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24
Measuring Domestic Output and
National Income
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Measuring Domestic Output and National Income
Objectives:
1. What gross domestic product (GDP) is defined and
measured.
2. The relationships between GDP, net domestic product,
national income, personal income, and disposable income.
3. Discuss the GDP price index
4. Describing the difference between nominal GDP & real
GDP.
5. Some limitations of the GDP measure.
Prof. Mohammad El-Sakka – Kuwait University
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Assessing the Economy’s Performance
• National income accounts:
-Measure the economy’s performance by measuring the
flows of income and expenditures over a period of time.
-They serve a similar purpose for the economy, as do
income statements for business firms.
-Consistent definition of terms and measurement techniques
allows us to use the national accounts in comparing
conditions over time and across countries.
-The national income accounts provide a basis for of
appropriate public policies to improve economic
performance.
Prof. Mohammad El-Sakka – Kuwait University
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Gross Domestic Product
First:
GDP is the monetary measure of the total market value of all
final goods and services produced within a country in one year.
Note:
1. Money valuation allows the summing of apples and oranges;
money acts as the common denominator.
2. GDP includes only final products and services; it avoids
double or multiple counting, by eliminating any intermediate
goods used in production of these final goods or services.
Prof. Mohammad El-Sakka – Kuwait University
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Gross Domestic Product
(1)
Stage of Production
(2)
Sales Value
Of Materials
Or Product
$
(3)
Value
Added
0
]--------$120 (= $120 - $ 0)
Firm A, sheep ranch
120
Firm B, wool producer
180
Firm C, coat manufacturer
220
Firm D, clothing manufacturer
270 ]-------- 50 (= 270- 220)
Firm E, retail clothier (market value)
350 ]-------- 80 (= 350 – 270)
Total Sales Value
]-------- 60 (= 180 - 120)
]-------- 40 (= 220 - 180)
$1140
Value Added (total income)
$350
Two ways to calculate GDP
24-5
Gross Domestic Product
3. GDP is the value of what has been produced in the
economy over the year, not what was actually sold.
Second;
GDP Excludes Nonproduction Transactions
1. GDP is designed to measure what is produced or created
over the current time period. Existing assets or property
that sold or transferred, including used items, are not
counted.
2. Purely financial transactions are excluded.
• a. Public transfer payments, like social security or cash
welfare benefits.
• b. Private transfer payments, like student allowances or
alimony payments.
Prof. Mohammad El-Sakka – Kuwait University
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Gross Domestic Product
• c. The sale of stocks and bonds represent a transfer of
existing assets. (However, the brokers’ fees are included for
services rendered.)
3. Secondhand sales are excluded; they do not represent
current output. (However, any value added between purchase
and resale is included, e.g. used car dealers.)
Prof. Mohammad El-Sakka – Kuwait University
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Two Approaches to GDP
There are two Ways to Look at GDP: Spending approach
and Income approach:
Remember from last chapter:
 What is spent on a product is income to those who helped
to produce and sell it.
As a result, this is an important identity and the foundation
of the national accounting process.
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
First : Spending (Expenditures) Approach:
1. GDP is divided into the categories of buyers in the market;
household consumers, businesses, government, and
foreign buyers.
2. Personal Consumption Expenditures(C) includes
durable goods (lasting 3 years or more), nondurable goods
and services.
3. Gross Private Domestic Investment-(Ig)
• All final purchases of machinery, equipment, and tools by
businesses.
• All construction (including residential).
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
• Changes in business inventory.
- If total output exceeds current sales, inventories build up.
- If businesses are able to sell more than they currently
produce, this entry will be a negative number.
• Noninvestment transactions – despite how the term
“investment” is used by the general public, investment does
not include transfers of ownership of paper assets (stocks and
bonds) or real assets (houses, jewelry, art). Only newly
created capital is counted as investment.
• Net Private Domestic Investment—(In).
-Each year as current output is being produced, existing
capital equipment is wearing out and buildings are
deteriorating; this is called depreciation or consumption of
fixed capital
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
- Gross Investment minus depreciation (consumption of fixed
capital) is called net investment.
- If more new structures and capital equipment are produced
in a given year than are used up, the productive capacity of
the economy will expand.
- When gross investment and depreciation are equal, a
nation’s productive capacity is static.
- When gross investment is less than depreciation, an
economy’s production capacity declines.
