1. National Income Accounting (NIA)
Outline:
Functions of NIA
Gross Domestic Product (GDP)
The Value Added approach to GDP
The Expenditure Approach to GDP
The Factor Payments Approach to GDP
Real versus Nominal GDP
Problems with GDP

2. National income accounting (NIA) is the measurement of aggregate or total economic activity.
NIA is useful for assessing the performance of the macroeconomy. NIA is also helpful in evaluating the effectiveness of policy initiatives such as the Bush tax cuts.

3. Flow variables A Flow Variable
is measure of a process that takes place over a period of time.
Examples: Income, spending, output.

4. Stock variables are measured at a specific point in time.
Examples: Checking account balance, credit card debt, inventories.

5. Production is a flow variable

6. GDP is our basic measure of economic activity
Gross Domestic Product (GDP)
GDP is the market value of new goods and services produced in the economy in one year within the nation’s borders.
GDP is our basic measure of economic activity

7. Three approaches to measuring GDP
The value-added approach
The expenditure approach
The income approach

8. Value-Added Value-added is the increase in the market value of a good
that takes place
at each stage of the production
-distribution process.
Value-Added
The revenue a firm receives minus the cost of the intermediate goods it buys.

9. Stages of Production $5.00 Notebook Paper $3.50 Notebook Paper
$1.50 Raw Paper
$1.00 Wood Chips
Office Supplies Manufacturer
Lumber Mill
Paper Mill
Wholesaler
Retailer

10. Summing the value-added at each stage
Lumber milling
$1.00
Paper processing
.50
Office Supply Manufacturing
.75
Wholesaling
1.25
Retailing
1.50
Total
$5.00

11. Don't double count!
To count the notebook in GDP, we count the final transaction only. Otherwise, we would be counting value added twice.

12. We can measure output (GDP) by summing value added by all firms in one year. This would also be equal to total factor payments distributed.

13. The expenditure approach
Here we simply add up all expenditures for new goods and services in one year
The expenditure approach
GDP = C + I + G + NX
Where,
C is personal consumption expenditure; I is gross private domestic investment; G is government expenditure (local, state, and federal); and NX is net exports, or Exports minus Imports

14. Consumption
Household spending for newly-produced goods and services is defined as consumption. We distinguish between 3 categories or types:
Spending for consumer durables
Spending for consumer nondurables
Spending for consumer services.

15. Consumer Spending by Type, 2007 (in billions)
Total spending by U.S. households in 2007 was a $9.9 trillion
Source: Bureau of Economic Analysis

17. What is investment?
All spending by business firms for newly built equipment ,business structures, and software.
All changes in business inventories of raw materials, semi-finished articles, and finished goods.
All spending by households for newly-built homes.

18. Investment does NOT include
The purchase of stocks, bonds, or other financial assets.
Secondhand sales
Remember that investment only happens when there is production of new tangible capital goods

21. The residential construction industry is in a major slump.

22. Government Expenditures
All expenditures for newly produced, final goods and services by all levels of government.
For purposes of computing GDP, G DOES NOT include transfer payments such as social security or food stamps.

23. Net Exports (NX) of the U.S. (Monthly)

25. MEASURING U.S. GDP The Expenditure Approach
You might like to tell your students that measuring real GDP is actually very cheap. The BEA (in the Department of Commerce) employs fewer than 500 economists, accountants, statisticians, and IT specialists at an annual cost of less that $70 million. It costs each American less than 0.25¢ (a quarter of a cent) to measure the value of the nation’s production. For some further perspective, the National Oceanic and Atmospheric Administration (also in the Department of Commerce), whose mission is to “describe and predict changes in the Earth’s environment, and conserve and manage wisely the nation’s coastal and marine resources so as to ensure sustainable economic opportunities,” employs more than 11,000 scientists and support personnel at an annual cost of $3.2 billion!

26. Value of production = Income = Expenditure
The market value of goods and services produced MUST be equivalent to factor payments of firms for the use of resources AND expenditure for goods and services.

27. The Income Approach The NIA divides earned income into 2 categories:
Wages or compensation of employees: Includes wages and salaries plus fringe benefits—such as health insurance, pension, and social security contributions.
Interest, Rent, and Profit or the net operating surplus: the sum of the incomes earned by capital, land, and entrepreneurship.

