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7 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 • Assess health of economy • Compares levels of production • Track long run course • Grown, constant, or declined • Formulate policy • Safeguard and improve economy’s health LO1 Gross Domestic Product • Gross Domestic Product (GDP) -Total value of final goods and services produced in a country in a given year. (Aggregate Output) • As long as a company is within a country’s border, their numbers go into the country’s GDP (even if they are foreign-owned). 2-3 Gross Domestic Product (GDP) • Gross Domestic Product (GDP): Total market value of all final goods and services produced within a country within a year LO1 Gross National Product (GNP) Total value of final goods and services produced by a country in a given year. 2-5 Gross Domestic Product • Monetary measure • Avoids multiple counting • Excludes intermediate goods • Counts market value of final goods • Value added counted LO1 Gross Domestic Product • Intermediate Goods • Purchased for resale • Further processing • Manufacturing • Final Goods • Purchased by end user LO1 Gross Domestic Product • Value added counted • Sum of value added = GDP LO1 Excludes Non-Production Transactions • Excludes financial transactions • Public transfer payments • Private transfer payments • Stock (and bond) market transactions • Excludes second hand sales LO1 Gross Domestic Product GDP 2014: $17.4T •Source: World Development Indicators database, World Bank, 1 July 2015 2-10 Two Approaches to GDP • Income approach (earnings or allocation) • Count income derived from • LO2 production Expenditure approach (output) • Count sum of money spent buying the final goods Two Approaches to GDP • GDP, output, and income all refer to the same thing and can be used interchangeably. LO2 Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2 Income or Allocations Approach Wages Plus Rents Plus Interest Plus Profits Plus Statistical Adjustments LO2 Expenditures Approach LO2 Expenditures or Output Approach Consumption Expenditures by Households (C) Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2 Expenditures Approach • Personal consumption expenditures (C) • Durable goods (3 years +, 10%) • Nondurable goods (< 3 years, 30%) • Services (60%) • Spending on houses is not included • Largest component of GDP LO2 Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses (G) Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2 Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2 Expenditures Approach • Gross private domestic investment (Ig) • Machinery, equipment, and tools • All construction (includes residential) •R & D • Creation of music, art, film, software, etc. • Changes in inventories LO2 Changes in Inventories Changes in inventories represent the difference between what was produced during the year, and what was purchased. LO2 Positive and Negative Changes in Inventories LO2 Changes in Inventories • If inventories increase, more was produced than purchased, so the increase in inventories must be added to Ig and GDP. (unconsumed output) • Vice versa if inventories fell. LO2 Net Investment (In) LO2 Net Investment • Net Investment includes only added capital during the year. (Gross Investment minus Depreciation) • In = Ig – Depreciation • Depreciation (Consumption of Fixed Capital - CFC) = amount of capital goods used during the year. LO2 Net Investment • Ig > CFC; therefore In > 0 and economy is growing. • Ig = CFC; therefore In = 0 and economy is stagnant. • Ig < CFC; therefore In < 0 and economy is experiencing negative growth (disinvesting). LO2 Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services (G) Plus Expenditures by Foreigners LO2 Expenditures Approach • Government purchases (G) 1. Goods and services to provide public services 2. Publicly owned capital 3. R&D + other to increase economy know-how • Excludes transfer payments LO2 Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners (Net Exports = Xn) LO2 Expenditures Approach • Net exports (Xn) • Add exported goods (X) • Subtract imported goods (M) • Xn = exports (X) – imports (M) LO2 Expenditures or Output Approach Consumption Expenditures by Households (C) Plus Investment Expenditures by Businesses (Ig) Plus Government Purchases of Goods and Services (G) Plus Expenditures by Foreigners (Xn) LO2 Expenditures Approach GDP = C+Ig+G+Xn LO2 U.S. Economy 2012 in Billions Receipts Expenditures Approach Allocations Income Approach Personal Consumption (C)$11,150 Compensation Gross Private Domestic Rents 541 Interest 440 Investment (Ig) 2,475 $ 8,612 Government Purchases (G) 3,167 Proprietor’s Income 1,225 Net Exports (Xn) Corporate Profits 2,031 -547 Taxes on Production and Imports 1,123 National Income $13,972 Net Foreign Factor Income (-) Consumption of Fixed 253 2,543 Capital (+) Statistical Discrepancy (+) Gross Domestic Product $ 16,245 Gross Domestic Product -17 $ 16,245 Source: Bureau of Economic Analysis, www.bea.gov LO2 Comparative GDP LO2 Other National Accounts • Net Domestic Product (NDP) • Measures what has been added to the stock of capital and the new output = replacement of capital goods used up in production of output. • NDP = GDP – consumption of fixed capital LO2 Other National Accounts • National Income (NI) • Includes all income earned by U.S.-owned resources whether they are located in the United States or abroad LO2 Other National Accounts • Personal Income (PI) • Includes all income received whether it was earned or unearned LO2 Other National Accounts • Disposable Income (DI) • Income that households receive (personal income minus taxes) • and able to spend as they desire (consumption or savings) DI = C + S LO2 U.S. Income Relationships 2012 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 $ 16,245 2,543 $ 13,702 -17 253 $ 13,972 1,066 951 435 542 2,766 $ 13,744 1,498 $ 12,246 Nominal vs. Real GDP LO2 Nominal vs. Real GDP • Nominal GDP • Uses current prices year produced • Real GDP • Adjusted for inflation • Use base year’s prices LO3 CPI Market Basket GDP Price Index • Use price index to determine real GDP Price Index In Given Year Real GDP LO3 Price Good in Specific Year =Price of Good In Base Year x 100 = Nominal GDP Price Index (in hundredths) Real-World Considerations • More complicated than the “one-good • • LO4 scenario Assigns a “weight” to several categories of goods and services based on the relative proportion of each category in total output The U.S. GDP PI is “chain-typeannual-weights price index” Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • The underground economy LO4 Underground Economy LO4 Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • The underground economy • GDP and the environment • Composition and distribution of the • LO4 output Noneconomic sources of well-being