CHAPTER 24

Measuring Domestic Output and National Income

The subject of Chapter 24 is national 'Income accounting. The first measure that you will learn about in the chapter is the gross domestic product (GOP). The GOP is an important economic statistic because it provides the best estimate of the total market value of all final goods and services produced by our economy in one year. You will also discover why GOP is a monetary measure that counts only the value of final goods and services and excludes nonproductive transactions such as secondhand sales.

National income accounting involves estimating output, or income, for the nation's society as a whole, rather than for an individual business firm or family. Note that the terms output and Income are interchangeable because the nation's domestic output and its income are identical. The value of the nation's output equals the total expendi­tures for this output, and these expenditures become the income of those who have produced this output. Conse­quentfy, there are two equally acceptable methods­expenditures or income-for determining GOP.

From an expenditure perspective, GOP is composed of four expenditure categories: personal consumption expen­ditures (C), gross private domestic investment (Ig), govern­ment purchases (G), and net exports (Xn). These expendi­tures become income for people or the government when they are paid out in the form of employee compensation, rents, interest, proprietors' income, corporate profits, and taxes on production and imports. GOP can be calculated from national income by making adjustments to account for net foreign factor income, a statistical discrepancy, and depreciation. In national income accounting, the amount spent to purchase this year's total output is equal to money income derived from production of this year's output.

This chapter also explains the relationship of GOP to other national Income accounts. These accounts include net domestic product (NOP), national income (NI) as de­rived from NOP, personal income (PI), and disposable income (01). The relationship between GOP, NOP, NI, PI, and 01 is shown in Table 24.4 of the text. The circular flow using the expenditures and 'income approaches to GOP are illustrated in Figure 24.3 of the text.

The next to the last section of the chapter shows you how to calculate real GOP from nominal GOP. This ad­justment is important because nominal GOP is measured in monetary units, so if accurate comparisons are to be made for GOP over time, these monetary measures must be adjusted to take account of changes in the price le~el. ~ Simple example is presented to show how a GOP p~lce Index is constructed. The index is then used to adjust nominal GDP to obtain real GDP and make correct GOP

--- -- --- -- -- ...

comparisons from one year to the next. The text also pro­vides data for the U.S. economy so you can see why the calculation of real GOP is necessary and how it is used.

The last section of the chapter looks at the shortcom­Ings of GOP as a measure of total output and economic well-being. You will leam about economic factors that are excluded from GOP measurement-nonmarket or illegal transactions, changes in leisure and product quality, dif­ferences in the composition and distribution of output, and the environmental effects of GOP production-and how their exclusion can lead to an under- or overstatement of economic welf-being. Although national income accounts are not perfect measures of all economic conditions, they are stiff reasonably accurate and useful indicators of the performance of the national economy.

• CHECKLIST

When you have studied this chapter you should be able to

D Identify three ways national income accounting can be used for economic decision making. D Give a definition of the gross domestic product (GOP). D Explain why GOP is a monetary measure. D Describe how GOP measures value added and avoids multiple counting. D Give examples of two types of nonproduction transac­tions that are excluded from GOP. D Describe the relationship between the expenditures and income approaches to GOP accounting. D List the three types of expenditures included in per-sonal consumption expenditures (C). .' D Identify three items included in gross private domestic investment (Ig) . D Explain how positive or negative changes in invento­ries affect investment. D Distinguish between gross and net investment. D Discuss how differences in the amount of net invest­men~ affect the production capacity of the economy. o List the two components included in government pur­chases (G) . o Describe the meaning and calculation of net exports (Xn).

o Compute GOP using the expenditures approach when given national income accounting data. ~ Identify the six income items that make up U.S. national Income.

o List three things that can happen to corporate profits.

297

298 CHAPTER 24

o Explain why taxes on production and imports are in­cluded as part of national income. o Describe the effect of net foreign factor income on na­tional income accounts. ~ Define consumption of fixed capital and discuss how It affects national income accounts. o ~om~ute GDP using the income approach when given national Income accounting data. o Define net domestic product (NDP). o Show how to derive U.S. national income (NI) from net domestic product (NDP). o Define personal income (PI) in national income accounts. o Explain how to obtain disposable income (DI) from personal income (PI). . o Use Figure 24.3 in the text to describe the circular flow model for GDP. o Distinguish between nominal and real GDP. o Construct a price index when given price and quantity data. o Obtain a price index when given data on nominal and real GDP. . o Discuss some real-world factors that affect the GDP price index. o List seven shortcomings of GDP as a measure of total output and economic well-being. o Identify some of the sources of data the Bureau of Eco­nomic Analysis uses to estimate consumption, investment, government purchases, and net exports (Last Word).

• CHAPTER OUTLINE

1. National Income accounting consists of concepts that enable those who use them to measure the economy's output, to compare it with past outputs, to explain its size and the reasons for changes in its size, and to formulate policies designed to increase it.

2. The market value of all final goods and services pro­duced in the domestic economy during the year is mea­sured by the gross domestic product (GDP).

a. GDP is a monetary measure that is calculated In dol­lar terms rather than in terms of physical units of output. b. GDP includes in its calculation only the value of final goods (consumption goods, capital goods, and services purchased by final users and that will not be resold or processed further during the current year). (1) GDP excludes the value of Intermediate goods (ones that are purchased for resale or further processing) because including both final goods and intermediate goods would result in multiple counting of the goods and overstate GDP. (2) Another way to avoid multiple counting is to measure and add only the value added at each stage of the pro­duction process. Value added is the market value of a firm's output minus the value of the inputs the firm bought from others to produce the output. c. Nooproduction transactions are not included in GDP. (1) Purely financial transactions such as public trans­fer payments, private transfer payments, and stock market transactions are simply exchanges of money or paper assets and do not create output.

