ECON140-Chapter 25-Measuring Domestic Output and National Income

Chapter 25:
Measuring Domestic Output

and National Income
Dr. Shamlan Waleed Albahar

ECON 140
Department of Economics, College of Business Administration
Kuwait University
Spring 2024
Assessing the Economy’s Performance
• It is known that any firm needs to check its accounting data to know the status of
its costs and profits and make sure that things are going well.
• A country should do a similar check at the national level to check on the whole
economy’s performance. We call these measures “National Income Accounting.”
• This accounting enables economists and policymakers to: ↳
& Ø Measure the health of the economy by comparing levels of production at
regular intervals.
- 5
I Ø To see whether the economy has grown, been constant, or declined in a

specific period of time (can be short-run or long-run).
3 Ø Establish policies that improve the economy’s health.
• National Income Accounting is compiled and reported by some governmental
institution that specializes in data gathering.
Ø EX: in Kuwait “Central Statistical Bureau (CSB)” and in US “Bureau of Economic
Analysis (BEA).”
25-2
Dr. Shamlan Albahar ECON 140
Measuring Aggregate Output

What §are The primary measure of the whole economy’s performance is its aggregate output.
?
§ How can we measure aggregate output?
• Aggregate = total
• Can we say we a country produced 5 billion units? No
• Can we add bananas, t-shirts, shoes, food, oil and electricity all together? No
• No!
• We cannot add output itself but we can add how much each different unit of
output is worth and get the total value of output.
• We should attach a price tag to each product to indicate how society values these
products.
• Instead of saying we produced X bananas, Y t-shirts, Z shoes, M tons of food, V
barrels of oil and W kilowatt-hour of electricity, we instead say we produced an
output that is worth 10 million KD.
Mr
• GDP does that for us. & XP + xXP =
25-3
Gross Domestic Product (GDP)
or total output
• The primary measure of the whole economy’s performance is its aggregate output.
This is most commonly calculated using Gross Domestic Product (GDP).
*
• Gross Domestic Product (GDP) is the market value in a country’s currency (e.g. KD
* #
or $) of all final goods and services produced within the borders of a country in a
- -
-i
* specific period. ↳newris -sij j dedgle E ! & -
S
!
25 · P serit Goods
,
Ø The market value in a country’s currency (e.g. KD or $) = it’s a monetary measure

of output telling us how much the output of a country is worth.
Ø of all final goods and services = to avoid multiple counting of goods, GDP includes
only the market value of final goods purchased by their final users and ignores
intermediate goods, which are goods either purchased for resale or for further
processing into final goods.
Ø produced = GDP ignores money transactions that do not involve the production of
something new.~! bli ! * - did *
Ø within the borders of a country = anything produced inside the country no matter
who produced it (e.g. anything produced in Kuwait even by a foreign company).
Ø in a specific period = mostly one year (annual GDP) but sometimes calculated
25-4
every three months (quarterly GDP).
GDP Excludes
Nonproduction Transactions
out
• Nonproduction transactions must be excluded from GDP because they DO NOT
contribute to the current production of final goods. There are two types of
nonproduction transactions: purely financial transactions and secondhand sales.
• 1. GDP excludes purely financial transactions -so
⑭p
!
-= -( =
Ø Public transfer payments (e.g.*Social Security, welfare payments)

Ø Private transfer payments (e.g. cash gifts from parents)
Ø Stock market transactions (no added production: only a change in owner).
• 2. GDP excludes secondhand sales
Ø EX: selling your used car to a friend
§ Note the following:
• Do not mix wages and social security payments. Wages are counted in GDP
because the recipients contribute to current production in return for their
received wages, but retirees contribute nothing to current production in
return.
• Note that payments for the services provided by a stockbroker are included in
GDP because their services are part of the economy’s current output of goods
and services. 25-5
Comparative GDP
25-6
Three Approaches to Measure GDP

Three equivalent approaches to measuring GDP
Product Approach Expenditures Approach Income Approach
Consumption by Wages
Households C +
In Final product zValue added Rents
+
method method +
Investment by
Adding the Adding together
Businesses
La Interest
+
market values of the market values
all final products + Profits
of each good
+
produced in each Government Taxes on production
production stage Purchases G and imports
minus the value + +
of intermediate
goods used for
NX
Net Exports Statistical
that production Adjustments 25-7
Households +
Final product Value added Rents
+
method method +
Investment by Interest
Businesses +
of each good
+
production stage Purchases and imports
minus the value + +
of intermediate
goods used for Net Exports Statistical
Measuring GDP: Product Approach

• Final product method: Simply adding the market values of all final products by
multiplying their price tags by quantities produced.
- xafpxa
25-9
I

• Value added method: Adding together the market values of each good produced
in each production stage minus the value of intermediate goods used for that
production.
Sheep Ranch Wool Processor Suit Clothing Retail

