Chapter 20
GROSS DOMESTIC
PRODUCT ACCOUNTING
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Economic Principles
The circular flow of resources,
goods, and services
The circular flow of money
The expenditure approach to
measuring GDP
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Economic Principles
The income approach to measuring
GDP
The relationship between GDP,
NDP, and national income
The limitations of GDP as a
measure of economic well-being
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Gross Domestic Product
Accounting
Circular flow of goods, services, and
resources
• The movement of goods and services from
firms to households, and of resources from
households to firms.
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EXHIBIT 1
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THE CIRCULAR FLOW OF GOODS,
SERVICES, AND RESOURCES
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Exhibit 1: The Circular Flow of
Goods, Services, and Resources
1. What do households supply to the
resource market?
• Households supply their resources—labor,
capital, land, entrepreneurship—to the firms in
the resource market.
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Exhibit 1: The Circular Flow of
Goods, Services, and Resources
2. What do firms provide to households
in the product market?
• Firms provide households with goods and
services in the product market.
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Gross Domestic Product
Accounting
Circular flow of money
• The movement of income in the form of
resource payments from firms to
households, and of income in the form of
revenue from households to firms.
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EXHIBIT 2
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THE CIRCULAR FLOW OF MONEY
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Exhibit 2: The Circular Flow of Money
What do firms in the resource market
pay to households for resources
provided?
• Firms pay money in the form of wages,
interest, rent and profit to households for
resources supplied.
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Two Approaches to Calculating GDP
• Economists calculate GDP in two
ways: the expenditure approach to
GDP and the income approach to GDP.
• Regardless of which method is used,
the values should be equivalent.
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The Expenditure Approach
Expenditure approach
• A method of calculating GDP that adds all
expenditures made for final goods and services
by households, firms and government.
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The Expenditure Approach
When using the expenditure approach
to GDP, one must be certain that only
final goods and services are counted.
Otherwise, goods may be double
counted.
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The Expenditure Approach
Final goods
• Goods purchased for final use, not for resale.
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The Expenditure Approach
Intermediate goods
• Goods used to produce other goods.
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The Expenditure Approach
Value added
• The difference between the value of a good
that a firm produces and the value of the
goods the firm uses to produce it.
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EXHIBIT 3
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MARKET VALUE AND VALUE ADDED OF
GOODS PRODUCED
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Exhibit 3: Market Value and
Value Added Goods Produced
1. What is the total market value of
the wool sweater in Exhibit 3?
• The total market value is $94.
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Exhibit 3: Market Value and
Value Added Goods Produced
2. Why shouldn’t the total market value
be used when calculating GDP?
• The total market value counts the original
resource multiple times.
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Exhibit 3: Market Value and
Value Added Goods Produced
2. Why shouldn’t the total market value
be used when calculating GDP?
• For example, the $4 value for wool on the
sheep makes up part of the $13 value for
wool fabric and $50 value for a wool sweater.
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The Expenditure Approach
There are four expenditure categories
of GDP:
1. Personal consumption
2. Gross private domestic investment
3. Government purchases
4. Net exports
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The Expenditure Approach
1. Personal consumption expenditures
(C):
• All goods and services bought by households.
These expenditures are grouped into categories
of durable goods, nondurable goods, and
services.
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The Expenditure Approach
1a. Durable goods:
• Goods expected to last at least a year. For
example, refrigerators, automobiles, and
washing machines.
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The Expenditure Approach
1a. Durable goods:
• During recessions, consumers tend to hang
on to their durable goods, so that sales of new
durable goods are relatively weak. During
times of prosperity, consumers are more likely
to discard old durables, and sales of new
durables are strong.
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The Expenditure Approach
1b. Nondurable goods:
• Goods expected to last less than a year. For
example, food, clothing, gasoline and
toiletries. Households spend more on
nondurables than on durables.
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The Expenditure Approach
1c. Services:
• Productive activities that are instantaneously
consumed. For example, medical care, a
lecture, and appliance repair. Households
spend more on services than durable and
nondurable goods combined.
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The Expenditure Approach
2. Gross private domestic investment
(I):
• The purchase by firms of plant, equipment, and
inventory goods.
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The Expenditure Approach
2. Gross private domestic investment
(I):
• Plant (or new structure) and equipment
purchases may either replace worn out plants
and equipment or increase the quantity of
plants and equipment.
