National Income Accounting
Principles of Macroeconomics
Professor Dalton
ECON 201
Boise State University
National Income Accounting
 National income accounting – a set of
rules and definitions for measuring
economic activity in the aggregate
economy – that is, in the economy as a
whole.
 National income accounting is a way of
measuring total, or aggregate production.
The National Income
Accounting Identity
 The equality of output and income is an
accounting identity in the national income
accounts.
 The identity can be seen in the circular flow of
income in an economy: for an economy as a
whole, income must equal expenditure.
 Supply and demand determine the market
equilibrium price and quantity that is produced
and exchanged in each market.
The Circular-Flow Diagram
$
Product Markets
$
Businesses
Households
$
$
Factor Markets
The Circular-Flow Diagram
$
Product Markets
$
Businesses
Households
$
$
Factor Markets
The Economy’s
Income and Expenditure
 A measure of the income and
expenditures of an economy is Gross
Domestic Product (GDP).
 Gross Domestic Product measures:
• an economy’s total expenditure on newly
produced goods and services or the total
income earned from the production of these
goods and services.
Gross Domestic Product
 The total market
value of all final
goods and services
produced during a
given period of
time within a
country.
Gross National Product
 The total market
value of all final
goods and services
produced during a
given period of
time by a nation’s
residents,
regardless of the
place produced.
Measuring Output
 GDP is output produced within a country’s
borders, while GNP is output produced by a
country’s citizens.
 The difference between GDP and GNP is net
foreign factor income (GNP = GDP + NFFI).
• Net foreign factor income = income from foreign
sources of domestic factors minus income from
domestic sources of foreign factors (foreign income
of our citizens minus income earned in U.S. by noncitizens).
GDP v. Wealth
 GDP is a flow – a quantity during a certain
time period; reported quarterly on an
annualized basis.
 Wealth is a stock – a quantity measured
at a point in time.
• Wealth accounts – balance sheet of an
economy’s stocks of assets and liabilities.
Important Features of GDP
 Output is valued at market determined
prices; Output is measured in dollar
terms.
 GDP records only the output of final
goods. We want to count “production”
only once.
What Is and What Is Not
Counted in GDP?
 GDP includes all items produced in the
economy and sold legally in markets.
 GDP does not include items produced and
consumed at home and never enter the
marketplace.
 GDP does not include items produced and
sold illicitly, such as illegal drugs.
GDP Measures Final Output
 GDP does not measure total transactions
in the economy.
• It counts final output but not intermediate
goods.
• Counting the sale of final goods and
intermediate products would result in double
and triple counting.
Calculating GDP
 Calculating GDP:
• All goods and services produced by an
economy must be weighted; each good and
service is multiplied by its price. Once
quantities of a particular good or service are
multiplied by its price, we arrive at a value
measure of the good or service. All the units
of value are added to arrive at GDP.
Calculating GDP: Examples
 Selling a stock or bond does not add to GDP;
The stock broker's commission from the sales
does add to GDP.
 Social security payments, welfare payments,
and veterans' benefits are not included in GDP;
Only the cost of transferring is included in GDP.
 The work of unpaid house-spouses does not
appear in GDP calculations; GDP only measures
market activities so unpaid value added is not
included in GDP.
Two Methods of Computing
An Economy’s Income
 Expenditure Approach :
• Sum the total expenditures by households
(from the top portion of the circular flow).
 Income Approach :
• Sum the total wages and profit paid by firms
for resources (from the bottom portion of the
circular flow).
The Circular-Flow Diagram
$
Product Markets
$
Businesses
Households
$
$
Factor Markets
The Expenditure Approach
 The expenditure approach measures the
expenditures in product markets.
 GDP is equal to the sum of the four
categories of expenditures.
GDP = C + I + G + (X - M)
Components of GDP
 Consumption (C) :
• Is the spending by on goods and services
 e.g. buying clothing, food, movie tickets
 Investment (I) :
• Is the purchases of capital equipment and
structures
 e.g. factories, houses, etc.
Consumption
 When individuals receive income, they can
spend it on domestic goods, save it, pay taxes,
or buy foreign goods.
 Personal consumption expenditures –
payments by households for goods and services.
 Consumption is the largest and most important
of the flows.
 It is also the most obvious way in which income
received is returned to firms.
Investment
 The portion of income that individuals save
leaves the income stream and goes into
financial markets; in financial markets,
businesses acquire resources for investment.
 Gross private investment – business
spending on equipment, structures, and
inventories.
• Depreciation – the decrease in an asset's value due
to it wearing out.
• Net private investment – gross private investment
minus depreciation.
Components of GDP
 Government Purchases (G) :
• Includes spending on goods and services by
local, state and federal governments (e.g.
roads, police, etc.).
• Does not include transfer payments.
 Net Exports (NX) or (X – M ) :
• Exports minus imports.
Government
 Taxes are either spent by government on goods
and services or are returned to individuals in the
form of transfer payments.
 Government consumption expenditures
and gross investment – government
payments for goods and services or investment
in equipment and structures.
 If the government runs a deficit, it must borrow
from financial markets to make up the
difference, competing with businesses for saving
of households.
Net Exports
 Spending on imports are subtracted from total
expenditures because spending on imports
“leaks from the system” and does not add to
domestic production.
 Exports to foreign nations are added to total
expenditures because spending on exports is
“injected into the system” and adds to domestic
production.
 These two flows are usually combined into net
exports.
GDP by Expenditures
Consumption
Investment
Government Purchases
Plus Exports
Minus Imports
GDP
$8,282.5
$1,947.0
$2,197.2
$1,189.5
$1,801.2
$11,814.9
2004:3 Current Dollar GDP (Billions) For updated information, contact
FRED or the Bureau of Economic Analysis.
