Chapter 6

Measuring Total Output and Income

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Gross Domestic Product Formal definition: Nominal GDP

Total value of all final goods and services produced in an economy in given year valued at the current price

Real GDP

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Total value of all final goods and services produced in an economy in given year valued at the current price

Total value of all final goods and services produced in an economy in given year adjusted to eliminate the effect of price change

final

current price

adjusted to eliminate the effect of price change

GDP Accounting Bureau of Economic Analysis (BEA)

measures nation’s GDP How do economists at BEA measure

the total value of goods and services produced in an economy

We can go to each and every producers in the economy and ask the value of their output

Well, even if you do that, how do you define value?

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GDP Accounting To a producer, value of his product

might be different from those who buy that product

BEA looks at the market value or the value at which the product is bought and sold

So, if Apple produces 1m ipod in 2010 and each is sold at $150

Total value created in the economy is 1m x $150 = $150m

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GDP Accounting It is not hard to visit companies like

Apple, GM, General Mills and IBM, but for smaller companies, manufacturers, self employed individual it is almost impossible

To simplify their job, BEA does not ask output and price information and multiply them to get the value, but ask the company’s income information

Note, the income will already have the price and quantity information in it

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GDP Accounting So what BEA would get the following

from Apple

Note, by doing so they will directly get the market value

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Income from Amount

ipod 150m

iphone 500m

Mac Book 1b

ipad 300m

Approaches to GDP Accounting

Also note, someone’s income is always someone else’s expenditure

Apple’s income is Bob’s expenditure who just bought his first iphone

There are two approaches to GDP accounting: Income Approach

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Expenditure Approach

Expenditure Approach to GDP

In this approach, BEA counts the expenditures of all major spenders in the economy

There are four of them:

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Consumption

Investment

Government Purchases

Net Export

Component of GDP

Consumption measures the value of goods and services purchased by households during a time period

Investment is the value of all goods produced during a period that will be used in the production of other goods and services. This is often the capital investment Inventory investment is also counted

as investment

Component of GDP

Government purchases Goods and services produced in an

economy, but purchased by government agencies during a time period, and

Total value of output produced by government agencies themselves during a time period.

Component of GDP

Transfer payments are payments that do not require the recipient to produce a good or service in order to receive them

This means, Transfer Payments are government expenditure but not a GDP contributing expenditure

Therefore, it will not be included in the GDP

BEA needs to be careful here

Component of GDP

The final component of expenditure approach is Net Exports that counts the part of the US GDP that goes to the rest of the world

But, note US also imports a lot of goods and services from the rest of the world

Since we are trying to measure GDP using expenditures, we want to include only the part of expenditure that foreigners do on US made products

However, we only have Export and Import expenditures

Component of GDP

Exports (X)Total value of a country’s goods and services to buyers in the rest of the world

Imports (M)Total value foreign-produces goods and services purchased by a country’s residents

Net Exports are exports minus imports. Exports (X) – Imports (M) = Net

exports (Xn)

Components of GDP

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How to compute Final Output

Goods Produced by

Purchased by

Price

Logs Logger Sawmill 12,000

Lumber

Sawmill Builders 25,000

House

Builders Household

125,000

Total Value with double counting

162, 000

Final market value 125,000

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Total Value Added

12,000

13,000

100,000

125, 000