Manufacturer Wholesaler Clothier
Ø 1st stage. Ø 2nd stage. Ø 3rd stage. Ø 4th stage. Ø Final stage.
Ø No intermediate Ø Buys sheep at Ø Buys wool at Ø Buys suit at Ø Buys suit at $270
good. $120 $180 $220 Ø Sells suit at $350
Ø Sells sheep at Ø Sells wool at Ø Sells basic suit Ø Sells suit to Ø Value added=$350-
$120 $180 at $220 store at $270 $270=$80
Ø Value added= Ø Value Ø Value Ø Value
$120-0=$120 t added=$180- added=$220-
+ added=$270-
$120=$60
$180=$40 ↳ $220=$50 t 25-10
-
-
330

production.
Sheep Ranch Wool Processor Suit Clothing Retail

Manufacturer Wholesaler Clothier
Ø Value added= Ø Value Ø Value Ø Value Ø Value added=$350-
$120-0=$120 added=$180- added=$220- added=$270- $270=$80
$120=$60 $180=$40 $220=$50
• Total Value added in all stages of production=$120+$60+$40+$50+$80= $350
25-11
• Final product method: Simply adding the market values of all final products by
multiplying their price tags by quantities produced.
find product - Valueadded
metho method
production.
Ø Using this
method will
avoid
multiple
counting. or Value
&
added
method
Final product method 25-12


Households +
+
method method +
Businesses +
of each good
+
minus the value + +
of intermediate
Expenditures Approach
§ Expenditure approach:
• GDP (sometimes Y is used as a symbol) = C + Ig + G + NX
Ø C: personal consumption expenditures
Ø Ig: investment by businesses (gross private domestic investment)
Ø G: government purchases
Ø NX: net exports
§ Personal consumption expenditures (C)
Ø Covers all expenditures by households on goods (durable and nondurable) and
services during a year.
Ø Durable good: a good with an expected life of 3 or more years. EX: cars, TV
and phones.
Ø Nondurable good: a good with an expected life of less than 3 years. EX: food,
cosmetics and gasoline.
Ø Services like consumers expenditures on lawyers, doctors and barbers.
25-14
Expenditures Approach ↑
§ Gross private domestic investment (Ig)

.
&1. Machinery, equipment, and tools Tilgsis-st
2. All construction siblgg -
gosly"dS. & -I
3. Positive and negative changes in inventories "E Inventryis
1
E-&
3
X
d Inventory 25
-
3
• All of these three categories represent ways businesses invest in themselves.
Construction also includes residential construction because homes could be rented
to produce income.
• We need to count all output produced in a given year as part of that year’s GDP,
even if some of it remained unsold by the end of the year.
Ø Produced in 2019 but unsold = part of 2019 GDP even if it is sold in 2020
(investment category, specifically inventories).
Ø If inventories decrease in a given year (goods produced in prior years: already
counted as GDP in those years): we subtract it from total investment that year.
• Noninvestment transactions are excluded.
Ø Investment does not include the transfer of paper assets (stocks, bonds) or the
resale of tangible assets (houses, jewelry, boats). These transactions only
involve the transfer of ownership of existing assets NOT the creation of new
25-15
capital assets.
Gross Investment Vs. Net Investment
• GDP calculates gross private domestic investment (Ig).
Ø “private” = investment by private businesses, not by government (public)
agencies.
Ø “domestic” = investment taking place inside the country, not abroad.
Ø “gross” = includes investment in replacement capital and in added capital.
v Newe Es Captid &5. e
Ses -56
• Businesses make investments in replacement capital because capital depreciates
Capitals over time (its value decrease over time).
Ø Value of fixed assets decrease over time: due to continuous use of these D
assets for a long time, which decreases their productive capacity – or due to
natural factors like rain – or due to change in technology or change in demand.
②
Ø The investment spent to replace the existing investment due to depreciation is

counted in gross investment.
Ø In contrast, net private domestic investment includes only investment in the
form of added capital.
Ø Net investment = gross investment - depreciation
· 25-16
I
=Greotn Sage
Net e
Replacement capital
lines Twent
(
Gross I + add
Investment Capital
Gross >
Dep
Gross = Dep
Gust Dep
538,2)* 35 S
abS 10+
§ Government purchases (G) G
25 g 0
-
GDP &
Ø Expenditures for goods and services that government consumes in providing

public services.
Ø Expenditures for publicly owned capital such as schools and roads.
Ø All governmental purchases of resources including labor (e.g. public sector
wages).
·
Ø It does NOT include government transfer payments (e.g. social security and
welfare payments) because, as we previously said, they do not contribute to
-
production.
25-17
• Net exports (NX)
Ø Net exports are calculated by subtracting the value of imported goods from
the value of exported goods.
Ø NX= exports (X) – imports (M)
Ø Why subtract imports? Not all of the C, Ig, and G expenditures are for
domestically produced goods. Because we want to count only the part of C, Ig,
and G when measuring GDP that goes to purchasing domestically produced
goods and services, we subtract the spending that goes to imports.
• Adding up all four expenditure components calculates GDP, a measure of the

market value of a specific year’s total output.
GDP = C + Ig + G + NX import
export
GDP = C + Ig + G + X - M I
1.
GPp + M C + b + G + X
-
-
=
2-
ex 29 - di
* si
: 5.3
29
-
GPPS* 25-18
-
- =
-
-