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
=
Gross Investment
Depreciation
Net Investment
Gross
Investment
Net
Investment
Depreciation
Increase
Stock of
Capital
Consumption
& Government
Spending
Stock of
Capital
January 1
Year’s GDP
December 31
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
4. Government Purchases (of consumption goods and
capital goods)-(G)
- Includes spending by all levels of government (federal, state
and local).
- Includes all direct purchases of resources (labor in particular).
- This entry excludes transfer payments since these outlays do
not reflect current production.
Prof. Mohammad El-Sakka – Kuwait University
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First : Spending (Expenditures) Approach:
5. Net Exports-(Xn)
- All spending on final goods produced in the U.S. must be
included in GDP, whether the purchase is made here or abroad.
- Often goods purchased and measured in the U.S. are
produced elsewhere (Imports).
- Therefore, net exports, (Xn) is the difference: (exports minus
imports) and can be either a positive or negative number
depending on which is the larger amount.
Final Result Based on the Spending(expenditures)
Approah :
GDP = C + Ig + G + Xn
Prof. Mohammad El-Sakka – Kuwait University
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Second : Income Approach
Second: Income Approach to GDP: Demonstrates how
the expenditures on final products are allocated to resource
suppliers as income:
1. Compensation of employees includes wages, salaries,
fringe benefits, salary and supplements, and payments made
on behalf of workers like social security and other health and
pension plans.
2. Rents: payments for supplying property resources (adjusted
for depreciation it is net rent).
3. Interest: payments from private business to suppliers of
money capital.
4. Proprietors’ income: income of incorporated businesses,
sole proprietorships, partnerships, and cooperatives.
Prof. Mohammad El-Sakka – Kuwait University
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Second : Income Approach
5. Corporate profits: After corporate income taxes are paid to
government, dividends are distributed to the shareholders,
and the remainder is left as undistributed corporate profits
(also referred to as retained earnings).
6. Taxes on production and imports: general sales taxes,
excise taxes, business property taxes, license fees, and
customs duties.
National Income = Compensation of employees + Rents +
Interest + Proprietors’ income + Corporate profits +
Taxes on production and imports
Prof. Mohammad El-Sakka – Kuwait University
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Second : Income Approach
Some important remarks:
-
Adjustments between National Income & GDP:
• Net foreign factor income:
(nationals’ income earned abroad - the income of foreigners
earned in the country)
Prof. Mohammad El-Sakka – Kuwait University
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Second : Income Approach
•
Statistical discrepancy:
a statistical discrepancy added to national income to equalize
the income and expenditures approaches (calculated GDP by
Income or expenditures approaches should yield same number
of GDP)
• Depreciation/Consumption of Fixed Capital:
The firm also regards the decline of its capital stock as a cost of
production. The depreciation allowance is set aside to replace
the machinery and equipment used up. In addition to the
depreciation of private capital, public capital (government
buildings, port facilities, etc.), must be included in this entry.
Therefore,
GDP - Depreciation of Fixed Capital = Net domestic product (NDP)
- Statistical discrepancy + Net foreign factor income = National
Income
Prof. Mohammad El-Sakka – Kuwait University
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Other National Accounts
Other National Accounts:
A. Net domestic product (NDP) is equal to GDP minus depreciation
allowance (consumption of fixed capital).
B. National income (NI) is income earned by American-owned
resources here or abroad. Adjust (NDP) by adding net foreign
factor income. (Note: This may be a negative number if
foreigners earned more in U.S. than American resources earned
abroad.)
