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McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Measuring Domestic Output and National Income

• National Income Accounting• Assess health of economy

• Compares levels of production

• Track long run course• Grown, constant, or declined

• Formulate policy• Safeguard and improve economy’s health

Assessing the Economy’s Performance

LO1

• Gross Domestic Product (GDP) -- Total value of final goods and services produced in a country in a given year. (Aggregate Output)

• As long as a company is within a country’s border, their numbers go into the country’s GDP (even if they are foreign-owned).

Gross Domestic Product

2-3

• Gross Domestic Product (GDP): Total market value of all final goods and services produced within a country within a year

Gross Domestic Product (GDP)

LO1

2-5

Total value of final goods and services produced by a country in a given year.

Gross National Product (GNP)

Gross Domestic Product

• Monetary measure

• Avoids multiple counting

• Excludes intermediate goods

• Counts market value of final goods

• Value added counted

LO1

Gross Domestic Product

• Intermediate Goods

• Purchased for resale

• Further processing

• Manufacturing

• Final Goods

• Purchased by end user

LO1

Gross Domestic Product

• Value added counted

•Sum of value added = GDP

LO1

Excludes Non-Production Transactions

• Excludes financial transactions

• Public transfer payments

• Private transfer payments

• Stock (and bond) market transactions

• Excludes second hand sales

LO1

2-10

GDP 2014: $17.4T

•Source: World Development Indicators database, World Bank, 1 July 2015

Gross Domestic Product

Two Approaches to GDP

• Income approach (earnings or allocation)

• Count income derived from production

• Expenditure approach (output)

• Count sum of money spent buying the final goods

LO2

Two Approaches to GDP

• GDP, output, and income all refer to the same thing and can be used interchangeably.

LO2

Expenditures or Output Approach

Consumption Expenditures by Households

Plus

Investment Expenditures by Businesses

Plus

Government Purchases of Goods and Services

Plus

Expenditures by Foreigners

LO2

Income or Allocations Approach

Wages

Plus

Rents

Plus

Interest

Plus

Profits

Plus

Statistical Adjustments

LO2

Expenditures Approach

LO2

Expenditures or Output Approach

Consumption Expenditures by Households (C)

Plus

Investment Expenditures by Businesses

Plus

Government Purchases of Goods and Services

Plus

Expenditures by Foreigners

LO2

Expenditures Approach

• Personal consumption expenditures (C)• Durable goods (3 years +, 10%)

• Nondurable goods (< 3 years, 30%)

• Services (60%)

• Spending on houses is not included

• Largest component of GDP

LO2

Expenditures or Output Approach

Consumption Expenditures by Households

Plus

Investment Expenditures by Businesses (G)

Plus

Government Purchases of Goods and Services

Plus

Expenditures by Foreigners

LO2

Expenditures or Output Approach

Consumption Expenditures by Households

Plus

Investment Expenditures by Businesses

Plus

Government Purchases of Goods and Services

Plus

Expenditures by Foreigners

LO2

Expenditures Approach

• Gross private domestic investment (Ig)

• Machinery, equipment, and tools• All construction (includes residential)

• R & D

• Creation of music, art, film, software, etc.

• Changes in inventories

LO2

Changes in Inventories

Changes in inventories represent the difference between what was produced during the year, and what was purchased.

LO2

Positive and Negative Changes in Inventories

LO2

Changes in Inventories

• If inventories increase, more was produced than purchased, so the increase in inventories must be added to Ig and GDP. (unconsumed output)

• Vice versa if inventories fell.

LO2

Net Investment (In)

LO2

Net Investment

• Net Investment includes only added capital during the year. (Gross Investment minus Depreciation)

• In = Ig – Depreciation

• Depreciation (Consumption of Fixed Capital - CFC) = amount of capital

goods used during the year.

LO2

Net Investment

• Ig > CFC; therefore In > 0 and economy is growing.

• Ig = CFC; therefore In = 0 and economy is stagnant.

• Ig < CFC; therefore In < 0 and economy is experiencing negative growth (disinvesting).

