Download Chapter 5 Presentation - Kellogg Community College

Macroeconomics
Unit 5
National Income Accounting
The Top Five Concepts
Introduction
In this unit we explore the components of GDP and the output
or income that is contained within each component.
We also learn the importance of calculating real economic
growth by eliminating the effects of inflation.
Finally we examine the topics of investment and personal
income.
Concept 1: GDP
GDP is the total market value of all final goods and services
produced within a nation’s borders in a given time period.
It is measured in monetary terms – meaning the total dollar
value of each good or service valued at its market price.
GDP measures only output produced within a specific nation’s
borders. For example, the GDP for the United States includes
all final goods and services produced within the U.S., including
output by foreign owned companies who have factories here.
Concept 1: GDP
GDP does not include everything that is
actually produced within a country. Only
final goods and services are reported, not
unfinished goods. In addition the following
items are not included:
• Unreported income is not included.
• Some babysitting, lawn care, cleaning,
painting, etc.
• Illegal activities are also not included.
Concept 1: GDP
Intermediate goods which are purchased
for use as an input in the production of final
goods or services are not included in the
GDP number. This eliminates counting
output twice.
Examples of intermediate goods includes
processor chips of personal computers,
seats for new cars, hamburger buns being
used for hamburgers at a fast food
restaurant.
Types of GDP
Nominal GDP is the value of final output produced in a given
time period, measured in the prices of that period (current
prices). Nominal GDP numbers are the most often reported in
the media.
For example, the nominal GDP in the year 2000 was $9.963
trillion. The nominal GDP in the year 1995 was $7.4 trillion.
Can we easily compare these two numbers as stated? NO!
Why? Because there was also inflation during the five year
period which is reflected in the 2000 GDP figure. To eliminate
the effects of inflation we must calculate the real GDP.
GNP
GNP refers to Gross National Product. GNP was frequently
used in the past to show economic growth. GNP is the value of
all final goods and services produced by companies whose
headquarters are located in a specific country.
For example, if Kellogg’s, the cereal company, had a plant
operating in Japan, that plant’s output would be reported under
U.S. GNP. Similarly if Toyota had an assembly plant in the
U.S., the total output from that plant would be reported in
Toyota’s home country Japan.
The switch from GNP to GDP occurred to more accurately
reflect output within a nation’s borders regardless of a
company’s country of origin.
Concept 2: Calculating Real GDP
Real GDP is calculated by taking the nominal GDP for a
specific year, and dividing it by the price index. Real GDP
provides an accurate number that can be used to measure true
economic growth.
A price index provides you with information about how much
prices have changed from year to year.
Formula:
Real GDP in year t = nominal GDP in year t / price index
Concept 2: Calculating Real GDP
Going back to our previous example, in 1995 nominal GDP was
$7.4 trillion and in 2000 nominal GDP was $9.963 trillion. How
much did GDP really change during the five year period?
If the change in the price index from 1995 to 2000 was 9%, we are
ready to calculate the real GDP:
Real GDP in 2000 = $9.963 trillion / 1.09 = $9.14 trillion
(1995 Prices)
Notice that the 9% increase in prices was converted to a price
index by adding 1 to the 9% (.09) change. Now we can compare
the two years.
Concept 2: Calculating Real GDP
Our nominal GDP in 1995 was $7.4 trillion and the real GDP in
2000 was $9.14 trillion in 1995 prices. Therefore we can say
that real GDP grew by $1.74 trillion during the five year period.
Students normally have a difficult time with these conversions
to real GDP. Before attempting to solve any problems, read the
question carefully. What are you being asked to compare or
convert?
Lets do another problem.
Concept 2: Calculating Real GDP
In 2000 the nominal GDP was $9.963 trillion. What is the
real GDP in 2000 using1990 prices? Average prices for the
time period increased by 26.6%.
Real GDP in year 2000 = nominal GDP in 2000 / price index
(1990 Prices)
To solve this problem you simply plug in the numbers.
Real GDP in 2000 = $9.963 trillion / 1.266 = $7.869 trillion
(1990 prices)
Concept 2: Calculating Real GDP
If the nominal GDP for 1990 was $5.803 trillion, our economy
actual grew by $2.066 trillion ($7.869 trillion - $5.803 trillion).
If we did not calculate real GDP, we would wrongly assume that
our economy grew by $4.160 trillion ($9.963 trillion - $5.803
trillion). That’s the importance of calculating the real GDP – it
tells us if true economic growth is occurring and the actual
amount of growth. Nominal GDP can increase simply because
of price increases over time.