(2) Sales of secondhand or used goods are excluded because they were counted in past production and do not contribute to current production. d. Measurement of GDP can be accomplished by either the expenditures approach or the income approach but the same result is obtained by the two methods. '

3. Computation of the GDP by the expenditures approach requires the summation of the total amounts of the fOur types of spending for final goods and services.

a. Personal consumption expenditures (C) are the expenditures of households for durable goods and nondurable goodS and for services. b. Gross private domestic Investment (/g) is the sum of the spending by business firms for machinery, equipment, and tools; spending by firms and house­holds for new construction (buildings); and the changes in the inventories of business firms. (1) An increase in inventories in a given year increases investment that year because it is part of the output of the economy that was produced but not sold that year, a decrease in inventories in a given year decreases investment that year because it was included as part of the output from a prior year. (2) Investment does not include expenditures for stocks or bonds (a transfer of paper assets) or for used or secondhand capital goods (because they were counted as part of investment in the year they were new capital goods). (3) Gross investment exceeds net investment by the value of the capital goods worn out during the year. An economy in which net investment is positive is one with an expanding production capacity. c. Government purchases (G) are the expenditures made by all levels of governments (federal, state, and local) for final goods from businesses, and for the direct purchases of resources, including labor. (1) :he government purchases are made to provide public good.s and se~ices, and for spending on publicly owned capital (public goods with a long lifetime such as highways or schools). (2) It should be noted that transfer payments made by the government to individuals, such as Social Security payments, are not included in government purchases because they simply transfer income to individuals and do not generate production.

. d. Net exports (Xn) in an economy is calculated as ~he difference between exports (X) and imports (M). It IS equal to the .expenditures made by foreigners for goods and services produced in the economy minus the expenditures made by the consumers govern­men~s, and investors of the economy for g~odS and services produced in foreign nations. e. In equation form, C + 19 + G + Xn = GDP.

4. ~omput~tion of GDP by the Income approach requires ad~lng the Income derived from the production and sales of final goods and services. The six income items are:

a. C?mpensation of employees (the sum of wages and sal~ne~ and wage and salary supplements, such as SOCial Insurance and private pension or health funds for workers).

b. Rents (the income received b This rent is a net measure of th/d~operty owners). gross rent and property depreciar I erence between

c. Interest (only the interest pa mlon

. . cial institutions or business firm~ a~;t.s made b¥ flnan­payments made by gove Included; Interest

. , . mment are excluded) d. Propnetors Income (the profits or n t ' . proprietors or unincorporated bus' I e filncome of sole

ness Irms). e. Corporate profits (the eamings of co . are allocated in the fOllowing three ~rations). They . t . . ways. as corporate Income axes, dividends paid to stockh Id d· t 'b ted 0 ers, and un-

IS n u Corporate profits retained b . f Taxes on prod Y Corporations. . . " uctlon and Imports are added be-

cause ~ey are initially income for households that later gets p?-Id to government in the form of taxes. This cat­egory Includes general sales taxes, excise taxes busi­ness property taxes, license fees, and custom d'uties. g. !he ~um of all of the above six categories equals nati~ I~~ (employee compensation, rents, interest, propnet~rs In~me, COrporate profits, and taxes on ~roduction and Imports). To obtain GOP from national Income, three adjustments must be made. (.1) N~t foreign factor income is subtracted from na­tional Income because it reflects income earned from pr~uction 0':"Si~e the United States. Net foreign fac­tor Income IS Income eamed by American-owned resources abroad minus income earned by foreign­owned resources in the United States. (2) A statistical discrepancy is added to national in­come to make the income approach match the expen­ditures approach. (3) The consumption of fixed capital is added to national income to get to GOP because it is a cost of production that does not add to anyone's income. It cov­ers depreciation of private capital goods and publicly owned capital goods such as roads or bridges.

5. Four other national accounts are important in evaluat­ing the performance of the economy. Each has a distinct definition and can be computed by making additions to or deductions from another measure.

a. Net domestic product (NOP) is the annual output of final goods and services over and above the pri­vately and publicly owned capital goods worn out dur­ing the year. It is equal to the GOP minus depreciation (consumption of fixed capital). b. Natlona/lncome (N/) is the total income eamed by U.S. owners of land and capital and by the U.S. sup­pliers of labor and entrepreneurial ability during the year plus taxes on production and imports. It equals NOP minus a statistical discrepancy and plus net for­eign factor income. c. Persona/Income (P/) is the total income received­whether it is earned or uneamed-by the households of the economy before the payment of personal taxes. It is found by taking national income and adding trans­fer payments, and then subtracting taxes on production and imports, Social Security contributions, co~rate income taxes and undistributed corporate profits. d. Olsposab;e Income (01) is the total income avail­able to households after the payment of personal

MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME 299

taxes. It is calculated by taking personal income and then subtracting personal taxes. It is also equal to per­sonal consumption expenditures plus personal saving. e. The relationships among the five income-output measures are summarized in Table 24.4. f. Figure 24.3 is a more realistic and complex circular flow diagram that shows the flows of expenditures and incomes among the households, business firms, and govemments in the economy.

