Measuring National Output and National Income

PRINCIPLE OF ECONOMIC

6 EDITION

KARL CASE, RAY FAIR

PRENTICE HALL BUSINESS PUBLISHING

COPY RIGHT 2002

  

National Income and Product Accounts

•         National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy.

•         The Department of Commerce is responsible for producing and maintaining the “National Income and Product Accounts” that keep track of GDP.

Gross Domestic Product

•         Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country.

Final Goods and Services

•         The term final goods and services refers to goods and services produced for final use.

•         Intermediate goods are goods produced by one firm for use in further processing by another firm.

Value Added

•         Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.

•         In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales.  We do not use the value of total sales in an economy to measure how much output has been produced.

Exclusions from GDP

•         GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.

GDP Versus GNP

•         GDP is the value of output produced by factors of production located within a country.  Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP).

Calculating GDP

GDP can be computed in two ways:

•         The expenditure approach:  A method of computing GDP that measures the amount spent on all final goods during a given period.

•         The income approach:  A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.

The Expenditure Approach

Expenditure categories:

•         Personal consumption expenditures (C)—household spending on consumer goods.

•         Gross private domestic investment (I)—spending by firms and households on new capital:  plant, equipment, inventory, and new residential structures.

•         Expenditure categories:

•         Government consumption and gross investment (G)

•         Net exports (EX – IM)—net spending by the rest of the world, or exports (EX) minus imports (IM)

The Expenditure Approach

•        The expenditure approach calculates GDP by adding together these four components of spending.  In equation form:

                                               

                                      

Personal Consumption Expenditures

•         Personal consumption expenditures (C) are expenditures by consumers on the following:

•         Durable goods:  Goods that last a relatively long time, such as cars and household appliances.

•         Nondurable goods:  Goods that are used up fairly quickly, such as food and clothing.

•         Services:  The things that we buy that do not involve the production of physical things, such as legal and medical services and education.

Gross Private Domestic Investment

•         Investment refers to the purchase of new capital.

•         Total investment by the private sector is called gross private domestic investment.  It includes the purchase of new housing, plants, equipment, and inventory by the private (or non-government) sector.

Gross Investment versus Net Investment

•         Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period.

•         Depreciation is the amount by which an asset’s value falls in a given period.

•         Net investment equals gross investment minus depreciation.

Government Consumption and Gross Investment

•         Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

Net Exports

•         Net exports (EX – IM) is the difference between exports (sales to foreigners of U.S.-produced goods and services) and imports (U.S. purchases of goods and services from abroad).  The figure can be positive or negative.

The Income Approach

•         National income is the total income earned by the factors of production owned by a country’s citizens.

•         The income approach to GDP breaks down GDP into four components:

From GDP to Disposable Income

•         Net national product equals gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock.

From GDP to Disposable Income

•         Personal income is the total income of households.  Equals (national income) minus (corporate profits minus dividends) minus (social insurance payments) plus (interest income received from the government and households).

•         Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.

Disposable Personal Income and Personal Saving

•         The personal saving rate is the percentage of disposable personal income that is saved.  If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously.

Nominal versus Real GDP

•         Nominal GDP is GDP measured in current dollars, or the current prices we pay for things.  Nominal GDP includes all the components of GDP valued at their current prices.

•         When a variable is measured in current dollars, it is described in nominal terms.

Calculating Real GDP

•         A weight is the importance attached to an item within a group of items.

•         A base year is the year chosen for the weights in a fixed-weight procedure.

•         A fixed-weight procedure uses weights from a given base year.

Calculating the GDP Price Index

•         The GDP price index is one measure of the overall price level.

•         The old procedure used by the Bureau of Economic Analysis (BEA) to estimate changes in the overall price level used the quantities produced in a chosen year (the base year) as weights.  But overall price increases are sensitive to the choice of the base year.  The new procedure, known as the chained price index, avoids the problems associated with the use of fixed weights.

The Problems of Fixed Weights

The use of fixed price weights to estimate real GDP leads to problems because it ignores:

1. Structural changes in the economy.
2. Supply shifts, which cause large decreases in price and large increases in quantity supplied.
3. The substitution effect of price increases.

Limitations of the GDP Concept

•         Society is better off when crime decreases, but a decrease in crime is not reflected in GDP.

•         An increase in leisure is an increase in social welfare, not counted in GDP.

•         Nonmarket and domestic activities are not counted even though they amount to real production.

•         GDP accounting rules do not adjust for production that pollutes the environment.

•         GDP has nothing to say about the distribution of output.  Redistributive income policies have no direct impact on GDP.

•         GDP is neutral to the kinds of goods an economy produces.

The Underground Economy

•         The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

Per Capita GDP/GNP

•         Per capita GDP or GNP measures a country’s GDP or GNP divided by its population.

•         Per capita GDP is a better measure of well-being for the average person that its total GDP or GNP.