Measuring National Output and National Income. Gross Domestic Product. National Income and Product Accounts

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1 C H A P T E R 18 Measuring National Output and National Income Prepared by: Fernando Quijano and Yvonn Quijano Gross Domestic Product Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country. 2of 38 National Income and Product Accounts National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy. The U.S. Department of Commerce is responsible for producing and maintaining the National Income and Product Accounts that keep track of GDP. 3of 38

2 Final Goods and Services The term final goods and services in GDP refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm. 4of 38 Value Added Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales. 5of 38 (3) Shipping (4) Retail sale Total value added Value Added Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) STAGE OF PRODUCTION (1) Oil drilling (2) Refining VALUE OF SALES $ VALUE ADDED $ $1.00 6of 38

3 Exclusions of Used Goods and Paper Transactions GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced. 7of 38 Exclusion of Output Produced Abroad by Domestically Owned Factors of Production GDP is the value of output produced by factors of production located within a country. Output produced by a country s citizens, regardless of where the output is produced, is measured by gross national product (GNP). 8of 38 Calculating GDP GDP can be computed in two ways: The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. The income approach: A method of computing GDP that measures the income wages, rents, interest, and profits received by all factors of production in producing final goods. 9of 38

4 The Expenditure Approach Expenditure categories: Personal consumption expenditures (C) household spending on consumer goods. Gross private domestic investment (I) spending by firms and households on new capital: plant, equipment, inventory, and new residential structures. 10 of 38 The Expenditure Approach Expenditure categories: Government consumption and gross investment (G) Net exports (EX IM) net spending by the rest of the world, or exports (EX) minus imports (IM) 11 of 38 The Expenditure Approach The expenditure approach calculates GDP by adding together the four components of spending. In equation form: GDP = C + I + G + ( EX IM) 12 of 38

5 Components of GDP, 1999: The Expenditure Approach Components of GDP, 2002: The Expenditure Approach BILLIONS OF DOLLARS Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories 3.9 Government consumption and gross investment (G) Federal State and local Net exports (EX IM) Exports (EX) Imports (IM) Total gross domestic product (GDP) Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis PERCENTAGE OF GDP of 38 Personal Consumption Expenditures Personal consumption expenditures (C) are expenditures by consumers on the following: Durable goods: Goods that last a relatively long time, such as cars and appliances. Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. Services: Things that do not involve the production of physical things, such as legal services, medical services, and education. 14 of 38 Gross Private Domestic Investment Investment refers to the purchase of new capital. Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector. 15 of 38

6 Gross Private Domestic Investment Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later. 16 of 38 Gross Private Domestic Investment Remember that GDP is not the market value of total sales during a period it is the market value of total production. The relationship between total production and total sales is: GDP = final sales + change in business inventories 17 of 38 Gross Investment versus Net Investment Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. Depreciation is the amount by which an asset s value falls in a given period. Net investment equals gross investment minus depreciation. capital end of period = capital beginning of period + net investment 18 of 38

7 Government Consumption and Gross Investment Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services. 19 of 38 Net Exports Net exports (EX IM) is the difference between exports and imports. The figure can be positive or negative. Exports (EX) are sales to foreigners of U.S.-produced goods and services. Imports (IM) are U.S. purchases of goods and services from abroad). 20 of 38 The Income Approach National income is the total income earned by the factors of production owned by a country s citizens. The income approach to GDP breaks down GDP into four components: GDP = national income + depreciation + (indirect taxes subsidies) + net factor payments to the rest of the world + other 21 of 38

8 National income Compensation of employees Proprietors income Corporate profits Net interest Rental income The Income Approach Components of GDP, 2002: The Income Approach Depreciation Indirect taxes minus subsidies Net factor payments to the rest of the world Other Gross domestic product Source: See Table BILLIONS OF DOLLARS 8, , , ,205.6 PERCENTAGE OF GDP of 38 From GDP to Disposable Personal Income GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2002 GDP Plus: receipts of factor income from the rest of the world Less: payments of factor income to the rest of the world Equals: GNP Less: depreciation Equals: net national product (NNP) Less: indirect taxes minus subsidies plus other Equals: national income Less: corporate profits minus dividends Less: social insurance payments Plus: personal interest income received from the government and consumers Plus: transfer payments to persons Equals: personal income Less: personal taxes Equals: disposable personal income Source: See Table DOLLARS (BILLIONS) 10, , , , , , , , , of 38 From GDP to Disposable Personal Income Net national product equals gross national product minus depreciation; a nation s total product minus what is required to maintain the value of its capital stock. Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes. 24 of 38