7 -
Product Approach 2- Expenditures Approach3- Income Approach
T Consumption by Wages
2
-
Households +
+
method method +
Businesses +
of each good
+
minus the value + +
of intermediate
Income Approach
• Expenditure approach
Ø Counts total money spent buying the final goods.
Ø A focus on: who buys the goods?
• Income approach
Ø Counts income derived from production.
25-20
Ø Wages, rental income, interest income, profit.
Income Approach
Statistical
Adjustments
• The expenditures and income approaches are two different ways to look at the
same thing.
• In theory, either method should yield equal results.
• Income approach:
GDP = Wages + Rents + Interest + Profits + Taxes on production and imports +
Statistical Adjustments 25-21
Other Methods for National Account
e
• Mainly used national account is GDP.
• There are other national accounts
used as well:
E
Ø Net Domestic Product (NDP)
Ø National Income (NI)
Ø Personal Income (PI)
Ø Disposable Income (DI):
personal income less personal
taxes.
25-22
Nominal GDP vs. Real GDP

•
GDP is a monetary measure of production in a given country's currency (e.g. KD or $).
•
Using KD or dollar values creates problems (1 KD in 1970 is not the same as 1 KD in
2020).
§ Nominal GDP
• A measure of GDP based on prices at the time when output was produced.
§ Real GDP
• A measure of GDP for various years as if the value of the currency (e.g. KD or $)
had always been the same as it was in some base year.
-
8/
Ø Base year: a year chosen as a reference point for comparison with some
I 2985px X( +
*
earlier or later year.
GDP GDP
x
• It’s an inflation-adjusted measure that reflects changes in the price level.

=
• In order to calculate real GDP, a base year must be selected (e.g. choosing 1970
as a base year) and then the current year’s prices adjusted accordingly (2020
prices adjusted to reflect 1970 KD).

GDP
↳
Base GDP
Lo
-real
25-23
197- 12B ND
Grp
d2023
a we
BR
S B
ND-homail 2
·
.
• To calculate real GDP, we use a GDP price index that is equal to the price of a
collection of goods and services (market basket) in a specific year divided by the
price for the same goods and services in a base year multiplied by 100.
J
Price of Market Basket
(in given year) 2. 23
GDP Price Index = x 100
(in given year) 2023 Price of Same Basket
(in base year) 2013
• Real GDP can then be calculated from nominal GDP as follows:
Nominal GDP
Real GDP = x 100
GDP Price Index -
is unit Less
Or
-CoReal GDP
Nominal GDP = x GDP Price Index
100
--
25-24

• Suppose we want to calculate GDP in 2019 and the base year is the year 2000.
(in 2019)
GDP Price Index = x 100
(in 2019) Price of Same Basket
(in 2000)
Nominal GDP
Real GDP (in 2019)
x 100
(in 2019) = GDP Price Index
(in 2019)
Or
Real GDP
(in 2019)
Nominal GDP = x GDP Price Index
(in 2019) 100 (in 2019)
25-25
• Assume an economy that only produces pizza (so the market basket used for GDP
price index only contains one item: pizza).
• Also assume that Base Year = Year 1. "
-s
-
38 #
&*
&
25-26

• Let’s do the calculations for year 2. price Pricemanket
Basket
X be
index =
P-RiD
GivenYukikXpe- GPP Bose
-at
Rea-maits
PXP
↓ b XD
Mo Zu ylos 3Xb
=
~
↳ ---
lo
Base indelI

GDP Price Index = (in Year 2) x 100
(in Year 2) Price of Same Basket
(in Year 1)
20 x 100
=
10
= 200
25-27
• Using the final product method, we calculate nominal GDP.
• Why use final product method in this example? The given info in table is final
product prices and quantities.
Ø Final product method: multiplying the final products price tags by their
produced quantities.
Ø There is only one product in this example: pizza.
Nominal GDP = Price of Pizza x Quantities of Pizza sold

(in Year 2) (in Year 2) (in Year 2)
= 20 x 7 = 140 25-28

• Since we know the GDP price index and nominal GDP, we can now calculate real
GDP in year 2.
Nominal GDP
Real GDP (in Year 2) x 100
=
(in Year 2) GDP Price Index
(in Year 2)
140 x 100
=
200

