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Measuring Domestic Measuring Domestic Output & National Output & National IncomeIncomeChapter 6Chapter 6

In this chapter, you will In this chapter, you will learn:learn:

1.1. How gross domestic product (GDP) is defined and measured.How gross domestic product (GDP) is defined and measured.

2.2. The relationships among GDP, net domestic product, national The relationships among GDP, net domestic product, national income, personal income, and disposable incomeincome, personal income, and disposable income

3.3. The nature & function of a GDP price indexThe nature & function of a GDP price index

4.4. The difference between nominal GDP & real GDPThe difference between nominal GDP & real GDP

5.5. Some limitations of the GDP measureSome limitations of the GDP measure

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National Income Accounting National Income Accounting (7.1)(7.1)

Measures the economy’s overall performanceMeasures the economy’s overall performance

Enables economists & policymakers toEnables economists & policymakers to

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

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

3.3. Formulate policies that will safeguard & improve the economy’s Formulate policies that will safeguard & improve the economy’s healthhealth

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Gross Domestic ProductGross Domestic Product

Total market value of all Total market value of all finalfinal goods & services goods & services produced within a country’s borders in a given yearproduced within a country’s borders in a given year

Primary measure of the economy’s performancePrimary measure of the economy’s performance

Ex. Value of cars produced at a Toyota factory in Ex. Value of cars produced at a Toyota factory in Ohio count as U.S. GDP but not McDonald’s Ohio count as U.S. GDP but not McDonald’s cheeseburgers produced in Canada.cheeseburgers produced in Canada.

Avoid multiple countingAvoid multiple counting

To measure aggregate output accurately, all goods & services To measure aggregate output accurately, all goods & services produced in a particular year must be counted one time onlyproduced in a particular year must be counted one time only

To avoid multiple counting, GDP includes only To avoid multiple counting, GDP includes only finalfinal goods & goods & ignores ignores intermediate intermediate goodsgoods

IntermediateIntermediate Goods & services purchased for resale or further processingGoods & services purchased for resale or further processing

FinalFinal Consumption & capital goods that are purchased by their final

users.

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GDP Excludes GDP Excludes nonproduction transactionsnonproduction transactions

Must be excluded because they have nothing to do with the Must be excluded because they have nothing to do with the generation of final goodsgeneration of final goods

Public transfer paymentsPublic transfer payments Social security payments, welfare, veterans’ payments are Social security payments, welfare, veterans’ payments are

excluded because they don’t contribute excluded because they don’t contribute current productioncurrent production

Private transfer paymentsPrivate transfer payments Ex. Cash giftsEx. Cash gifts

Stock market transactionsStock market transactions Swapping stock for money doesn’t create new production Swapping stock for money doesn’t create new production

eithereither

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Secondhand sales Secondhand sales (used goods)(used goods)

Contribute nothing to current production Contribute nothing to current production and are excluded from GDPand are excluded from GDP

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Two ways of looking at Two ways of looking at GDPGDP How is the market value measured?How is the market value measured?

How much did the final user pay for it?How much did the final user pay for it?

Another way to measure market value:Another way to measure market value:

Add up wage, rental, interest, & profit incomes Add up wage, rental, interest, & profit incomes that were created in producing the productthat were created in producing the product

The Expenditures ApproachThe Expenditures Approach

Add up all spending on final goods & services that has taken Add up all spending on final goods & services that has taken place throughout the yearplace throughout the year

Personal consumption (C)Personal consumption (C)

Gross Private Domestic Investment (I)Gross Private Domestic Investment (I)

Positive & Negative Changes in InventoriesPositive & Negative Changes in Inventories

Noninvestment TransactionsNoninvestment Transactions

Net private domestic investment = gross investment-Net private domestic investment = gross investment-depreciationdepreciation

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Expenditures (cont)Expenditures (cont)

Government Purchases (G)Government Purchases (G) Expenditures for goods and services that Expenditures for goods and services that

government consumes in providing public government consumes in providing public servicesservices

Expenditures for Expenditures for publicly owned capitalpublicly owned capital such such as schools and highwaysas schools and highways

Does Does notnot include government transfer include government transfer payments (ex. Social security)payments (ex. Social security)

Net Exports (x)Net Exports (x) Exports - ImportsExports - Imports

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Putting it all togetherPutting it all together

Taken together, the four categories of Taken together, the four categories of expenditures provide a measure of the expenditures provide a measure of the market value of a given year’s total market value of a given year’s total output – its GDPoutput – its GDP

GDP = C + I + G + (X-M)GDP = C + I + G + (X-M)

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IncomeIncome

Items that make up Items that make up national incomenational income

1.1. Compensation of employeesCompensation of employees Wages & salaries paid by business and government to their Wages & salaries paid by business and government to their

employeesemployees

2.2. RentRent Income received by households & businesses that supply property Income received by households & businesses that supply property

resourcesresources Include monthly payments tenants make to landlords & lease Include monthly payments tenants make to landlords & lease

payments corporations pay for the use of office spacepayments corporations pay for the use of office space

3.3. InterestInterest Money paid by private businesses to the suppliers of loans used to Money paid by private businesses to the suppliers of loans used to

purchase capitalpurchase capital Interest households receive on savings, CD’s, & corporate bondsInterest households receive on savings, CD’s, & corporate bonds

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Income Approach (cont.)Income Approach (cont.)

