chapter 17: measuring national output and national income

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

National IncomeNational Incomeand Product Accountsand Product Accounts

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

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


Gross Domestic ProductGross Domestic Product

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


Final Goods and ServicesFinal Goods and Services

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

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


Value AddedValue Added

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

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


Value AddedValue Added

Value Added in the Production of a Gallon of GasolineValue Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) (Hypothetical Numbers)

STAGE OF PRODUCTIONSTAGE OF PRODUCTION VALUE OF SALESVALUE OF SALES VALUE ADDEDVALUE ADDED(1)(1) Oil drillingOil drilling $$ .50.50 $$ .50.50

(2)(2) RefiningRefining .65.65 .15.15

(3)(3) ShippingShipping .80.80 .15.15

(4)(4) Retail saleRetail sale 1.001.00 .20.20

Total value addedTotal value added $$1.001.00


Exclusions from GDPExclusions from GDP

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


GDP Versus GNPGDP Versus GNP

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


Calculating GDPCalculating GDP

GDP can be computed in two ways:GDP can be computed in two ways:

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

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


The Expenditure ApproachThe Expenditure Approach

Expenditure categories:Expenditure categories:

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

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



• Government consumption and Government consumption and gross investment (G)gross investment (G)

Expenditure categories:Expenditure categories:

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



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

GDP C I G X M ( )


Personal Consumption ExpendituresPersonal Consumption Expenditures

• Personal consumption expenditures (C) Personal consumption expenditures (C) are expenditures by consumers on the are expenditures by consumers on the following:following:• Durable goodsDurable goods: Goods that last a relatively : Goods that last a relatively

long time, such as cars and household long time, such as cars and household appliances.appliances.

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

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


Components of GDP, 1999:Components of GDP, 1999:The Expenditure ApproachThe Expenditure Approach

Components of GDP, 1999: The Expenditure ApproachComponents of GDP, 1999: The Expenditure ApproachBILLIONS OFBILLIONS OF

DOLLARSDOLLARSPERCENTAGEPERCENTAGE

OF GDPOF GDPTotal gross domestic productTotal gross domestic product 9,299.29,299.2 100.0100.0Personal consumption expenditures (C)Personal consumption expenditures (C) 6,268.76,268.7 67.467.4

Durable goodsDurable goods 761.3761.3 8.28.2Nondurable goodsNondurable goods 1,845.51,845.5 19.819.8ServicesServices 3,661.93,661.9 39.439.4

Gross private domestic investment (l)Gross private domestic investment (l) 1,650.11,650.1 17.717.7NonresidentialNonresidential 1,203.11,203.1 12.912.9ResidentialResidential 403.8403.8 4.34.3Change in business inventoriesChange in business inventories 43.343.3 0.50.5

Government consumption and gross investment (G)Government consumption and gross investment (G) 1,634.41,634.4 17.617.6FederalFederal 568.6568.6 6.16.1State and localState and local 1,065.81,065.8 11.511.5

Net exports (EX – IM)Net exports (EX – IM) 254.0254.0 2.72.7Exports (Exports (EXEX)) 990.2990.2 10.610.6Imports (Imports (IMIM)) 1,244.21,244.2 13.413.4

Note: Numbers may not add exactly because of rounding.Note: Numbers may not add exactly because of rounding.Source:Source: U.S. Department of Commerce, Bureau of Economic Analysis. U.S. Department of Commerce, Bureau of Economic Analysis.


Gross Private Domestic InvestmentGross Private Domestic Investment

• InvestmentInvestment refers to the purchase of refers to the purchase of new capital.new capital.

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


Gross Private Domestic InvestmentGross Private Domestic Investment

• Nonresidential investmentNonresidential investment includes includes expenditures by firms for machines, tools, expenditures by firms for machines, tools, plants, and so on.plants, and so on.

• Residential investmentResidential investment includes includes expenditures by households and firms on expenditures by households and firms on new houses and apartment buildings.new houses and apartment buildings.

• Change in inventoriesChange in inventories computes the computes the amount by which firms’ inventories change amount by which firms’ inventories change during a given period. Inventories are the during a given period. Inventories are the goods that firms produce now but intend to goods that firms produce now but intend to sell later.sell later.


