Download GDP

6
Measuring Domestic
Output and National
Income
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Copyright 2008 The McGraw-Hill Companies
Learning objectives
• In this chapter you will learn:
A. How gross domestic product (GDP) is defined and
measured.
B. The relationships between GDP, net domestic product,
national income, personal income, and disposable income.
C. The nature and function of a GDP price index.
D. The difference between nominal GDP and real GDP.
E. Some limitations of the GDP measure.
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Assessing the Economy’s Performance
•
National income accounting measures the economy’s
performance by measuring the flows of income and
expenditures over a period of time. National income accounts
enable us to:
a. Measure the economy’s overall performance by measuring
the flows of income and expenditures over a period of time
(Assess the health of the economy)
b. Track the long run course of the economy: growing,
declining, or constant (compare conditions over time and
across countries)
c. Provide a basis for appropriate public policies to improve
economic performance (improve the economy’s health)
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Gross Domestic Product
GDP is the monetary measure of the total market value of all
final goods and services produced within a country in one year.
Note GDP is a monetary measure i.e.,
GDP=Quantities of goods and sericves x prices
1. Money valuation allows the summing of apples and oranges;
money acts as the common denominator. (See Table 6.1.)
2. GDP includes only final products and services (goods and
services purchased for final use, not for resale or
reprocessing or manufacturing); it avoids double or
multiple counting, by eliminating any intermediate goods
used in production of these final goods or services. (Table 6.2
illustrates how including sales of intermediate goods would
overstate GDP.)
3. GDP is the value of what has been produced in the economy
over the year, not what was actually sold.
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Example
Suit production
stages of production
firm A: sheep ranch
firm B: wool processor
firm C: suit manufacturer
firm D: Clothing wholesaler
firm E: Retail Clothier
Total Sales value
Value Added
sales value of
materials or product
0
120
180
220
270
350
1140
Value added
120 (=120-0)
60 (=180-120)
40 (=220-180)
50 (=270-220)
80 (=350-270)
350
Two ways to calculate GDP
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GDP Excludes Non-production Transactions
GDP is designed to measure what is produced or
created over the current time period.
1. Existing assets or property that are sold or
transferred, including used items, are not counted.
2. Purely financial transactions are excluded.
a. Public transfer payments, like social security or cash
welfare benefits.
b. Private transfer payments, like student allowances or
alimony payments.
c. The sale of stocks and bonds represent a transfer of
existing assets. (However, the brokers’ fees are included
for services rendered.)
3. Secondhand sales are excluded, they do not represent
current output. (However, any value added between
purchase and resale is included, e.g. used car
dealers.)
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Two Ways to Look at GDP: Spending and Income.
What is spent on a product is income to those who helped to
produce and sell it. This is an important identity and the
foundation of the national accounting process.
Expenditures Approach (See Figure 6.1 and Table 6.3)
•
GDP is divided into the categories of buyers in the market;
household consumers, businesses, government, and foreign
buyers.
1. Personal Consumption Expenditures (C) includes durable
goods (lasting 3 years or more), nondurable goods and
services.
2.
a.
b.
c.
Gross Private Domestic Investment-(Ig)
All final purchases of machinery, equipment, and tools by
businesses.
All construction (including residential).
Changes in business inventory (±).
i.
ii.
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If total output exceeds current sales, inventories build up.
If businesses are able to sell more than they currently produce,
this entry will be a negative number.
Copyright 2008 The McGraw-Hill Companies
Non-investment transactions – despite how the term
“investment” is used by the general public, investment does
not include transfers of ownership of paper assets (stocks and
bonds) or real assets (houses, jewelry, art). Only newly
created capital is counted as investment.
Net Private Domestic Investment -(In).
i. Each year as current output is being produced, existing
capital equipment is wearing out and buildings are
deteriorating; this is called depreciation or consumption of
fixed capital.
ii. Gross Investment minus depreciation (consumption of fixed
capital) is called net investment.
iii. If more new structures and capital equipment are produced
in a given year than what are used up, the productive capacity
of the economy will expand. (Figure 6.2)
iv. When gross investment and depreciation are equal, a nation’s
productive capacity is static.
v. When gross investment is less than depreciation, an
economy’s production capacity declines.