4.4. Proprietor’s incomeProprietor’s income Net income of sole proprietorships & Net income of sole proprietorships &

partnershipspartnerships

5.5. Corporate profitsCorporate profits Earnings of corporationsEarnings of corporations

Corporate income taxesCorporate income taxes DividendsDividends Undistributed corporate profitsUndistributed corporate profits

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Income Approach (cont.)Income Approach (cont.)

6.6. Taxes on production & importsTaxes on production & imports Includes the following:Includes the following:

1.1. General sales taxesGeneral sales taxes

2.2. Excise taxesExcise taxes

3.3. Business property taxesBusiness property taxes

4.4. License feesLicense fees

5.5. Customs dutiesCustoms duties

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From National Income to From National Income to GDPGDP

National income is the total of all sources National income is the total of all sources of private income plus government of private income plus government revenuerevenue

All income that flows to American-All income that flows to American-supplied resources, whether here or supplied resources, whether here or abroadabroad

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Net Foreign Factor Net Foreign Factor IncomeIncome

When moving from national income to GDP, When moving from national income to GDP, we must consider the income Americans gain we must consider the income Americans gain from supplying resources abroad from supplying resources abroad

Income foreigners gain by supplying resources Income foreigners gain by supplying resources in the U.S.in the U.S.

Difference is Difference is net foreign factor incomenet foreign factor income

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Consumption of fixed Consumption of fixed capitalcapital

Huge depreciation charge made against Huge depreciation charge made against private & publicly owned capital each yearprivate & publicly owned capital each year

Allowance for capital that has been Allowance for capital that has been “consumed” in producing this year’s GDP“consumed” in producing this year’s GDP

Portion of GDP that is set aside to pay for the Portion of GDP that is set aside to pay for the ultimate replacement of those capital goodsultimate replacement of those capital goods

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Other National Accounts (7.2)Other National Accounts (7.2)

Net domestic product (NDP)Net domestic product (NDP)NDP=GDP-consumption of fixed capital (depreciation)NDP=GDP-consumption of fixed capital (depreciation)

National income (NI)National income (NI) Includes all income earned through the use of American-Includes all income earned through the use of American-

owned resources, (home or abroad)owned resources, (home or abroad) Also includes taxes on production of importsAlso includes taxes on production of imports

Personal income (PI)- includes all income received (earned or Personal income (PI)- includes all income received (earned or unearned)unearned)

Disposable income (DI)-personal income less personal taxesDisposable income (DI)-personal income less personal taxes

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Nominal GDP vs. Real GDP (7.3)Nominal GDP vs. Real GDP (7.3)

START HERESTART HERE NominalNominal

GDP based on prices that prevailed when output was GDP based on prices that prevailed when output was producedproduced

Real Real GDP that has been deflated or inflated to reflect changes in GDP that has been deflated or inflated to reflect changes in

the price levelthe price level

These adjustments give us a measure of GDP for These adjustments give us a measure of GDP for various years as if the value of the dollar had always various years as if the value of the dollar had always been the same as it was in a reference yearbeen the same as it was in a reference year

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GDP Price IndexGDP Price Index

Price indexPrice index Measure of the price of a specified collection Measure of the price of a specified collection

of goods & services (market basket) in a of goods & services (market basket) in a given yeargiven year

This # will be compared to the price of an This # will be compared to the price of an identical collection of goods & services in identical collection of goods & services in a reference year (base year)a reference year (base year)

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Calculating Real GDP Calculating Real GDP (Base year=year 1) (Table 7.5)(Base year=year 1) (Table 7.5)

YearYear

Units of Units of outputoutput

Price of Price of pizza/unitpizza/unit

Price Price indexindex(year (year

1=100)1=100)

UnadjustedUnadjusted or or

Nominal Nominal GDP GDP

(2)x(3)(2)x(3)

AdjustedAdjusted or real, or real, GDPGDP

11 55 $10$10 100100 $50$50 5050

22 77 2020 200200 140140 7070

33 88 2525 250250 200200 8080

44 1010 3030

55 1111 2828

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Shortcomings of GDPShortcomings of GDP

Nonmarket activitiesNonmarket activities

LeisureLeisure

Improved product qualityImproved product quality

Underground economyUnderground economy

GDP & environmentGDP & environment