National Income Accounting (NIA)
Outline:
1. Functions of NIA
2. Gross Domestic Product (GDP)
3. The Value Added approach to GDP
4. The Expenditure Approach to GDP
5. The Factor Payments Approach to GDP
6. Real versus Nominal GDP
7. Problems with GDP
National income accounting (NIA) is the
measurement of aggregate or total economic activity.
NIA is useful for assessing the
performance of the
macroeconomy. NIA is also
helpful in evaluating the
effectiveness of policy initiatives
such as the Bush tax cuts.
Flow variables
A Flow Variable
is measure of a
process that takes
place over a
period of time.
Examples: Income,
spending, output.
Stock variables
Stock variables are measured
at a specific point in time.
Examples: Checking
account balance, credit
card debt, inventories.
Production is a flow
variable
Gross Domestic Product (GDP)
GDP is the market value of new goods and
services produced in the economy in one year
within the nation’s borders.
GDP is our basic
measure of economic
activity
Three approaches to measuring GDP
• The value-added
approach
• The expenditure
approach
• The income approach
Value-Added
The revenue a firm
receives minus the cost
of the intermediate
goods it buys.
Value-added is the increase
in the market value of a good
that takes place
at each stage of the production
-distribution process.
$1.00
Wood
Chips
Lumber
Mill
$1.50
Raw
Paper
Paper
Mill
$2.25
Notebook
Paper
Office Supplies
Manufacturer
$3.50
Notebook
Paper
Wholesaler
$5.00
Notebook
Paper
Retailer
Summing the value-added at each stage
Stage
Lumber milling
Value Added
$1.00
Paper processing
.50
Office Supply
Manufacturing
Wholesaling
.75
1.25
Retailing
1.50
Total
$5.00
To count the
notebook in GDP,
we count the final
transaction only.
Otherwise, we
would be counting
value added twice.
We can measure output
(GDP) by summing value
added by all firms in one
year. This would also be
equal to total factor
payments distributed.
The expenditure approach
Here we simply
add up all
expenditures for
new goods
and services in one
year
GDP = C + I + G + NX
Where,
C is personal consumption expenditure;
I is gross private domestic investment;
G is government expenditure (local, state, and federal);
and
NX is net exports, or Exports minus Imports
Consumption
Household spending for newly-produced
goods and services is defined as
consumption. We distinguish between 3
categories or types:
Spending for consumer durables
Spending for consumer nondurables
Spending for consumer services.
Consumer Spending by Type, 2007 (in billions)
Category
Durables
Spending in
2007
Percent
(billions) of Total
$1,082.5
11
Nondurables
2,804.5
29
Services
5,949.7
60
Source: Bureau of Economic Analysis
Total spending by
U.S. households
in 2007 was a
$9.9
trillion
What is investment?
All spending by business firms for
newly built equipment ,business
structures, and software.
All changes in business inventories of
raw materials, semi-finished articles, and
finished goods.
All spending by households for newlybuilt homes.
Investment does NOT include
•The purchase of stocks, bonds, or
other financial assets.
•Secondhand sales
Remember that
investment only happens
when there is production
of new tangible capital
goods
Components of Investment, 2007 (in billions)
$540.20
$505.10
Bus. Structures
Equip. & Software
Residential
$1,024
Inventory investment
(-30.4 billion) not
included
The residential construction industry is
in a major slump.
Government Expenditures
All expenditures for newly produced, final
goods and services by all levels of
government.
For purposes of
computing GDP, G
DOES NOT include
transfer payments such
as social security or
food stamps.
Net Exports (NX) of the U.S. (Monthly)
MEASURING U.S. GDP
The Expenditure Approach
Value of production = Income = Expenditure
The market value of goods
and services produced MUST
be equivalent to factor
payments of firms for the use
of resources AND expenditure
for goods and services.
The Income Approach
The NIA divides earned income into 2
categories:
1. Wages or compensation of employees:
Includes wages and salaries plus fringe
benefits—such as health insurance, pension,
and social security contributions.
2. Interest, Rent, and Profit or the net
operating surplus: the sum of the incomes
earned by capital, land, and
entrepreneurship.
Interest, Rent, and Profit
–Interest is the income households receive on
loans they make minus the interest they pay on
their borrowing.
–Rent includes payments for the use of land and
other rented inputs.
–Profit includes the profits of corporations and
small businesses.
Net Domestic Product at Factor Cost:
The sum of factor payments—wages, interest, rent
and profits.
