MEASURING AGGREGATE ECONOMIC ACTIVITY

National Income Accounting Why measure? National income accounting A way of measuring total, or aggregate production. Gross Domestic Product (GDP) The total value of all final goods and services produced in an economy in a one-year period.

Calculating GDP Adding together millions of goods and services. Adding apples and oranges All of the quantities of goods and services produced are multiplied (weighted) by their market price per unit to determine a value measure of that good or service. The sum of all of these values is GDP.

The Expenditure Approach GDP is the sum of four categories of expenditures. GDP = C + I + G + (X – M) Consumption Investment Includes inventories Government Spending Valued at cost Excludes transfer payments Net exports

CALCULATING GDP Suppose that consumption is $1150, investment is $400, and government purchases are $500. Exports are $100 and imports are $150. How much is Gross Domestic Product? GDP = C + I + G + (X – M) by substitution, GDP = 1150 + 400 + 500 + (100-150) GDP = $2000

GDP IN THE U.S. vs. BELGIUM GDP = C + I + G + Exports - Imports U.S. $14,000 B = 70% + 17% + 19% + 11% - 17% Belgium $365 B = 53% + 21% + 23% + 87% - 84%

Flows vs. Stocks Flows Stocks Involves a time period GDP is reported on an annualized basis About $14 Trillion ($14,000,000,000,000) Stocks An amount at a point in time Wealth accounts—assets minus liabilities About $50 Trillion ($50,000,000,000,0000)

GDP Measures Final Output Final vs. Intermediate goods and services Final output – goods and services purchased for final use. Intermediate products are used as an input in the production of some other product. GDP counts only final goods and services Counting both final and intermediate goods would result in double counting.

Two Ways of Eliminating Double Counting Calculate only final output. A firm would report how much it sold to consumers and how much it sold to producers (intermediate goods). Follow the value added approach. Value added is the increase in value that a firm contributes to a product or service. It is calculated by subtracting intermediate goods (the cost of materials that a firm uses to produce a good or service) from the value of its sales.

Value Added Approach Participants Cost of Value of Value Added Materials Sales Farmer $ 0 $ 100 $ 100 Cone factory 150 100 250 and ice Cream maker Middleperson 250 400 150 Vendor 400 500 100 Totals $ 750 $1,250 $500

What is Counted in GDP? Not counted Counted Value of resold goods Government transfer payments Sales of stocks or bonds Non-market transactions---e.g., work of housespouses Counted Value added by a used car dealer Commissions of stock brokers

GDP and NDP Net domestic product is GDP adjusted for depreciation – the amount of capital used up in producing that year’s GDP. NDP = C + (I – depreciation) + G + (X-M) NDP measures output available for purchase.

GDP AND GNP When is the difference important? Gross Domestic Product (GDP) Total value of all final goods and services produced in country in a one-year period. Gross National Product (GNP) Total value of all final goods and services produce by the citizens and businesses of a country in a one- year. When is the difference important?

The Income Approach Aggregate income is the total income earned by citizens and businesses in a country in a year. Aggregate income consists of: employee compensation rent paid to households (But not to businesses) interest paid to households (But not to businesses) profits

The Income Approach United States Aggregate Income $14 Trillion Employee compensation 70% Rents 1% Interest 5% Profits 24%

Income = Expenditures Whenever a good or service is produced (output), somebody receives income for producing it. Aggregate Income = Aggregate Production Profit is a residual that makes income and expenditures equal.

Comparing GDP Among Countries Per capita GDP Used to compare relative standards of living among various countries. Because of differences in nonmarket activities and difference in product prices, per capita GDP may be a misleading measure of living standards. Purchasing power parity Adjusts for relative price differences before making comparisons.

Economic Welfare Over Time If increases in GDP are due to increases in prices, then welfare does not increase. Changes in welfare over time are best indicated by changes in real GDP, nominal GDP adjusted for inflation. And % ∆ in Nominal GDP = % ∆ in Real GDP + inflation

CALCULATING REAL GDP Suppose that in year 1 nominal GDP is $1200; in year 2, $1300. The GDP deflator is 110 and 115, respectively. Find the change in nominal GDP. How much of the change is due to a real increase in output and how much is due to price changes?

Limitations of National Income Accounting GDP measures economic activity, not welfare. GDP does not measure happiness, nor does it measure economic welfare. Non-market activities are not included Subcategories are often interdependent. For example, the line between consumption and investment may be unclear. Measurement problems exist.

Genuine Progress Indicator The genuine progress indicator (GPI) makes a variety of adjustments to GDP to better measure the progress of society rather than just economic activity. The GPI includes social goals such as pollution reduction, education, and health.