National Income Accounting How Do We Measure The Size and Health of an Economy?

Gross Domestic Product (GDP) The dollar value of all final goods and services produced within a country’s borders in a given period of time (usually a year).

Gross National Product (GNP) A subtle difference: The dollar value of all final goods and services produced by a nation’s citizens in a given period of time (usually a year).

Let’s do some examples to see the difference

GDP Does NOT Include Intermediate goods/services (only final goods/services) 2 nd hand sales AKA used goods Not produced this year, so have already been counted in a previous year Stocks/bonds/securities Transfer payments Public, like welfare/social security Private, like gifts Transactions that cannot be counted or are not reported Do-it-yourself or stay-at-home parent services Black market transactions

Calculating GDP: 2 Methods/Approaches 1.Expenditures Method/Approach: Add up all the spending 2.Income Method/Approach: Add up all the incomes In theory, these should produce the same total.

The Expenditures Method GDP = C + I g + G + X n (add up all the spending) You must memorize this to be successful in this class!

Consumption (C) Consumer Spending (Spending by households) (on goods and services) This is typically the largest component of GDP

Investment (I g ) “Gross Private Domestic Investment” Spending by businesses Includes ***purchases of capital ALL construction, even residential construction (houses) ∆ Inventories Why should we add positive changes? Why subtract negative changes?

Gross vs. Net Gross _____________ - Depreciation = Net ______________ I g tells us how much new capital was produced (even if it just replaced depreciated capital). I n tells us how much extra capital there is (over and above the production necessary to replace depreciated capital). +I n means increase in productive capacity (increased stock of capital) -I n means decrease in productive capacity (decreased stock of capital) * Depreciation is also called “capital consumption allowance” or “consumption of fixed capital”. Not to be confused with Consumption (C)

Government Spending (G) Includes government purchases of: Goods/services “public capital” (parks, highways, other infrastructure) Resources (like labor) Again, does NOT include transfer payments.

Net Exports (X n ) = Exports - Imports X n = X – M (Some books will abbreviate this with “NX”) Why do we subtract imports?

Once Again, The Expenditures Method GDP = C + I g + G + X n You must memorize this to be successful in this class!

The Income Method Add up all the incomes: Rent +Wages (sometimes called “Wages and Salaries” or “Compensation of Employees”) +Interest +Profit

But profit won’t be given, so you must add up it’s parts Rent +Wages (sometimes called “Wages and Salaries” or “Compensation of Employees”) +Interest +Profit (2 kinds) +Proprietors’ Income Corporate Income/Profit (also not given, so must add 3 parts) +Corporate Income Taxes +Dividends +Retained Earnings (AKA “Undistributed Corporate Profits”) = National Income (NI) [fork in the road]

The Big 3 Adjustments Rent +Wages (sometimes called “Wages and Salaries” or “Compensation of Employees”) +Interest +Profit (2 kinds) Proprietors’ Income Corporate Income (also not given, so must add 3 parts) Corporate Income Taxes Dividends Retained Earnings (AKA “Undistributed Corporate Profits”) = National Income + Indirect Business Taxes (memorize!) = NNP +Depreciation (AKA capital consumption allowance AKA consumption of fixed capital) =GNP +Net Foreign Factor (=factor payments to rest of world - factor payments from rest of world) =GDP

The Side Calculations National Income (NI) [earned, whether received by a human or not] - Corporate Income Taxes -Retained Earnings (AKA “Undistributed Corporate Profits”) -Social Security Contributions + Transfer Payments = Personal Income (PI) [received by a human, whether earned or not] -Personal Taxes = Disposable Income (DI) -Consumption (C) = Savings (S)

Shortcomings of GDP GDP is not a perfect measure of economic well-being. It fails to include: Non-market transactions (homemaking, do-it-yourself) Black market transactions and unreported income Satisfaction from work Satisfaction from leisure Improvements in product quality The negative effects of production on the environment Problems with inequality What is “per-capita GDP?”

Nominal GDP vs. Real GDP Nominal (GDP, wages, etc.) stated in “this year’s” dollars NOT adjusted for changes in prices (inflation), so CANNOT be used to make year-to-year comparisons Real (GDP, wages, etc.) stated in “base year” dollars Adjusted for changes in prices (inflation), so CAN be used to make year-to-year comparisons

How to fix nominal figures to make them real Price Indexes used to measure inflation measure the price of a “market basket” of goods and services then compare them to a “base year” PI for the base year: always = 100 PI that adjusts GDP: GDP Price Index AKA “GDP deflator” PI that adjusts wages (later in the course): Consumer Price Index (CPI)

How to fix nominal figures to make them real