Notes Chapter 7.doc - Chapter 7 GDP and CPI Tracking the...

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Chapter 7 GDP and CPI: Tracking the Macroeconomics 7.1 The National Accounts Almost all countries calculate a set of numbers known as the national income and product accounts . The national income and product accounts, or national accounts, keep track of the flows of money between different parts of the economy. 7.1.1 The Circular-Flow Model A circular flow of funds connects the four sectors of the economy—households, firms, government , and the rest of the world —via three types of markets: the factor markets, the markets for goods and services , and the financial markets . The arrows show the direction of funds. [Figure 7] In the markets for goods and services , funds flow from the government and households to firms to pay for purchases of goods and services. Exports to the rest of the world generate a flow of funds into the economy and imports lead to a flow of funds out of the economy. Funds flow from firms to households in the form of wages , interest on bonds , dividends on stocks , and rent on land through the factor markets . After paying taxes to the government and receiving government transfers, households allocate the remaining income— disposable income—to private savings and consumer spending. A stock is a share in the ownership of a company held by a shareholder. If you hold stocks for a firm, you are one of the owners of the firms. You enjoy the firm’s profits by earning dividends. You share the success and failure of the firm (the value of the stocks you hold keeps changing correspondingly). 1
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A bond is borrowing in the form of an IOU that pays interest. If you hold bonds issued by a firm, you are lending money to the firm. You receive interest payments periodically and your principle back when the bond expires/matures. In addition, households receive government transfers (such as social security payments, unemployment compensation, and welfare checks, etc. ) from the government. Disposable income , income plus government transfers minus taxes, is available to spend on consumption or to save. Private savings , equal to disposable income minus consumer spending, is disposable income that is not spent on consumption. Via the financial markets , private savings and funds from the rest of the world (foreign lending and purchases of stocks) are channeled into investment spending by firms, government borrowing, as well as foreign borrowing and sales of stocks. Government purchases of goods and services ( G ) is paid for by tax receipts, as well as by government borrowing . If we add up consumer spending on goods and services, investment spending by firms, government purchases of goods and services, and exports, then subtract the value of imports, the total flow of funds represented by this calculation is total spending on final goods and services produced in the United States. Equivalently, it’s the value of all the final goods and services produced in the United States—that is, the gross domestic product of the economy .
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