Section 3- Module 10
MEASURING THE ECONOMY’S PERFORMANCE
BY J. A. SACCO
MODULE 10
The Simple Circular Flow
 National Income Accounting
 Three Main Methods of Measuring GDP

MEASURING THE ECONOMY’S PERFORMANCE
National Income Accounting : To measure a
nations income and its components. To measure
an aggregate performance.
This module deals with the methods of measuring
an economy's performance and economic activity
First need to look at the flow of goods and services from
businesses to consumers and payments from consumers to
businesses that constitutes economic activity.
THE CIRCULAR FLOW DIAGRAM
Two Markets
Product Market
Households
are the buyers
Businesses are the sellers
Households buy consumers
goods/services
Pay money to businesses for those
goods/services
Households create the demand
Businesses are the suppliers
Total Output- Total Monetary value
of all goods and services
Resource Market
Businesses are the buyers
Households are the sellers
Households sell their resources
such as labor, land, capital, and
entrepreneurship.
Businesses are the buyers of
these resources. These
expenditures (payments) become
income for households
Total Income- wages, rents,
interest, profits. The cost of
producing entire output of goods
and services
THE CIRCULAR FLOW OF
INCOME AND PRODUCT
Businesses
Households
THE CIRCULAR FLOW OF
INCOME AND PRODUCT
Businesses
Households
THE CIRCULAR FLOW OF
INCOME AND PRODUCT
Businesses
Households
THE CIRCULAR FLOW OF
INCOME AND PRODUCT
Businesses
Households
THE CIRCULAR FLOW OF
INCOME AND PRODUCT
Businesses
Households
THE SIMPLE CIRCULAR FLOW

Two Observations
1) In every economic exchange, the seller receives
exactly the same amount that the buyer spends
2) Goods and services flow in one direction and
money payments flow in the other.
Total Income = Total Output
THE SIMPLE CIRCULAR FLOW

Product Markets

Businesses
Households
Transactions in which
households buy goods
THE SIMPLE CIRCULAR FLOW

Final Goods and
Services

Businesses
Households
Goods and services
that are at their final
stage of production
and will not be
transformed into yet
other goods or
services
THE SIMPLE CIRCULAR FLOW

Factor Markets

Businesses
Households
Transactions in which
business buy
resources
THE SIMPLE CIRCULAR FLOW

Total Income

Businesses
Households
The yearly amount
earned by the nation’s
factors of production
THE SIMPLE CIRCULAR FLOW

Question

Businesses
Households
Why must total
income be identical to
the dollar value of
total output?
WHY THE DOLLAR VALUE OF OUTPUT MUST
ALWAYS EQUAL TOTAL INCOME?
Problem:


Total output (Product Market) = $1,000
Total income (Resource Market)- wages, rents, interest for
that output = $900
Why the discrepancy?
Profit
Always the residual item that makes
Total output = Total Income
GDP- THREE METHODS
Method 2Expenditure
Approach
Method 3Income
Approach
Method 1- Value Added
Approach
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NATIONAL INCOME ACCOUNTING

Gross Domestic Product (GDP)
 The
total market value of all final goods and services
produced by factors of production located within a
nation’s borders during a given period .
 GDP measures the dollar value of output
 GDP measures the dollar value of final goods and
services
 GDP is a Flow!
The key to calculating GDP is in determining
what is counted and what is not counted.
19
NATIONAL INCOME ACCOUNTING

Stress of Final Output
 What
is a final good?
 Wheat?
 Steel?
 Oil?
 Bread?
 Automobile?
 Gasoline?
NATIONAL INCOME ACCOUNTING

Intermediate Goods not counted!
 Goods
used up entirely in the production of final
goods
 Only final goods are counted in GDP. If you count
intermediate goods you are guilty of double
counting
 We must look at the value added (METHOD 1)
 The amount of dollars contributed to a product at
each stage of development, not the dollar value of
each sale.
GDP- VALUE ADDED APPROACH
Value Added Approach
SALES VALUE AND VALUE ADDED AT EACH
STAGE OF DONUT PRODUCTION
Stage of Production
Dollar Value of Sales
Value Added
$.01
Stage 1: Fertilizer and Seed
$.01
Stage 2: Growing
.02
Stage 3: Milling
.04
Stage 4: Baking
.10
Stage 5: Retailing
.15
Total dollar value of all sales
$.32
$.01
$.02
$.06
$.05
Total value added
$.15
Value added is what must be calculated!
NATIONAL INCOME ACCOUNTING
NOT INCLUDED – NOTHING BEING PRODUCED!
 Financial Transactions
1) Securities
 Stocks
and bonds
2) Government Transfer Payments
 Social
security
 Unemployment compensation
3) Private Transfer Payments
 Individual
gifts
 Corporate gifts
NATIONAL INCOME ACCOUNTING

Transfer of Secondhand Goods
 Why
not count the sale of a used car, stereo, or
snowboard as part of GDP?

Other Excluded Transactions
 Household
production
 Legal underground transactions
 Illegal underground transactions
What Should Be Included in GDP?