6. Nominal GOP is the total output of final goods and services produced by an economy in 1 year multiplied by the market prices when they were produced. Prices, however, change each year. To compare total output over time, nominal GOP is converted to real GOP to account for these price changes.

a. There are two methods for deriving real GDP from nominal GDP. The first method involves computing a price Index. (1) This price index is a ratio of the price of a market basket in a given year to the price of the same market basket in a base year, with the ratio multiplied by 100. If the market basket of goods in the base year was $10 and the market basket of the same goods in the next year was $15, then the price index would be 150 [$15/10 x 100]. (2) To obtain real GOP, divide nominal GOP by the price index expressed in hundredths. If nominal GOP was $14,000 billion 'and the price index was 120, then real GOP would be $11,666.6 billion [$14,000 billionl1 .20]. b. In the second method, nominal GOP is broken down into prices and quantities for each year. Real GOP is found by using base-year prices and multiplying them by each year's physical quantities. The GOP price index for a particular year is the ratio of nominal GOP to real GOP for that year. If nominal GOP was $14,000 billion and real GOP was $11,666.6 billion, then the GOP index would be 1.20 [$14,000 billonl$11 ,666.6 billion]. c. In the real world, complex methods are used to calculate the GOP price index. The price index is use­ful for calculating real GOP. The price index number for a reference period is arbitrarily set at 100. (1) For years when the price index is below 100 divid­~ng nominal . GOP by the price index (in hund:edths) Inflates nominal GOP to obtain real GOP. (2) F~r .y~ars wh.en the price index is greater than 100, diViding nominal GOP by the price index (in hun­dredths) deflates nominal GOP to obtain real GOP.

7. GOP has shortcomings as a measure of total output and economic well-being.

a. It. excludes the value of non market final goods and services that are not bought and sold in the markets such as the unpaid work done by people on their houses: b. It excludes the amount of increased leisure enjoyed by the partiCipants in the economy. c. It does not fully account for the value of improvements in the quality of products that occur over the years. d. It does not measure the market value of the final goods and services produced in the underground sec­~or of the economy because that income and activity IS not reported.

300 CHAP~ER 24

•• It does not record Ihe pollullon or environmental COSIS 01 producing IInal goods and services. ,. It does nol measure changes in the composition and the distribution of the domestic output. g. It does not measure noneconomic sources of well­being such as a reduction in crime, drug Of alcohol abuse, or better relationships among people and nations.

8. (Last Word). The Bureau of Economic Analysis (BEA) is a unit of the Department of Commerce that is respon­sible for compiling the National Income and Product Ac­counts. It obtains data from multiple sources to estimate consumption, investment, government purchases, and net exports for the calculation of GOP.

• HINTS AND TIPS

1. Read through the chapter several times. A careful reading will enable you to avoid the necessity of memo­rizing. Begin by making sure you know precisely what GOP means and what is included in and excluded from its measurement.

2. Accounting Is essentially an adding-up process. This chapter explains in detail and lists the items that must be added to obtain GOP by the expenditures approach or in­come approach. It Is up to you to leam what to add on the expenditure side and what to add on the Income side. Fig­ure 24.1 is an important accounting reference for this task.

3. Changes in the price level have a significant effect on the measurement 01 GOP. Practice converting nominal GOP to real GOP using a price index. Problems 4 and 5 In this Study Guide should help you understand nominal and real GOP and the convorslon process.

4, GOP Is a good measure of the market value 01 the output ollinal goods and services thtlt ore produced In an economy In 1 yom; however. tho moasure Is nol perfect. 80 you ohould be awore of lie IImllolions. which 01'9 notod ot tho end of tho chaptor.

• tMPORTANT TEAMS

nitlonlliinoome lIooounUng

gro .. dom •• Uo produol (OOP)

In'.rmlldh,,'e uoodt

Ihl111 gondl mulll,)I. counting

Vllh,. tl{ldlld

... f'ltIn(lIIur., II J'I,lffllltl h

InllMn. "llllrOHOh

V"IIII,,"1 {JflllIi IlIllIJ,lnn .kllil,,,lIlHfIUI (e )

(jlllllhi. Qoo(l.

nOIl/lur.hl, UOOIII

.IIvIO., flrOf,. prlv'" MIll •• lln

11I1I •• IIll.nl (I, )

nel prll/a" doma,tlo Inl/""",nl

gOl/.rl1l\\.nl pUI'Chll.'. (G)

na' ,.port. (X,J

lUI. on production and IIlIllOr't

1111110111111 h\co",O (NI)

oonlllmflllon of .hlll(! (JAI,IIII (rlttf'NlIlIIIUo,,)

nl' (10111'1110 PI'()(\\lQI (NOt')

,'.fIlO",,1 ")(10"" ("I)

rlil,)o"hii 1"1''''''' (01)

IIOlllII'11 ant' , •• 1 UIW

Ilrh~. Il\illlll

• FILiAH QU£ST1OHS

1 NatJOnal inCOO".e ~ ' q is wa: ~ ~.5e t pr~ a means of ~q track d -e !e'~ ~ ItIfr"-

pIoymeflt prodl.JcOOn) ~ ~Je ~ and the course i1 haS ~ (H9[ e;e b"g ~ r . enj t"J!

information needed to rr,aj(e pJJdic {rJi'Qes.., pa-rea !ha!w. ~h~, a. ce':l~e ------

economy·

2. Gross dOmeSf;c prod1.d ~-es f1s ft::ta

(marl<et. nonmarket) ______ va~ d ali

me<:flClte. final) g:::ocds are $iE!!i\~ ;n-

duced in a COlrJry 1l"I1 year. eYe! 2 yea-s ------

3. GOP for a nat'.on ind'OOes goods and 5eN'iCeS ;r-:-­

duced (within. outside Its ~ boundaries. This ~.:ln rr.ea.~ ma~ ~ ~ ,:i! cars at a Toyota plan! Iccated rI ~ U - ~ ~

be (included. exduded ~ ~ . .;:;:.: .. ::or: of U.S. GOP.

