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Chapter 7
National Economic Accounting
I. Expenditure Approach: measures the values of the goods and services that are
bought
Income Approach: measures incomes generated in producing the national output
Another way of saying this is the expenditure approach adds up prices for all the
output in the economy (over a one-year period) while the income approach adds
up the costs for all the inputs needed to make the output.
Table 7-2 (p.171) demonstrates the equality of the two approaches. All the value
of the output is distributed to the various factors of production and nonincome
costs.
II. Gross Domestic Product (GDP) takes the expenditure approach, adding up
values of good bought by C, I, and G, and subtracting the trade deficit (X-M=Xn).
GDP is defined as the market value of all final goods and services produced in a
year in a given economy. A given economy nearly always just means, “in one
country.”
A. Final goods and services means that only the price paid when the new
production is bought gets counted. Most of the economy’s output goes
through stages of production, and changes hands from producer to producer,
each one adding some value in the good’s process of becoming final. To
add in the values of the good at intermediate steps would be doublecounting, because all intermediate values are included in the final price.
B. Work in progress and unsold inventory at the end of the year represents
output for the year, so that must be added in GDP. Also, some of the output
bought this year was from last year’s inventory or partially built last year.
So last year’s inventory (that gets sold this year) must be subtracted from
this year’s inventory (that gets sold next year) and the result is a net
inventory figure (could be positive or negative) that you add to GDP.
C. C= Personal Consumption Expenditures. Consumers buy three types of
goods
i. Durable goods: last a long time, like appliances, vehicles, computers,
phones
ii. Nondurable goods: used up quickly, like food, personal hygiene
products, clothing
iii. Services: someone does something for you, such as serving food,
accounting or tax work, legal work, doctor
D. I= Gross Private Domestic Investment
i. Investment that only replaces worn-out capital is counted – that is
why it
is “gross” as opposed to “net”
ii. Private means non-government (that would be public) spending
iii. Domestic means within the nation’s borders, regardless of the
nationality of the owner/ company doing the investment spending.
iv. Investment consists of machinery/equipment, business and residential
construction, and the net inventory
E. G= Government Expenditures includes goods, services, and investment paid
for by the government.
i. The Government makes transfer payments (income security) in the
form of welfare, unemployment benefits, and various subsidies to
industry such as agriculture. Since these transfers of money are not in
return for any good or services purchased, they do not get counted in
GDP.
F. Xn=Exports are output from the US economy and imports are bought here
but not
part of our country’s output, so the value of X (exports) must be
added while M (imports) subtracted. X-M=Xn (net exports) and this value is
added to GDP.
III. Gross Domestic Income (GDI) relies on the income approach to total the
income at market prices generated in the production of all final goods and services
during a given period (one year, usually) in a given economy (usually one
country). Since the value of the output is completely distributed among all forms
of income, the GDP and GDI must be equal for the same time period.
1. GDI is calculated by totaling the payments to the four factors of production,
plus depreciation (D: the capital consumption allowance), Indirect Business
Taxes (T), and Net Factor Income from abroad.
2. Depreciation must be included in the GDI because some being capital used
up is part of the cost of producing a good – but this can cot be included in
payments to the factors of production. Similarly IBT, or simply T, is not
payment to the factors for inputs, it is just another cost producers pass on to
consumers, this one mandated by the government.
3. Finally, income to factors of production owned by foreigners is deducted
from GDI while income to domestic owned factors of production located in
foreign countries is added to the GDI. The net of these two is called Net
Factor Income From Abroad (Yn)
IV. While the US used to rely on the GNP for an indication of the country’s
material well-being, it now relies primarily on GDP because it allows easy
comparison to other countries’ income accounting methods. The difference is that
GDP includes the value of goods and services produced within the nation’s
borders, and GNP includes the value of goods and services produced by factors
owned by US citizens. So a car factory in Michigan owned by Ford is part of GDP
and GNP. But if it is in Michigan and owned by Toyota, then it is part of GDP but
not GNP. Another way to look at it is if Ford owns the plant, but it builds in
Canada, it’s part of GNP but not GDP. So a major advantage of GDP is it gives a
better indication of economic activity actually taking place in a given country
because the number includes all production that takes place domestically.
Numerically, the difference between GNP and GDP is Yn.
1. In a country like Mexico where much of the factories (capital) and other
types of production facilities are owned by foreigners, GDP can exceed GNP
by around 5%.
2. GDP to GNP ratios for developed countries, and since almost all the
numbers are very close to 100% this means that GDP and GNP are
approximately equal, as in the US. The ratio for Canada is 103.7%, meaning
GDP is 3.7 percent more than GNP there, reflecting the wide range of
industrial interests, largely those of American businesses that choose to
produce there due to the buying power of the dollar.
V.
Reminders on Deflating GDP
1.
Nominal=Current=Money GDP is GDP based on the prices in which the
output was produced.
2. Real=Constant GDP is GDP based on the prices of goods in a base year (this
eliminates the effect of prices on GDP since the base year, deleting inflation)
3. Mathematically, how do economists change the NGDP (commonly reported
GDP numbers) to RGDP (an indication of actual output, not simply the
effects of inflation)? The Bureau of Labor Statistics (BLS) has to track
prices, specifically, the prices of goods and services in a “market basket” for
a family of four in the urban area. The first total expenditures for this
typical family is set to equal 100 (mathematically the dollar value of the
market basket is multiplied by 100/ dollar value of the market basket, so the
base year value always equals 100).