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The Expenditure Approach
2a. Inventory investment:
• Stocks of finished goods and raw materials
that firms keep in reserve to facilitate
production and sales.
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The Expenditure Approach
3. Government purchases (G):
• All goods and services bought by
government. For example, goods such as
national defense materials, interstate
highway, and post offices, and services such
as justice and education.
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The Expenditure Approach
4. Net exports (X – M):
• An economy’s exports to other economies,
minus its imports from other economies.
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The Expenditure Approach
All final goods and services that
make up GDP, then, can be expressed
in the form:
GDP = C + I + G + (X – M)
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EXHIBIT 4
EXPENDITURE APPROACH TO 2008 GDP
($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008.
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Exhibit 4: Expenditure Approach to
2008 GDP ($ billions)
1. What was the largest category of
GDP expenditure in 2008?
• The largest category was personal consumption
expenditures at $10,053.7 billion.
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Exhibit 4: Expenditure Approach to
2008 GDP ($ billions)
2. Why was the net exports category
of expenditure negative in 2008?
• The category was negative (–$717.9 billion)
because the value of U.S. imports was greater
than the value of U.S. exports.
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EXHIBIT
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EXPANDED CIRCULAR FLOW: INCOME
AND EXPENDITURE APPROACHES TO GDP
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The Income Approach
Income approach
• A method of calculating GDP that adds all the
incomes earned in the production of final
goods and services.
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The Income Approach
National income
• The sum of all payments made to resource
owners for the use of their resources.
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The Income Approach
The income payments are arranged
into five categories: (1) the
compensation of employees, (2)
interest, (3) corporate profit, (4) rental
income, and (5) proprietors’ income.
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The Income Approach
The compensation of employees is
divided into two categories: wages
and salaries and supplements.
Supplements (or fringe benefits)
include such things as bonuses, paid
vacations, and contributions to
employees’ Social Security.
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The Income Approach
Corporate profit represents the return
to owners of incorporated firms.
Corporate profit is divided into three
categories—dividends, corporate
reinvestment, and corporate taxes.
All three are included in the income
approach to GDP.
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The Income Approach
Rent is the payment for use of
property. Although most people don’t
pay themselves rent for using their
own property, the rent is still estimated
in GDP accounting. Net rental income
is total rental income minus
depreciation.
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The Income Approach
Proprietors’ income is the income
earned by unincorporated firms for
the goods and services they produce.
Proprietors’ income is the net income
after paying such expenses as rent,
utilities, and supplies.
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EXHIBIT 5
2008 NATIONAL INCOME ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008.
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Exhibit 5: 2008 National Income
($ billions)
What was the largest category of
income in the U.S. in 2008 according
to Exhibit 5?
• Compensation of employees was by far the
largest category of income at $8,110.7 billion,
or 64.9 percent of the national income.
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Bringing GDP and National
Income into Accord
GDP, according to Exhibit 4, was
$14,201 billion in 2008. Yet national
income, according to Exhibit 5, was
only $12,481.3 billion.
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Bringing GDP and National
Income into Accord
In order to bring the two into accord,
first gross domestic product is
converted to gross national product.
Then depreciation of capital and
indirect business taxes are subtracted
from gross national product.
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Bringing GDP and National
Income into Accord
Gross National Product (GNP)
• The market value of all final goods and
services in an economy produced by
resources owned by people of that economy,
regardless of where the resources are located.
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Bringing GDP and National
Income into Accord
While GDP measures location, GNP
measures ownership. For example,
the value of goods produced by a
U.S.-owned firm in Spain are not
counted in our GDP, but are counted
in our GNP.
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Bringing GDP and National
Income into Accord
Capital depreciation
• The value of existing capital stock used up in
the process of producing goods and services.
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Bringing GDP and National
Income into Accord
Net Domestic Product (NDP)
• GDP minus capital depreciation.
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Bringing GDP and National
Income into Accord
Indirect business taxes include
general sales taxes, excise taxes,
customs duties and license fees.
They are indirect because they are
taxes levied not on the firms directly,
but on the goods and services.
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EXHIBIT 6
THE RELATIONSHIP BETWEEN GROSS
DOMESTIC PRODUCT, GROSS NATIONAL
PRODUCT, NET NATIONAL PRODUCT, AND
NATIONAL INCOME: 2008 ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008.
