Chapter 6
Measuring National Output and National
Income
CHAPTER OUTLINE
Gross Domestic Product
Final Goods and Services
Calculating GDP
The Expenditure Approach
The Income Approach
Nominal versus Real GDP
Calculating Real GDP
Calculating the GDP Deflator
Limitations of the GDP Concept
GDP and Social Welfare
Measuring National Output and National Income
national income and product accounts Data collected and published by the
government describing the various components of national income and output
in the economy. http://www.bea.gov/
While there are literally thousands of variables in the national income and
product accounts, in this chapter we discuss only the most important.
Aggregate Production is Measured by
Gross Domestic Product (GDP)
• Gross Domestic Product (GDP) is the:
– total value of all final goods and services
produced for the marketplace during a
given period, within the nation’s borders.
• Total value…
– GDP is measured in dollar values (P x Q)
3
Production and GDP
• …of all final…
– final means goods and services sold to
their final user
 side note- Intermediate goods
– goods that are inputs for the production of final
goods
– Value of intermediate goods is included in the
value of final products
• …goods and services…
• Goods: tangibles
• Services: intangibles
4
Production and GDP
• …produced…
– not included: land, stocks and bonds used
goods … are not produced
• …for the marketplace…
– with the intention of being sold
• …during a given period…
– a specific period of time (annual/quarter)
• …within a nation’s borders
– regardless of who owns the resources
5
Intermediate and Final Good
Tires taken from that pile and mounted on the wheels of
the new car before it is sold are considered intermediate
goods.
Tires taken from that pile to replace tires on your old car
are considered final goods.
If we included the value of the tires (an intermediate good)
on new cars and the value of new cars (including the tires),
we would be double counting.
Tracking and Reporting GDP
• GDP is a flow variable
– Flow variable: measures a rate of
production
• $40 billion worth of output each day
• $1.2 trillion each month
• $14.5 trillion for the year
• In general, flow variables are measured
per unit of time
Tracking and Reporting GDP
• Annualization
– The government reports GDP as an
annual rate
– But, it is measured and reported (as an
annual rate) each quarter
Annualized data for GDP, real GDP, and growth rate, by quarters
Self test - How do we calculate the 3.8%
real GDP growth rate for 2010-II?
Tracking and Reporting GDP
• Nominal variable
– A variable measured without adjustment
for price changes
– Nominal GDP
• Real variable
– A variable adjusted for changes in prices
– Real GDP
Tracking and Reporting GDP
• Comparing variables measured in dollars
over time
– It is important to translate nominal values
to real values
• Annual growth rate of real GDP
– Reported quarterly
– Annualized
Value Added
value added The difference between the value of goods as they leave
a stage of production and the cost of the goods as they entered that
stage.
In calculating GDP, we can sum up the value added at each stage of
production or we can take the value of final sales. We do not use the
value of total sales in an economy to measure how much output has
been produced.
TABLE 6.1 Value Added in the Production of a Gallon of
Gasoline (Hypothetical Numbers)
Stage of Production
Value of Sales
Value Added
$3.00
$3.00
(2) Refining
3.30
0.30
(3) Shipping
3.60
0.30
(4) Retail sale
4.00
0.40
(1) Oil drilling
Total value added
$4.00
What’s Not Included in GDP
•
Non-market goods and services such as chores performed
at home by family members.
•
Underground activities, both legal and illegal such as legal
unrecorded activities paid for in cash or illegal gambling
•
Sales of used goods (no production)
•
Financial transactions such as trading of stocks and bonds
(no production)
•
Government transfer payments: a payment to a person that
is not for goods and services currently supplied such as
social security (no production)
13
Exclusion of Output Produced Abroad
by Domestically Owned Factors of Production
• GDP is the value of output produced by factors of
production located within a country.
• Output produced by a country’s citizens,
regardless of where the output is produced, is
measured by gross national product (GNP).
GNP versus GDP
• Gross National Product (GNP):
total income earned by the nation’s
factors of production, regardless of
where located
• Gross Domestic Product (GDP):
total income earned by domesticallylocated factors of production,
regardless of nationality.