4. GOP is a (monetary. ~~ measure that permits compa~ ~ th:l t~.a~!@. ~

lute) ______ worth o· ~~ and ~""~'$S...

5. In measumg GOP. c:ri'j n.~~.

goodsandseMcesare~ ~~ and SCMces ~ ~-.a. the a\.'X'\.~-W .. ~'W ~ ~ .

under-) stn, ~ GOP, ~ _. ':"'i~ • • ' ":~

Cl"'lt.lnti~.

8. GOP llXOttntir'lg \l)'"d1..~~ (~'n~k.~.

. _____ tt~I"_~ctX~" ~'t., .",~.

___ h..,\f i $-'\, ~

T. P~I~t)MI OO'~~I"'~~,'1' ' ~~X ~~ ~ at~ ~ ~~, tllt~~ ul h()lI~f1h"h.~ t\.'f 0\,,')..1$ ~\"'''t1 ~ ~\.!~ '"'~ .. , '"

"t~ (d\u't\b!(), ''''I\'ct\Jf;\b~)) ~ , , ~1~, ~"'~ ~.\.'1"" Ai.' 10\)(1, whk~h t\t~

{hollii\I\U. (t" '\I"~>t)

8. () I\'~tt l'INf\M ~1I.~\~~h,.' ~,,~tt, t t\,~ ~ , .• ,,' So

Ih~ hlll\II'IIIX'h:\l'i\.." ~~ \ ~"t'\lt~l , "\"~ It tlM,1lt 1'\1 l'\':'II"~I\~~ ~ ~11,'\\1 ~Il\i\

greater than depreciation, net private domestic Invest­

ment is (positive, negative) and the pro­duction capacity of the economy Is (declining, expanding)

10. An economy's net exports equal its exports (minus, plus)

_----- its imports. If exports are less than im­

ports, net exports are (positive, negative) , but if exports are greater than Imports, net exports are

11. Using the expenditure approach, the GOP equation

equals (NDP + NI + PI, C + Ig + G + Xn) ____ _

12. The compensation of employees in the system of na­tional income accounting consists of actual wages and

salaries (plus, minus) wage and salary supplements. Salary supplements are the payments employers make to Social Security or (public, private)

_____ insurance programs and to ____ _ pension, health, and welfare funds.

13. Corporate profits are disposed of in three ways:

corporate income (taxes, interest) , (de-

preciation, dividends) . and undistributed

corporate (taxes, prOfits) ____ _

14. Three adjustments are made to national income to

obtain (GOP, 01) _____ --'. Net foreign factor in-

come is (added, subtracted) , a statistical

discrepancy is . and the consumption of

fixed capital is _____ '

15. Gross domestic product overstates the economy's production because it fails to make allowance for (multiple

counting, depreciation) ______ or the need to

replace (consumer, capital) goods. When the adjustment is made, the calculations produce (net

domestic product, national income) ------

16. National income is equal to net domestic product

(plus, minus) net foreign factor income

_____ , a statistical discrepancy. Personal income

equals national income (plus, minus) -----­

transfer payments ~he sum. of .taxes o~ production and imports. Social Secunty contnbutlons, c~r porate income taxes, and undistributed corporate pr?flts. Disposable income equals personal income (plus, minus)

_____ personal taxes.

17. A GOP that reflects the prices prevailing ~hen the output is produced is called unadjusted, or (nominal, real)

GOP, but a GOP figure that Is deflated -----

MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME 301

or Inflated for price level changes is called adjusted or

_____ GOP.

18. To calculate a price Index In a given year, the com­bined price of a market basket of goods and services in

that year is (divided, multiplied) by the combined price of the market basket in the base year.

The result is then by 100.

19. Real GOP is calculated by dividing (the price Index,

nominal GOP) by . The price index expressed in hundredths is calcuiated by divid-

ing (real, nominal) GOP by ----­GOP.

20. For several reasons, GOP has shortcomings as a measure of total' output or economic well-being.

a. It does not include the (market, nonmarket)

_____ transactions that result in the produc­tion of goods and services or the amount of (work,

leisure) of participants in the economy. b. It failS to record improvements in the (quantity, qual-

ity) of the products produced, or the

changes in the (level, composition) _____ ..... and distribution of the economy's total output. c. It does not take into account the undesirable effects of GOP production on the (government, environment)

_ ____ or the goods and services produced

in the (market, underground) economy.

• TRUE-FAlSE QUESTIONS

Circle T if the statement is true, F if it is false.