28. Interest, Rent, and Profit
Interest is the income households receive on loans they make minus the interest they pay on their borrowing.
Rent includes payments for the use of land and other rented inputs.
Profit includes the profits of corporations and small businesses.

29. Net Domestic Product at Factor Cost: The sum of factor payments—wages, interest, rent and profits.
We must make two adjustments to get from net domestic product at factor cost to GDP
From factor cost to market price;
From gross to net.

30. From Factor Cost to Market Price
The expenditure approach values goods at market prices; the income approach values them at factor cost.
Indirect taxes (such as sales taxes) make market prices exceed factor cost.
Subsidies (payments by government to firms) make factor cost exceed market prices.
To convert the value at factor cost to the value at market prices, we must:
Add indirect taxes and subtract subsidies

31. From Gross to Net
The expenditure approach measures gross product; the income approach measures net product.
Gross profit is a firm’s profit before subtracting the depreciation of capital.
Net profit is a firm’s profit after subtracting the depreciation of capital.
Depreciation is the decrease in the value of capital that results from its use and from obsolescence.

32. MEASURING U.S. GDP: The Income Approach

34. Real versus Nominal GDP
We use money to measure the market value of new goods and services produced produced in the economy.
The value (or purchasing power) of money is subject to change over time.
Hence we need to adjust nominal GDP (that is, GDP measured at current prices) for changes in the value of money.
GDP adjusted for changes in the value of money is called real GDP.

35. Nominal GDP Calculation
To calculate nominal GDP in 2002, sum the expenditures on apples and oranges in 2002 as follows:
Expenditure on apples = 100 × $ = $100 Expenditure on oranges = 200 × $ = $100 Nominal GDP = $100 + $ = $200

36. Now we will calculate nominal GDP for 2003 and compare
Expenditure on apples = 160 × $ = $80 Expenditure on oranges = 220 × $ = $495 Nominal GDP = $80 + $ = $575
Our problem is that the nominal GDP figures do not give us an accurate read of period-to-period changes in actual production. Notice that a part of the change in nominal GDP from 2002 to 2003 resulted from a change in prices.

37. “Traditional” Real GDP calculation
The traditional method converts nominal GDP to real GDP by measuring GDP in all periods at “base period prices”
To correct for changes in the value of money , we will establish 2002 as our base year. That is, we will measure 2003 output at 2002 prices.

38. Traditional method: measuring 2003 GDP at 2002 prices
Expenditure on apples = 160 × $ = $160 Expenditure on oranges = 220 × $ = $110 Nominal GDP = $80 + $ = $270
Thus, real GDP increased from 2002 to 2003—but not by as much as nominal GDP

39. New Method of Calculating Real GDP
To use this method, we must value 2002 output at 2003 prices and 2003 output at 2002 prices.
2002Quantities and 2003 Prices
2003 Quantities and 2002 Prices
Item
Quantity
Price
Apples
100
$0.50
Oranges
200
$2.25
Item
Quantity
Price
Apples
160
$1.00
Oranges
220
$0.50
Measured at 2002 prices, Real GDP increased by 35% from 2002 to 2003 [($70/$200) × 100]
Measured at 2003 prices, real GDP increased by 15% from 2002 to 2003 [($75/$500) × 100]

40. The next step is to average together the percentage increases for 2002 and 2003. Thus we have:
Therefore, since real GDP in 2002 is $200, this chain-weighted method of converting nominal to real GDP gives us real GDP in 2003 of $250.

42. GDP per Person in the United States

43. Limitations of (real) GDP as a measure of the standard of living
Household (non-market) production
The underground economy
Leisure time
Environment quality

44. Economist Quality of Life Index
The Economist Index weighs the following factors
Income
Health
Freedom
Unemployment
Family life
Climate,
Political stability and security
Gender equality
Family and community life

45. Index ranges from 1 to 10. Source: The Economist
Country/Rank1
Index
Ireland/1
8.33
Norway/3
8.05
Australia/6
7.93
Italy/8
7.81
Spain/10
7.73
USA/13
7.62
Japan/17
7.39
France/25
7.08
Mexico/32
6.77
China/60
6.08
Indonesia/71
5.81
Russia/105
4.80
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