GNP versus GDP
• GNP = GDP + (payments received by U.S
owned factors of production from abroad)
less (payments made to foreign ownd factors of
production)
• (GNP - GDP) = (factor payments from abroad)
less (factor payments to abroad)
GNP versus GDP
• Payments received by U.S. factors of production from
abroad include:
- wages earned by U.S. citizens working abroad
- profits earned by U.S.-owned businesses
located abroad
- income (interest, dividends, rent) generated from the
foreign assets owned by U.S. citizens
• Payments to foreign factors of production include:
- wages earned by foreign workers in the U.S.
- profits earned by foreign-owned businesses located
in the U.S.
- income (interest, dividends, rent) that foreigners earn
on U.S. assets
(GNP – GDP) as a percentage of GDP
for selected countries, 1997.
U.S.A.
Bangladesh
Brazil
Canada
Chile
Ireland
Kuwait
Mexico
Saudi Arabia
Singapore
0.1%
3.3
-2.0
-3.2
-8.8
-16.2
20.8
-3.2
3.3
4.2
Calculating GDP
expenditure approach A method of computing GDP that
measures the total amount spent on all final goods and
services during a given period.
income approach A method of computing GDP that
measures the income—wages, rents, interest, and profits—
received by all factors of production in producing final
goods and services.
The Expenditure Approach
There are four main categories of expenditure:
Personal consumption expenditures (C): household spending on
consumer goods
Gross private domestic investment (I): spending by firms and
households on new capital, that is, plant, equipment, inventory, and
new residential structures
Government consumption and gross investment (G)
Net exports (EX − IM): net spending by the rest of the world, or
exports (EX) minus imports (IM)
GDP = C + I + G + (EX − IM)
TABLE 6.2 Components of U.S. GDP, 2012: The Expenditure Approach
Billions of Dollars
Personal consumption expenditures (C)
Durable goods
Nondurable goods
Services
Gross private domestic investment (l)
Nonresidential
Residential
Change in business inventories
Government consumption and gross
investment (G)
Federal
State and local
Net exports (EX – IM)
Exports (EX)
Imports (IM)
Gross domestic product
11,119.5
Percentage of GDP
70.9
1,218.8
2,563.0
7,337.7
2,059.5
7.8
16.3
46.8
13.1
1,616.6
382.4
60.6
3,063.6
10.3
2.4
0.4
19.5
1,214.2
1,849.4
−566.7
7.7
11.8
−3.6
2,179.7
2,746.3
15,676.0
Note: Numbers may not add exactly because of rounding.
13.9
17.5
100.0
Personal Consumption Expenditures (C)
personal consumption expenditures (C) Expenditures by
consumers on goods and services.
durable goods Goods that last a relatively long time, such as cars and
household appliances.
nondurable goods Goods that are used up fairly quickly, such as food
and clothing.
services The things we buy that do not involve the production of
physical things, such as legal and medical services and education.
Items not included in C:
• Imported consumption goods and components
• New home construction
Items included in C even though households
don’t actually buy them
• Total value of food products produced on farms
that are consumed by the farmers and their
families themselves
• Total value of housing services provided by
owner-occupied homes
EC ON OMIC S IN PRACTICE
Where Does eBay Get Counted?
eBay’s business is to provide a marketplace for exchange. In doing so, it uses
labor and capital and creates value.
In return for creating this value, eBay charges fees to the sellers that use its
site. The value of these fees enter into GDP.
Items that people sell on eBay do not contribute to current GDP. The cost of
finding an interested buyer for those goods, however, does get counted.
THINKING PRACTICALLY
1. John has a 2009 Honda Civic. In 2013, he sells it to Mary for $10,000.
Is that $10,000 counted in the GDP for 2013?
2. If John is an automobile dealer, does that change your answer to Question 1 at all?
Gross Private Domestic Investment (I)
gross private domestic investment (I) Total investment in capital—that is,
the purchase of new housing, plants, equipment, and inventory by the private
(or nongovernment) sector.
nonresidential investment Expenditures by firms for machines, tools, plants,
and so on.
residential investment Expenditures by households and firms on new houses
and apartment buildings.
change in business inventories The amount by which firms’ inventories
change during a period. Inventories are the goods that firms produce now but
intend to sell later.
