MEASURING AGGREGATE
ECONOMIC ACTIVITY
National Income Accounting
• Why measure?
• National income accounting
– A way of measuring total, or aggregate production.
• Gross Domestic Product (GDP)
– The total value of all final goods and services produced
in an economy in a one-year period.
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Calculating GDP
• Adding together millions of goods and services.
• Adding apples and oranges
– All of the quantities of goods and services produced
are multiplied (weighted) by their market price per
unit to determine a value measure of that good or
service.
• The sum of all of these values is GDP.
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The Expenditure Approach
• GDP is the sum of four categories of
expenditures.
GDP = C + I + G + (X – M)
• Consumption
• Investment
– Includes inventories
• Government Spending
– Valued at cost
– Excludes transfer payments
• Net exports
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CALCULATING GDP
Suppose that consumption is $1150, investment is $400, and government
purchases are $500. Exports are $100 and imports are $150. How much is
Gross Domestic Product?
GDP = C + I + G + (X – M) by substitution,
GDP = 1150 + 400 + 500 + (100-150)
GDP = $2000
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GDP IN THE U.S. vs. BELGIUM
GDP
= C + I + G + Exports - Imports
U.S.
$14,000 B = 70% + 17% + 19% + 11% - 17%
Belgium $365 B = 53% + 21% + 23% + 87% - 84%
Flows vs. Stocks
• Flows
– Involves a time period
– GDP is reported on an annualized basis
– About $14 Trillion ($14,000,000,000,000)
• Stocks
– An amount at a point in time
– Wealth accounts—assets minus liabilities
– About $50 Trillion ($50,000,000,000,0000)
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GDP Measures Final Output
• Final vs. Intermediate goods and services
– Final output – goods and services purchased for final use.
– Intermediate products are used as an input in the
production of some other product.
• GDP counts only final goods and services
• Counting both final and intermediate goods would
result in double counting.
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Two Ways of Eliminating Double
Counting
• Calculate only final output.
– A firm would report how much it sold to consumers and how
much it sold to producers (intermediate goods).
• Follow the value added approach.
– Value added is the increase in value that a firm contributes to
a product or service.
– It is calculated by subtracting intermediate goods (the cost of
materials that a firm uses to produce a good or service) from
the value of its sales.
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Value Added Approach
Participants
Farmer
Cone factory
and ice
Cream maker
Middleperson
Vendor
Totals
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Cost of
Materials
$ 0
Value of
Sales
$ 100
Value Added
100
250
150
250
400
$ 750
400
500
$1,250
150
100
$500
$ 100
What is Counted in GDP?
• Not counted
– Value of resold goods
– Government transfer payments
– Sales of stocks or bonds
– Non-market transactions---e.g., work of
housespouses
• Counted
– Value added by a used car dealer
– Commissions of stock brokers
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GDP and NDP
• Net domestic product is GDP adjusted for
depreciation – the amount of capital used up in
producing that year’s GDP.
NDP = C + (I – depreciation) + G + (X-M)
• NDP measures output available for purchase.
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GDP AND GNP
• Gross Domestic Product (GDP)
– Total value of all final goods and services produced in
country in a one-year period.
• Gross National Product (GNP)
– Total value of all final goods and services produce by the
citizens and businesses of a country in a one- year.
• When is the difference important?
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The Income Approach
• Aggregate income is the total income earned by
citizens and businesses in a country in a year.
• Aggregate income consists of:
–
–
–
–
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employee compensation
rent paid to households (But not to businesses)
interest paid to households (But not to businesses)
profits
The Income Approach
• United States
Aggregate Income
$14 Trillion
Employee compensation
70%
Rents
1%
Interest
5%
Profits
24%
Income = Expenditures
• Whenever a good or service is produced
(output), somebody receives income for
producing it.
• Aggregate Income = Aggregate Production
• Profit is a residual that makes income and
expenditures equal.
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Comparing GDP Among Countries
• Per capita GDP
– Used to compare relative standards of living among various
countries.
– Because of differences in nonmarket activities and
difference in product prices, per capita GDP may be a
misleading measure of living standards.
• Purchasing power parity
– Adjusts for relative price differences before making
comparisons.
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Economic Welfare Over Time
• If increases in GDP are due to increases in prices, then
welfare does not increase.
• Changes in welfare over time are best indicated by
changes in real GDP, nominal GDP adjusted for inflation.
Nominal GDP
Real GDP 
 100
GDP deflator
• And
% ∆ in Nominal GDP = % ∆ in Real GDP + inflation
CALCULATING REAL GDP
Suppose that in year 1 nominal GDP is $1200; in year 2, $1300. The GDP deflator
is 110 and 115, respectively. Find the change in nominal GDP. How much of the
change is due to a real increase in output and how much is due to price changes?
1300 - 1200
%nominal GDP 
 100  8.3%
1200
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115 - 110
%price 
 100  4.5%
110
%nominal GDP  %real GDP  inflation
8.3%  %real GDP  4.5%
%real GDP  3.8%
Limitations of National Income
Accounting
• GDP measures economic activity, not welfare.
– GDP does not measure happiness, nor does it measure
economic welfare.
– Non-market activities are not included
• Subcategories are often interdependent.
– For example, the line between consumption and
investment may be unclear.
• Measurement problems exist.
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Genuine Progress Indicator
• The genuine progress indicator (GPI) makes
a variety of adjustments to GDP to better
measure the progress of society rather than
just economic activity.
• The GPI includes social goals such as
pollution reduction, education, and health.
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