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

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

Measuring National Output Measuring National Output and National Incomeand National Income


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.


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.


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


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 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.


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.

measuring national output and national income

Education

expenditure

gdp price

expenditure

income approach

capita gdp

base year

thebase year

ray fair