NATIONAL INCOME ACCOUNTING GDP: What it is and what it is not!

Why do we measure National Income (GDP)  National Income is a broad measure of economic activity, and thus, tells us how large an economy is.  It gives us an idea of how “wealthy” a nation is.  It helps us to see what standard of living a nation enjoys.  GDP is the most important measure of National Income, and we will use it heavily this year.

GDP  Gross Domestic Product is defined as “The total value of all FINAL goods and services produced within our DOMESTIC border within a given year.  We do not want to DOUBLE COUNT anything in valuing national output.

What counts toward GDP?  FINAL goods and services: Counts only goods purchased at retail locations. 1. We count chicken legs sold at the grocery store to you only, not the feed or the sale to Giant Eagle. 2. The final sale price will capture all of the value of the chicken including all inputs and profits along the way This makes sure all VALUE ADDED is accounted for.

What counts (continued)  WITHIN OUR DOMESTIC BORDERS: 1. Goods produced within our borders generate the income needed to purchase them. 2. Even if Toyota (Japanese company) makes a car here it counts toward our GDP. Income is paid to American workers. 3. NOTE: If we buy an oversized novelty whatever, the imported portion is subtracted from GDP, but the value added by Americans will be included. This guarantees that we catch the correct amount of income and economic activity.

What does NOT count toward GDP?  FINANCIAL TRANSACTIONS: We do not count things like stock market transactions or social security checks to seniors. This money will buy final goods, we will count it then, not TWICE!  USED GOODS: They were counted toward an earlier years’ GDP, lets not count them TWICE!  BLACK MARKETS: GDP only counts legitimate transactions, it misses a lot of activity. It generates income but it is not recognizable to government accountants.

How do we measure National Income?  The main goal of any national income measure is to CAPTURE all of the value of all economic activity!!!!!  There are TWO different ways to do this: 1. The Income Method 2. The Expenditures Method

THE EXPENDITURES METHOD  The Expenditure Method relies on capturing all of the spending done in the economy at retail.  We will work with this method almost exclusively in class this year, so make sure you understand it well.  Spending is broken down into FOUR categories, this way we can track spending to see what areas are doing well and which need attention.

EXPENDITURE CATEGORIES  CONSUMPTION: This is spending on “stuff” by the citizenry. It is the largest category of the four. (70%)  INVESTMENT: This is spending by business on CAPITAL goods. DO NOT confuse this with buying stock and such, they do not count! It is the most VOLATILE and changes the most frequently. (15%) 1. People buying NEW houses count as investment. 2. Businesses building inventories count here as well.  GOVERNMENT: This is spending on FINAL goods and serv. by government. Not welfare or other transfer payments (20%)  NET EXPORTS: Exports are added to GDP, imports are subtracted because they add income to other nations’ GDP. (-5%)

SIMPLE FORMULA  You will see the following formula MANY times this year in class, since the Expenditures Approach is what we use the most: C + I + G + (X-M) = GDP  The sum total of all components: $14,204,322,000,000

The Income Approach  Rather than tally final sales of goods, we can track the INCOME generated by all economic activity. General categories of income are: 1. Wages and Salaries: Paid to workers 2. Rents: Paid to resource and land owners. 3. Interest: Paid for use of money capital 4. Proprietors Income: Small business owners income. 5. Corporate Profits: Earnings of owners of corporations

Expenditures or Income?  Adding spending or breaking down income will generate the same number. The reason is simple, your spending becomes someone’s income, and their income will be spending too. Thus the two must yield similar results.  The most important thing is the we only count economic activity ONCE, this is the only way to ensure an accurate record of what our economy produces.

Remember this diagram? It shows what we have been talking about. Notice the BLUE arrows on the left hand side, they are the income and expenditures that we are using for GDP accounting.

Rank Country US$ 1 Luxembourg 113,044 2 Norway 94,387 3 Qatar 93,204 4 Switzerland 68,433 5 Denmark 62,097 6 Ireland 60,510 7 United Arab EmiratesUnited Arab Emirates 55,028 8 Iceland 53,058 9 Netherlands 52, Sweden 52, Finland 51, Austria 50, United States 47, Belgium 47, Australia 46, France 46, Kuwait 45, Canada 45, Germany 44, United KingdomUnited Kingdom 43,734