Measures the economy’s overall performance. Bureau of Economic Analysis compiles the

national income accounts for the U.S. economy.

http://www.bea.gov/

Assess the health of the economy by comparing levels of production at regular intervals

Track the long-run course of the economy to see whether it has grown, been constant, or declined.

Formulate policies that will safe guard and improve the economy’s health.

The total market value of all final goods and services produced in a given year

All goods & services produced by either citizen-supplied or foreign-supplied resources employed in the country

Michigan Plant

Japanese owned factory in Ohio

They have to apply a price tag to each product to figure GDP

Have to have a monetary measure to compare GDP from one year to the next

GDP includes only the market value of final goods and ignores intermediate goods altogether.

Intermediate goods: goods & services that are purchased for resale or for further processing or manufacturing.

Final goods: goods & services that are purchased for final use by the consumer, not resale or for further processing or manufacturing.

5 stages in developing a wool suit

GDP Excludes Nonproduction Transactions

• Financial Transactions such as:1.Public transfer payments: social security

payments, welfare payments, and veteran’s payments that the government makes directly to the households. Recipients do nothing productive in return.

GDP Excludes Nonproduction Transactions

2. Private transfer payments: money that parents give children or cash gifts for Christmas or birthdays. They produce no output!!

GDP Excludes Nonproduction Transactions

3. Stock Market Transactions: The buying and selling of stocks (and bonds) is a matter of swapping bits of paper.

Payments for the services of a stock broker ARE included….they produce a service.

Secondhand Sales

• They contribute nothing to current production and therefore are not included into GDP.

• They were counted the first time they were sold.

Two ways of looking at GDP: spending and income

Expenditures Approach• GDP as the sum of all the

money spent in buying goods and services.

• How much the final user paid for a good or service

• G & S bought by households, businesses, & government

• GDP = C + Ig + G + Xn

Income Approach• GDP in terms of the income

derived or created from producing a good or service.

• Earnings or allocations approach

• Wages + Rents + Interest + Profits = GDP

The Expenditures Approach

Personal Consumption Expenditures (C)

• Covers all expenditures by households on durable consumer goods, nondurable consumer goods, and consumer expenditures for services.

Durable consumer goods

Nondurable consumer goods

Consumer expenditures for services

Gross Domestic Investment (Ig)

Includes the following:• All final purchases of

machinery, equipment, & tools by business enterprises

• All construction (residential & business)

• Changes in inventories

Box making machinery

Positive and Negative Changes in Inventories• Inventories can either increase or decrease over

some period.• Suppose they increased by $10 billion in a year.

That means that the economy produced $10 billion more output than was purchased.

• We need to count all output that was produced in that year even though some of it remained unsold at the end of year.

• Suppose they decreased by $10 billion in a year. It means that the economy sold $10 billion more of output & it will overstate the GDP by $10 billion that year.

• So in that year we consider the $10 billion decline in inventories as “negative investment” and subtract it from total investment that year.

Noninvestment TransactionsWhat is NOT investment??Investment does not include:• Transfer of paper assets

(stocks and bonds)• The resale of tangible assets

(houses, jewelry, boats)These transfer ownership of existing

assets; they do not create new capital assets– assets that create jobs & income.

Gross Investment vs. Net Investment

“domestic” means by private businesses

“gross” means all investments those depreciated and new

Net private domestic investment is ONLY investment in the form of added capital THUS

Net investment= gross investment – depreciation

Government Purchases (G)

• Government consumption expenditures

1. Expenditures for goods & services that gov’t consumes in providing public services.

2. Expenditures for social capital such as schools & highways

Gov’t buying laptops for schools

Net Exports (Xn)

• GDP records all spending on goods & services produced in the U.S., including spending on U.S. output by people abroad.

• At the same time we spend a great deal on imports.

• National Income accountants use “exports less imports” or net exports.

• Xn = exports (x) – imports (m)

Putting it all together!!!

• GDP = C + Ig + G + XnPersonal consumption expenditures ------------- $6759Gross private domestic investment--------------- 1834Government purchases------------------------------ 1743Net exports--------------------------------------------- -370

6759 + 1834 + 1743 – 370 = $9966

Wages plus

Rents plus Interest plus Profits plus Statistical adjustments

Consist of the income received by the households and businesses that supply property resources.

They include monthly payments by renters by private and business.

Net rent is used----- gross rental income minus depreciation of the rental property

Consists of the money paid by private businesses to the suppliers of money capital.

Includes interest households receive on savings deposits, certificates of deposit, and corporate bonds.

Proprietors Income consists of the net income of sole proprietorship, partnerships, and other unincorporated businesses.

Corporate Profits include:

1. Corporate income taxes2. Dividends: part of the

corporate profits paid to stockholders

3. Undistributed corporate profits: money saved by corporations to be invested later in new plants & equipment. Retained earnings

Indirect Business Taxes General sales taxes,

excise taxes, business property taxes, license fees, & custom duties.

Product sells for $1 but gov’t puts a $.05 tax.