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Exhibit 6: The Relationship
Between GDP, GNP, Net
National Product, and National
Income: 2008
How is national income derived from
gross domestic product?
• First, GDP is converted to GNP. This is done by
subtracting factor payments to the rest of the
world and adding factor payments from the
rest of the world.
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Exhibit 6: The Relationship
Between GDP, GNP, Net
National Product, and National
Income: 2008
How is national income derived from
gross domestic product?
• Second, capital depreciation is subtracted
from GNP. The result is net national product.
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Exhibit 6: The Relationship
Between GDP, GNP, Net
National Product, and National
Income: 2008
How is national income derived from
gross domestic product?
• Third, indirect business taxes are subtracted
from net national product. The result is
national income.
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Personal Income and Personal
Disposable Income
Personal income
• National income, plus income received but
not earned, minus income earned but not
received.
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Personal Income and Personal
Disposable Income
Transfer payments
• Income received but not earned. For example,
government-supplied income from retirement
benefits, veteran benefits, unemployment
insurance benefits, disability payments and
subsidies to farmers.
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Personal Income and Personal
Disposable Income
Transfer payments
• The government transfers income from
taxpayers (who earned the income in the first
place) to those receiving benefits.
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Personal Income and Personal
Disposable Income
Disposable personal income
• Personal income minus direct taxes.
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EXHIBIT 7
U.S. ECONOMIC PERFORMANCE, 1998–2005
(CURRENT AND CONSTANT $,
BASE YEAR ¼ 2000; AND PERCENT)
Source: Economic Report of the President, Washington, D.C., 2006, Statistical Tables. Except for the per capita data, all other data are in billion
of U.S. dollars.
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Exhibit 7: U.S. Economic
Performance, 1998–2005
1. Looking at GDP, national income,
personal income, or personal
disposable income, the annual rate
of growth is?
• Over 6 percent. Adjusting for price changes
over the 25 years reduces GDP growth rate
3.1 percent per year.
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Exhibit 7: U.S. Economic
Performance, 1998–2005
2. But is it a does GDP really measure
everything produced in the
national economy?
• It is a quite legitimate means of
measurement. The point is knowing and
understanding what measure we are using
and why we use it.
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How Comprehensive Is GDP?
GDP tries to measure everything that
appears on the market. Yet, not
everything produced in the economy
gets onto the market, and some
things that contribute to our
economic well-being aren’t even
produced.
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How Comprehensive Is GDP?
The value of housework is one
example of an important service that
is usually not included in GDP. The
work is only included if it is
performed by someone outside the
household, such as a housekeeper,
nanny, or cook.
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How Comprehensive Is GDP?
Underground economy
• The unreported or illegal production of goods
and services in the economy that is not
counted in GDP.
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EXHIBIT 8
UNDERGROUND ECONOMIES, SELECTED
COUNTRIES (PERCENT OF GDP)
Source: The Tax Foundation, Washington, D.C., 2006. Data compiled by
Friedrich Schneider, Johannes Kelper University (Linz, Austria).
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Exhibit 8: Underground
Economies, Selected Countries
Why would socially conscious and
law-abiding societies such as
Sweden and Switzerland have larger
underground economies?
• Taxes and other government regulation may
create an irresistible temptation.
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How Comprehensive Is GDP?
Illegal unreported activities may
include drug trafficking, money
laundering, bribery, prostitution,
illegal gambling, fraud and burglary.
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How Comprehensive Is GDP?
Tax avoidance is the main reason
why legal activities may go
unreported. Swapping services or
simply understating the value of
income earned are two ways to avoid
paying taxes.
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How Comprehensive Is GDP?
Finally, legal and illegal immigrants
may work for less than minimum wage
at off-the-books entry-level jobs.
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How Comprehensive Is GDP?
The quality of goods and services
produced may not be included in
GDP. For example, a good may be of
higher quality, but cost less, than a
similar good. The economic value of
the improved quality good is not
recorded.
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How Comprehensive Is GDP?
The costs of environmental damage
are another factor not taken into
account in GDP.
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How Comprehensive Is GDP?
While the expense associated with
cleaning up the pollution we create
contributes to GDP, the actual
pollution created is not subtracted
from GDP.
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How Comprehensive Is GDP?
Many economists agree that despite
the exclusion of some forms of
economic value, our measure of GDP
is sufficiently comprehensive to be a
reliable indicator of changes in the
overall performance of the economy.
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