Principles of Economics Chapter 6

CHAPTER
6
Measuring National Output and National Income
Prepared by: Fernando Quijano and Yvonn Quijano
2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
Gross Domestic Product

C H A P T E R 6: Measuring National Output and National Income
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.
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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.
Principles of Economics, 7/e Karl Case, Ray Fair 3 of 38
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.
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.
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Value Added
Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers)

STAGE OF PRODUCTION (1) Oil drilling (2) Refining (3) Shipping (4) Retail sale Total value added VALUE OF SALES $ .50 .65 .80 1.00 VALUE ADDED $ .50 .15 .15 .20 $ 1.00
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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.
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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 countrys citizens, regardless of where the output is produced, is measured by gross national product (GNP).
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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 incomewages, rents, interest, and profitsreceived by all factors of production in producing final goods.
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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.

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)
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The expenditure approach calculates GDP by adding together the four components of spending. In equation form:
GDP C I G ( EX IM )
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Components of GDP, 1999: The Expenditure Approach

Components of GDP, 2002: The Expenditure Approach
BILLIONS OF DOLLARS PERCENTAGE OF GDP
Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories 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.
7303.7 871.9 2115.0 4316.8 1543.2 1117.4 471.9 3.9 1972.9 693.7 1279.2 423.6 1014.9 1438.5 10446.2
69.9 8.3 20.2 41.3 14.8 10.7 4.5 0 18.9 6.6 12.2 4.1 9.8 13.8 100.0
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Karl Case, Ray Fair
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.
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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.
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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.

Remember that GDP is not the market value of total sales during a periodit is the market value of total production.
The relationship between total production and total sales is:

GDP = final sales + change in business inventories
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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 assets value falls in a given period. Net investment equals gross investment minus depreciation. capitalend of period = capitalbeginning of period + net investment
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Government Consumption and Gross Investment

Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.
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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).
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The Income Approach

National income is the total income earned by the factors of production owned by a countrys 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
The Income Approach

Components of GDP, 2002: The Income Approach

BILLIONS OF DOLLARS PERCENTAGE OF GDP
National income
Compensation of employees Proprietors income
8,199.9
6,010.0 943.5
80.3
58.9 7.3
Corporate profits
Net interest Rental income
748.9
554.8 142.7
7.3
5.4 1.4
Depreciation Indirect taxes minus subsidies Net factor payments to the rest of the world Other Gross domestic product
Source: See Table 18.2.
1,351.3 739.4 11.1 96.1 10,205.6
13.2 7.2 0.1 0.9 100.0

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Karl Case, Ray Fair
From GDP to Disposable Personal Income

GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2002 DOLLARS (BILLIONS) 10,205.6 + 342.1 353.2 10,194.5 1,351.3 8,843.2 643.3 8,199.9 332.6 731.2 + 439.1 +1,148.7 8,723.9 1,306.2 7,417.7
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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: Less: Plus: Plus: corporate profits minus dividends social insurance payments personal interest income received from the government and consumers transfer payments to persons
Equals: personal income

Less: personal taxes
Equals: disposable personal income

Karl Case, Ray Fair
From GDP to Disposable Personal Income

Net national product equals gross national product minus depreciation; a nations 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.
Disposable Personal Income and Personal Saving

Disposable Personal Income and Personal Saving, 2002
DOLLARS (BILLIONS)
Disposable personal income Less: 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:
7,417.7 7063.5 204.3 31.3 118.6 1.6%
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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.
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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.
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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.
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Calculating Real GDP

A Three-Good Economy
(1) (2) (3) (4) (5) GDP IN YEAR 1 IN YEAR 1 PRICES P 1 x Q1 $3.00 2.10 7.00 $12.10 Nominal GDP in year 1 (6) GDP IN YEAR 2 IN YEAR 1 PRICES P 1 x Q2 $5.50 1.20 8.40 $15.10 (7) GDP IN YEAR 1 IN YEAR 2 PRICES P 2 x Q1 $2.40 7.00 9.00 $18.40 (8) GDP IN YEAR 2 IN YEAR 2 PRICES P 2 X Q2 $4.40 4.00 10.80 $19.20 Nominal GDP in year 2
PRODUCTION YEAR 1 YEAR 2 Q1 Q2 Good A Good B Good C Total 6 7 10 11 4 12
PRICE PER UNIT YEAR 1 YEAR 2 P1 P2 $.50 .30 .70 $ .40 1.00 .90
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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.
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.
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.
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.
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.
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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.
Gross National Income per Capita

Per Capita Gross National Income for Selected Countries, 2002

COUNTRY Switzerland Japan Norway United States Denmark Ireland Sweden United Kingdom Netherlands Austria Finland Germany Belgium France Canada Australia Italy Spain Greece U.S. DOLLARS 36,970 35,990 35,530 34,870 31,090 28,880 25,400 24,230 24,040 23,940 23,840 23,700 23,340 22,640 21,340 18,770 18,470 14,860 11,780 COUNTRY Portugal South Korea Argentina Mexico Czech Republic Brazil South Africa Turkey Colombia Jordan Romania Philippines China Indonesia India Pakistan Nepal Rwanda Ethiopia U.S. DOLLARS 10,670 9,400 6,860 5,540 5,270 3,060 2,900 2,540 1,910 1,750 1,710 1,050 890 680 460 420 250 220 100
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Source: The World Bank Atlas, 2002.
Review Terms and Concepts

base year change in business inventories compensation of employees corporate profits current dollars depreciation disposable personal income, or after-tax income durable goods
government consumption and gross investment (G) gross domestic product (GDP) gross investment gross national income (GNI)
gross national product (GNP)

gross private domestic investment (I) income approach indirect taxes
expenditure approach
final goods and services fixed-weight procedure
intermediate goods
national income national income and product accounts
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Review Terms and Concepts

net exports (EX IM) net factor payments to the rest of the world net interest net investment
personal saving personal saving rate proprietors income rental income residential investment services subsidies underground economy value added weight
net national product (NNP)

nominal GDP nondurable goods nonresidential investment
personal consumption expenditures (C)

personal income
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Principles of Economics Chapter 6

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CHAPTER

Prepared by: Fernando Quijano and Yvonn Quijano

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

Gross Domestic Product

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 6: Measuring National Output and National Income

National Income and Product Accounts

2004 Prentice Hall Business Publishing

Final Goods and Services

2004 Prentice Hall Business Publishing

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers)

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 6: Measuring National Output and National Income

Exclusions of Used Goods and Paper Transactions

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 6: Measuring National Output and National Income

Exclusion of Output Produced Abroad by Domestically Owned Factors of Production

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

GDP can be computed in two ways:

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

The Expenditure Approach

Personal consumption expenditures (C)household spending on consumer goods.

2004 Prentice Hall Business Publishing

The Expenditure Approach

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

The Expenditure Approach

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 6: Measuring National Output and National Income

Components of GDP, 1999: The Expenditure Approach

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

Personal Consumption Expenditures

Personal consumption expenditures (C) are expenditures by consumers on the following:

long time, such as cars and appliances.

fairly quickly, such as food and clothing.

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

Gross Private Domestic Investment

Investment refers to the purchase of new capital.

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair