Download Chapter 20

Chapter 20
The
Measurement
of National
Income
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
In this chapter you will learn to
1. Use the concept of value added to solve the problem of
“double counting” when measuring national income.
2. Describe the income approach and the expenditure approach to
measuring national income.
3. Explain the difference between real and nominal GDP and the
meaning of the GDP deflator.
4. Describe the important omissions from official measures of GDP.
5. Explain why real per capita GDP is a good measure of average
“material” living standards but an incomplete measure of overall
“well-being.”
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20-2
National Output and Value Added
Production occurs in stages — most firms produce outputs
that are other firms’ inputs
- intermediate products
- final products
Each firm’s contribution to total output is its value added
= revenues – cost of intermediate goods
= income to factors of production
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National Output and Value Added
Intermediate goods: Outputs that are used as inputs
by other producers in a further stage of production.
Final goods: Goods that are not used as inputs by
other firms but are produced to be sold for
consumption, investment, government, or exports.
Value added: The value of a firm’s output minus the
value of the inputs that it purchases from other firms
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20-4
Gross Domestic Product
Summing value added avoids the problem of double counting
when measuring total output.
Total value added in the economy is called Gross Domestic
Product (GDP).
APPLYING ECONOMIC CONCEPTS 20.1
Value Added Through Stages of
Production
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20-5
National Income Accounting:
The Basics
Three methods for measuring national income (output):
• total value added from domestic production
• total expenditures on domestic output
• total income generated by domestic production
Because of the circular flow of income, these three measures
yield the same total — GDP.
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Figure 20.1 The Circular Flow
of Expenditure and Income
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GDP from the Expenditure Side
Consider adding up the expenditures needed to purchase the
final output produced in any given year.
There are four broad expenditure categories:
- consumption
- investment
- government purchases
- net exports
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GDP from the Expenditure Side
Actual consumption expenditure (Ca) includes expenditure
on all final goods during the year.
Actual investment expenditure (Ia) is expenditure on the
production of goods not for present consumption, including:
• inventories
• plant and equipment
• residential housing
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GDP from the Expenditure Side
Actual government purchases (Ga) are the purchases of currently
produced goods and services by the government
• only purchases of goods and services count, so that
• a great deal of government “expenditure” does not count
• excluding transfer payments
Actual net exports (NXa) is the difference between exports and
imports: NXa = (Xa - IMa)
• exports are purchases of U.S.-produced goods and services by
foreigners.
• imports are subtracted because they are not produced in the U.S.
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Total Expenditures
Since total domestic output must equal total expenditure on
domestic output, we have:
GDP = Ca + Ia + Ga + NXa
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Table 20.1 GDP from the
Expenditure Side, 2006
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GDP from the Income Side
GDP is also the sum of factor incomes and other claims on
the value of output.
Factor incomes include:
- wages
- rent, interest, and profits
net domestic
income
Nonfactor payments include:
- indirect taxes (net of subsidies)
- depreciation of existing physical capital
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GDP from the Income Side
GDP from the income side is therefore equal to:
GDP = Net domestic income +
Indirect taxes (less subsidies) +
Depreciation
EXTENSIONS IN THEORY 20.1
Arbitrary Decisions in National
Income Accounting
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Table 20.2 GDP from the
Income Side, 2006
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National Income Accounting:
Some Further Issues
GDP and GNP
A measure of national output closely related to GDP is Gross
National Product (GNP).
The difference between GDP and GNP is the difference
between income produced and income received.
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National Income Accounting:
Some Further Issues
GDP is superior as a measure of domestic economic activity.
GNP is superior as a measure of living standards of
residents.
A more “refined” measure is disposable personal income:
It equals GNP minus:
- any part not actually paid to households
- personal income taxes
- plus transfer payments received by households
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Real and Nominal GDP
GDP that is valued at constant (base-period) dollars is real
national income.
GDP Deflator =
Nominal GDP
x 100
Real GDP
The GDP deflator is a very comprehensive index of prices
because it includes the prices of all goods and services
produced in the country.
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Real and Nominal GDP
Do the CPI and the GDP Deflator Move Together?
Broadly, the two price indexes move together, due to underlying
inflationary forces. But because one tracks consumer prices and
the other tracks the prices of goods produced in the country, there
will be some differences.
APPLYING ECONOMIC CONCEPTS 20.2
Calculating Nominal and Real GDP
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Table 20.3 Nominal and Real GDP:
Selected Years (billions of dollars)
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Omissions from GDP
National income accountants cannot measure economic
activity that takes place outside of regular, legal markets:
• illegal activities
• leisure
• the underground economy
• Nonmarket activities
• economic “bads”
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GDP and Living Standards
Unless the unmeasured economic activity changes rapidly,
changes in GDP will do a reasonable job of measuring
changes in material living standards.
“Well-being” is a broader concept than material living
standards:
- GDP is not a complete measure of economic wellbeing
- but income is a very important part of well-being
and GDP is a good measure of income.
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Table 20.4 Data for a
Hypothetical Economy
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Table 20.5 Value of Production Using
Current Year Prices: Nominal GDP
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Table 20.6 Value of Production Using
Year 1 Prices: Traditional Real GDP
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Table 20.7 An Alternative Traditional
Measure: Real GDP Based on Year 2 Prices
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Table 20.8 Real GDP Growth
Using Year 1 or Year 2 Prices
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