Change in Business Inventories
GDP = Final sales + Change in business inventories
Gross Investment versus Net
Investment
depreciation The amount by which an asset’s value falls in a given
period.
gross investment The total value of all newly produced capital goods
(plant, equipment, housing, and inventory) produced in a given period.
net investment Gross investment minus depreciation.
capitalend of period = capitalbeginning of period + net investment
Government Expenditures (G)
government purchases (G) Spending by federal, state,
and local governments on goods and services and
government investment in bridges, highways, etc.
government outlays
Government purchases plus transfer payments
Transfer payments
• Money redistributed from one group of citizens
(taxpayers) to another (the poor, the unemployed, the
elderly)
• not associated with production of goods and services
• included in government budgets as outlays
• not included in the government purchase component of
GDP
Net Exports (EX − IM)
net exports (EX − IM) The difference between exports (sales to
foreigners of U.S.-produced goods and services) and imports (U.S.
purchases of goods and services from abroad). The figure can be
positive or negative.
Factor Payment (Income) Approach to GDP
Factor payments
– Payments to the owners of resources that are
used in production
Factor payments approach: Called The Income
Approach
GDP = sum the factor payments earned by all
households in the economy (wages and salaries,
rent, interest, and profit)
Total output of the economy (GDP) = total
income earned in the economy
Total expenditure (GDP) = total income
earned in the economy
29
Why does expenditure = income
In every transaction,
the buyer’s expenditure becomes the seller’s
income.
Thus, the sum of all expenditure equals
the sum of all income.
Simple Circular Flow
Income($)
Labor
Households
The circular flow diagram shows
the income received and
payments made by each
sector of the economy.
Goods(bread)
Expenditure($)
Firms
Nominal versus Real GDP
current dollars The current prices that we pay for goods and services.
nominal GDP Gross domestic product measured in current dollars.
weight The importance attached to an item within a group of items.
Calculating Real GDP
TABLE 6.6 A Three-Good Economy
(1)
(2)
Production
Year 1 Year 2
Q1
Q2
(3)
(4)
Price per Unit
Year 1 Year 2
P1
P2
(5)
GDP in
Year 1 in
Year 1
Prices
P1 × Q1
(6)
GDP in
Year 2 in
Year 1
Prices
P1 × Q2
(7)
GDP in
Year 1 in
Year 2
Prices
P2 × Q1
(8)
GDP in
Year 2 in
Year 2
Prices
P2 × Q2
$0.50 $0.40
$3.00
$5.50
$2.40
$4.40
Good A
6
11
Good B
7
4
0.30
1.00
2.10
1.20
7.00
4.00
Good C
10
12
0.70
0.90
7.00
8.40
9.00
10.80
$12.10
$15.10
$18.40
$19.20
Total
Nominal
GDP in
year 1
Nominal
GDP in
year 2
base year The year chosen for the weights in a fixed-weight procedure.
fixed-weight procedure A procedure that uses weights from a given base year.
Calculating Real GDP
Nominal GDP measures the value of all
final goods and services using current
prices.
Real GDP measures the value of all final
goods and services using the prices of a
base year.
Real GDP controls for inflation
Changes in nominal GDP can be due to:
 changes in prices (P)
 changes in quantities of output produced (Q)
 Remember: total sales = P x Q
Changes in real GDP can only be due to changes in
quantities (Q), because real GDP is constructed
using constant base-year prices. P is held
constant
Example - Calculation of Real GDP
(NOTE: Numerical Calculation of Real GDP presented in
this and the next 4 slides is not covered in the text)
2009
2010
2011
P
Q
P
Q
P
Q
good A
$30
900
$31
1,000
$36
1,050
good B
$100
192
$102
200
$100
205
Compute nominal GDP in each year
Compute real GDP in each year using 2009 as
the base year.
