National-Income Accounting

National-Income Accounting National-income accounting refers to the measurement of aggregate economic activity, particularly national income and its components.

Gross Domestic Product (GDP) Gross domestic product (GDP) is the total market value of final goods and services produced within a nation’s borders in a given time period. (Usually a year)

Gross Domestic Product Total Market Value means the dollar value of every one of the good or service produced during the period of time. Final goods and service means that production is only counted in the final stage. This is to keep things such as a car’s engine from being counted twice.

GDP Versus GNP Gross National Product (GNP) refers to output produced by American-owned factors regardless of location. GDP refers to output produced within America’s borders.

GDP Versus GNP GDP is geographically focused, including all output produced within a nation’s borders regardless of whose factors of production are used to produce it. Japanese companies producing in America count, but not American companies abroad.

GDP per Capita GDP per capita is total GDP divided by total population–average GDP. GDP per capita is commonly used as a measure of a country’s standard of living. However, it is not always an accurate measure.

Exceptions from the GDP There are three major exceptions when creating GDP. Non-Market Activities Unreported Incomes Intermediate Goods

Non-Market Activities GDP measures exclude most goods and services produced that are not sold in the market. A homemaker who cleans, washes, gardens, shops and cooks produces goods of value. Because they are not exchanged in the market they are not included in GDP.

Unreported Income The GDP statistics fail to capture market activities that are not reported to tax or census authorities. The underground economy is motivated by tax avoidance or to conceal illegal activities.

Intermediate Goods Intermediate goods are goods or services purchased for use as input in the production of final goods or services. For example, the engine or chassis of a car are not counted, so as to keep them from being counted twice.

Value Added Value added is the increase in the market value of a product that takes place at each stage of the production process.

Value Added in Various Stages of Production

Two Ways to Calculate GDP Compute the value of the final output. Count only the value added at each stage of production.

Real Versus Nominal GDP Nominal GDP is the value of final output produced in a given period, measured in the prices of that period. Real GDP is the value of final output produced in a given period, adjusted for changing prices.

Computing Real GDP The base period is the time period used for comparative analysis. From this base year, we find the GDP deflator for other years. The GDP deflator is a measure of price changes over time.

Computing Real GDP The general formula for computing real GDP is:

Changes in GDP: Nominal Versus Real 6000 7000 5000 4000 3000 8000 9000 $10000 1980 1985 1990 1996 1995 2000 GDP (billions of dollars per year) Nominal GDP

Net Domestic Product Changes in real GDP tell us how much the economy’s output is growing. Growth is at the expense of future output unless factors of production are replaced.

Net Domestic Product Depreciation is the consumption of capital in the production process — the wearing out of plant and equipment.

NDP = GDP – depreciation Net Domestic Product Net domestic product is the amount of output we could consume without reducing our stock of capital. NDP = GDP – depreciation

Net Domestic Product Investment is spending on (production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories. The distinction between GDP and NDP is mirrored in the difference between gross investment and net investment.

Net Domestic Product Gross investment is total investment expenditure in a given time period. Net investment is gross investment less depreciation.

Net Domestic Product The stock of capital — the total collection of plant and equipment — will not grow unless gross investment exceeds depreciation.

The Uses of Output The GDP accounts also tell us what mix of output has been selected, that is, society’s answer to the core issue of WHAT to produce.

The Uses of Output The major uses of total output conform to the four sets of market participants: consumers, business firms, government, and foreigners.

Consumption Goods and services used by households are called consumption goods. Consumer spending claims nearly two-thirds of our annual output.

Investment Investment goods are the plant, machinery, and equipment that we produce. Also includes net inventory changes and new residential construction.

Government Spending Resources purchased by the government sector are unavailable for consumption or investment purposes.

Net Exports Exports are goods and services sold to foreign buyers. Imports are goods and services purchased from foreign sources.

Net Exports Exports are added to GDP and imports are subtracted. Net Exports are the value of exports minus the value of imports.

Computing GDP The value of GDP can be computed by adding up expenditures of market participants: GDP = C + I + G + (X – IM) Where: C = Consumption expenditure X = exports I = investment expenditure IM = imports G = government expenditure

Measures of Income GDP accounts have two sides. One side focuses on expenditure – the demand side. The other side focuses on income – the supply side.

Output = Income Factor market Product market VALUE OF INCOME VALUE OF OUTPUT Net exports Consumer spending Investment spending Wages Profits Interest Rent Government spending Sales taxes Depreciation Factor market Product market

National Income By charting the flow of income through the economy, we see FOR WHOM the output is produced.

NDP = GDP – depreciation Depreciation charges reduce GDP to the level of NDP (Net Domestic Product) before any income is available to current factors of production. NDP = GDP – depreciation

Net Foreign Factor Income Wages, interest, and profits paid to foreigners are not part of U.S. income. They need to be subtracted from the income flow.

Net Foreign Factor Income Incomes earned by U.S. citizens in other nations represents an inflow of income to U.S. households and are added.

National Income Once depreciation charges and indirect business taxes are subtracted from GDP and net foreign income is added, we have national income.

NI = NDP – indirect business taxes + net foreign factor income National Income National income (NI) is total income earned by current factors of production. NI = NDP – indirect business taxes + net foreign factor income

+ (transfer payments + net interest) Personal Income Personal income (PI) is the income received by households before payment of personal taxes. Personal income = National income – (corporate taxes + retained earnings + Social Security taxes) + (transfer payments + net interest)

Disposable income = personal income – personal taxes Disposable income (DI) is the after-tax income of households. It is personal income less personal taxes. Disposable income = personal income – personal taxes

Disposable income Saving is that part of disposable income not spent on current consumption –disposable income less consumption.

Disposable income = Consumption + Saving All disposable income is either consumed or saved. Disposable income = Consumption + Saving

The Flow of Income

Total income (GDP) ends up distributed the following way: To households, in the form of disposable income. To businesses, in the form of retained earnings and depreciation allowances. To government, in the form of taxes.