Gross Investment versusGross Investment versusNet InvestmentNet Investment

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

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

• Net investmentNet investment equals gross equals gross investment minus depreciation.investment minus depreciation.

capitalend of period = capitalbeginning of period + net investment


Government Consumption andGovernment Consumption andGross InvestmentGross Investment

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


Net ExportsNet Exports

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


The Income ApproachThe Income Approach

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

• The The income approachincome approach to to GDPGDP breaks breaks down down GDPGDP into four components: into four components:

GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other


The Income ApproachThe Income Approach

Components of GDP, 1999: The Income ApproachComponents of GDP, 1999: The Income ApproachBILLIONS OFBILLIONS OF

DOLLARSDOLLARSPERCENTAGEPERCENTAGE

OF GDPOF GDPGross domestic productGross domestic product 9,299.29,299.2 100.0100.0National incomeNational income 7,469.77,469.7 80.380.3

Compensation of employeesCompensation of employees 5,299.85,299.8 57.057.0Proprietors’ incomeProprietors’ income 663.5663.5 7.17.1Corporate profitsCorporate profits 856.0856.0 9.29.2Net interestNet interest 507.1507.1 5.55.5Rental incomeRental income 143.4143.4 1.51.5

DepreciationDepreciation 1,161.01,161.0 12.512.5Indirect taxes minus subsidiesIndirect taxes minus subsidies 689.7689.7 7.47.4Net factor payments to the rest of the worldNet factor payments to the rest of the world 11.011.0 0.10.1OtherOther 32.232.2 0.30.3

Source:Source: See Table 17.2. See Table 17.2.


From GDP to Disposable IncomeFrom GDP to Disposable Income

GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 19991999

DOLLARSDOLLARS(BILLIONS)(BILLIONS)

GDPGDP 9,299.29,299.2Plus: receipts of factor income from the rest of the worldPlus: receipts of factor income from the rest of the world + 305.9+ 305.9Less: payments of factor income to the rest of the worldLess: payments of factor income to the rest of the world 316.9316.9

Equals: Equals: GNPGNP 9,288.29,288.2Less: depreciationLess: depreciation 1,161.01,161.0

Equals: Equals: net national product (NNP)net national product (NNP) 8,127.18,127.1Less: indirect taxes minus subsidies plus otherLess: indirect taxes minus subsidies plus other 675.5675.5

Equals: Equals: national incomenational income 7,469.77,469.7Less: corporate profits minus dividendsLess: corporate profits minus dividends 485.7485.7Less: social insurance paymentsLess: social insurance payments 662.1662.1Plus: personal interest income received from the government and consumersPlus: personal interest income received from the government and consumers + 456.6+ 456.6Plus: transfer payments to personsPlus: transfer payments to persons +1,011.0+1,011.0

Equals: Equals: personal incomepersonal income 7,789.67,789.6Less: personal taxesLess: personal taxes 1,152.01,152.0

Equals: Equals: disposable personal incomedisposable personal income 6,637.76,637.7Source:Source: See Table 17.2. See Table 17.2.



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



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

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


Disposable Personal Income and Disposable Personal Income and Personal SavingPersonal Saving

Disposable Personal Income and Personal Saving, 1999Disposable Personal Income and Personal Saving, 1999DOLLARSDOLLARS(BILLIONS)(BILLIONS)

Disposable personal incomeDisposable personal income 6,637.76,637.7Less:Less:

Personal consumption expendituresPersonal consumption expenditures 6,268.76,268.7Interest paid by consumers to businessInterest paid by consumers to business 194.8194.8Personal transfer payments to foreignersPersonal transfer payments to foreigners 26.626.6

Equals: personal savingEquals: personal saving 147.6147.6Personal savings as a percentage of disposable personal income:Personal savings as a percentage of disposable personal income: 2.2%2.2%Source:Source: See Table 17.2. See Table 17.2.