Example - Calculation of Real GDP
Nominal GDP multiply P & Q from same year
2009: $46,200 = $30  900 + $100  192
2010: $51,400 = $31 x 1000 + $102 x 200
2011: $58,300 = $36 x 1050 + $100 x 205
Real GDP multiply each year’s Q by 2009 P
2009: $46,200 = $30 x 900 + $100 x 192
2010: $50,000 = $30 x 1000 + $100 x 200
2011: $52,000 = $30  1050 + $100  205
GDP Deflator
The inflation rate is the percentage increase in the
overall level of prices.
One measure of the price level is
the GDP Deflator, defined as
Nominal GDP
GDP deflator = 100 
Real GDP
Self Test
Nominal GDP
Real GDP
2009
$46,200
$46,200
2010
51,400
50,000
2011
58,300
52,000
GDP
deflator
inflation
rate
n.a.
Compute the GDP deflator in each year.
Use GDP deflator to compute the inflation rate from
2009 to 2010, and from 2010 to 2011.
Answers
Nom. GDP
Real GDP
GDP
deflator
inflation
rate
2009
$46,200
$46,200
100.0
n.a.
2010
51,400
50,000
102.8
2.8%
2011
58,300
52,000
112.1
9.05%
Calculate the growth rate in NGDP for 2011.
Calculate the Growth rate in RGDP for 2011.
Inflation rate and growth rate is a percent
change
Inflation rate and growth rate in 2011 -
Calculating the GDP Deflator
Policy makers not only need good measures of how real
output is changing but also good measures of how the
overall price level is changing.
The GDP deflator is one measure of the overall price level.
However, the fixed-weight procedure has flaws such as it
ignores the substitution away from goods whose prices are
increasing and toward goods whose prices are decreasing
or increasing less rapidly.
How GDP Is Used
Short-run – Business cycle
• recession
• expansion
Long-run – Trend growth
• Measure the long-run growth rate of the
economy’s output
44
The Business Cycle
+3%
peak
-2%
+4%
trough
Over time, real GDP fluctuates around an overall long-run upward
trend. Such fluctuations are called business cycles. When output rises,
we are in the expansion phase of the cycle; when output falls, we are in
a recession.
LIMITATIONS OF THE GDP CONCEPT
GDP AND SOCIAL WELFARE
If crime levels went down, society would be better off,
but a decrease in crime is not an increase in output
and is not reflected in GDP.
An increase in leisure is also an increase in social
welfare, but sometimes associated with a decrease
in GDP.
Most nonmarket and domestic activities, such as
housework and child care, are not counted in GDP
even though they amount to real production.
LIMITATIONS OF THE GDP CONCEPT
Underground (informal) economy - the part of the
economy in which transactions take place and in
which income is generated that is unreported and
therefore not counted in GDP.
distribution of income - GDP also has nothing to
say about the distribution of output among
individuals in a society.
pollution – environmental deterioration is not
subtracted out.
Looking Ahead
This chapter has introduced many key variables in which macroeconomists are
interested, including GDP and its components.
There is much more to be learned about the data that macroeconomists use.
In the next chapter, we will discuss the data on employment, unemployment,
and the labor force.
In later chapters, we will discuss the data on money and interest rates.
Finally, we will discuss in more detail the data on the relationship between the
United States and the rest of the world.
REVIEW TERMS AND CONCEPTS
base year
GDP
change in business inventories
GDP deflator
compensation of employees
gross investment
corporate profits
gross national product (GNP)
current dollars
gross private domestic investment (I)
depreciation
income approach
disposable personal income, or after-tax
income
indirect taxes minus subsidies
durable goods
intermediate goods
expenditure approach
national income
final goods and services
national income and product accounts
fixed-weight procedure
government consumption and gross
investment (G)
informal economy
REVIEW TERMS AND CONCEPTS
net exports (EX − IM)
real GDP
net investment
rental income
net national product (NNP)
residential investment
nominal GDP
services
nondurable goods
value added
nonresidential investment
Expenditure approach to GDP: GDP =
C + I + G + (EX − IM)
personal consumption expenditures (C)
personal income
personal saving
personal saving rate
GDP = Final sales + Change in
business inventories
capitalend of period = capitalbeginning of period +
net investment