MEASURING NATIONAL OUTPUT AND NATIONAL INCOME TOPIC 2 MEASURING NATIONAL OUTPUT AND NATIONAL INCOME

Gross Domestic Product Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country.

National Income and Product Accounts National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy.

Final Goods and Services The term final goods and services in GDP refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm.

Value Added Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales.

Value Added Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED (1) Oil drilling $ .50 (2) Refining .65 .15 (3) Shipping .80 (4) Retail sale 1.00 .20 Total value added

Exclusions of Used Goods and Paper Transactions GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.

Exclusion of Output Produced Abroad by Domestically Owned Factors of Production GDP is the value of output produced by factors of production located within a country. Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP).

Calculating GDP GDP can be computed in two ways: The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. The income approach: A method of computing GDP that measures the income -wages, rents, interest, and profits - received by all factors of production in producing final goods.

The Expenditure Approach Expenditure categories: Personal consumption expenditures (C) -household spending on consumer goods. Gross private domestic investment (I) - spending by firms and households on new capital: plant, equipment, inventory, and new residential structures. Government consumption and gross investment (G) Net exports (EX – IM) - net spending by the rest of the world, or exports (EX) minus imports (IM)

The Expenditure Approach The expenditure approach calculates GDP by adding together the four components of spending. In equation form: GDP = C + I + G + ( EX - IM )

Components of GDP, 1999: The Expenditure Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP Personal consumption expenditures (C) 7303.7 69.9 Durable goods 871.9 8.3 Nondurable goods 2115.0 20.2 Services 4316.8 41.3 Gross private domestic investment (l) 1543.2 14.8 Nonresidential 1117.4 10.7 Residential 471.9 4.5 Change in business inventories 3.9 Government consumption and gross investment (G) 1972.9 18.9 Federal 693.7 6.6 State and local 1279.2 12.2 Net exports (EX – IM) - 423.6 - 4.1 Exports (EX) 1014.9 9.8 Imports (IM) 1438.5 13.8 Total gross domestic product (GDP) 10446.2 100.0

Personal Consumption Expenditures Personal consumption expenditures (C) are expenditures by consumers on the following: Durable goods: Goods that last a relatively long time, such as cars and appliances. Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

Gross Private Domestic Investment Investment refers to the purchase of new capital. Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector.

Gross Private Domestic Investment Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

Gross Private Domestic Investment Remember that GDP is not the market value of total sales during a period - it is the market value of total production. The relationship between total production and total sales is: GDP = final sales + change in business inventories

Gross Investment versus Net Investment Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. Depreciation is the amount by which an asset’s value falls in a given period. Net investment equals gross investment minus depreciation. capitalend of period = capitalbeginning of period + net investment

Government Consumption and Gross Investment Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

Net Exports Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative. Exports (EX) are sales to foreigners of Malaysia produced goods and services. Imports (IM) are Malaysia purchases of goods and services from abroad).

The Income Approach National income is the total income earned by the factors of production owned by a country’s citizens. The income approach to GDP breaks down GDP into four components: GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other

The Income Approach Components of GDP, 2002: The Income Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP National income 8,199.9 80.3 Compensation of employees 6,010.0 58.9 Proprietors’ income 943.5 7.3 Corporate profits 748.9 Net interest 554.8 5.4 Rental income 142.7 1.4 Depreciation 1,351.3 13.2 Indirect taxes minus subsidies 739.4 7.2 Net factor payments to the rest of the world 11.1 0.1 Other - 96.1 - 0.9 Gross domestic product 10,205.6 100.0

From GDP to Disposable Personal Income GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2002 DOLLARS (BILLIONS) GDP 10,205.6 Plus: receipts of factor income from the rest of the world + 342.1 Less: payments of factor income to the rest of the world - 353.2 Equals: GNP 10,194.5 Less: depreciation - 1,351.3 Equals: net national product (NNP) 8,843.2 Less: indirect taxes minus subsidies plus other - 643.3 Equals: national income 8,199.9 Less: corporate profits minus dividends - 332.6 Less: social insurance payments - 731.2 Plus: personal interest income received from the government and consumers + 439.1 Plus: transfer payments to persons +1,148.7 Equals: personal income 8,723.9 Less: personal taxes - 1,306.2 Equals: disposable personal income 7,417.7

From GDP to Disposable Personal Income Net national product equals gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock. Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.

Nominal Versus Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. When a variable is measured in current dollars, it is described in nominal terms.

GDP and Social Welfare Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP. An increase in leisure is an increase in social welfare, but not counted in GDP. Nonmarket and household activities are not counted in GDP even though they amount to real production.

GDP accounting rules do not adjust for production that pollutes the environment. GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. GDP is neutral to the kinds of goods an economy produces.

The Underground Economy The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.