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3.
•
•
•
4.
a.
b.
c.
•
Government Purchases (of consumption goods and capital
goods) – (G)
Includes spending by all levels of government (federal, state
and local).
Includes all direct purchases of resources (labor in
particular).
This entry excludes transfer payments since these outlays do
not reflect current production.
Net Exports-(Xn)
All spending on final goods produced in Kuwait must be
included in GDP, whether the purchase is made here or
abroad.
Often goods purchased and measured in Kuwait are
produced elsewhere (Imports).
Therefore, net exports, (Xn) is the difference: (exports
minus imports) and can be either a positive or negative
number depending on which is the larger amount.
Summary: GDP = C + Ig + G + Xn
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Expenditure Approach
1. Personal Consumption Expenditures
• Durable Consumer Goods
• Nondurable Consumer Goods
• Consumer Expenditures for Services
2. Gross Private Domestic Investment
• Machinery, Equipment, and Tools
• All Construction
• Changes in Inventories
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C
Ig
Expenditure Approach
G
3. Government Purchases
• Expenditures for Goods and
Services
• Expenditures for Social Capital
4. Net Exports
Xn = Exports (X) – Imports (M) Xn
Putting It All Together:
GDP = C + I + G + Xn
GDP= $8,746 + 2,105 + 2,363 - 727 = $12,487 in
2005
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Income Approach to GDP (See Table 6.3): Demonstrates how
the expenditures on final products are allocated to resource
suppliers.
1. Compensation of employees includes:
•
wages,
•
salaries,
•
fringe benefits,
•
supplements,
•
and payments made on behalf of workers like social
security and other health and pension plans.
2. Rents: payments for supplying property resources
(adjusted for depreciation it is net rent).
3. Interest:
payments from private business to suppliers of
money capital.
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4. Proprietors’ income: income of incorporated businesses, sole
proprietorships, partnerships, and cooperatives.
5. Corporate profits, include:
• corporate income taxes paid to government,
• dividends distributed to the shareholders,
• the remainder is left as undistributed corporate profits (also
referred to as retained earnings).
6. Taxes on production and imports: general sales taxes, excise
taxes, business property taxes, license fees, and customs
duties.
• The sum of the above entries equals national income: all
income earned by Kuwaiti supplied resources, whether here
or abroad, plus taxes on production and imports.
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• Adjustments required to balance both sides of the account:
a. Net foreign factor income: National income measures the
income of Kuwaitis both here and abroad. GDP measures the
output of the geographical Kuwait regardless of the
nationality of the contributors. To make this final adjustment,
the income of foreign nationals must be added and Kuwaiti
income earned abroad must be subtracted. Sometimes this
entry is a negative number. (Without this adjustment you
have GNP.)
b. Statistical discrepancy: NIPA accountants add a statistical
discrepancy to national income to equalize the income and
expenditures approaches ($43 billion in USA in 2005).
c. Depreciation/Consumption of Fixed Capital: The firm also
regards the decline of its capital stock as a cost of production.
The depreciation allowance is set aside to replace the
machinery and equipment used up. In addition to the
depreciation of private capital, public capital (government
buildings, port facilities, etc.), must be included in this entry.
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GDP Approaches Compared
Accounting Statement for the U.S. Economy, 2005
in Billions
Receipts
Expenditures Approach
Allocations
Income Approach
Personal Consumption (C) $ 8746 Compensation
Gross Private Domestic
Rents
$ 7125
73
Investment (Ig)
2105 Interest
498
Government Purchases (G)
2363 Proprietor’s Income
939
Net Exports (Xn)
-727 Corporate Profits
Taxes on Production and
1352
917
Imports
National Income
Net Foreign Factor Income
Statistical Discrepancy
$10,904
-34
43
Consumption of Fixed
Capital
Gross Domestic Product $ 12,487 Gross Domestic Product
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1574
$ 12,487
Comparative GDPs
GLOBAL PERSPECTIVE
Select Nations GDPs - 2005
GDP in Trillions of Dollars
0
United States
Japan
Germany
China
United Kingdom
France
Italy
Spain
Canada
Brazil
Korea, Rep.
