07 Measuring Domestic Output and National Income McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

National Income Accounting measures economy’s overall performance Bureau of Economic Analysis compiles National Income and Product Accounts Assess health of economy Track long-run growth & performance Formulate policy Assessing the Economy’s Performance LO1 7-2

Gross Domestic Product Measure of aggregate output Monetary measure Avoid multiple counting Market value of final goods Ignore intermediate goods Count only value added LO1 7-4

Gross Domestic Product (1) Stage of Production (2) Sales Value Of Materials Or Product $ 0 Firm A, sheep ranch120 Firm B, wool producer180 Firm C, coat manufacturer220 Firm D, clothing manufacturer270 Firm E, retail clothier350 Total Sales Value$1140 Value Added (total income) (3) Value Added ] $120 (= $120 - $ 0) ] (= ) ] (= ) ] (= ) ] (= 350 – 270) $350 LO1 7-6

Gross Domestic Product Exclude financial transactions Public transfer payments Private transfer payments Stock (and bond) market transactions Exclude second hand sales Sell used car to a friend LO1 7-7

Two Approaches to GDP Income approach Count income derived from production Wages, rental income, interest income, profit Expenditure approach Count sum of money spent buying the final goods Who buys the goods? LO2 7-8

GDPGDP == + Consumption by Households Investment by Businesses Government Purchases Expenditures By Foreigners Wages Rents Interest Profits Statistical Adjustments + Two Approaches to GDP Expenditures or Output Approach Income or Allocations Approach LO2 7-10

Expenditures Approach Personal consumption expenditures (C) Durable consumer goods Nondurable consumer goods Consumer expenditures for services Domestic plus foreign-produced goods (both included in expenditures) LO2 7-11

Expenditures Approach Gross private domestic investment (I g ) Machinery, equipment, and tools All construction Changes in inventories Creation of new capital assets LO2 7-12

Expenditures Approach January 1Year’s GDPDecember 31 Consumption & Government Spending Depreciation Net Investment Gross Investment Stock of Capital Increase Stock of Capital Gross Investment Depreciation Net Investment - = LO2 7-14

Expenditures Approach Government purchases (G) Expenditures for goods and services Expenditures for publicly owned capital Excludes transfer payments Net exports (X n ) Add exported goods Subtract imported goods X n = exports – imports GDP = C + I g + G + X n LO2 7-15

Compensation Rents Interest Proprietor’s Income Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income (-) Statistical Discrepancy (+) Consumption of Fixed Capital (+) Gross Domestic Product $ $12, $ 14,256 Personal Consumption (C) Gross Private Domestic Investment (I g ) Government Purchases (G) Net Exports (X n ) Gross Domestic Product In Billions Receipts Expenditures Approach Allocations Income Approach $10, $ 14,256 U.S. Economy 2009 LO2 7-16

Comparative GDP LO2 7-17

The Income Approach Compensation of employees Rents Interest Proprietor’s income Corporate profits Corporate income taxes Dividends Undistributed corporate profits Taxes on production and imports LO2 7-18

The Income Approach From national income to GDP Subtract net foreign factor income Statistical discrepancy Consumption of fixed capital Other national accounts Net domestic product (NDP) National income (NI) Personal income (PI) Disposable income (DI) LO2 7-19

U.S. Income Relationships 2009 Gross Domestic Product (GDP) Less: Consumption of Fixed Capital Equals: Net Domestic Product (NDP) Less: Statistical Discrepancy Plus: Net Foreign Factor Income Equals: National Income (NI) Less: Taxes on Production and Imports Less: Social Security Contributions Less: Corporate Income Taxes Less: Undistributed Corporate Profits Plus: Transfer Payments Equals: Personal Income (PI) Less: Personal Taxes Equals: Disposable Income (DI) $ 14, $ 12, $ 12, $ 12, $ 10,924 LO2 7-20

The Circular Flow of Payments LO2 7-21

Nominal vs. Real GDP GDP is a dollar measure of production Using dollar values creates problems Nominal GDP Use prevailing price Real GDP Reflect changes in price Use base year price LO3 7-23

GDP Price Index Use price index to determine real GDP Price Index In Given Year =x100 Price of Market Basket In Specific Year Price of Same Basket In Base Year Real GDP = Nominal GDP Price Index (in hundredths) LO3 7-24

GDP Price Index Calculating Real GDP (Base Year = Yr 1) Year (1) Units of Output (2) Price of Pizza Per Unit (3) Price Index (Year 1 = 100) (4) Unadjusted, or Nominal, GDP (1) X (2) (5) Adjusted, or Real, GDP 15$10100$ LO3 7-25

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 7-27

Underground Economy LO4 7-28