A painter purchases new paintbrushes for his business.
The services of an accountant.
A purchase of a new automobile.
A Social Security check paid to a retired worker.
The sale of a new home.
An increase in business inventories.
The government’s purchase of a new fighter jet.
Unemployment paid to a laid-off worker.
The wood the carpenter purchases to build a cabinet.
The money you get from your parents for cutting the lawn.
GDP-EXPENDITURE APPROACH
Method 2Expenditure
Approach
27
EXPENDITURE APPROACH

Expenditure Approach
A
way of computing national income by adding up
the dollar value at current market prices of all final
goods and services.
28
EXPENDITURE APPROACH
Businesses
Expenditure Approach
Households
29
EXPENDITURE APPROACH

Deriving GDP by the Expenditure Approach
 Consumption
Expenditure
(C)
Durables
Life
span of more than three years
Nondurables
Life span of less than three years
Services
Intangible commodities
30
TWO MAIN METHODS
OF MEASURING GDP

Deriving GDP by the Expenditure Approach
 Gross
Private Domestic Investment
 What
(I)
producers do to add to productive capacity
 The creation of capital goods, such as factories and
machines, that can yield production and hence
consumption in the future
31
TWO MAIN METHODS
OF MEASURING GDP

Deriving GDP by the Expenditure Approach
 Gross
Private Domestic Investment
 Fixed
(I)
Investment- Producer durables/capital goods
 Inventory Investment- Final product that is held in
inventory waiting to be sold. Hold inventories of their
product to meet future expected orders. Inventories
include all finished goods on hand, goods in process, and
raw materials. Counted towards present GDP but
subtracted when sold.
 New Residential Structures are part of I, not part of C.
32
TWO MAIN METHODS
OF MEASURING GDP

Deriving GDP by the Expenditure Approach
 Government
 State,
Expenditures
local, and federal
 Valued at cost
(G)
33
EXPENDITURE APPROACH

Deriving GDP by the Expenditure Approach
 Net
Exports (Foreign Expenditures)
(X-M)
Net exports ( X )  total exports - total imports
THE COMPONENTS OF GDP
Repetez: GDP is total spending. (Expenditure)
 Four components:

 Consumption
(C)
 Investment (I)
 Government Purchases (G)
 Net Exports (X-M)

These components add up to GDP (denoted Y):
Y = C + I + G + (X-M)
MEASURING U.S. GDP

The Expenditure Approach
Measures
GDP by using data on consumption
expenditure, investment, government expenditure on
goods and services, and net exports.
36
GDP AND ITS COMPONENTS
GDP BY THE INCOME APPROACH
Called GDI (Gross Domestic Income)
 We have looked at GDP through the “product
market” of the Circular Flow Diagram. Now look
at the Resource (Factor) Market or the Income
Approach to determine national accounting of
the macroeconomy.

GDI=GDP
38
TWO MAIN METHODS
OF MEASURING GDP

Income Approach
A
way of measuring national income by adding up
income received by all factors of production
39
GDP BY THE INCOME APPROACH
Income Approach
Businesses
Households
GDP- INCOME APPROACH
Method 3Income
Approach
GDP BY THE INCOME APPROACH

Gross Domestic Income (GDI)
1) Wages- All wages, salaries, incentive payments,
social security taxes of both employer/employee
2) Interest (Net Interest)
Interest Received ───
Interest Paid
• Savings accounts
Interest on mortgages
• CD’s
Credit Cards
• Interest Bearing Acc’ts
Loans
GDP BY THE INCOME APPROACH
3) Rent- All income earned by individuals for the
use of their assets
• Farms, Houses, Stores, royalties from
copyrights/patents, oil wells
4) Profits- Total Gross Corporate Profits plus
proprietor’s income or unincorporated
businesses such as sole proprietorships,
partnerships, and producer’s cooperatives.
GDP BY THE INCOME APPROACH
W+I+R+P
Actual factor payments made to owners of the
factors of production.
GDP AND GDI
Regardless: GDP
=
(Expenditure)
GDI
(Income)
GROSS DOMESTIC PRODUCT AND
GROSS DOMESTIC INCOME, 1998
(IN BILLIONS OF 1998 DOLLARS PER YEAR)
Expenditure Point of View--Product Flow
Expenditures by Different Sectors:
Household sector
Personal consumption expenses
$5,659.4
Government sector
Purchase of goods and services
1,466.4
Business sector
Gross private domestic investment
(including depreciation)
1,329.8
Foreign sector
Net exports of goods and services
-123.4
Gross Domestic Product
$8,332.2
GROSS DOMESTIC PRODUCT AND
GROSS DOMESTIC INCOME, 1998
(IN BILLIONS OF 1998 DOLLARS PER YEAR)
Income Point of View--Cost Flow
Domestic Income (at Factor Cost):
Wages
All wages, salaries, and supplemental
employee compensation
Rent
All rental income of individuals plus
implicit rent on owner-occupied dwellings
Interest
Net interest paid by business
Profit
Proprietorial income
Corporate profits before taxes deducted
Nonincome expense items
Indirect business taxes and other adjustments
Depreciation
Statistical discrepancy
Gross Domestic Product
$4,901.4
142.8
464.7
519.7
701.3
730.8
951.3
-79.8
$8,332.2