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07 Measuring Domestic Output and National Income McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Assessing the Economy’s Performance • National Income Accounting measures • LO1 economy’s overall performance Bureau of Economic Analysis compiles National Income and Product Accounts • Assess health of economy • Track long-run growth & performance • Formulate policy 7-2 Gross Domestic Product • Measure of aggregate output • Monetary measure • Avoid multiple counting • Market value of final goods • Ignore intermediate goods • Count only value added LO1 7-4 Gross Domestic Product (1) Stage of Production (2) Sales Value Of Materials Or Product $ 0 Firm A, sheep ranch 120 Firm B, wool producer 180 Firm C, coat manufacturer 220 Firm D, clothing manufacturer 270 Firm E, retail clothier 350 Total Sales Value $1140 Value Added (total income) LO1 (3) Value Added ]--------$120 (= $120 - $ 0) ]-------- 60 (= 180 - 120) ]-------- 40 (= 220 - 180) ]-------- 50 (= 270- 220) ]-------- 80 (= 350 – 270) $350 7-6 Gross Domestic Product • Exclude financial transactions • Public transfer payments • Private transfer payments • Stock (and bond) market transactions • Exclude second hand sales • Sell used car to a friend LO1 7-7 Two Approaches to GDP • Income approach • Count income derived from production • Wages, rental income, interest income, • LO2 profit Expenditure approach • Count sum of money spent buying the final goods • Who buys the goods? 7-8 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 LO2 G = D= P + + + + Interest Profits Statistical Adjustments 7-10 Expenditures Approach • Personal consumption expenditures (C) • Durable consumer goods • Nondurable consumer goods • Consumer expenditures for services • Domestic plus foreign-produced goods (both included in expenditures) LO2 7-11 Expenditures Approach • Gross private domestic investment (Ig) • Machinery, equipment, and tools • All construction • Changes in inventories • Creation of new capital assets LO2 7-12 Expenditures Approach = Gross Investment Depreciation Net Investment Gross Investment Net Investment Depreciation Increase LO2 Stock of Capital Consumption & Government Spending Stock of Capital January 1 Year’s GDP December 31 7-14 Expenditures Approach • Government purchases (G) • Expenditures for goods and services • Expenditures for publicly owned capital • Excludes transfer payments • Net exports (Xn) • Add exported goods • Subtract imported goods • Xn = exports – imports • GDP = C + Ig + G + Xn LO2 7-15 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 LO2 Gross Domestic Product 1864 $ 14,256 7-16 Comparative GDP LO2 7-17 The Income Approach • Compensation of employees • Rents • Interest • Proprietor’s income • Corporate profits • Corporate income taxes • Dividends • Undistributed corporate profits • Taxes on production and imports LO2 7-18 The Income Approach • From national income to GDP • Subtract net foreign factor income • Statistical discrepancy • Consumption of fixed capital • Other national accounts • Net domestic product (NDP) • National income (NI) • Personal income (PI) • Disposable income (DI) LO2 7-19 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) LO2 $ 14,256 1864 $ 12,392 209 105 $ 12,288 1090 967 315 418 2528 $ 12,026 1102 $ 10,924 7-20 The Circular Flow of Payments LO2 7-21 Nominal vs. Real GDP • GDP is a dollar measure of production • Using dollar values creates problems • Nominal GDP • Use prevailing price • Real GDP • Reflect changes in price • Use base year price LO3 7-23 GDP Price Index • Use price index to determine real GDP Price Index In Given Year Real GDP LO3 = = Price of Market Basket In Specific Year Price of Same Basket In Base Year x 100 Nominal GDP Price Index (in hundredths) 7-24 GDP Price Index • Calculating Real GDP (Base Year = Yr 1) LO3 (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 --- --- --- 5 11 28 --- --- --7-25 Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • The underground economy • GDP and the environment • Composition and distribution of the output • Noneconomic sources of well-being LO4 7-27 Underground Economy LO4 7-28