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Chapter 20
Gross Domestic Product
Accounting
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Economic Principles
The circular flow of resources,
goods, and services
The circular flow of money
The expenditure approach to
measuring GDP
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Economic Principles
The income approach to
measuring GDP
The relationship between GDP,
NDP, and national income
The limitations of GDP as a
measure of economic well-being
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Gross Domestic Product
Accounting
Circular flow of goods, services,
and resources
• The movement of goods and services from
firms to households, and of resources from
households to firms.
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EXHIBIT 1
THE CIRCULAR FLOW OF GOODS,
SERVICES, AND RESOURCES
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Two Approaches to
Calculating GDP
• Economists calculate GDP in two
ways: the expenditure approach to
GDP and the income approach to
GDP.
• Regardless of which method is
used, the values should be
equivalent.
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The Expenditure Approach
Expenditure approach
• A method of calculating GDP that adds
all expenditures made for final goods and
services by households, firms and
government.
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The Expenditure Approach
When using the expenditure
approach to GDP, one must be
certain that only final goods and
services are counted. Otherwise,
goods may be double counted.
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The Expenditure Approach
Final goods
• Goods purchased for final use, not for resale.
Intermediate goods
• Goods used to produce other goods.
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The Expenditure Approach
Value added
• The difference between the value of a
good that a firm produces and the value of
the goods the firm uses to produce it.
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EXHIBIT 3
MARKET VALUE AND VALUE ADDED OF
GOODS PRODUCED
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The Expenditure Approach
There are four expenditure
categories of GDP:
1. Personal consumption
2. Gross private domestic investment
3. Government purchases
4. Net exports
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The Expenditure Approach
1. Personal consumption
expenditures (C)
• All goods and services bought by
households. These expenditures are grouped
into categories of durable goods, nondurable
goods, and services.
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The Expenditure Approach
1a. Durable goods
• Goods expected to last at least a year. For
example, refrigerators, automobiles, and
washing machines.
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The Expenditure Approach
1a. Durable goods
• During recessions, consumers tend to hang
on to their durable goods, so that sales of
new durable goods are relatively weak.
During times of prosperity, consumers are
more likely to discard old durables, and
sales of new durables are strong.
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The Expenditure Approach
1b. Nondurable goods
• Goods expected to last less than a year.
For example, food, clothing, gasoline and
toiletries. Households spend more on
nondurables than on durables.
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The Expenditure Approach
1c. Services
• Productive activities that are
instantaneously consumed. For example,
medical care, a lecture, and appliance
repair. Households spend more on services
than durable and nondurable goods
combined.
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The Expenditure Approach
2. Gross private domestic
investment (I)
• The purchase by firms of plant, equipment,
and inventory goods.
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The Expenditure Approach
2. Gross private domestic
investment (I)
• Plant (or new structure) and equipment
purchases may either replace worn out
plants and equipment or increase the
quantity of plants and equipment.
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The Expenditure Approach
2a. Inventory investment
• Stocks of finished goods and raw
materials that firms keep in reserve to
facilitate production and sales.
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The Expenditure Approach
3. Government purchases (G)
• All goods and services bought by
government. For example, goods such as
national defense materials, interstate
highway, and post offices, and services
such as justice and education.
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The Expenditure Approach
4. Net exports (X - M)
• An economy’s exports to other economies,
minus its imports from other economies.
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The Expenditure Approach
All final goods and services that
make up GDP, then, can be
expressed in the form:
GDP = C + I + G + (X – M).
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EXHIBIT 4
EXPENDITURE APPROACH TO 2003 GDP
($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003.
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The Income Approach
Income approach
• A method of calculating GDP that adds all
the incomes earned in the production of
final goods and services.
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The Income Approach
National income
• The sum of all payments made to resource
owners for the use of their resources.
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The Income Approach
Corporate profit represents the
return to owners of incorporated
firms. Corporate profit is divided
into three categories—dividends,
corporate reinvestment, and
corporate taxes. All three are
included in the income approach
to GDP.
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The Income Approach
Proprietors’ income is the income
earned by unincorporated firms
for the goods and services they
produce. Proprietors’ income is
the net income after paying such
expenses as rent, utilities, and
supplies.
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EXHIBIT 5
2003 NATIONAL INCOME ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003.
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Bringing GDP and National
Income into Accord
Gross National Product (GNP)
• The market value of all final goods and
services in an economy produced by
resources owned by people of that economy,
regardless of where the resources are
located.
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Bringing GDP and National
Income into Accord
While GDP measures location,
GNP measures ownership. For
example, the value of goods
produced by a U.S.-owned firm in
Spain are not counted in our GDP,
but are counted in our GNP.
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EXHIBIT 7
THE RELATIONSHIP BETWEEN GROSS
DOMESTIC PRODUCT, GROSS NATIONAL
PRODUCT, NET NATIONAL PRODUCT, AND
NATIONAL INCOME: 2003 ($ BILLIONS)
Note: Net domestic product = $8,767.7 billion. The use of NNP instead of NDP to derive national incomes conforms to the derivation of national
income used by government sources. Note also that because GDP and GNP are almost identical, NDP and NNP are almost identical.
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003.
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Relationship Between GDP and GNP
•GDP is converted to GNP. This is done by
subtracting factor payments to the rest of
the world and adding factor payments from
the rest of the world.
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Personal Income and Personal
Disposable Income
Disposable personal income
• Personal income minus direct taxes.
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How Comprehensive Is GDP?
GDP tries to measure everything that
appears on the market. Yet, not everything
produced in the economy gets onto the
market, and some things that contribute to
our economic well-being aren’t even
produced.
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How Comprehensive Is GDP?
The value of housework is one
example of an important service
that is usually not included in
GDP. The work is only included if
it is performed by someone
outside the household, such as a
housekeeper, nanny, or cook.
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How Comprehensive Is GDP?
Underground economy
• The unreported or illegal production of goods
and services in the economy that is not counted
in GDP.
• Illegal unreported activities may include drug trafficking,
money laundering, bribery, prostitution, illegal gambling,
fraud and burglary.
• Tax avoidance is the main reason why legal activities may go
unreported. Swapping services or simply understating the
value of income earned are two ways to avoid paying taxes.
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How Comprehensive Is GDP?
The costs of environmental
damage are another factor not
taken into account in GDP.
While the expense associated with cleaning up the pollution we
create contributes to GDP, the actual pollution created is not
subtracted from GDP.
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How Comprehensive Is GDP?
Many economists agree that despite the
exclusion of some forms of economic value,
our measure of GDP is sufficiently
comprehensive to be a reliable indicator of
changes in the overall performance of the
economy.
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