ECO 2013 Macroeconomics
Measuring Domestic Output, National Income and the Price
Level
Chapter 7
National Income Accounting
 Measures the economy’s overall performance
 Enables economists and policymakers to:
o Assess the health of the economy by comparing levels of
production at regular intervals
o Track the long run course of the economy to see whether it
has grown, been constant, or decline
o Formulate policies that will safeguard and improve the
economy’s health
Gross Domestic Product
The total market value of all final goods and services produced in a
given year.
 Monetary measure
 Avoid multiple counting
o Intermediate goods – are goods and services that are
purchased for resale or for further processing or
manufacturing
o Final goods - are goods and services that are purchased for
final use by the consumer, not for resale or for further
processing or manufacturing
 Excludes nonproduction transactions
o Those nonproduction transactions must be excluded from
GDP because they have nothing to do with the generation
of final goods.
o Nonproduction transactions are of two types:
 Purely financial transactions
 Secondhand sales
o Financial transactions
 Public transfer payments – these are the social
security payments, welfare payments, and veteran’s
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ECO 2013 Macroeconomics
payments that the government makes directly to
households.
 Private transfer payments - includes the money that
parents give children or cash gifts given. They
produce no output. They transfer funds from one
private individual to another and consequently do
not enter into the GDP
 Secondhand sales –

 Includes all production within the domestic economy whether
American or Foreign owned corporations
The Expenditure Approach
GDP = Consumption + Investment + Government + Net Exports
Consumption: purchases of durable and nondurable goods
Gross Private Domestic Investment:
 All final purchases of machinery, equipment, and
tools by business enterprises
 All construction
 Changes in inventories
o Increase in inventories
o Decrease in inventories
 Not include the transfer of paper assets or the resale of
tangible assets.
 Gross investment (GI) includes those goods that
replace old assets and any net additions to the
economy’s stock of capital
o Net investment = GI – depreciation
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Government Purchases:
 Expenditures for goods and services that government
consumes in providing public services
 Expenditures for social capital such as school
 Does not include government transfer payments
Net Exports:
 Exports minus Imports
 Exports are foreign sales of domestic produced goods
 Imports are domestic sales of foreign produced goods
The Income Approach
Sum of:
 Compensation for employees – the largest share of national
income
 Rents – income received by the households and business that
supply property resources
 Interest – money paid by private businesses to the suppliers
of money capital
 Proprietors’ Income - profits
 Corporate profits – are the earnings of the owners of
corporations. Three categories:
o Corporate income taxes – these taxes are levied on
corporations’ net earnings and flow to the government
o Dividends – these are the part of corporate profits that
are paid to the corporate stockholders
o Undistributed corporate profits – these are the money
saved by corporations to be invested later in new
plans and equipment.
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National Income to GDP
The national income accountants add together:
Employee compensation + rents + interest + proprietorships income +
corporate profit = National Income
National income is all the income that flows to American supplied
resources, whether here or abroad
To arrive at GDP we add:
 Indirect business taxes – include general sales taxes, excise
taxes, business property taxes, license fees, and customs
duties.
 Consumption of fixed capital (depreciation) – allowance for
the capital that is consumed in producing the year’s GDP
o Set aside to replace capital in the future
 Net foreign factor – composed of income from supplying
resources abroad an the income foreigners gain by supplying
resources in the US
Other national income accounts
 Net Domestic Product = GDP – consumption of fixed capital
o GDP does not make allowances for replacing the capital goods
used up in each year’s production.
o It does not tell us how much new output was available for
consumption and for additions to the stock of capital.
 National Income – how much Americans earned for their
contributions of land, labor, and capital.
o Net domestic product – indirect business taxes – net foreign
factor = national income
 Personal income – all income received whether earned or unearned
and received by households.
o National income – social security compensation – corporate
income taxes – undistributed corporate profits + transfer
payments
 Disposable income – is personal income less personal taxes.
o Personal income – personal taxes = disposable income
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ECO 2013 Macroeconomics
Nominal GDP and Real GDP
GDP measures the total spending on goods and services in all
markets in the economy.
If total spending rises from one year to the next, one of two
things must be true:
1. The economy is producing a larger output of goods and
services
2. Goods and services are being sold at higher prices.
So how can we determine which is correct. The way around the
problem is to DEFLATE GDP when prices rise and INFLATE
GDP when prices fall.
These adjustments give us a measure of GDP for various years
as if the value of the dollar had always been the same as it was
in some reference year.
GDP based on the prices that prevailed when the output was
produced is called unadjusted GDP or Nominal GDP.
Price index – is a measure of the price of a specified collection
of goods and services called a market basket in a given year as
compared to the price of an identical collection of goods and
services in a reference year.
Price index =
Price of market basket in specific year
Price of same market basket in base year
X 100
Real GDP - the production of goods and services valued at
constant prices.
REAL GDP = Nominal GDP
Price index
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Nominal GDP uses current prices to place a value on the
economy’s production of goods and services. Real GDP uses
constant base-year prices to place a value on the economy’s
production of goods and services.
Because real GDP is not affected by changes in prices, changes
in real GDP reflect only changes in the amounts being
produced. Thus, real GDP is a measure of the economy’s
production of goods and services.
Because real GDP measures the economy’s production of
goods and services, it reflects the economy’s ability to satisfy
people’s needs and desires.
Thus, real GDP is a better gauge of economic well being than is
nominal GDP.
The GDP Deflator
Measures the current level of prices relative to the level
of prices in the base year.
= Nominal GDP x 100
Real GDP
Measure the average level of prices in the economy.
Consumer Price Index
 Compiled by Bureau of Labor Statistics
 Commonly in the news
 Price of a market basket of some 300 consumer goods and
services that presumably are purchased by a typical urban
consumer.
Shortcomings of GDP
 Nonmarket transactions – services of homemakers
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 Leisure – increase in leisure time as increased the well being
of the people but GDP does not reflect well being
 Improved Product Quality – fails to take into account the
value of improvements in product quality
 The Underground Economy – value of unrecorded cash and
barter transactions. 798 billion
 The Environment – social costs of the negative by-products
reduce our economic well being.
 Composition and Distribution of Output – GDP does not tell
us whether the mix of goods and services is enriching or
potentially detrimental to society
 Per Capita Output -
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