The Relative Size
of GDP Components
Investment
16.5%
Government
Purchases
18.6%
Net Exports -5.2%
Consumption 70.1%
2004:3 GDP
The Income Approach
 The income approach measures the factor
payments by businesses in factor markets.
 National income (NI) is the total
income earned by households; employee
compensation, rent, interest, and profits.
GDP = w + r + i + π
The Circular-Flow Diagram
$
Product Markets
$
Businesses
Households
$
$
Factor Markets
Components of National Income
 Employee compensation (w) consists of
payments for labor such as salaries and wages.
 Rent (r) consists of payments for use of land
and buildings.
 Interest (i) includes payments for loans by
households to firms.
 Profits (π) are payments to the owners of
firms.
Components of National Income
Actual national income accounts are:
Compensation of Employees
Proprietor’s Income
Rental Income
Corporate Profits
Net Interest and miscellaneous
Expenditure = Income
 Income and expenditures must be equal
because of the rules of double-entry
bookkeeping. Profit is the balancing item.
 To go from GDP to national income:
• GDP + net foreign factor income = GNP
• GNP – minus depreciation – indirect business
taxes = National Income
Expenditure = Income
Net foreign
factor income
Net exports
Government
expenditures
Depreciation
Indirect business taxes
Rents
Interest
Investment
Profits
Consumption
GNP
GDP
National
Income
Employee
compensation
(1)
Expenditures
=
(2)
Output
=
(3)
Income
GDP by Incomes
(and adjustments)
Wages & Salaries
Rent
Interest
Profits & Proprietor’s Income
= National Income
Plus Depreciation
Plus Indirect Business Taxes
Minus Net Foreign Factor Income
(Plus Statistical Discrepancy)
= GDP
$ 6,657.4
$
153.8
$
546.7
$ 2,020.9
$ 9,378.8
$ 1,497.9
$
885.9
$
38.2
$
90.4
$ 11,814.9
2004:3 Current Dollar GDP (Billions) For updated information, contact FRED or
the Bureau of Economic Analysis.
Relative Size of National
Income Components
Corporate Profits = 11.9%
Net Interest = 5.8%
Rental Income = 1.6%
Proprietors’
Income =
9.6%
Wages and Salaries = 71.0%
2004:3 GDP
Real versus Nominal GDP
 GDP is the market value of the economy’s
current production, referred to as
Nominal GDP.
 Real GDP measures any given year’s
total output in “constant” prices.
 An accurate view of the economy requires
adjusting nominal to real GDP, using the
GDP Price Deflator.
GDP Price Deflator
 The GDP Price Deflator is a price index
that uses a bundle of all final goods and
services.
• The GDP Price Deflator tells us the rise in
nominal GDP that is attributable to a rise in
prices.
Real and Nominal GDP
 Real GDP is arrived at by dividing nominal
GDP by the GDP deflator.
Real GDP =
Nominal GDP x 100
GDP Deflator
Real and Nominal GDP
1998
2004
Price Quantity $ Value
CD’s
Tapes
Price
Quantity
$ Value
$15
1,000 $15,000
$30
1,300
$39,000
$5
2,000 $10,000
$10
2,600
$26,000
Nominal GDP
$25,000
$65,000
Real and Nominal GDP
1998
2004
Price Quantity $ Value
CD’s
Tapes
Price
Quantity
$ Value
$15
1,000 $15,000
$30$15
1,300 $39,000$19,500
$5
2,000 $10,000
$10$5
2,600 $26,000$13,000
Nominal GDP
$25,000
$65,000$32,500
Limitations of National
Income Accounting
 Limitations of national income accounting
include the following:
• Measurement problems exist.
• GDP measures economic activity, not welfare.
• Subcategories are often interdependent.
GDP and Well-Being
 GDP per person (GDP per capita) tells us
the income of the average person in the
economy.
• It is a good measure of the material well-being of the
economy as a whole.
• More real GDP means being able to consume more
goods and services.
• It is not intended to be a measure of happiness or
quality of life.
GDP and Well-Being
 Some factors and issues not in GDP that
lead to the “well-being” of the economy:
• Factors that contribute to a good life such as
leisure.
• Factors that lead to a quality environment.
• The value of almost all activity that takes
place outside of organized markets, e.g.
volunteer work and child-rearing.
GDP Measures Market Activity
 GDP does not measure happiness, nor
does it measure economic welfare.
 Welfare is a complicated idea, very
difficult to measure.
Measurement Errors
 GDP figures leave out the following:
• Illegal drug sales.
• Under-the-counter sales of goods to avoid
income and sales taxes.
• Work performed and paid for in cash.
• Unreported sales.
• Prostitution, loan sharking, extortion, and
other illegal activities.
Measurement Errors
 A second type of measurement error
occurs in adjusting GDP for inflation.
• If the price and the quality of a product go up
together, has the price really gone up?
• Is it possible to measure the value of quality
increases?
Other Measures of Income
 Net domestic product (NDP )
• GDP minus depreciation (capital consumption
adjustment).
 Net National Product (NNP)
• GNP minus depreciation.
Other Measures of Income
 Personal income (PI)
• national income plus net transfer payments
from government minus amounts attributed
but not received.
PI = NI + Transfer payments from government
+ Net non-business interest income
– Corporate retained earnings
– Social security taxes
Other Measures of Income
 Disposable personal income (DPI)
• personal income minus personal income taxes
and payroll taxes.
 Disposable personal income is what
people have readily available to spend.
DPI = PI - Personal taxes