MEASURING AGGREGATE ECONOMIC ACTIVITY

7-2

National Income Accounting

• Why measure?

• National income accounting – A way of measuring total, or aggregate production.

• Gross Domestic Product (GDP)– The total value of all final goods and services produced

in an economy in a one-year period.

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Calculating GDP• Adding together millions of goods and services.

• Adding apples and oranges– All of the quantities of goods and services produced

are multiplied (weighted) by their market price per unit to determine a value measure of that good or service.

• The sum of all of these values is GDP.

7-4

The Expenditure Approach• GDP is the sum of four categories of

expenditures. GDP = C + I + G + (X – M)• Consumption• Investment– Includes inventories

• Government Spending– Valued at cost– Excludes transfer payments

• Net exports

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CALCULATING GDPSuppose that consumption is $1150, investment is $400, and government purchases are $500. Exports are $100 and imports are $150. How much isGross Domestic Product?

GDP = C + I + G + (X – M) by substitution, GDP = 1150 + 400 + 500 + (100-150) GDP = $2000

GDP IN THE U.S. vs. BELGIUM

GDP = C + I + G + Exports - Imports

U.S. $14,000 B = 70% + 17% + 19% + 11% - 17%Belgium $365 B = 53% + 21% + 23% + 87% - 84%

7-7

Flows vs. Stocks

• Flows– Involves a time period– GDP is reported on an annualized basis– About $14 Trillion ($14,000,000,000,000)

• Stocks– An amount at a point in time– Wealth accounts—assets minus liabilities – About $50 Trillion ($50,000,000,000,0000)

7-8

GDP Measures Final Output• Final vs. Intermediate goods and services– Final output – goods and services purchased for final use.– Intermediate products are used as an input in the

production of some other product.

• GDP counts only final goods and services

• Counting both final and intermediate goods would result in double counting.

7-9

Two Ways of Eliminating Double Counting

• Calculate only final output.– A firm would report how much it sold to consumers and how

much it sold to producers (intermediate goods).

• Follow the value added approach.– Value added is the increase in value that a firm contributes

to a product or service.– It is calculated by subtracting intermediate goods (the cost of

materials that a firm uses to produce a good or service) from the value of its sales.

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Value Added Approach

Participants Cost ofMaterials

Value ofSales

Value Added

Farmer $ 0 $ 100 $ 100Cone factoryand iceCream maker

100 250 150

Middleperson 250 400 150Vendor 400 500 100Totals $ 750 $1,250 $500

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What is Counted in GDP?

• Not counted– Value of resold goods– Government transfer payments– Sales of stocks or bonds– Non-market transactions---e.g., work of

housespouses• Counted– Value added by a used car dealer– Commissions of stock brokers

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GDP and NDP

• Net domestic product is GDP adjusted for depreciation – the amount of capital used up in producing that year’s GDP.

NDP = C + (I – depreciation) + G + (X-M)

• NDP measures output available for purchase.

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GDP AND GNP • Gross Domestic Product (GDP) – Total value of all final goods and services produced in

country in a one-year period.

• Gross National Product (GNP)– Total value of all final goods and services produce by the

citizens and businesses of a country in a one- year.

• When is the difference important?

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The Income Approach

• Aggregate income is the total income earned by citizens and businesses in a country in a year.

• Aggregate income consists of:– employee compensation– rent paid to households (But not to businesses)– interest paid to households (But not to businesses) – profits

The Income Approach

• United States Aggregate Income $14 Trillion

Employee compensation 70% Rents 1% Interest 5% Profits 24%

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Income = Expenditures• Whenever a good or service is produced

(output), somebody receives income for producing it.

• Aggregate Income = Aggregate Production

• Profit is a residual that makes income and expenditures equal.

7-17

Comparing GDP Among Countries

• Per capita GDP – Used to compare relative standards of living among various

countries.– Because of differences in nonmarket activities and

difference in product prices, per capita GDP may be a misleading measure of living standards.

• Purchasing power parity – Adjusts for relative price differences before making

comparisons.

7-18

Economic Welfare Over Time

• If increases in GDP are due to increases in prices, then welfare does not increase.

• Changes in welfare over time are best indicated by changes in real GDP, nominal GDP adjusted for inflation.

• And % ∆ in Nominal GDP = % ∆ in Real GDP + inflation

100deflator GDP

GDP Nominal GDP Real

7-19

CALCULATING REAL GDPSuppose that in year 1 nominal GDP is $1200; in year 2, $1300. The GDP deflator is 110 and 115, respectively. Find the change in nominal GDP. How much of the change is due to a real increase in output and how much is due to price changes?

%3.81001200

1200-1300 GDP nominal%

%5.4100110

110-115price%

3.8% GDP real%

4.5% GDP real% 8.3%

nflationi GDP real%GDP nominal%

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Limitations of National Income Accounting

• GDP measures economic activity, not welfare.– GDP does not measure happiness, nor does it measure

economic welfare.– Non-market activities are not included

• Subcategories are often interdependent.– For example, the line between consumption and investment

may be unclear.

• Measurement problems exist.

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Genuine Progress Indicator

• The genuine progress indicator (GPI) makes a variety of adjustments to GDP to better measure the progress of society rather than just economic activity.

• The GPI includes social goals such as pollution reduction, education, and health.