The BLS continues tracking prices in years after the base year. So if 1979 is
the base year, the CPI or consumer price index for 1979 = 100. In 1980 the
BLS sees in their survey that the price of the market basket has increased
overall 5%. So 1980 CPI = 105.
NGDP = 8.4 trillion dollars.
RGDP = NGDP/CPI * 100= 8.4/105 * 100 = 8 trillion.
Trick question: how much did RGDP increase from 1979?
Not enough information to answer; all we know is inflation was 5%. If we
know that RGDP in 1979 was 7.3 trillion, then we could say RGDP grew
almost 10% in 1980. What this does is reports GDP (1980) in 1979 dollars,
making the prices constant for “constant” or “real” GDP. In this example
there was inflation so the CPI adjustment “deflates” NGDP.
4. Besides the CPI, the BLS tracks the WPI to watch what happens to
wholesale prices and the Commerce Dept. has the general price index which
is the best indication of all prices in the economy. It works the same way to
deflate NGDP as the CPI.
VI.Excluded from GDP
1. GDP only includes output that has a recorded payment. This excludes any
unpaid labor, whether it is by an in-home parent or (cleaning, cooking,
laundry, driving, gardening) chores by children, volunteering in the
community, do-it-yourself projects for home improvement or building
furniture. Only if any of these services is bought from someone is it part of
GDP.
2. Illegal transactions are not recorded so do not get included in GDP.
3. Economic transactions involving no new production. This includes:
i. Sale of used goods – initial value already recorded in the year the good
was produced
ii. Intermediate goods - all intermediate values are included in the final
price
iii.Sale of financial instruments – bonds, stocks, options and any other
financial securities are just a change in ownership, not any new production.
The only aspect of the transaction that would count in GDP is the
brokerage fee to conduct the transaction.
VII. GDP is “Gross” because it includes all I, not adjusting for the fact that a
substantial portion of I only replaces D (depreciated, worn-out capital). In (Net
Private I) is I-D.
New capital investment, minus the used up capital, of a given year, is In.
So GDP- D is NNP and GDI-D is NNI.
NI (National Income) is the net income at factor prices generated in the production
of all final goods and services. At factor prices means at the prices in the factor
markets not the product markets, so IBT (like excise & sales taxes) are not
included. It is “net” so depreciation is not included. So NI is total payments to the
factors of production, or NNP-IBT.
Personal Income (PI) is similar to NI except it only includes income earned by
individuals. Therefore, income such as corporate profits and retained earnings are
subtracted, while income such as dividends and government transfer payments to
individuals are added to NI.
DI (disposable income) can be found simply by subtracting PT (personal taxes like
income and property taxes) from PI, leaving only the money people have available
to spend. DI is after-tax income. DI also equals the sum of the three (accounting)
categories that PI can be spent on: C, PS (personal savings), and ICL (interest on
consumer loans).
Table 7-5 (p.172) is a step-by-step guide showing how only slight alterations mark
the difference between each successive National Income Accounting measure.
VIII. Final Value and Value-Added methods
Final Value only adds the prices of the goods sold to the final user, that is,
the price paid by whoever buys the new good.
Value-Added combines the value of each good at each stage of its production.
This is especially clear when you have several companies who each do some part
of the production before the product reaches the market. The example given in the
table (p.164) is of 200 ice cream cones (final goods), which begins as farm output.
The farm output required for the final goods has a value at which it is sold by the
farmer. The next company to add value is the “Cone factory and Ice cream
maker,” which processes the raw ingredients into a bulk manufactured product.
The factory adds value, as does the middleperson whose business it is to route
goods to retailers. Then the Ice Cream Vendor adds value by storing it in an
appealing location that will get noticed by consumers, having staff on hand to
explain the qualities of the product and conduct the final transaction, and using part
of their “overhead” (expenses) to get the product sold. Their value-added is
combined with the values-added at previous stages to get the final value.
Final Value is the US method of calculation; however several European countries
use a Value-Added Tax.
IX. Does GDP necessarily improve well-being?
The assumption that GDP (and particularly GDP per capita) tracks the well-being
of individuals in a country remains the dominant belief. There are challenges to
this linkage, including:
1. All the forms of excluded output do in fact improve well-being, despite the
fact they are uncounted in GDP. This includes volunteer work, household
labor, chores for kids, all uncounted production that improves well-being
(the exception is illegal economic activity)
2. Much of the counted output ignores byproducts that decrease well-being.
The clearest example of this is air or water pollution caused by industrial
output. While a ten-year period in which output doubles may make the GDP
growth rate soar, the pollution resulting may decrease well-being for
individuals. A more indirect example is that large corporations expanding
market share often increases GDP, but can put other forms of more localized
businesses into bankruptcy, causing net job loss, fewer choices, and farther
traveling distances for consumers (think of Wal-Mart).
3. Output that does count may not add to well-being. Advertising that gives
bad information or does not assist in economic decision making is an
example. An argument can be made that defense spending, past a certain
point, adds nothing to well-being. Also, the question of whether GDP
growth is desirable has been raised because a characteristic of growth is
pollution.
On the other hand, eliminating pollution completely is not realistic because the
opportunity cost to do so becomes too much for industry to cover and continue
operating, and GDP growth generates money for research and implementation of
cleaner production methods.