or a
- If the elasticity of supply is elastic, the supply curve would be perfectly horizontal, and the supplier's entire income would be comprised of opportunity cost.
Look Out!
Do not confuse "economic rent" with "rent". The rent paid each month to live in an apartment, or to lease a car is not the same. Remember that economic rent is simply a component of the income received by a supplier of a good or service. |
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Macro Economics
Physical vs. Financial Capital
The term physical capital applies to the stock of buildings, equipment, instruments, raw materials, semi-finished and finished goods in inventory, and other physical objects used by a firm to produce its goods and/or services.
Financial capital includes the resources used to purchase those physical objects; those resources come from savings. Interest represents the price of capital; the actual market interest rate will be the rate at which the supply of capital is equal to the quantity of capital demanded.
Comparing the Future Marginal Revenue Product of Capital with Future Capital PricesA firm needs to examine the future marginal revenue product of capital when making a decision to employ more capital. The firm converts the value of those future income streams to a value in the present. Present value is the current worth of a future income stream, discounted to reflect the fact that a dollar in the future is worth less than a dollar today. The general form of the present value calculation is:
Formula 4.2
present value = future value / (1 + r)
Where: "r" represents the relevant interest rate
Note that if future value stays the same, and interest rates decrease, future value increases. As interest rates decline, more investments of capital become profitable to the firm, and the quantity of capital demanded will increase.
Main Influences on the Demand & Supply of CapitalThe main influences on the demand for capital are:
·the interest rate·expectations concerning future business conditions - if firms believe that future business conditions will be poor, they will be less likely to make investments
The main influences on the supply of capital are:
·the interest rate·income - as incomes increase, people generally save a larger proportion of their income·expectations about future income - if people expect their income to decline, then they will tend to save more now so as to even out their consumption. College students will tend not to be savers, as they usually expect their future incomes to be significantly higher than the present.
The equilibrium interest rate will tend to fluctuate over time. Population changes, technological changes, and expectations are some of the factors that will influence the demand and/or supply for capital.
Renewable and Non-renewable ResourcesRenewable natural resources (a form of physical capital) are those resources that tend to be replenished by nature. Examples include water or solar energy. Non-renewable natural resources are not available (for practical purposes) once they are used. Examples include natural gas, oil, and coal.
The basic principle regarding the equilibrium for non-renewable natural resources is that the price of the resource today should be equal to the present value of the next period's expected price for the same resource. Essentially, the prices for a non-renewable resource are expected to increase at a rate equal to the interest rate.
Suppose an oil producer expects prices for oil to be lower in the future. A profit-maximizing oil producer would try to sell as much oil in the present, and then invest the proceeds. If the price of oil is expected to increase at a rate greater than the interest rate, then the oil producer should let as much oil as possible stay in the ground.
Keep in mind that prices for non-renewable resources do not exactly follow this pattern because the future is always uncertain. Technological changes and political uncertainties are some of the many factors that make forecasting price changes difficult.
Posted by Muhammad Atif Saeed | |
Posted in
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Macro Economics
I. Components of Marginal Product and Marginal Revenue
Marginal ProductThe marginal product is the change in output that occurs when one more unit of input (such as a unit of labor) is added.
Marginal RevenueMarginal revenue is the increase in total revenue that occurs with the production of one more unit of output.
Value of Marginal ProductFor a particular resource, the value of marginal product (VMP) is the resource's marginal product multiplied by the product price.
Marginal Revenue ProductThe marginal revenue product of a resource is defined as the increase in a firm's total revenue attributable to employing one more unit of that resource. The increase in output due to adding one more resource unit is called the marginal product. The marginal revenue product is calculated as the marginal product times the marginal revenue.
The Relationship Between MRP and DemandDue to the law of diminishing returns, we expect that both the marginal product and the marginal revenue product for an input will decline as more of the input is deployed.
A firm seeking to maximize profit will increase employment of a variable input unit until the MRP of that input is just equal to what it pays for the input. This rule will be followed by price takers and price searchers.
As the price of an input goes up, fewer units of that resource will generate the MRP needed to entice the firm to employ that resource. The demand curve for a resource will be downward sloping, as shown in figure 4.1 below:
Figure 4.1: Results of Regulating Price and Output
Values for the demand curve will depend upon the price of the good being produced, the productivity of the resource in question, and the amount of other resources used by the firm.
A profit-maximizing firm will continue to employ units of a resource as long as the MRP associated with the unit exceeds the firm's cost. If we assume the units of each resource are perfectly divisible, then the following conditions will apply to a firm with 3 production inputs (A, B, and C).
MRPa=Pa
MRPb =Pb
MRPc= Pc
Pa is equal to the price (or wage rate) of resource A, Pb is equal to the price (or wage rate) of resource B, and Pc is equal to the price (or wage rate) of resource C.
Suppose resource A represents highly skilled labor and resource B represents labor with low skills. If a firm can get 100 units of additional output by purchasing $500 worth of highly skilled labor and only 50 additional units of output by hiring $500 worth of labor with low skills, then per unit costs will be reduced by hiring the highly-skilled labor. Expenses can always be reduced by substituting resources with relatively high marginal product per dollar spent for resources that have a relatively low marginal product per dollar. This substitution will continue to occur if per unit costs are to be minimized until the following relationship is achieved:
MRPa = MRPb = MRPcinan-------- -------- --------
Pa Pb Pc
Note that this relationship also implies that if skilled laborers are three times as productive as unskilled labor, then firms will be willing to pay skilled laborers three times as much as unskilled labor.
Posted by Muhammad Atif Saeed | |
Posted in
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Macro Economics
There are many limitations to using GDP as a way to measure current income and production. Major ones include:
Changes in quality and the inclusion of new goods - higher quality and/or new products often replace older products. Many products, such as cars and medical devices, are of higher quality and offer better features than what was available previously. Many consumer electronics, such as cell phones and DVD players, did not exist until recently.
·Leisure/human costs - GDP does not take into account leisure time, nor is consideration given to how hard people work to produce output. Also, jobs are now safer and less physically strenuous than they were in the past. Because GDP does not take these factors into account, changes in real income could be understated.
·Underground economy - Barter and cash transactions that take place outside of recorded marketplaces are referred to as the underground economy and are not included in GDP statistics. These activities are sometimes legal ones that are undertaken so as to avoid taxes and sometimes they are outright illegal acts, such as trafficking in illegal drugs.
·Harmful Side Effects - Economic "bads", such as pollution, are not included in GDP statistics. While no subtractions to GDP are made for their harmful effects, market transactions made in an effort to correct the bad effects are added to GDP.
·Non-Market Production - Goods and services produced but not exchanged for money, known as "nonmarket production", are not measured, even though they have value. For instance, if you grow your own food, the value of that food will not be included in GDP. If you decide to watch TV instead of growing your own food and now have to purchase it, then the value of your food will be included in GDP.
Alternative Measures of Domestic IncomeOther than GDP and GNP, there are alternative measures of domestic income, such as national income, personal income and disposable personal income.
National IncomeNational income is computed by subtracting indirect business taxes, the net income of foreigners, and depreciation from GDP. It represents the income earned by a country's citizens. National income can also be computed by summing interest, rents, employee compensation (wages and benefits), proprietors' income and corporate profits.
·Personal income represents income available for personal use. It is computed by making various adjustments to national income. Social insurance taxes and corporate profits are subtracted from national income, while net interest, corporate dividends and transfer payments are added.
·Disposable personal income (or disposable income) is income available to people after taxes; i.e., it is personal income less individual taxes.
