Chapter 24
Measuring Domestic Output
and National Income
Objectives
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Define and measure GDP
GDP and income relationships
The nature and function of a GDP price
index
The difference between nominal GDP and
real GDP
Some limitations of the GDP measure
Assessing the Economy’s
Performance

National income accounting measures the
economy’s performance by measuring the flows of
income and expenditures over a period of time.

National income accounts serve a similar purpose
for the economy, as do income statements for
business firms.
Assessing the Economy’s
Performance

Consistent definition of terms and measurement
techniques allows us to use the national accounts in
comparing conditions over time and across
countries.

The national income accounts provide a basis for
appropriate public policies to improve economic
performance.
Gross Domestic Product (GDP)

Gross Domestic Product:
 Measures total production in an economy.
 Is the market value of all the final goods and
services produced within a country in a given time
period (usually one year).
 The US Department of Commerce is in charge of
measuring U.S. GDP, and measures it quarterly.
Gross Domestic Product
Four things to note about the definition of GDP:
1. Value Produced: GDP is measured using market
values, not quantities.
 To measure total production, we must add together the
production of apples and oranges, for example.
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Which is the greater total production:100 apples and 50
oranges or 50 apples and 100 oranges?
To answer that question, we need to value items at their
market value-at the prices at which the items are traded
in markets.
By using market prices to value production, we can add
the apples and oranges together.
Gross Domestic Product
2. What produced: GDP includes only the market
value of final goods or services.
 Final good or service: A good or service purchased
by a final user.
 Intermediate good or service: A good or service that
is used as a component of a final good or service.
 The same good can be either final or intermediate
depending on how it is used. For example, a Ford car
is a final good, but a Firestone tire that Ford buys and
installs on the car is an intermediate good. But if you
by a replacement Firestone tire for your car, the tire is
then a final good.
Gross Domestic Product
3.
4.
Where produced: Only goods and services that are
produced within a country count as part of that
country’s GDP. For example, Nike Corporation, a US
firm, produces sneakers in China; the market value of
those shoes is part of China’s GDP, not part of US
GDP.
When produced: GDP measures the value of
production during a given time period. This time period
is either a quarter or a year. The Federal Reserve and
others use the quarterly GDP data to keep track of the
short-term evolution of the economy, and economists
use the annual GDP data to examine long-term trends.
Measuring GDP
 Two ways of looking at GDP: Spending and
Income.
1. What is spent on a product is income to those who
helped to produce and sell it.
2. This is an important identity and the foundation of
the national accounting process.
Measuring GDP: Expenditures
Approach
1.
GDP is divided into the categories of buyers in the
market: household consumers, businesses,
government, and foreign buyers.
The four components of GDP are:
Personal Consumption Expenditures: Consumption
 Consumption (C): Spending by households on
goods and services, not including spending on
new houses.
 In particular, it includes durable goods (lasting 3
years or more), nondurable goods and services.
Measuring GDP: Expenditures
Approach
2.
Gross Private Domestic Investment: Investment
 Investment (I): Spending by firms on new
factories, office buildings, machinery, and
inventories, and spending by households on new
houses.
 Changes in business inventory.
i.
ii.
If total output exceeds current sales, inventories
build up.
If businesses are able to sell more than they
currently produce, this entry will be a negative
number.
Measuring GDP: Expenditures
Approach
2.

Gross Private Domestic Investment: Investment
Net Private Domestic Investment


Each year as current output is being produced,
existing capital equipment is wearing out and buildings
are deteriorating; this is called depreciation or
consumption of fixed capital.
Gross Investment minus depreciation (consumption of
fixed capital) is called net investment.
Measuring GDP: Expenditures
Approach
Government Consumption and Gross Investment:
Government Purchases
3.
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Government purchases (G): Spending by federal,
state, and local governments on goods and services.
This entry excludes transfer payments since these
outlays do not reflect current production.
Net Exports of Goods and Services: Net Exports
4.
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Net exports (NX): Exports minus imports.
Exports (X): Expenditures by foreigners for U.S. goods
produced domestically
Imports (M): Dollar amount of our purchases of foreign
products
Measuring GDP: Expenditures
Approach
Putting all the components together, we have the
following identity:
GDP = Y = C + I + G + NX
Shortcomings in GDP as a
Measure of Total Production

Household Production is not included.


Household production: Goods and services people
produce for themselves.
The Underground Economy is not accounted for

Underground economy: Buying and selling of goods
and services that is concealed from the government to
avoid taxes or regulations or because the goods and
services are illegal.
Shortcomings of GDP as a Measure
of Well-Being
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The value of leisure is not included in GDP
GDP is not adjusted for negative effects of
production such as pollution
GDP is not adjusted for other social indicators such
as crime, illiteracy, life expectancy
Equity: A large GDP per capita does not mean that
the wealth of a nation is shared equally.
Other National Accounts

Net domestic product (NDP) is equal to GDP minus
depreciation (consumption of fixed capital).

National income (NI) is income earned by
American-owned resources here or abroad. Adjust
NDP by adding net foreign factor income. (Note:
This may be a negative number if foreigners earned
more in U.S. than American resources earned
abroad.)
Other National Accounts

Personal income (PI) is income received by
households. To calculate, take NI minus payroll
taxes (social security contributions), minus corporate
profits taxes, minus undistributed corporate profits,
and add transfer payments.

Disposable income (DI) is personal income less
personal taxes (personal Income taxes, personal
property taxes, and inheritance taxes)

Households divide their disposable income between
consumption and saving
Nominal versus Real GDP
What matters to people is the real value of money
or income - its purchasing power-not the “face”
value of money or income.
 Nominal GDP: The value of final goods and
services evaluated at current year prices.


Nominal GDP is the dollar value of an economy’s final
output measured at current market prices.
Real GDP The value of final goods and services
evaluated at base year prices.

Real GDP is an estimate of the value of an economy’s final
output, adjusting for changes in the overall price level.
Nominal versus Real GDP
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Valid comparisons cannot be made with nominal
GDP alone, since both prices and quantities are
subject to change. Some method to separate the
two effects must be devised.
The adjustment process in a one-good economy
(1st method)
One method is to first determine a price index, and
then adjust the nominal GDP figures by dividing by
the price index (in hundredths)
Nominal versus Real GDP
First, determine the GDP Price Index

It measures the average level of prices for some
specified set of goods and services, relative to the
prices in a specified base year.
Price
Index
In Given
Year
=
Price of Market Basket
In Specific Year
Price of Same Basket
In Base Year
x 100
Note that the price index = 100 at the base year.
Nominal versus Real GDP
Then, use the price index to determine real GDP
Real
GDP
=
Nominal GDP
Price Index (in hundredths)
We inflate when prices fall
We deflate when prices rise
Nominal versus Real GDP
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The adjustment process in a one-good economy
(2nd method)
An alternative method is to gather separate data on
the quantity of physical output and determine what it
would sell for in the base year. The result is Real
GDP. The price index is implied in the ratio:
Nominal GDP/Real GDP. Multiply by 100 to put it in
standard index form.
U.S. GDP Over Time
Real vs. Nominal GDP (Base = 2000) 1990-2004
Comparative GDP
Selected Nations GDPs, 2007
GDP in Trillions of Dollars
0
1
2
3
4
5
6
7
United States
Japan
Germany
China
United Kingdom
France
Italy
Canada
Spain
Brazil
Russia
India
South Korea
Mexico
Australia
Source: World Bank
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10
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