1. National income accounting allows us to assess the performance of the economy and make policies to im­prove that performance. T F

2. Gross domestic product measures at their market values the total output of all goods and services produced in the economy during a year. T F

3. GOP is a count of the physical quantity of output and is not a monetary measure. T F

4. Final goods are consumption goods, capital goods, and services that are purchased by their end users rather than being ones used for further processing or manufacturing. T F

5. GOP includes the sale of Intermediate goods and ex-cludes the sale of final goods. T F

6. The total value added to a product and the value of the final product are equal. T F

7. Social Security payments and other public transfer payments are counted as part of GOP. T F

J

,.....

302 CHAPTER 24

8. The sale of stocks and bonds is excluded from GOP. T F

9. In computing gross domestic product, private transfer payments are excluded because they do not represent pay. ments for currently produced goods and services. T F

10. The two approaches to the measurement of the gross domestic product yield identical results because one ap­proach measures the total amount spent on the products produced by business firms during a year while the sec· ond approach measures the total income of business firms during the year. T F

11. Personal consumption expenditures only include ex­penditures for durable and nondurable goods. T F

12. The expenditure made by a household to have a new home built is a personal consumption expenditure. T F

13. In national income accounting. any increase in the inventories of business firms is included in gross private domestic investment. T F

14. If gross private domestic investment is greater than depreciation during a given year, the economy's produc­tion capacity has declined during that year. T F

15. Government purchases include spending by all units of government on the finished products of business, but ex­dude all direct purchases of resources such as labor. T F

16_ The net exports of an economy equal its exports of goods and services less its imports of goods and services. T F

17. The income approach to GOP includes compensa­tion of employees, rents. interest income, proprietors' income. corporate profits. and taxes on production and impo~. T F

18. Taxes on production and imports are the difference between gross private domestic investment and net pri­vate domestic investment. T F

19. Net foreign factor income is the difference between the earnings of foreign-owned resources in the United States and the earnings from U.S.-supplied resources abroad. T F

20. A GOP that has been deflated or inflated to reflect changes in the price level is called real GOP. T F

21. To adjust nominal GOP for a given year to obtain real GOP. it is necessary to multiply nominal GOP by the price index (expressed in hundredths) for that year. T F

22. If nominal GOP for an economy is $11.000 billion and the price index is 110. then real GOP is $10.000 billion. T F

23. GOP is a precise measure of the economic well-being of society. T F

24. The productive services of a homemaker are included in GOP. T F

25. The external costs from pollution and other activities associated with the production of the GOP are deducted from total output. T F

• MULnPLE-CHOICE QUESnONS

Circle the lener that corresponds to the best answer.

1. Which is a primary use for national income accounting? (8) It provides a basiS for assessing the performance

of the economy. (b) II measures economic efficiency in specific

industries. (c) It estimates expenditures on nonproduction

transactionS. (d) It analyzes the cost of pollution to the economy.

2. Gross domestic product (GOP) is defined as (8) personal consumption expenditures and gross private domestic investment (b) the sum of wage and salary compensation of employees. corporate profits. and interest income (c) the market value of final goods and services pro­duced within a country in 1 year (d) the market value of all final and intermediate goods and services produced by the economy in 1 year

3. GOP provides an indication of society's valuation of the relative worth of goods and services because it

(8) provides an estimate of the value of secondhand sales (b) gives increased weight to security transactions (c) is an estimate of income received (d) is a monetary measure

4. To include the value of the parts used in producing the automobiles turned out during a year in gross domes­tic product for that year would be an example' of

(8) including a non market transaction (b) including a nonproduction transaction (c) including a noninvestment transaction (d) multiple counting

5. Which of the following is a public transfer payment? (8) the Social Security benefits sent to a retired worker (b) the sale of shares of stock in Microsoft Corporation (c) the sale of a used (secondhand) toy house at a garage sale (d) the birthday gift of a check for $50 sent by a grand­mother to her grandchild

6. The sale in year 2 of an automobile produced in year 1 would not be included in the gross domestic product for year 2; doing so would involve

(a) including a non market transaction (b) including a nonproduction transaction (c) including a noninvestment transaction (d) public transfer payments

7. The service a babysitter performs when she stays at home with her baby brother while her parents are out and for which she receives no payment is not included in the gross domestic product because

(a) this is a non market transaction (b) this is a nonproduction transaction (c) this is a noninvestment transaction (d) multiple counting would be involved

8. Acco~ding to national inco~e accounting, money in­come denved from the production of this year's output is equal to

(8) corporate profits and the consumption of fixed capital

(b) the amount spent to purchase this year's total output (c) the sum of interest income and the compensation of employees

(d) gross private domestic investment less the con­sumption of fixed capital

9. Which would be considered an investment according to economists?

(a) the purchase of newly issued shares of stock in Microsoft (b) the construction of a new computer chip factory by Intel (c) the resale of stock originally issued by the General Electric corporation (d) the sale of a retail department store building by Sears to JCPenney

10. A refrigerator was produced by its manufacturer in year 1, sold to a retailer in year 1, and sold by the retailer to a final consumer in year 2. The refrigerator was

(a) counted as consumption in year 1 (b) counted as savings in year 1 (c) counted as investment in year 1 (d) not included in the gross domestic product of year 1

11. The annual charge that estimates the amount of pri­vate capital equipment used up in each year's production is called

(a) investment (b) depreciation (c) value added (d) multiple counting

12. If gross private domestic investment is greater than depreciation, the economy will most likely be

(a) static (b) declining (c) expanding (d) inflationary

13. GOP in an economy is $3452 billion. Consumer ex­penditures are $2343 billion, govem~ent purc~~ses are $865 billion, and gross investment IS $379 billion. Net exports are

(a) +$93 billion (b) +$123 billion (c) -$45 billion (d) -$135 billion

14. What can happen to the allocation of corporate profits? (a) It is paid to proprietors as inc~~e. (b) It is paid to stockholders as dlvl.dends. . (c) It is paid to the govemment as Interest Income. (d) It is retained by the corporation as rents.