Disposable Personal Income and Disposable Personal Income and Personal SavingPersonal Saving

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


Nominal versus Real GDPNominal versus Real GDP

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

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


Calculating Real GDPCalculating Real GDP

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

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

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


Calculating Real GDPCalculating Real GDP

A Three-Good EconomyA Three-Good Economy(1)(1) (2)(2) (3)(3) (4)(4) (5)(5) (6)(6) (7)(7) (8)(8)

GDP INGDP IN GDP INGDP IN GDP INGDP IN GDP INGDP INYEAR 1YEAR 1 YEAR 2YEAR 2 YEAR 1YEAR 1 YEAR 2YEAR 2

ININ ININ ININ ININPRODUCTIONPRODUCTION PRICE PER UNITPRICE PER UNIT YEAR 1YEAR 1 YEAR 1YEAR 1 YEAR 2YEAR 2 YEAR 2YEAR 2

YEAR 1YEAR 1 YEAR 2YEAR 2 YEAR 1YEAR 1 YEAR 2YEAR 2 PRICESPRICES PRICESPRICES PRICESPRICES PRICESPRICESQQ11 QQ22 PP11 PP22 PP11 x x QQ11 PP11 x x QQ22 PP22 x x QQ11 PP22 X X QQ22

Good Good AA 66 1111 $.50$.50 $ .40$ .40 $3.00$3.00 $5.50$5.50 $2.40$2.40 $4.40$4.40

Good Good BB 77 44 .30.30 1.001.00 2.102.10 1.201.20 7.007.00 4.004.00

Good Good CC 1010 1212 .70.70 .90.90 7.007.00 8.408.40 9.009.00 10.8010.80

TotalTotal $12.10$12.10 $15.10$15.10 $18.40$18.40 $19.20$19.20

Nominal GDPNominal GDPin year 1in year 1

Nominal GDPNominal GDPin year 2in year 2


Calculating the GDP Price IndexCalculating the GDP Price Index

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

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


The Problems of Fixed WeightsThe Problems of Fixed Weights

1.1. Structural changes in the economy.Structural changes in the economy.

2.2. Supply shifts, which cause large Supply shifts, which cause large decreases in price and large increases in decreases in price and large increases in quantity supplied.quantity supplied.

3.3. The substitution effect of price increases.The substitution effect of price increases.

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


Limitations of the GDP ConceptLimitations of the GDP Concept

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

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

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


Limitations of the GDP ConceptLimitations of the GDP Concept

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

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

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


The Underground EconomyThe Underground Economy

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


Per Capita GDP/GNPPer Capita GDP/GNP

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

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


Per Capita GDP/GNPPer Capita GDP/GNP

Per Capita GNP for Selected Countries, 1998Per Capita GNP for Selected Countries, 1998COUNTRYCOUNTRY U.S. DOLLARSU.S. DOLLARS COUNTRYCOUNTRY U.S. DOLLARSU.S. DOLLARS

SwitzerlandSwitzerland 40,08040,080 PortugalPortugal 10,69010,690NorwayNorway 34,33034,330 ArgentinaArgentina 8,9708,970DenmarkDenmark 33,26033,260 South KoreaSouth Korea 7,9707,970JapanJapan 32,38032,380 Czech RepublicCzech Republic 5,0405,040United StatesUnited States 29,34029,340 BrazilBrazil 4,5704,570AustriaAustria 26,85026,850 MexicoMexico 3,9703,970GermanyGermany 25,85025,850 TurkeyTurkey 3,1603,160SwedenSweden 25,62025,620 South AfricaSouth Africa 2,8802,880BelgiumBelgium 25,38025,380 ColombiaColombia 2,6002,600FranceFrance 24,94024,940 JordanJordan 1,5201,520NetherlandsNetherlands 24,76024,760 RomaniaRomania 1,3901,390FinlandFinland 24,11024,110 PhilippinesPhilippines 1,0501,050United KingdomUnited Kingdom 21,40021,400 ChinaChina 750750AustraliaAustralia 20,30020,300 IndonesiaIndonesia 680680ItalyItaly 20,25020,250 PakistanPakistan 480480CanadaCanada 20,02020,020 IndiaIndia 430430IrelandIreland 18,34018,340 RwandaRwanda 230230IsraelIsrael 15,94015,940 NepalNepal 210210SpainSpain 14,08014,080 EthiopiaEthiopia 100100GreeceGreece 11,65011,650

Source: The World Bank Atlas, 2000.Source: The World Bank Atlas, 2000.

chapter 17: measuring national output and national income

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