National-Income
Accounting
Chapter 5
McGraw-Hill/Irwin
©2008 The McGraw-Hill Companies,
All Rights Reserved
Chapter Overview
Part 2: Measuring Macro Outcomes:
5. National-Income Accounting:
6. Unemployment
7. Inflation
2
Chapter Overview
5. National-Income Accounting:
1. Measures of Output (Review of GDP, +…).
2. The Uses of Output
(Review: GDP = C+I+G+(X-M)).
3. Measures of Income.
3
1. Measures of
Output
(Review of GDP).
4
Measures of Output
National-income accounting:
the measurement of aggregate
economic activity,
particularly national income and its
components.
These are Macroeconomic
measures.
Why are economists interested in
these measures? …
5
Gross Domestic Product (GDP)
Gross domestic product (GDP):
is the total dollar value of final output
produced within a nation’s borders in a
given time period.
LO1
6
Gross Domestic Product (GDP)
Each good and service produced and
brought to market has a price.
That price serves as a measure of
value for calculating total output.
LO1
7
GDP Versus GNP
GDP:
geographically focused,
includes all output produced within a
nation’s borders, …
regardless of whose factors of
production are used to produce it
(foreign or domestic).
LO1
8
GDP Versus GNP
GNP - Gross National Product :
the old standard of measure,
refers to output produced by Americanowned factors, regardless of location
GDP is the new standard of measure
since 1992.
GNP is dead I
say! - It’s over!
LO1
9
International Comparisons
The geographic focus of GDP facilitates
international comparisons of economic
activity.
LO1
10
GDP per Capita
REVIEW:
GDP per capita:
total GDP divided by total population
(average GDP).
commonly used as a measure of a
country’s standard of living.
11
World GDP per Capita
12
GDP per Capita
However:
Measures of per capita GDP tell us
nothing about the way GDP is actually
distributed or used,
It is only a statistical average.
13
Measurement Problems
The methods of calculating GDP
create several problems:
Non-market activities.
Unreported income.
Value added (double counting).
Price fluctuations (real vs. nominal).
14
Non-Market Activities
15
Non-Market Activities
GDP measures exclude most goods
and services produced that are not
sold in the market.
This causes GDP to be understated.
Exclusion of non-market activities
causes problems when:
comparing living standards over time,
or between countries.
LO1
16
Unreported Income
17
Unreported Income
The GDP statistics fail to capture
market activities that are not reported
to tax or census authorities.
The underground economy is
motivated by tax avoidance or to
conceal illegal activities.
LO1
18
Value Added
19
Value Added
The production of most goods and
services involves a series of stages.
To accurately measure GDP we must
distinguish between two types of
goods:
intermediate goods, and…
final goods.
This avoids what in the accounting
field is known as “double counting.”
LO1
20
Value Added in Various Stages of
Production
(Pg. 91)
Stages of Production
1. Farmer grows wheat, sells it
to miller
Value of
Transactions
Value Added
$0.12
$0.12
2. Miller mills wheat to flour,
sells it to baker
0.28
0.16
3. Baker bakes bagel, sells it
to bagel store
0.60
0.32
4. Bagel store retails bagel to
consumer
0.75
0.15
$1.75
$0.75
Total
LO1
21
Value Added
Intermediate goods:
goods or services purchased for use as
inputs in the production of final goods
or services.
Value added:
the increase in the market value of a
product that takes place at each stage
of the production process.
LO1
22
Two Ways to Calculate GDP
1. Compute the value of the final
output.
2. Count only the value added at each
stage of production.
LO2
23
Value added
Stages of Production
Transaction Value
Value Added
1. Logger produces logs for
the sawmill:
$500
$500
2. Sawmill produces lumber
for the furniture factory:
$1,200
$700
3. Furniture factory produces
furniture for the Store:
$5,000
$3,800
4. Store sells furniture to the
Public:
$7,500
$2,500
Total Value of Transactions:
$14,200
$7,500
24
Real Versus Nominal GDP
25
Computing Real GDP
Inflation:
the increase in the average level of
prices of goods and services.
Inflation distorts comparisons of GDP
over time.
Nominal vs. Real GDP accounting for inflation.
26
Computing Real GDP
A base period is picked to be the time
period used for comparative analysis.
It is the basis for the indexing of price
changes.