= 70
E 25-29
· gerbek
Real GDP
Rea E
30x
30 -
3 GRP
• Remember that nominal GDP is based on prices at the time when output was
produced
• It would be wrong to compare nominal GDP in year 2 ($140) with nominal GDP
in year 1 ($50) because the dollar in year 2 is not the same as year 1 in terms of
purchasing power (e.g. due to inflation).
Ø We can NOT say that the economy has grown by $90 from year 1 to year 2.
• On the other hand, it would be correct to compare real GDP in year 2 ($70) with
real GDP in year 1 ($50) because the dollars used are the same (year 1 dollars).
Ø We can say that the economy has grown by $20 (year 1 dollars) from year 1 25-30
to year 2.
• Note that nominal GDP = real GDP for base year (year 1).
• Exercise: Find the GDP price index, nominal GDP and real GDP in years 4 and 5.
25-31
Shortcomings of GDP
§ GDP is a reasonably accurate and highly useful measure of how the economy is
performing.
• GDP is a measure of income in an economy.
• GDP is a measure of the value of output produced in an economy.
• However, GDP is not a perfect/complete measure of well-being in society.
§ GDP has several shortcomings:
1. Nonmarket activities are not measured (e.g. the work you do at home like-under est
cleaning).
2. The value of leisure time (e.g. on weekends and holidays) is not measured under est
·
although it increases the utility (satisfaction/happiness) of workers.

3. GDP fails to capture the full value of improvements in product quality (e.g.
GDP assumes an iPhone in 2010 is the same as an iPhone in 2019 if we
-Under est
account for GDP price index – This is because GDP is a quantitative measure
rather than a qualitative measure).
4. GDP fails to capture the underground economy (e.g. illegal drug trade). -under est
25-32
Underground Economy
25-33
Shortcomings of GDP
5. GDP fails to account for the environmental effects of production (e.g.
pollution) although it negatively reduces the well being of society (e.g. health over est
effects, climate change).
6. GDP does not tell us whether the currently produced mix of goods and
services is making society better off or worse off (e.g. producing a gun that is over est
used for crimes has an equal weight to producing a laptop if the they have the
same price).
7. GDP reveals nothing about the way how output is distributed (e.g. does 90
percent of the output go to high income 10 percent of the households or is it
more evenly distributed?).
8. There are noneconomic sources of well-being that could make a society better
off without necessarily raising GDP (e.g. reduction of crime).
25-34
Shortcomings of GDP
5. GDP fails to account for the environmental effects of production (e.g.
pollution) although it negatively reduces the well being of society (e.g. health
effects, climate change).
6. GDP does not tell us whether the currently produced mix of goods and
services is making society better off or worse off (e.g. producing a gun that is
used for crimes has an equal weight to producing a laptop if the they have the
same price).
7. GDP reveals nothing about the way how output is distributed (e.g. does 90
percent of the output go to high income 10 percent of the households or is it
more evenly distributed?).
8. There are noneconomic sources of well-being that could make a society better
off without necessarily raising GDP (e.g. reduction of crime).
25-34

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Chapter 25:

Measuring Domestic Output

Dr. Shamlan Waleed Albahar

I Ø To see whether the economy has grown, been constant, or declined in a

Measuring Aggregate Output

Ø The market value in a country’s currency (e.g. KD or $) = it’s a monetary measure

Ø Public transfer payments (e.g.*Social Security, welfare payments)

Three Approaches to Measure GDP

Product Approach Expenditures Approach Income Approach

Product Approach Expenditures Approach Income Approach

Measuring GDP: Product Approach

Measuring GDP: Product Approach

Sheep Ranch Wool Processor Suit Clothing Retail

Measuring GDP: Product Approach

Sheep Ranch Wool Processor Suit Clothing Retail

• Total Value added in all stages of production=$120+$60+$40+$50+$80= $350

Final product method 25-12

Three Approaches to Measure GDP

Product Approach Expenditures Approach Income Approach

§ Gross private domestic investment (Ig)

Ø The investment spent to replace the existing investment due to depreciation is

Ø Expenditures for goods and services that government consumes in providing

• Adding up all four expenditure components calculates GDP, a measure of the

Three Approaches to Measure GDP

Nominal GDP vs. Real GDP

• It’s an inflation-adjusted measure that reflects changes in the price level.

Dr. Shamlan Albahar ECON 140

Nominal GDP vs. Real GDP

Nominal GDP vs. Real GDP

Price of Market Basket

Nominal GDP = Price of Pizza x Quantities of Pizza sold

Nominal GDP vs. Real GDP

Dr. Shamlan Albahar ECON 140

Nominal GDP vs. Real GDP

although it increases the utility (satisfaction/happiness) of workers.

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