15. The allowance for the private and publicly ow~ed capital that has been used up or consumed in prodUCing the year's GOP is

(a) net domestic product . (b) consumption of fixed capital

MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME 303

(c) undistributed corporate profits (d) taxes on production and imports

Questions 16 through 22 use the national income ac­counting data given in the following table.

Net private domestiC investment

Personal taxes

Transfer payments

Taxes on production and imports

Corporate income taxes

Personal consumption expenditures

Consumption of fixed capital

U.S. exports

Dividends

Government purchases

Net foreign factor income

Undistributed corporate profits

Social Security contributions

U.S. imports

Statistical discrepancy

Billions of dollars

$ 32 39

19

8 11

217

7

15 15 51 o

10 4

17

o

16. Gross private domestic investment is equal to (8) $32 billion (b) $39 billion (c) $45 billion (d) $56 billion

17. Net exports are equal to (a) -$2 billion (b) $2 billion (c) -$32 billion (d) $32 billion

. 18. The gross domestic product is equal to (8) $298 billion (b) $302 billion (c) $317 billion (d) $305 billion

19. The net domestic product is equal to (8) $298 billion (b) $302 billion (c) $317 billion (d) $321 billion

20. National income is equal to (8) $245 billion (b) $278 billion (c) $298 billion (d) $310 billion

21 . Personal income is equal to (8) $266 billion (b) $284 billion (c) $290 billion (d) $315 billion

22. Disposable income is equal to (8) $245 billion (b) $284 billion

304 CHAPTER 24

(e) $305 billion (d) $321 billion

23. If both nominal gross domestic product and the level of prices are rising. it is evident that

(I) real GOP is constant (b) real GOP is declining (e) real GOP is rising but not so rapidly as prices (d) no conclusion can be drawn concerning the real GOP of the economy on the basis of this information

24. Suppose nominal GOP rose from $500 billion to $600 billion while the GOP price index increased from 125 to 150. Real GOP

(I) was constant (b) increased (e) decreased (d) cannot be calculated from these figures

25. In an economy. the total expenditure for a market basket of goods in year 1 (the base year) was $4000 billion. In year 2, the total expenditure for the same mar­ket basket of goods was $4500 billion. What was the GOP price index for the economy in year 2?

(8) .88 (b) 1.13 (e) 188 (d) 113

26. Nominal GOP is less than real GOP in an economy in year 1. In year 2, nominal GOP is equal to real GOP. In year 3, nominal GOP is slightly greater than real GOP. In year 4, nominal GOP is Significantly greater than real GOP. Which year is most likely to be the base year that Is being used to calculate the price index for this economy?

(I) 1 (b) 2 (e) 3 (d) 4

27. Nominal GOP was $3774 billion in year 1 and the GOP deflator was 108 and nominal GOP was $3989 in year 2 and the GOP deflator that year was 112. What was real GOP in years 1 and 2, respectively?

(a) $3494 billion and $3562 billion (b) $3339 billion and $3695 billion (e) $3595 billion and $3725 billion (d) $3643 billion and $3854 billion

28_ A price index one year was 145, and the next year" was 167. What is the approximate percentage change in the price level from one year to the next as measured by that index?

(a) 12% (b) 13% (e) 14% (d) 15%

29. GOP accounting Includes (a) the goods and services produced in the under­ground economy (b) expenditures for equipment to reduce the pollution of the environment (e) the value of the leisure enjoyed by citizens (d) the goods and services produced but not bought and sold in the markets of the economy

30. Which is a major reason why GOP: not an accurate . d of society's economIC well-being. In ex . I fie'

(a) It includes changes In the va ue . 0 Isure. (b) It excludes many improvements In product QUality. (e) It includes transactions from the underground

economy. . (d) It excludes transactions from the buying and S9Uing

of stocks.

• PROBLEMS

1. Following are national income accounting figures for the United States.

Exports Dividends Consumption of fixed capital

Corporale profits Compensalion of employees

Govemmenl purchases

Rents Taxes on produclion and imports Gross privale domeslic inveslment Corporale income laxes Transfer peymenls Inleresl Proprietors' income

Personal consumption expendilures Imports Social Security conlribulions Undistributed corporale profils Personal laxes Nel foreign factor income Sialistical discrepancy

Billion. ofcloll8q

$ 367 60

307

203 1722

sn 33

255

437

88 320

201

132

1810

338

148

55

372 o o

I. In the following table, use any of these figures to prepare an income statement for the economy similar to the one found in Table 24.3 of the text.