Real GDP shows real growth!
Concept 2: Calculating Real GDP
Let’s do one more problem – just in case!
Suppose the price level is 100 for 1996 and the price level is
103.3 in 1998. If the nominal GDP in 1998 was $8,800
billion, what is the real GDP in 1998 using 1996 prices?
In this problem we are already using a price index. To solve
this problem, simply divide the nominal GDP of $8,800 billion
by the price index (103.3), and multiply the result by 100. Or
if you prefer, divide the nominal GDP of $8,800 billion by
1.033. In either case the answer is $8,518.9 billion.
The real GDP in 1998 (using 1996 prices) was $8,518.9
billion.
Inflation & GDP
The changes in the value of GDP between each year is
affected by growth (or decline) and inflation or deflation.
Inflation is an increase in the average prices of goods and
services. Deflation is a decrease in the average prices of
goods and services.
When the government reports real GDP values, they use a
chain-weighted index to compute them. Instead of a single
base year, a moving average of several years is used. This
increases the accuracy of price changes.
GDP Changes
Increases in nominal GDP reflect higher prices as well as more
output (growth).
Increases in real GDP reflect changes in growth only. The
effects of inflation are removed. Therefore if an individual
wishes to examine changes in economic growth, it is better to
use real GDP which eliminates the effects of inflation.
Net Domestic Product
Net Domestic Product is equal to GDP minus depreciation.
Depreciation is defined as the consumption of capital in the
production process; the wearing out of plant and equipment.
Different capital items may have different depreciation rates
depending upon the estimated life of the item.
Each year a dollar amount is subtracted from the initial value of
an item to reflect depreciation.
In terms of economic growth business must invest not only
enough to cover depreciation, but exceed it in order to have
true economic growth.
Concept 3: Investment
Investment is the expenditures on new plant, equipment, and
structures (all are capital items) in a given time period, plus
changes in business inventory. New residential construction
is also included in this category.
Gross investment is the total expenditure on investment
during a given time period.
Net investment is equal to gross investment less
depreciation.
To have economic growth net investment must be positive.
Concept 3: Investment
Investment rates are watched by economists.
If gross investment exceeds the amount of depreciation, then
business is expanding production, and our capital stock is
increasing.
If gross investment is less than depreciation, then our
equipment is wearing out faster than it is being replaced – we
have a decline in capital stock.
Net investment is positive when gross investment exceeds
depreciation, and negative when it is less.
Uses of Output
In unit 2 we learned that most of all output produced in the United
States is produced for consumer consumption.
Output is also produced for investment. Investment output
consists of plants, equipment, etc. Investment output is used by
companies to produce final goods and services. Investment
goods also consist of changes in business inventories and new
residential construction.
Output is also consumed by federal, state, and local
governments. Some output is produced for export while we also
import output from other countries.
Uses of Output
The final category of output is called Net
Exports.
Net Exports contains the total dollar value of
all goods and services exported, minus the
total dollar value of all goods and services
imported.
If Net Exports are positive, we are exporting
more than we are importing. If it is negative,
we are importing more than we are
exporting.
Concept 4: Uses of Output
We have examined four different categories of output:
Consumption (Consumer use of output)
Investment (Business use of output)
Government (Government use of output)
Net Exports (Exports - Imports)
Added together we get the value of GDP using this
formula:
GDP = C + I + G + (X – IM)
Output=Income
A basic economic principle is that all output produced is equal
to the total value of income.
The total market value of incomes will usually equal the market
value of output.
National Income
National Income (NI) is the total income earned by current
factors of production: To determine NI you take the total
amount of GDP less depreciation, less indirect business taxes,
and plus net foreign factor income.
Indirect business taxes remove income from the flow between
product and factor markets. Sales taxes are an example.
Net foreign factor income is the difference between the income
generated by foreign entities here, and the income generated
by domestic entities overseas.
Concept 5: Personal and Disposable Income
Personal income is the income received by households before
payment of personal taxes.
From National Income, you subtract corporate taxes, retained
earnings, Social Security payments, and add transfer payments
and net interest. Then you have the value of personal income.
Once personal taxes are paid, we are left with disposable
income. Disposable income is either spent or saved by
consumers.
Summary
•
•
•
•
•
•
GDP – what’s included/excluded.
Intermediate goods.
Real and nominal GDP.
Gross & Net Investment.
GDP=C + I + G + (X-IM)
Personal Income, Disposable Income.