sg05 - 5 Measuring a Nations Production and Income Chapter...

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5 Measuring a Nation’s Production and Income Chapter Summary You’ve probably read or heard headline news stories like “GDP growth is at 3%” or “GDP growth expected to slow.” In this chapter, you’ll learn what these numbers mean, who generates the numbers, and why they’re important to countries and their citizens. Here are the main points of the chapter: The primary measurement of a country’s output is called gross domestic product, or GDP. GDP is one of several acronyms you’ll learn in this chapter. GDP serves an important purpose, but has limitations because it doesn’t measure all of a country’s activities. Price changes from one year to the next affect GDP calculations. Economies experience business cycles in which an economy grows rapidly, followed by slowing growth, and then the economy grows rapidly again. Applying the Concepts After reading this chapter, you should be able to answer these three key questions: 1. How can we use economic analysis to compare the size of a major corporation to a country? 2. How do we determine when a recession has occurred in the United States? 3. Do increases in gross domestic product necessarily translate into improvements in the welfare of citizens? 5.1 The “Flip” Sides of Macroeconomic Activity: Production and Income Simply stated, production generates income. Workers go to work and produce goods and services. In exchange for their work they receive income. Firms take the goods and services produced by workers and sell them. Workers then take some of their income and spend it on newly produced goods and services. Production leads to income and income leads to production. Figure 5.1 illustrates this simple relationship between households and firms called the circular flow diagram. Households and firms participate in two markets: product markets, where final products and services are sold, and factor markets, where factors of production (such as labor and capital) are traded. Household income is created from the sale of factors of production. Revenue from the sale of goods and services generates income for the firms. Firms incur costs to pay for the factors they demand. Households
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Measuring a Nation’s Production and Income 63 have to pay for the goods they purchase. The green arrows show how income flows. The red arrows in Figure 5.1 show how goods and services flow. ± Study Tip A good way to understand the circular flow diagram is to look at the diagram from a transactions view. In other words, look at the transactions between income and goods. For example, look at the relationship between households and the factor market. You go to work and supply your time or labor to your employer. The employer in turn pays you income. Remember that markets are arrangements bringing buyers and sellers together.
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