Chapter 25

Measuring Domestic
Output and National
Income

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Assessing the Economy’s Performance

National Income Accounting measures economy’s

overall performance.

Why need to measure?

1. Assess current health of economy and to compare
with other countries
2. Track long run course and performance of specific
policy or economic approach
3. Formulate effective and appropriate policy
25-2
LO1
 Gross Domestic Product
• Monetary measure of aggregate output (final
goods and services ) produced within the
country’s geographical boundaries in the
calendar year

• Alternatively, measure value-added of each

stage of economic production within …
• Value added is the market value of a firm’s output
less the value of the inputs that the firm purchased
from others.
25-3
LO1
 Market transactions not Included
in GDP
1. Exclude financial transactions
• Public transfer payments
• Private transfer payments
• Transactions on financial assets

2. Exclude second hand sales

25-4
LO1
 AVOID DOUBLE COUNTING
(2)
Sales Value (3)
(1) Of Materials Value
Stage of Production Or Product Added
$ 0
]--------$120 (= $120 - $ 0)
Firm A, sheep ranch 120
]-------- 60 (= 180 - 120)
Firm B, wool producer 180
]-------- 40 (= 220 - 180)
Firm C, coat manufacturer 220
]-------- 50 (= 270- 220)
Firm D, clothing manufacturer 270
]-------- 80 (= 350 – 270)
Firm E, retail clothier 350

Total Sales Value $1140

Value Added (total income) $350 25-5

LO1
 The Circular Flow of INCOME

RESOURCE
MARKET
•Households sell
•Businesses buy

BUSINESSES HOUSEHOLDS
• buy resources • sell resources
• sell products • buy products

PRODUCT
MARKET
•Businesses sell
•Households buy
25-6
LO5
 Two Approaches to GDP
1. Expenditure approach (PRODUCT MARKET)
• Count sum of money spent buying the final
goods and services by different groups

2. Income approach (RESOURCE MARKET)

• Count income derived from production by
different resources

25-7
LO1
 Types of Expenditures

1. Personal consumption expenditures (C)

• Durable goods
• Nondurable goods
• Consumer expenditures for services

25-8
LO2
 Expenditures Approach
2. Gross private domestic investment (Ig)
a) Purchases on Machinery, equipment, and tools
b) All construction
c) Positive and negative changes in inventories
d) Expenditure to create new physical and intellectual
assets for production

Exercise
1.Investment in financial assets?
2.Cost of constructing houses for own occupation?

25-9
LO2
 Expenditures Approach
Gross Investment (e.g. 5 units)
- Depreciation (e.g. 2 units)
= Net Investment (3 units
Net
Investment
Gross
Investment
Depreciation

New stock
Consumption, Of capital?
Stock of government
Capital (20 units) expenditures,
and net exports
January 1 Year’s GDP December 31 25-10
LO2
 Expenditures Approach
3. Government purchases (G)
• government consumption expenditures and gross
investment
• Expenditures for providing or subsidizing public
infrastructure, goods and services
• Are government transfer payments included?
4. Net exports (Xn)
• Add exported goods; Subtract imported goods
• Xn= exports (X) – imports (M)

25-11
LO2
 Accounting Statement for
the U.S. Economy, 2012 (in Billions)

25-12
LO2
 The Income Approach

1. Compensation of employees
2. Rental
3. Interest
4. Proprietor’s income
5. Corporate profits
a) Corporate income taxes
b) Dividends
c) Undistributed corporate profits
6. Taxes on production and imports
25-13
LO3
 Accounting Statement for
the U.S. Economy, 2012 (in Billions)

25-14
LO2
 Additional Adjustments

• Consumption of fixed capital or depreciation

• Net foreign factor income : income own citizens gain from
supplying resources abroad minus income that foreigners
gain from supplying resources to the local economy

• Statistical discrepancy
• Income earned but not received
• Income received but not earned
• Personal income tax

25-15
LO3
 U.S. Income Relationships 2012

25-16
LO4
 Circular Flow Revisited

25-17
LO4
 Nominal GDP vs. Real GDP

• Since GDP is a monetary measure of

production, change in output QUANTITY and
market PRICES can both affect its value.
• To correct for the influence of changing prices.
Nominal GDP
• Use prices in the current year
Real GDP
• Use base year price
25-18
LO5
 GDP Price Index

• Calculating Real GDP (Base Year = Year 1)

(4)
(2) Unadjusted, (5)
(1) Price of (3) or Nominal, Adjusted,
Units of Pizza Price Index GDP or
Year Output Per Unit (Year 1 = 100) (1) X (2) Real, GDP
1 5 $10 100 $ 50 $50

2 7 20 200 140 70
3 8 25 250 200 80
4 10 30 --- --- ---
5 11 28 --- --- ---
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LO5
 Price Index

Price Price of Market Basket

In Current Year
Index
Current = Price of Same Basket
x 100
Year In Base Year

Real Nominal GDP

GDP = X 100
Price Index

25-20
LO5
 What GDP do not account for?
1. Nonmarket activities
2. Leisure deterioration
3. Improvement in product quality
4. Shadow/underground economy
5. Environmental cost
6. Composition and distribution of the output
7. Non-economic sources of well-being

25-21
LO6
 Underground Economy

25-22
LO6
 Sources of NIA Data

• Investment
• All consumption data sources
• Census Bureau’s Housing Starts Survey and
Housing Sales Survey
• Retail Trade Survey
• Wholesale Trade Survey
• Survey of Manufacturing

25-23
 Sources of NIA Data

• Government Purchases
• Office of Personnel Management
• Construction Surveys
• Census Bureau’s Survey of Government
Finance
• Net Exports
• U.S. Customs Service
• BEA Surveys and Analysis
25-24