We must make two
adjustments to get from net
domestic product at factor cost
to GDP
1. From factor cost to market price;
2. From gross to net.
From Factor Cost to Market Price
– The expenditure approach values goods at market prices;
the income approach values them at factor cost.
– Indirect taxes (such as sales taxes) make market prices
exceed factor cost.
– Subsidies (payments by government to firms) make factor
cost exceed market prices.
– To convert the value at factor cost to the value at market
prices, we must:
• Add indirect taxes and subtract subsidies
From Gross to Net
–The expenditure approach measures gross
product; the income approach measures net
product.
–Gross profit is a firm’s profit before
subtracting the depreciation of capital.
–Net profit is a firm’s profit after subtracting
the depreciation of capital.
–Depreciation is the decrease in the value of
capital that results from its use and from
obsolescence.
MEASURING U.S. GDP:
The Income Approach
Real versus Nominal GDP
•We use money to measure the market value of new
goods and services produced produced in the economy.
•The value (or purchasing power) of money is subject to
change over time.
•Hence we need to adjust nominal GDP (that is, GDP
measured at current prices) for changes in the value of
money.
•GDP adjusted for changes in the value of money is called
real GDP.
Nominal GDP Calculation
To calculate nominal GDP in 2002, sum the
expenditures on apples and oranges in 2002
as follows:
Expenditure on apples = 100 × $1
Expenditure on oranges = 200 × $0.50
Nominal GDP = $100 + $100
= $100
= $100
= $200
Now we will calculate nominal GDP for 2003
and compare
Expenditure on apples = 160 × $0.50
Expenditure on oranges = 220 × $2.25
Nominal GDP = $80 + $495
Our problem is that the nominal
GDP figures do not give us an
accurate read of period-to-period
changes in actual production.
Notice that a part of the change in
nominal GDP from 2002 to 2003
resulted from a change in prices.
= $80
= $495
= $575
“Traditional” Real GDP calculation
The traditional method converts nominal GDP to real GDP
by measuring GDP in all periods at “base period prices”
To correct for changes in the
value of money , we will
establish 2002 as our base
year. That is, we will
measure 2003 output at
2002 prices.
Traditional method: measuring 2003 GDP
at 2002 prices
Expenditure on apples = 160 × $1.00
Expenditure on oranges = 220 × $0.50
Nominal GDP = $80 + $495
Thus, real GDP increased from 2002 to
2003—but not by as much as nominal
GDP
= $160
= $110
= $270
New Method of Calculating Real GDP
To use this method, we must value 2002 output at 2003
prices and 2003 output at 2002 prices.
2003 Quantities and 2002 Prices
2002Quantities and 2003 Prices
Quantity
Price
Item
Apples
160
$1.00
Oranges
220
$0.50
Item
Quantity
Price
Apples
100
$0.50
Oranges
200
$2.25
•Measured at 2002 prices, Real GDP increased by 35%
from 2002 to 2003 [($70/$200) × 100]
•Measured at 2003 prices, real GDP increased by 15%
from 2002 to 2003 [($75/$500) × 100]
The next step is to average
together the percentage increases
for 2002 and 2003. Thus we have:
35%  15%
 Re alGDP 
 25%
2
Therefore, since real GDP in
2002 is $200, this chain-weighted
method of converting nominal to
real GDP gives us real GDP in
2003 of $250.
Gross Domestic Product (GDP) of the USA (in billions)
16000
14000
12000
10000
8000
6000
4000
90
92
94
96
98
00
Year
Chained 2000 Dollars
Source: www.bea.gov
02
04
06
Current Dollars
08
GDP per Person in the United States
35000
www.economagic.com
30000
25000
20000
15000
10000
5000
0
60
65
70
75
80
Nominal
85
90
95
Chained 1996 dollars
Limitations of (real) GDP as a
measure of the standard of
living
•Household (non-market) production
•The underground economy
•Leisure time
•Environment quality
Economist Quality of Life Index
The Economist
Index weighs
the following
factors
•Income
•Health
•Freedom
•Unemployment
•Family life
•Climate,
•Political stability and security
•Gender equality
•Family and community life
Index ranges from
1 to 10.
Source: The Economist
Country/Rank1 Index
1
Ireland/1
8.33
Norway/3
8.05
Australia/6
7.93
Italy/8
7.81
Spain/10
7.73
USA/13
7.62
Japan/17
7.39
France/25
7.08
Mexico/32
6.77
China/60
6.08
Indonesia/71
5.81
Russia/105
4.80
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