C. Personal income (PI) is income received by households:
= (NI) - payroll taxes (social security contributions), - corporate
profits taxes - undistributed corporate profits + transfer
payments
D. Disposable income (DI) = (personal income - personal taxes)
Prof. Mohammad El-Sakka – Kuwait University
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Example: 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)
Prof. Mohammad El-Sakka – Kuwait University
$ 14,256
1864
$ 12,392
209
105
$ 12,288
1090
967
315
418
2528
$ 12,026
1102
$ 10,924
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Summary: Two Approaches to GDP
Expenditures or
Output Approach
Income or
Allocations Approach
Consumption by
Households
Wages
Investment by
Businesses
Rents
+
+
Government
Purchases
+
Expenditures
By Foreigners
G
= D=
P
+
+
+
+
Interest
Profits
Statistical
Adjustments
Prof. Mohammad El-Sakka – Kuwait University
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Example of both approaches;
U.S. Economy 2009
In Billions
Receipts
Expenditures Approach
Allocations
Income Approach
Personal Consumption (C) $10,089
Compensation
$ 7792
Gross Private Domestic
Rents
268
788
Investment (Ig)
1628
Interest
Government Purchases (G)
2931
Proprietor’s Income
1041
Net Exports (Xn)
-392
Corporate Profits
1309
Taxes on Production and
Imports
National Income
1090
$12,288
Net Foreign Factor Income (-)
105
Statistical Discrepancy (+)
209
Consumption of Fixed
Capital (+)
Gross Domestic Product $ 14,256
Gross Domestic Product
Prof. Mohammad El-Sakka – Kuwait University
1864
$ 14,256
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Comparative GDP
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Circular Flow Revisited
Circular Flow Revisited (Read the book)
A. Compare to the simpler model presented in earlier chapters.
Now both government and foreign trade sectors are added.
B. Note that the inside covers of the text contain a useful historical
summary of national income accounts and related statistics.
Prof. Mohammad El-Sakka – Kuwait University
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The Circular Flow Revisited
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Other issues regarding National Accounts
Nominal versus Real GDP
A. Nominal GDP is the market value of all final goods and services
produced in a year.
1. GDP is a (P x Q) figure including every item produced in the
economy. Money is the common denominator that allows us to
sum the total output.
2. Nominal GDP is calculated using the current prices
prevailing when the output was produced but real GDP is a figure
that has been adjusted for price level changes.
Prof. Mohammad El-Sakka – Kuwait University
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Other issues regarding National Accounts
B. The adjustment process in a one-good economy. Valid
comparisons cannot be made with nominal GDP alone, since
both prices and quantities are subject to change. Some method
to separate the two effects must be devised:
One method is to first determine a price index,
(see equation 1) and then adjust the nominal GDP
figures by dividing by the price index (in
hundredths) (see equation 2).
Prof. Mohammad El-Sakka – Kuwait University
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GDP Price Index
• Use price index to determine real
GDP
- Equation One Price Index:
Price
Index
In Given
Year
=
Price of Market Basket
In Specific Year
Price of Same Basket
In Base Year
x 100
- Equation Two Real GDP:
Real
GDP
=
Nominal GDP
Price Index (in hundredths)
Prof. Mohammad El-Sakka – Kuwait University
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GDP Price Index
Calculating Real GDP (Base Year = Yr 1)
(5)
Adjusted,
or
Real,
GDP
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)
1
5
$10
100
$ 50
$50
2
7
20
200
140
70
3
8
25
250
200
80
4
10
30
---
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5
11
28
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Other issues regarding National Accounts
Shortcomings of GDP
1- GDP doesn’t measure some very useful output because it is
unpaid (homemakers’ services, parental child care, volunteer
efforts, and home improvement projects).
2- GDP doesn’t measure improved living conditions as a result of
more leisure.
3- GDP does not measure improvements in product quality or make
allowances for increased leisure time.
4- Illegal activities are not counted in GDP (estimated to be around
8% of U.S. GDP). This is referred to the Underground Economy.
Note: Legal economic activity may also be part of the
“underground Economy” usually in an effort to avoid taxation.
Prof. Mohammad El-Sakka – Kuwait University
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Underground Economy
Prof. Mohammad El-Sakka – Kuwait University
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Other issues regarding National Accounts
4 - GDP and the environment:
-The harmful effects of pollution are not deducted from GDP (oil
spills, increased incidence of cancer, destruction of habitat for
wildlife, the loss of a clear unobstructed view).
-GDP does include payments made for cleaning up the oil spills,
and the cost of health care for the cancer victim.
5- GDP makes no value adjustments for changes in the composition
of output or the distribution of income: Nominal GDP simply adds
the dollar value of what is produced; it makes no difference if the
product is a semi-automatic rifle or a jar of baby food.
Note: Per capita GDP may give some hint as to the relative
standard of living in the economy; but GDP figures do not provide
information about how the income is distributed.
Prof. Mohammad El-Sakka – Kuwait University
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Other issues regarding National Accounts
6- Noneconomic Sources of Well-Being like courtesy, crime
reduction, etc., are not covered in GDP.
Prof. Mohammad El-Sakka – Kuwait University
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