LO2

Expenditures or Output Approach

Consumption Expenditures by Households

Plus

Investment Expenditures by Businesses

Plus

Government Purchases of Goods and Services (G)

Plus

Expenditures by Foreigners

LO2

Expenditures Approach

• Government purchases (G)

1. Goods and services to provide public services

2. Publicly owned capital

3. R&D + other to increase economy know-how

• Excludes transfer payments

LO2

Expenditures or Output Approach

Consumption Expenditures by Households

Plus

Investment Expenditures by Businesses

Plus

Government Purchases of Goods and Services

Plus

Expenditures by Foreigners (Net Exports = Xn)

LO2

Expenditures Approach

• Net exports (Xn)

• Add exported goods (X)

• Subtract imported goods (M)

• Xn = exports (X) – imports (M)

LO2

Expenditures or Output Approach

Consumption Expenditures by Households (C)

Plus

Investment Expenditures by Businesses (Ig)

Plus

Government Purchases of Goods and Services (G)

Plus

Expenditures by Foreigners (Xn)

LO2

Expenditures Approach

GDP = C+Ig+G+Xn

LO2

Compensation

Rents

Interest

Proprietor’s Income

Corporate Profits

Taxes on Production and

Imports

National Income

Net Foreign Factor Income (-)

Consumption of Fixed

Capital (+)

Statistical Discrepancy (+)

Gross Domestic Product

$ 8,612

541

440

1,225

2,031

1,123

$13,972

253

2,543

-17

$ 16,245

Personal Consumption (C)

Gross Private Domestic

Investment (Ig)

Government Purchases (G)

Net Exports (Xn)

Gross Domestic Product

in Billions ReceiptsExpenditures Approach

AllocationsIncome Approach

$11,150

2,475

3,167

-547

$ 16,245

U.S. Economy 2012

LO2

Source: Bureau of Economic Analysis, www.bea.gov

Comparative GDP

LO2

Other National Accounts

• Net Domestic Product (NDP)• Measures what has been added to

the stock of capital and the new output = replacement of capital goods used up in production of output.

• NDP = GDP – consumption of fixed capital

LO2

Other National Accounts

• National Income (NI)• Includes all income earned by

U.S.-owned resources whether they are located in the United States or abroad

LO2

Other National Accounts

• Personal Income (PI)• Includes all income received

whether it was earned or unearned

LO2

Other National Accounts

• Disposable Income (DI)• Income that households receive

(personal income minus taxes)• and able to spend as they desire

(consumption or savings)

DI = C + S

LO2

U.S. Income Relationships 2012

Gross Domestic Product (GDP)Less: Consumption of Fixed CapitalEquals: Net Domestic Product (NDP)Less: Statistical DiscrepancyPlus: Net Foreign Factor IncomeEquals: National Income (NI)Less: Taxes on Production and ImportsLess: Social Security ContributionsLess: Corporate Income TaxesLess: Undistributed Corporate ProfitsPlus: Transfer PaymentsEquals: Personal Income (PI)Less: Personal TaxesEquals: Disposable Income (DI)

$ 16,2452,543

$ 13,702-17253

$ 13,9721,066

951435542

2,766$ 13,744

1,498$ 12,246

LO2

Nominal vs. Real GDP

LO2

Nominal vs. Real GDP

• Nominal GDP• Uses current prices year produced

• Real GDP• Adjusted for inflation• Use base year’s prices

LO3

CPI Market Basket

GDP Price Index

• Use price index to determine real GDP

PriceIndexIn GivenYear

= x100Price Good in Specific Year

Price of Good In Base Year

RealGDP =

Nominal GDP

Price Index (in hundredths)

LO3

Real-World Considerations

• More complicated than the “one-good scenario

• Assigns a “weight” to several categories of goods and services based on the relative proportion of each category in total output

• The U.S. GDP PI is “chain-type-annual-weights price index”

LO4

Shortcomings of GDP

• Nonmarket activities

• Leisure

• Improved product quality

• The underground economy

LO4

Underground Economy

LO4

Shortcomings of GDP

• Nonmarket activities

• Leisure

• Improved product quality

• The underground economy

• GDP and the environment

• Composition and distribution of the output

• Noneconomic sources of well-being

LO4