9 Less: Disposable Personal Income and Personal Saving Disposable Personal Income and Personal Saving, 2002 Disposable personal income Personal consumption expenditures Interest paid by consumers to business Personal transfer payments to foreigners Equals: personal saving Personal savings as a percentage of disposable personal income: Source: See Table DOLLARS (BILLIONS) 7, % 25 of 38 Disposable Personal Income and Personal Saving The personal saving rate is the percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously. 26 of 38 Nominal Versus Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. When a variable is measured in current dollars, it is described in nominal terms. 27 of 38

10 Calculating Real GDP A weight is the importance attached to an item within a group of items. A base year is the year chosen for the weights in a fixed-weight procedure. A fixed-weight procedure uses weights from a given base year. 28 of 38 A Three-Good Economy Good A Good B Good C Total (1) Calculating Real GDP (2) PRODUCTION YEAR 1 YEAR 2 Q 1 Q PRICE PER UNIT YEAR 1 YEAR 2 P 1 P 2 $.50 GDP IN YEAR 1 IN YEAR 1 PRICES P 1 x Q $12.10 Nominal GDP in year 1 (3) (4) $ (5) $ (6) GDP IN YEAR 2 IN YEAR 1 PRICES P 1 x Q 2 $ $15.10 (7) GDP IN YEAR 1 IN YEAR 2 PRICES P 2 x Q 1 $ $18.40 (8) GDP IN YEAR 2 IN YEAR 2 PRICES P 2 X Q 2 $ $19.20 Nominal GDP in year 2 29 of 38 Calculating the GDP Deflator The GDP deflator is one measure of the overall price level. The GDP deflator is computed by the Bureau of Economic Analysis (BEA). Overall price increases can be sensitive to the choice of the base year. For this reason, using fixedprice weights to compute real GDP has some problems. 30 of 38

11 The Problems of Fixed Weights The use of fixed price weights to estimate real GDP leads to problems because it ignores: 1. Structural changes in the economy. 2. Supply shifts, which cause large decreases in price and large increases in quantity supplied. 3. The substitution effect of price increases. 31 of 38 GDP and Social Welfare Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP. An increase in leisure is an increase in social welfare, but not counted in GDP. Nonmarket and household activities are not counted in GDP even though they amount to real production. 32 of 38 GDP and Social Welfare GDP accounting rules do not adjust for production that pollutes the environment. GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. GDP is neutral to the kinds of goods an economy produces. 33 of 38

12 The Underground Economy The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP. 34 of 38 Gross National Income per Capita To make comparisons of GNP between countries, currency exchange rates must be taken into account. Gross National Income (GNI) is a measure used to make international comparisons of output. GNI is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation. GNI divided by population equals gross national income per capita. 35 of 38 Gross National Income per Capita Per Capita Gross National Income for Selected Countries, 2002 COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS Switzerland 36,970 Portugal 10,670 Japan 35,990 South Korea 9,400 Norway 35,530 Argentina 6,860 United States 34,870 Mexico 5,540 Denmark 31,090 Czech Republic 5,270 Ireland 28,880 Brazil 3,060 Sweden 25,400 South Africa 2,900 United Kingdom 24,230 Turkey 2,540 Netherlands 24,040 Colombia 1,910 Austria 23,940 Jordan 1,750 Finland 23,840 Romania 1,710 Germany 23,700 Philippines 1,050 Belgium 23,340 China 890 France 22,640 Indonesia 680 Canada 21,340 India 460 Australia 18,770 Pakistan 420 Italy 18,470 Nepal 250 Spain 14,860 Rwanda 220 Greece 11,780 Ethiopia 100 Source: The World Bank Atlas, of 38

13 base year Review Terms and Concepts change in business inventories compensation of employees corporate profits current dollars depreciation disposable personal income, or after-tax tax income durable goods expenditure approach final goods and services fixed-weight procedure government consumption and gross investment (G)( gross domestic product (GDP( GDP) gross investment gross national income (GNI) gross national product (GNP( GNP) gross private domestic investment (I)( income approach indirect taxes intermediate goods national income national income and product accounts 37 of 38 Review Terms and Concepts net exports (EX( IM) net factor payments to the rest of the world net interest net investment net national product (NNP( NNP) nominal GDP nondurable goods nonresidential investment personal consumption expenditures (C)( personal income personal saving personal saving rate proprietors income rental income residential investment services subsidies underground economy value added weight 38 of 38