The retailer adds the tax to the price. Consumers pay $1.05.

Gov’t has to add the .05 to the $1 of national income in calculating GDP

Consumption of Fixed Capital

Depreciation is the amount estimated of how much of the capital is being used up each year.

The huge depreciation charge made vs. private & social capital each year is called consumption of fixed capital.

This must be added to national income to achieve balance with the economy’s expenditures

Net Foreign Factor Income National income is the total income of American,

whether it was earned in the U.S. or abroad. BUT GDP is a measure of domestic output. So, we must consider the income American gain

from supplying resources abroad & the income foreigners gain by supplying resources in the U.S.

In 2000, foreign-owned resources earned $9 billion more in the U.S. than American-owned resourced earned abroad. That difference is called net foreign factor income.

Several other national accounts provide additional useful information about the economy’s performance.

We can derive these accounts by making various adjustments to GDP.

1. Net Domestic Product (NDP)2. National Income (NI)3. Personal Income (PI)4. Disposable Income (DI)

GDP does not make allowances for replacing the capital goods used up in each year’s production.

We need to subtract consumption of fixed capital (depreciation) from GDP.

The result: Net domestic product

NDP= GDP- depreciation

OR

NDP = GDP – consumption of fixed capital

National income includes all income earned through the use of American-owned resources, whether they are located at home or abroad.

1. Subtract net foreign factor income from NDP (income earned by foreigners in the U.S. minus income earned by Americans abroad)

2. Subtract indirect business taxes from NDP.

PI includes all income received whether earned or unearned.

You have to add transfer payments since they are not earned by working.

You have to subtract social security taxes, corporate income taxes & undistributed corporate profits.

National Income---$8018SS contributions - 706

Corporate income taxes - 286Undistributed corp. profit - 274

Transfer payments +1530

Personal Income $8282

DI is personal income less personal taxes.

DI is the amount of income that households have left over after paying their personal taxes.

They are free to divide that income between consumption and saving

DI = C + S

We use money, or nominal, values as a common denominator in order to add that heterogeneous output (GDP) into a meaningful total.

BUT how can we compare the market values of GDP when the value of money changes from year to year??????

It is the quantity of goods that get produced & distributed to households that affects our standard of living, not the price of the goods.

To solve the problem ------- deflate GDP when prices rise & inflate GDP when prices fall. These adjustments give a measure of GDP for various years as if the value of the dollar had always been the same as it was in some reference year.

A GDP based on the prices that prevailed when the output was produced is called unadjusted GDP, or nominal GDP.

A GDP that has been deflated or inflated to reflect changes in the price level is called adjusted GDP, or real GDP.

GDP price index is a measure of the price of a specified collection of goods & services, called a “market basket,” in a given year as compared to the price of an identical collection of goods & services in a reference year.

That point of reference is known as the base period or base year.

Price price of market basketindex in in specific year X 100given = price of same marketYear basket in base year

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)

(5)Adjusted, or Real GDP

1 5 $10 100 $ 50 $50

2 7 20

200 140 70

3 8 25 250 200 80

4 10 30

5 11 28Real GDP = nominal GDP price index (in hundredths)

Price index nominal GDP(in hundredths) = real GDP

Compiled by the Bureau of Labor Statistics (BLS)

http://www.bls.gov/ This is the index that

the gov’t uses to measure the rate of inflation from month to month.

Reports the price of a market basket of some 300 consumer goods and services that presumably are purchased by a typical urban consumer.

Nonmarket Transactions

The services of homemakers & the labor of carpenters that work on their own homes never show up in GDP.

The portion of farmers output that they consume themselves is estimated & included in GDP

Leisure U.S. work week has

declined from 53 to about 36 hrs. a week.

Increase in leisure time has a positive effect on our overall well-being

Satisfaction that many people derive from their work is not included in GDP

Improved Product Quality

GDP fails to take into account the value of improvements in product quality.

This has a great deal to do with our economic well-being.

The Underground Economy

Gamblers, smugglers, prostitutes, “fences,” drug growers, & drug dealers have good reason to hide their income and is not counted in GDP.

Some do not report tips or portions of sales that may be in cash.

GDP & the environment

Dirty air, polluted water, toxic waste, congestion, and noise are costs not included in GDP.

We have some social costs of the negative by-products of our economy not counted in GDP

Composition & distribution of output

GDP assigns equal weight to an assault rifle and a set of encyclopedias as long as they both sell for the same price.

GDP does not tell us whether the mix of goods & services is enriching or potentially detrimental to our society.

Per capita output The most meaningful

measure of economic performance.

Found by dividing real GDP by population.

Measures only the magnitude of total output, it conceals changes in the standard of living of individuals & households.

Noneconomic sources of well-being

Just as a household’ s income does not measure its total happiness, a nation’s GDP does not measure its total well-being.

Things that could make things better—reduction of crime & violence, peaceful relations with other countries, greater civility toward one another, reduction of drug & alcohol abuse, etc.