28
Computing Real GDP
29
Computing Real GDP
The general formula for computing
real GDP is:
nominal GDP in year t
Real GDP in year t =
price index
$13,245 billion
Real GDP in 2006 =
 $12,822 billion
103.3
(2005 prices)
100
30
Computing Real GDP
31
Computing Real GDP
(Pg. 92)
Base year
2005
1. Nominal GDP (in billions)
$12,456
2. Change in nominal GDP
3. Change in the price level, 2005 to 2006
4. Real GDP in 2005 dollars
5. Change in real GDP
2006
$13,245
+ $789
Index value = 103.3
$12,456
3.3%
$12,822
+ $366
32
Changes in GDP: Nominal Versus
Real
33
Nominal to Real GDP
Year
1997
1998
1999
2000
2001
2002
2003
2004
2005
GDP Deflator
89
92
96
100
101
104
111
118
126
Nominal GDP
312
397
452
521
537
596
676
719
814
(Billions $)
Nom. Change
85
55
69
16
59
80
43
95
(Billions $)
Real GDP
(Billions $)
Real Change
351
432
81
470
38
521
51
531
10
573
42
609
36
609
0
646
37
(Billions $)
nominal GDP in year t
Real GDP in year t =
price index
34
Chain-Weighted Price
Adjustments
Chain-weighted indices use a
moving average of price levels in
consecutive years as an inflation
adjustment.
You won’t be tested on chainweighted indices.
LO3
35
Net Domestic Product (NDP)
Now let’s make an ADJUSTMENT to
GDP:
LO3
36
Net Domestic Product (NDP)
Example situation:
You produce
You’ve got
– $1,000
↑
Wore out
LO3
Produced→
$10,000
(GDP)
37
Net Domestic Product (NDP)
We can’t produce as much
output next year unless…
… we replace the
capital we use-up this
year.
Depreciation:
- the consumption of capital in the
production process.
(the wearing out of plant and equipment).
LO3
38
Net Domestic Product (NDP)
Depreciation
Depreciation
GDP
GDP
NDP
New
Capital
Stock
Depreciation
Old
Capital Stock
40
Net Domestic Product (NDP)
Net Domestic Product is what we’ve
produced (GDP), minus the capital
we’ve worn out (depreciation).
NDP = GDP – depreciation
The amount of output we (C+G) could
consume without reducing our stock of
capital.
LO3
41
Net Domestic Product
Depreciation
Depreciation
GDP
GDP
NDP
Depreciation
Capital
Stock
Old
Capital Stock
42
Gross vs. Net Investment
Investment:
production of new plant, equipment, and
structures (capital),…
…plus changes in business inventories,
…and new residential construction.
LO3
43
Gross vs. Net Investment
The difference between GDP and NDP is
mirrored by the difference between gross
investment and net investment:
Gross investment:
- total investment expenditure in a
given time period.
Net investment:
= gross investment – depreciation
LO3
44
Net Investment
Total capital
stock has
increased
Dep.
Gross
I
Investment
G
The change in
our capital stock
GDP
NDP
(positive)
C
Gross
Investment
New Old
Capital
Capital
Stock
Stock
Net Investment
Gross
Depreciation
Investment
Depreciation
45
Net Investment
Gross Inv.
Depreciation
Gross
I
Investment
Total capital
stock has
decreased
G
GDP
NDP
C
Depreciation
Capital
Stock
Depreciation
Depreciation
Gross Inv.
Net
Investment
(negative)
46
2. The Uses
of Output
( Re: C+I+G+(X-M) )
48
The Uses of Output
The 4 major uses of total output
parallel the four sets of market
participants:
Households – consumption (C) = 70%
Business Firms – investment (I) = 17%
Government – gov’t spending (G) = 20%
Foreigners - net exports (X-M) = –7%
49
3. Measures of
Income.
55
Measures of Income
GDP accounts have two sides.
Expenditures – the demand side.
Income – the supply side.
LO2
56
Measures of Income
Income = Output
…so…
Income = GDP
By charting the flow of income
through the economy, we see FOR
WHOM our output is produced.
LO2
57
The Circular Flow (pg. 44)
Goods and services
demanded
Product
markets
Goods and services
supplied
Business
Firms
Consumers
Factors of
production supplied
Factor
markets
Factors of
production demanded
58
Income = Output
(Pg. 97)
VALUE OF OUTPUT
VALUE OF INCOME
Consumer spending
Wages
Investment spending
Government spending
Product
market
Profits
Interest
Rent
Net exports
Taxes
LO2
Factor
market
Depreciation
Allowances
59
The Equivalence of Expenditure
and Income
(2006 data in billions of dollars) (Pg. 98)
Expenditure
Consumer goods and
services
Investment in plant,
equipment, and
inventory
Government goods
and services
Exports
Imports
Total value of output
LO2
Income
$9,269
2,212
2,527
1,466
(2,229)
$13,245
Wages and salaries
Corporate profits
Proprietors’ income
Farm income
Rents
Interest
Sales taxes
Depreciation
Statistical
discrepancy
Total value of
income
$7,489
1,070
1,015
20
164
583
740
1,576
70
$13,240
60
Measures of Income
Economists break down the nation’s
production into various measures of income:
GDP
NDP
NI
PI
DI
C
S
gross domestic product
net domestic product
national income
personal income
disposable income
consumption
savings
And don’t forget:
Net investment = gross investment - depreciation
LO2
61
Depreciation & Net Domestic Product
NDP = GDP – depreciation
LO3
63
National Income (NI)
National income (NI):
total income earned by current, domesticallyowned factors of production.