India
Mexico
Russian Fed.
Australia
1
2
3
4
5
6
7
8
9
10
12
$12.4
$4.5
$2.8
$2.2
$2.2
$2.1
$1.7
$1.1
$1.1
$.79
$.79
$.78
$.77
$.76
$.70
Source: World Bank
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Two Approaches to GDP
Expenditure
Approach
Income
Approach
Consumption by
Households
Wages
Investment by
Businesses
Rents
+
+
Government
Purchases
+
Expenditures
By Foreigners
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G
= D=
P
+
+
+
+
Interest
Profits
Statistical
Adjustments
IV.
1.
2.
3.
4.
Other National Accounts (see Table 6.4)
Net domestic product (NDP) is equal to GDP minus
depreciation allowance (consumption of fixed capital).
National income (NI) is income earned by American-owned
resources here or abroad. Adjust NDP by adding net foreign
factor income. (Note: This may be a negative number if
foreigners earned more in Kuwait than Kuwaiti resources
earned abroad.)
Personal income (PI) is income received by households. To
calculate PI, take NI minus taxes on production and
imports, minus payroll taxes (social security contributions),
minus corporate profits taxes, minus undistributed corporate
profits, and add transfer payments.
Disposable income (DI) is personal income less personal taxes.
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The Income Approach
• From National Income to GDP: add the following items to NI:
– Net Foreign Factor Income
– Statistical Discrepancy
– Consumption of Fixed Capital
• Other National Accounts
– Net Domestic Product (NDP)
• Subtract consumption of fixed capital from GDP
– National Income (NI). Subtract the following from NDP:
• Statistical discrepancy
• Net foreign factor income
– Personal Income (PI) subtract the following 4 items and add the 5th
item
•
•
•
•
•
Taxes on Production and Imports
Social Security Contributions
Corporate Income Taxes
Undistributed Corporate Profits
Transfer Payments
– Disposable Income (DI)
• subtract personal tax
– Note that DI = C (consumption) + S (saving)
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W 6.1
The Income Approach
Income Relationships – United States, 2005
Gross Domestic Product (GDP)
Consumption of Fixed Capital
Net Domestic Profit (NDP)
- Statistical Discrepancy
- Net Foreign Factor Income (-(-34))
National Income (NI)
1. Taxes on Production and Imports
2. Social Security Contributions
3. Corporate Income Taxes
4. Undistributed Corporate Profits
5. Transfer Payments
Personal Income (PI)
Personal Taxes
Disposable Income (DI)
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$ 12,487
-1,574
$ 10,913
-43
34
$ 10,904
-917
-871
-378
-460
+1,970
$ 10,248
-1,210
$ 9,038
V.
Circular Flow Revisited (see Figure 6.3)
A. Compare to the simpler model presented in earlier chapters.
Now both government and foreign trade sectors are added.
B. Note that the inside covers of the text contain a useful
historical summary of national income accounts and related
statistics.
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Circular Flow Revisited
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Nominal versus Real GDP
•
Nominal GDP is the market value of all final goods and
services produced in a year. This creates problems
when we compare GDP over time.
•
If GDP increases, this may be due to rises in quantities
or in prices or both. But it is only the quantity of goods
we produce that affects our standards of living not the
price.
•
To measure changes in the quantity of output, we need
a yardstick that stays the same size.
•
To make comparisons of real output, a K.D. must keep
the same purchasing power over time.
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•
•
•
Unadjusted (nominal) GDP: is based on current year
prices
Adjusted (nominal) GDP: is based on base year
prices
To overcome the problem we deflate GDP when
prices rise, or inflate GDP when prices fall. Adjusted
(real) GDP is deflated or inflated to reflect changes in
prices.
Adjustment process in one product economy.
Valid comparisons cannot be made with nominal
GDP alone, since both prices and quantities are
subject to change. Some methods to separate the
two effects must be devised.
