CHAPTER 7
Measuring Domestic Output, National Income, and the Price Level
National Income Accounting measures the economy’s overall
performance. It does for the economy as a whole what private
accounting does for the individual firm or for the individual household.
One measure of the economy’s overall performance is the Gross Domestic
Product: the total market value of all final goods and services produced
in a given year. It includes all goods and services produced by either
citizen-supplied or foreign-supplied resources employed within the
country.
It is a monetary measure
We must avoid multiple counting so all final goods are valued, not
intermediate goods that go into making up other goods.
GDP does not include public transfer payments, private transfer payments,
stock market transactions or second hand sales.
We can determine GDP for a particular year either by adding
up all that was spent to buy total output or by adding up all
the money that was derived as income from creating the
output. The first way is called the Expenditure
Approach. The second way is called the Income
Approach.
GROSS DOMESTIC PRODUCT
Expenditures Approach
Consumption
by Households
Income Approach
Wages
+
Expenditures
+
Rents
+
Interest
+
Profits
+
Statistical
by Foreigners
Adjustments
+
Investment
G
by Businesses
=
=
D
+
Government
P
Purchases
EXPENDITURES APPROACH
Personal Consumption Expenditure ( C )
•Durable Consumer Goods
•Nondurable Consumer Goods
•Consumer Expenditures for Services
EXPENDITURES APPROACH
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
•Machinery, Equipment, and Tools
•All Construction
•Changes in Inventories
•Noninvestment Transactions
•Gross vs. Net Investment
•Net Private Domestic Investment
EXPENDITURES APPROACH
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
Government Purchases ( G )
•Expenditures for Goods & Services
•Expenditures for Social Capital
•Does NOT include Government
Transfer Payments
EXPENDITURES APPROACH
Personal Consumption Expenditure ( C )
Gross Private Domestic Investment ( Ig )
Government Purchases ( G )
Net Exports ( Xn)
Net Exports (Xn) = Exports (X) – Imports (M)
Consumption of households means personal consumption
expenditures.
Gross private domestic investment includes all final purchases of
machinery, equipment and tools, all construction, and changes in
inventories.
Government purchases on goods and services and social capital
such as schools and highways.
Net exports are total exports (what others buy from us) minus
imports (what we buy from others).
So, GDP=C+Ig+G+Xn
Income Approach
Wages + Rents + Interest +Proprietor’s Income and Corporate
Profits
THE INCOME APPROACH
•
•
•
•
•
Compensation of Employees
Rents
Interest
Proprietors’ Incomes
Corporate Profits
• Corporate Income Taxes
• Dividends
• Undistributed Corporate
Profits
The income approach adds together rents, interest,
proprietors’ income (all businesses not corporations),
corporate profits (income taxes, dividends, undistributed
corporate profits also called retained earrings)
All the above categories added together equal National
Income.
To get to GDP from National Income we must add in three
items: indirect business taxes (sales tax, excise tax,
business property tax, license fees, customs duties),
consumption of fixed capital, and the net foreign factor
income (National income includes all income no matter
where it was earned, but GDP only includes income earned
in the US so and adjustment must be made. It can be a
negative or positive factor. If foreigners earn more in US
than we do in other countries, we will add that amount to
get GDP.)
Other National Accounts
We can calculate Net Domestic Product. This is GDP minus consumption
of fixed capital.
From National Income, we must subtract net foreign factor income and
indirect business taxes from.
Personal Income includes all income received whether earned or
unearned so we must add in transfer payments and take out taxes such
as social security, corporate income taxes, undistributed corporate
profits.
Disposable Income is personal income less personal taxes.
Remember that GDP is a measure of the market value of all final goods
and services in a given year. But how can we compare market values
of GDP from year to year since prices change as well as quantity. We
must DEFLATE GDP from NOMINAL to REAL GDP. We determine
real GDP by deflating nominal or money values using a price index.
OTHER NATIONAL ACCOUNTS
U.S. GDP, NDP, NI, PI, & DI, 2002
Gross Domestic Product (GDP)
$10,446
Consumption of fixed capital
-1,393
Net Domestic Product (NDP)
$9,053
Net foreign factor income earned
in the U.S.
- 10
Indirect business taxes
-695
National Income (NI)
$8,348
Social security contributions
-748
Corporate income taxes
-213
Undistributed corporate profits
-141
Transfer payments
+1,683
Personal Income (PI)
$8,929
Personal Taxes
-1,113
Disposable Income (DI)
$7,816
NOMINAL GDP vs. REAL GDP
Nominal Values
• Deflate GDP when prices rise
• Inflate GDP when prices fall
• Nominal GDP
• Calculating Real GDP
(4)
(2)
(3)
(5)
Unadjusted,
(1)
Price Price Index or Nominal, Adjusted,
Units of Pizza
Year 1 =
Or Real,
GDP,
Year Output Per Unit
100
GDP
(1)x(2)
1
2
3
4
5
5
7
8
10
11
$ 10
20
25
30
28
100
200
250
-
$ 50
140
200
-
$ 50
70
80
-
NOMINAL GDP vs. REAL GDP
• Adjustment Process
• GDP Price Index
Price of market basket
in specific year
Price Index
in a given
year
=
Real GDP
Price of same market
basket in base year
=
Nominal GDP
Price Index
(in hundredths)
An Alternative Method
Price Index
(in hundredths)
=
Nominal GDP
Real GDP
x 100
SHORTCOMINGS OF GDP
•Nonmarket Activities
•Leisure
•Improved Product Quality
•The Underground Economy
•GDP and the Environment
•Composition and
Distribution of Output
•Noneconomic Sources of
Well-Being