Receipt.: AII~tIOll.: EX{»rIdltu .... pprwch tncome approach

Item Amount Item Amount $_- $_-$- $-$- $-$- $-

$-$-

National Income S-$_ $_

Gross domesllc Gross domestic

$_

product $ product S-

b. Use the other national acCOunts to find

(1) Net domestic product is $ ------(2) National income is $ ------(3) Personal income is $ -------(4) Disposable income is $ ------

2. A farmer o~ns a plo! of ground and sells the right to pump crude 011 from his land to a crude'l d . 01 pro ucer The crude 011 producer agrees to pay the farmer $50 ~ barrel for . every barrel pumped from the farmer's land.

a. Dunng one year 10,000 barrels are pumped.

(1) The farmer receives a payment of $ from the crude oil producer. ---

(2) The value added by the farmer is $ b. The crude oil producer sells the 1-0-000--b-~rrels pumped to a petroleum refiner at a price of $110 a barrel.

(1) The crude oil producer receives a payment of

$ ___ from the refiner.

(2) The value added by the crude oil producer is

$--_. C. The refiner employs a pipeline company to transport the crude oil from the farmer's land to the refinery and pays the pipeline company a fee of $5 a barrel for the oil transported. (1) The pipeline company receives a payment of

$ from the refiner. (2) The value added by the pipeline company is

$--_. d. From the 10,000 barrels of crude oil, the refiner produces 400,000 gallons of gasoline which is sold to distributors and gasoline service stations at an average price of $3.50 per gallon. (1) The total payment received by the refiner from its

customers is $ __ _

(2) The value added by the refiner is $. __ _ e. The distributors and service stations sell the 400,000 gallons of gasoline to consumers at an average price of $3.75 a gallon. (1) The total payment received by distributors and

service stations is $, __ _

(2) The value added by them is $, __ _ (3) The total of the value added by the farmer, crude oil producer, pipeline company, refiner, and distribu-

tors and service stations is $ , and the market value of the gasoline sold to customers (the final good)

is $ __ _

3. Following is a list of items which mayor may not be included in the five income-output measures of the na­tional income accounts (GOP, NOP, NI, PI, 01). Indicate in the space to the right of each which of the income-output measures includes this item; it is possible for the item to be included In none, one, two, three, four, or all of the

MEASURING DOMESTIC OlJTPlJT AND NATIONAl INCOME 305

measures. If the item is included in none of the measures. indicate why it is not included.

8. Interest on the national debt _______ _

b. The sale of a used computer _______ _ c. The production of shoes that are not sold by the

manufacturer _________ -:::-_-:---:--d. The income of a dealer in illegal drugs

e. The purchase of a share of common stock on the

New York Stock Exchange ______ -:-_--: f. The interest paid on the bonds of the General

ElectriC, a corporation _______ :--__ -:-g. The labor performed by a homemaker

h. The labor performed by a paid babysitter

I. The monthly check received by a college student

from her parents ________ -:-__ -;-__ J. The purchase of a new tractor by a farmer

k. The labor performed by an assembly line worker in

repapering his own kitchen _________ _

I. The services of a lawyer _________ _ m. The purchase of shoes from the manufacturer by a

shoe retailer ______________ _

n. The monthly check received from the Social Security Administration by a college student whose parents

have died _______________ _

o. The rent a homeowner would receive if she did not

live in her own home ___________ _

4. Following is hypothetical data for a market basket of goods in year 1 and year 2 for an economy.

B. Compute the expenditures for year 1.

MARKET BASKET FOR YEAR 1 (BASE YEAR)

Products Quantity Price Expenditures Toys 3 $10 $ __

Pencils 5 2 $ __

Books 7 5 $ __ Total $

b. Compute the expenditures for year 2.

Products

Toys Pencils

Books

Total

MARKET BASKET FOR YEAR 2

Quantity Price

3 $11

5

7 3

6

Expenditures

$_­

$_­$_­$

c. In the space below, show how you computed the

GOP price index for year 2. ________ _

301 CHAPTER 24

5. The following table shows nominal GOP figures for 3 years and the price Indices for each of the 3 years. (The GOP figures are in billions.)

V .. r 1929 t933

1939

$104

56 91

Price Index 121 91

100

R_IOOP $ __ $ __

$

•. Use the price indices to compute the real GOP in each year. (You may round your answers to the nearest billion dollars.) Write answers in the table. b. Which of the 3 years appears to be the base year?

c. Between (1) 1929 and 1933 the economy experienced (inflation.

deflation) _---:-_____________ '

(2) 1933 and 1939 it experienced _____ ~ d. The nominal GOP figure

(1) for 1929 was (deftated, inflated, neither) ____ '

(2) for 1933 was ____________ .

(3) for 1939 was, ___________ _

e. The price level

(1) fell by _______ % from 1929 to 1933.

(2) rose by _______ % from 1933 to 1939.

• SHORT ANSWER AND ESSAY QUESTIONS

1. Of what use is national income accounting to econo­mists and policymakers?

2. What is the definition of GOP? How are the values of output produced at a U.S.-owned factory in the United States and a foreign-owned factory in the United States treated in GOP accounting?

3. Why is GOP a monetary measure?

4. How does GOP accounting avoid multiple counting and exaggeration of the value of GOP?

5. Why does GOP accounting exclude nonproduction transactions?

6. What are the two principal types of nonproduction transactions? Ust examples of each type.

7. What are the two sides to GOP accounting? What are the meaning and relationship between the two sides?

8. What would be included in personal consumption expenditures by households?

9. How is gross private domestic investment defined?

10. Is residential construction counted as investment or consumption? Explain.

11. Why is a change in inventories an investment?

12. How do you define an expanding production capacity using the concepts of gross private domestic investment and depreciation?