Wages, interest, and profits paid to foreigners are
not part of U.S. income.
They need to be subtracted from the income flow.
Incomes earned by U.S. citizens in other nations
represents an inflow of income to U.S. households
and are added.
This + & - is known as net foreign factor income.
LO3
64
National Income (NI)
Net foreign factor income =
+ Foreign wages earned by Americans
– American wages paid to foreigners
NI = NDP + net foreign factor
income
LO3
65
Personal Income (PI)
Personal income (PI):
the income received by HOUSEHOLDS
before payment of personal taxes.
Personal income (PI) = National income (NI),
– indirect bus. taxes,
– corporate taxes,
– retained earnings,
– Social Security taxes,
+ transfer payments,
+ net interest.
LO3
66
Disposable Income
Disposable income (DI):
the after-tax income of households.
It is PI minus personal (income) taxes.
It’s what’s left at the end for you and I to
spend.
Disposable income = personal income
– personal taxes
LO3
69
Measures of Income
Economists break down the nation’s
production into various measures of income:
GDP
NDP
NI
PI
DI
LO2
gross domestic product
net domestic product
national income
personal income
disposable income
70
Disposable Income
All disposable income is either:
consumed, or …
saved.
Saving:
disposable income less consumption;
(that part of disposable income not spent on
current consumption).
Disposable income = Consumption + Saving
LO3
71
The Flow of Income, 2006
(Pg. 99)
Income flow
Gross domestic product
(GDP)
Less depreciation
Net domestic product (NDP)
Plus net foreign factor
income
National Income (NI)
Amount
(in billions)
Income flow
Amount
(in billions)
$13,245
Less retained earnings
(391)
(1,576)
Less Social Security taxes
(945)
11,669
Plus transfer payments
1,602
54
Plus net interest
511
11,723
Personal income (PI)
11,514
Less personal (inc.) taxes
Less indirect business taxes
(751)
Disposable income
Consumption
Less corporate taxes
LO3
(235)
Saving
(1,361)
10,153
9,299
854
72
The Flow of Income
***What we produce (GDP) = Income
National Income Accounting
***GDP = C+I+G+(X-M)
Net Investment =
Gross Investment Depreciation
GDP
What we’ve produced (income) in our
borders, in total.
NDP
What we’ve produced (income) after
accounting for the capital we’ve used
up.
NI
What we’ve produced (income) after
depreciation, regardless of national
boundary.
PI
The gross income of households before
their income is taxed.
DI
Household income after taxes – what
we have leftover to spend.
- depreciation
+ net foreign factor income
- Indirect business tax
- Corporate tax
- Social Security tax
- Retained earnings
+ Transfer payments
+ Net interest
- minus personal taxes
Consumption
Savings
73
Problem 1
GDP
GDP
GDP
PI
DEP?
NDP
PI
GDP
GDP
PI
DI
PI
PI
NI
PI
74
Problem 2
GDP
GDP
GDP
PI
DEP?
NDP
PI
GDP
GDP
PI
DI
PI
PI
PI
NI
75
The Flow of Income
The dollar value of output will always
equal the dollar value of income.
LO2
77
The Flow of Income
Total income (GDP) ends up distributed in
the following way:
To households:
in the form of disposable income.
To businesses:
in the form of retained earnings and
depreciation allowances.
To government:
in the form of taxes.
LO2
78
Income and Expenditure
The flow of income that starts with
GDP ultimately returns to the market
in the form of:
new consumption (C),
investment (I), and …
government purchases (G).
LO2
79
Circular Flow of Spending and
Income
(Pg. 101)
LO2
80
Chapter Questions
1. The manuscript for this book was typed by
a friend. Had I hired a secretary to do the
same job, GDP would have been higher,
even though the amount of output would
have been identical. Why is this? Does
this make sense?
81
Chapter Questions
2. GDP I 1981 was $2.96 trillion. It grew to
$3.07 trillion in 1982, yet the quantity of
output actually decreased. How is this
possible?
82
Chapter Questions
3. If gross investment is not large enough to
replace the capital that depreciates in a
particular year, is net investment greater
or less than zero? What happens to our
production possibilities?
83
Chapter Questions
6. What jobs are likely part of the
underground economy?
7. How might the quality of life be adversely
affected by an increase in GDP?
84
National-Income
Accounting
End of Chapter 5
McGraw-Hill/Irwin
©2008 The McGraw-Hill Companies,
All Rights Reserved