Chapter 6 National Income Accounting Economics, 7th Edition Boyes/Melvin

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 2 Measuring Economic Activity After being blind-sided by the Great Depression, policymakers decided that they needed measures of economic activity. Simon Kuznets collected and organized the national income accounts of the United States in the late 1930s. Kuznets later received the Nobel Prize for his efforts.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 3 National Income Accounting Economists use National Income Accounting to evaluate the economic condition of a country and to compare conditions across time and countries.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 4 GDP – “Output” Gross Domestic Product (GDP) is the market value of final goods and services produced within a country during a specific time period, usually a year. Valued at Market Value Only Final Goods and Services Count: Sales at intermediate stages of production are not counted as their value is embodied within the final-user good. Their inclusion would result in double counting. Excludes financial transactions and income transfers since these do not reflect production. Must be produced within the geographic boundaries of the country. Net additions to inventory are current period output so are also included.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 5 The Circular Flow

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 6 Value Added It is possible to compute GDP by computing the value added at each stage of production. Value added is the difference between the value of output and the value of the intermediate goods used in the production of that output.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 7 Value Added Steel and cement have value, but not as much value as a bridge.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 8 GDP as Value-Added

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 9 GDP as Output Produced Inventory is a firm’s stock of unsold goods. GDP includes all output sold plus all goods produced but not sold.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 10 Inventory affects GDP in Japan Japan's economic growth slowed recently as companies such as Toshiba Corp. ate into inventory to satisfy demand. Japan's largest chipmaker could only supply 90 % of customer demand during the second quarter of ’06. Expectations were that the level might fall to as low as 70% in the remaining half of ‘06.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 11 Two Ways of Measuring GDP Expenditures on Final Goods = GDP = Income received for producing Final Goods

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 12 GDP as Expenditures GDP is the sum of the amount each sector (households, investors, governments, and foreigners) spends on final user goods and services. There are four components of GDP: personal consumption expenditures (C), gross private domestic investment (I), government purchases (G) of goods and services, and, net exports (X) ( exports - imports ) GDP = C + I + G + X

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 13 GDP as Expenditures Who Produces It?

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 14 U.S. Gross Domestic Product as Expenditures

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 15 GDP as Income The total value of output also can be computed by adding up the income of all sectors: Wages including benefits Interest--net interest paid by businesses to households plus net interest received from foreigners. Rent--income earned from selling the use of real estate. Profits--the sum of corporate profits plus proprietors’ income. Capital Consumption Allowance--the estimated value of capital goods used up or worn out in production (depreciation) plus the value of accidental damage to capital goods Indirect business taxes--taxes collected by businesses and turned over to governments.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 16 U.S. Gross Domestic Product as Income Received

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 17 National Income Accounts

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 18 GDP vs. GNP Gross Domestic Product (GDP) is the total value of final goods and services produced during a given period within the geographic boundaries of a country regardless of by whom. The goods and services are produced domestically. Gross National Product (GNP) is the total value of final goods and services produced during a given period by the citizens of a country no matter where they live. The goods and services are produced by the “nationals” of the country.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 19 Net National Product Net National Product (NNP) is GDP that is net of depreciation. NNP includes net investment instead of gross investment. –Gross investment is total investment, which includes investment expenditures that simply replace worn out capital goods. Such replacement investment does not add to the total capital stock. –Net investment excludes replacement investment. That is, it is gross investment minus CCA.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 20 National Income National Income (NI) is NNP less business taxes. NI is a measure of the income payments that actually go to resources.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 21 Personal Income and Personal Disposable Income Personal Income (PI) is national income plus income currently received but not earned, minus income currently earned but not received. Disposable Personal Income is PI minus personal taxes.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 22 Real and Nominal GDP Nominal GDP is a measure of national output based on the current prices of goods and services. Real GDP is a measure of the quantity of final goods and services produced, obtained by eliminating the influence of price changes from nominal GDP statistics.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 23 Prices and Quantities in a Hypothetical Economy

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 24 Real GDP Growth in Some Industrial Countries

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 25 Three Key Price Indexes Consumer Price Index (CPI) –measures the impact of price changes on the cost of the typical bundle of goods and services purchased by households. Producer Price Index (PPI) –A measure of the average prices received by producers for raw materials, intermediate, and final goods. The PPI used to be called the Wholesale Price Index (WPI). GDP Deflator (GDP Price Index or GDPPI) –Is a broader price index than the CPI. It is designed to measure the change in the average price of all the goods and services included in GDP.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 26 Price Indexes The value of a price index in any particular year indicates how prices have changed relative to a base year. The base year is the year against which all other years are compared. The index is 100  the percent change in prices from the base year. This type of index suffers from substitution bias as some buyers will change the mix of goods that they buy in response to price changes. Chain-type indexes of real GDP were created to correct for this bias. Such an index uses the mean of the growth rates using beginning and ending year prices.

Copyright © Houghton Mifflin Company. All rights reserved. 6 | 27 The GDP, PPI, and CPI