13. What do government purchaSeS include and what do

they exclude?

14. How are imports and exports handled in GOP

accounting?

15. What are six income components of GOP that add up to national income? Define and explain the characteristic: of each component.

16. What are the three adjustments made to the national income to get it to equal GOP? Define and explain the characteristics of each one.

17. Explain how to calculate net domestic product (NOP), national income (NI), personal income (PI). and disp0s­able income (01).

18. What is the difference between real and nominal GOP? Describe two methods economists use to detennine real GOP. Illustrate each method with an example.

19. Describe the real world relationship between nominal and real GOP in the United States. Explain why nominal GOP may be greater or less than real GOP depending on the year or period selected.

20. Why might GOP not be considered an accurate mea· sure of total output and the economic well-being of society? Identify seven shortcomings of GOP. '

ANSWERS

Chapter 24 Mea.urlng Domestic Output and Natlorlal Income

FlLL·IN QUESTIONS

1. production, policies 2. market, final, in 1 year 3. within, included 4. monetary, relative 5. final, intermediate, over, multiple 6. nonproduction, financial, second 7. durable, nondurable. services 8. capital, construction of new, inveniories 9. depreciation, positive, expanding

10. minus, negative, positive 11. C + Ig + G + Xn 12. plus, public, private 13. taxes, dividends, profits 14. GOP, subtracted, added, 'added 15. depreci~lion, capital, net domestic product 16. plus, minus, plus, minus, minus 17. nominal, real 18. divided, multiplied 19. nominal GOP, the price index, nominal, real 20. B. nonmarket, leisure; b. quality, composition· c. environ-ment, undergroUnd '

TRUE-FALSE QUESTIONS

1. T, p. 486 2. F, p. 486 3. F, p. 486 4. T, pp. 486-487 5. F, pp. 486-487

6. T,pp.487 7. F, p. 487 8. T,P.488 8. T, p. 488

10. F, p. 488

11. F, p. 489 12. F, p. 489 13. T. pp. 489-490 14. F, p. 490 15. F, p. 490

16. T, p. 491 17. T, p. 492 18. F, pp. 492-493

20. T, p. 497 21. F, p. 498 22. T, p. 498

24. F, p. 499 25. F, p. 500

19. T, p. 493 23. F, p. 499

MULTIPLE-CHOICE QUESTIONS

1. a,p. 486 2.c,p. 486 3.d, p.486 ... d, pp. 486-487 5. a, p.487 6.b,p.488 7. a, pp. 487, 499 8. b, p. 488 9.b, p. 489

10. c, p. 489-490

PROBLEMS

11. b, p. 490 12. c, p. 490 13.d, p. 491 14. b, p. 492 15. b, p. 493 16. b, pp.489-490 17. a, p. 491 lB. d, p. 491 19. a, pp. 494 20.c, pp. 494

21. b, pp. 494 22. a, pp. 495 23. d, p. 497 24. a, p. 498 25.d, p.498 26.b, pp. 498-499 27.a,pp. 498-499 28.d, pp. 498-499 29. b, p. 500 3O.b, pp. 49~00

1. a. See the following table; b. (1) 2546 (2) 2546 (3) 23 1948 ' , 20, (4)

Receipts: Expenditures approach Item Amount

Allocations: Income aeE.roach

Item Amount Personal Compensation of

consumption employees $1722 expenditures $1810 Rents 33

Gross private Interest 201 domestic Proprietors' income 132 investment 437 Corporate profits 203

Govemment Taxes on production purchases 577 and imports 255

Net exports 29 National income $2546 Net foreign factor

Income 0 Consumption of

fixed capital 307 Gross domestic Gross domestic

product $2853 product $2853

MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME 307

2. a. 500,000. (2) 500.000; b. (1) 1,100,000. (2) 600,000; c. (1) 50,000, (2) 50.000; d. (1) 1,400,000. (2) 250,000; B. (1) 1,500,000, (2) 100,000; f. 1,500,000, 1,500,000 3. B. personal income and disposable income, a public transfer payment; b. none, a secondhand sale; c. all, represents invest· ment (additions to inventories); d. none, illegal production and incomes are not included if not reported; B. none, a purely financial transaction; f. all; g. none, a nonmarket transaC1ion; h. all if re­ported as income, none if not reported; i. none, a private transfer payment; j. all; k. none, a non market transaction; I. all; m. all, represents additions to the inventory 01 the retailer; n. personal income and disposable income, a public transfer payment; o. all, estimate of rental value of owner-occupied homes is included in rents as if it were income and in personal consumption expen­ditures as if it were payment for a service 4, 8. 30, 10,35,75; b. 33, 15,42,90; c. ($90175) x 100 = 120 5. 8. 86,62,91; b. 1939; c. (1) deflation, (2) inflation; d. (1) de­flated, (2) inflated, (3) neither; B. (1) 24.8 (2) 9.9.

SHORT ANSWER AND ESSAY QUESTIONS

1. p. 486 2. p. 486 3. p. 486 ... pp. 486-487 5. pp. 487-488 6. pp. 487-488 7. p. 488

B. p. 489 9. p. 489

10. p. 489 11. p. 489 12.p.489-490 13. p. 490 14. p. 491

15. p. 492 16. pp. 493-494 17.pp. 494--495 18. p. 497 19.pp.498-499 20. pp.499-500