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NOMINAL GDP vs. REAL GDP: GDP Output of Pizza
(4)
(5)
(3)
(2)
(1)
Adjusted,
Base year
Units of Price of Price Index Unadjusted,
or Nominal, Or Real,
Year 1 =
Pizza
Output
GDP,
GDP
100
Year Of Pizza Per Unit
(1)x(2)
1
2
3
4
5
5
7
8
10
11
$ 10
20
25
30
28
100
200
250
-
$ 50
140
200
-
=(20/10)*100
$ 50
70
80
=(140/20)*100
Or
=Q*base year price
Note:
The market basket is composed of pizzas only
Year 1 is the base year
Real GDP can be calculated by multiplying units of output by base year prices
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• Adjustment Process:
• First Method: GDP Price Index:
1. first determine a price index,
2. then adjust the nominal GDP figures by dividing by
this price index
• Price index = (price of market basket in a specific
year/ price of the same basket in base year) x 100.
• Real GDP = (Nominal GDP/Price index) x 100
Price Index: is a measure of the price of a specified collection
of goods and services called a “market basket” in a given year
(e.g. current year) compared to the price of an identical
collection of goods and services in a reference (base) year.
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Adjustment Process:
• An alternative method
• Multiply current quantities of goods and services by
prices of the base year to calculate real GDP
• Multiply current quantities of goods and services by
current year prices to calculate nominal GDP
• Calculate the price index (Multiply by 100 to put it in
standard index form) by:
• Price index = (nominal GDP/real GDP) x 100
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VII. Shortcomings of GDP
•
GDP doesn’t measure some very useful output
because it is unpaid (homemakers’ services,
parental child care, volunteer efforts, home
improvement projects), these are non-market
transactions.
GDP doesn’t measure improved living conditions
as a result of more leisure.
GDP does not measure improvements in product
quality or make allowances for increased leisure
time.
The Underground Economy
•
•
•
–
–
Illegal activities are not counted in GDP (estimated to be
around 8% of U.S. GDP).
Legal economic activity may also be part of the
“underground,” usually in an effort to avoid taxation.
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• GDP and the environment.
1. The harmful effects of pollution are not deducted from
GDP (oil spills, increased incidence of cancer, destruction
of habitat for wildlife, the loss of a clear unobstructed
view).
2. GDP does include payments made for cleaning up the oil
spills, and the cost of health care for the cancer victim.
• GDP makes no value adjustments for changes in the
composition of output or the distribution of income.
– Nominal GDP simply adds the dollar value of what is
produced; it makes no difference if the product is a semiautomatic rifle or a jar of baby food.
– Per capita GDP may give some hint as to the relative
standard of living in the economy; but GDP figures do not
provide information about how the income is distributed.
• Noneconomic Sources of Well-Being like courtesy,
crime reduction, etc., are not covered in GDP.
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Shortcomings of GDP
GLOBAL PERSPECTIVE
Underground Economy as a Percentage
of GDP - Select Nations
Percentage of GDP
0
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United Kingdom
Japan
United States
Switzerland
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5
10
15
20
25
30
Source: Journal of Economic Literature
VIII. LAST WORD: Magical Mystery Tour
•
•
•
•
•
•
•
•
GDP is compiled by the Bureau of Economic Analysis
(BEA) in U.S. Commerce Department. Where does it get its
data? Explanation follows.
Consumption data comes from:
Census Bureau’s “Retain Trade Survey” from sample of
22,000 firms.
Census Bureau’s “Survey of Manufacturers,” which gets
information on consumer goods shipments from 50,000
firms.
Census Bureau’s “Service Survey” of 30,000 service
businesses.
Industry trade sources like auto and aircraft sales.
Investment data comes from:
All the consumption sources listed above.
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• Census construction surveys.
• Government purchase data is obtained from:
• U.S. Office of Personnel Management, which collects data on
wages and benefits.
• Census construction surveys of public projects.
• Census Bureau’s “Survey of Government Finance.”
• Net export information comes from:
• U.S. Customs Service data on exports and imports.
• BEA surveys on service exports and imports.
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