economics

McConnell
Brue
Flynn

Chapter 27
Measuring Domestic Output and
National Income

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 Chapter Contents
Assessing the Economy’s Performance
The Expenditures Approach
The Income Approach
Other National Accounts
Nominal GDP versus Real GDP
Shortcomings of GDP

27-2

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 Assessing the Economy’s Performance
National income accounting measures economy’s
overall performance.
Bureau of Economic Analysis compiles National
Income and Product Accounts:
• Assess health of economy
• Track long-run course
• Adjust economic policy
27-3
LO27.1
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 Gross Domestic Product
Gross domestic product (GDP): Measure of aggregate
output.
Avoid multiple counting
• Market value final goods and services
• Ignore intermediate goods and services
• Count value added
Domestic output only
27-4
LO27.1
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 Comparing Heterogeneous Output by Using
Money Prices

Year Annual Output Market Value

1 3 sofas and 2 computers 3 at $500 + 2 at $2,000 = $5,500
2 2 sofas and 3 computers 2 at $500 + 3 at $2,000 = $7,000

27-5
LO27.1
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 Value Added in a Five-Stage Production Process
(2)
Sales Value
(1) of Materials (3)
Stage of Production or Product Value Added
$ 0
Firm A, sheep ranch 120 $120 (= $120 − $ 0)

60 (= 180 − 120)
Firm B, wool processor 180
40 (= 220 − 180)
Firm C, coat manufacturer 220
50 (= 270 − 220)
Firm D, clothing wholesaler 270
Firm E, retail clothier 350 80 (= 350 − 270)

Total sales values $1,140

Value added (total income) $350

27-6
LO27.1
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 Gross Domestic Product: Transactions
Exclude financial transactions:
• Public transfer payments
• Private transfer payments
• Financial asset transactions
Exclude secondhand sales: Example: sell used car to a
friend.
27-7
LO27.1
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 Two Ways of Looking at GDP
Expenditures approach
• Count sum of money spent buying the final goods
• Who buys the goods?
Income approach
• Count income derived from production
• Wages, rental income, interest income, profit

27-8
LO27.1
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 The Expenditures and Income Approaches to GDP
Compared

27-9
LO27.1
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 Accounting Statement for the U.S. Economy Using the
Expenditures (Receipts) Approach, 2021
Billions
Sum of:
Personal consumption expenditures (C) $15,742
Gross private domestic investments (Ig) 4,120
Government purchases (G) 4,053
Net exports (Xn) -918
Equals:
Gross domestic product $22,996

27-10
LO27.1
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 Accounting Statement for the U.S. Economy, Using the
Income (Allocations) Approach, 2021 (in Billions)*
Billions
Sum of:
Compensation of employees $12,581
Rents 726
Interest 686
Proprietors’ income 1,822
Corporate profits 2,806
Taxes on production and imports 1,299
Equals:
National income $19,920
Less: Net foreign factor income 252
Plus: Consumption of fixed capital 3,848 *Some of the items in this table
Plus: Statistical discrepancy -520 combine related categories that
Equals: appear in the more detailed
accounts. All data are subject to
Gross domestic product $22,996
government revision.

27-11
LO27.1
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 Expenditures Approach (1 of 3)
Personal consumption expenditures (C)
• Durable goods
• Nondurable goods
• Consumer expenditures for services

27-12
LO27.2
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 Expenditures Approach (2 of 3)

Gross private domestic investment (Ig) includes:

• Machinery, equipment, and tools
• Residential construction.
• Research and development.
• Creation of new works of art, music, etc.
• Changes in inventories.
Creation of new capital assets.
Financial investment transactions excluded. 27-13
LO27.2
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 Expenditures Approach: Investment
Gross investment, depreciation, net investment, and the stock of
capital

27-14
LO27.2
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 Expenditures Approach (3 of 3)
Government purchases (G)
• Expenditures for goods and services
• Expenditures for publicly owned capital
• Expenditures on R&D
• Excludes transfer payments
Net exports (Xn)
• Add exported goods
• Subtract imported goods
• Xn= exports (X) - imports (M)
GDP = C + Ig + G + Xn 27-15
LO27.2
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 Global Perspective 27.1
COMPARATIVE GDPs IN TRILLIONS OF U.S. DOLLARS, SELECTED NATIONS, 2020

27-16
LO27.2
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 The Income Approach (1 of 2)
Compensation of employees
Rents
Interest
Proprietor’s income
Corporate profits
• Corporate income taxes
• Dividends
• Undistributed corporate profits
LO27.3Taxes on production and imports
27-17

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 The Income Approach (2 of 2)
From national income to GDP:
• Net foreign factor income
• Consumption of fixed capital
• Statistical discrepancy

27-18
LO27.3
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 Other National Accounts
• Net domestic product (NDP)
• National income (NI)
• Personal income (PI)
• Disposable income (DI)

27-19
LO27.4
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 U.S. Income Relationships, 2021
Billions
Gross domestic product (GDP) $22.996
Less: Consumption of fixed capital 3,848
Equals: Net domestic product $19,148

Net domestic product (NDP) $19,148

Less: Statistical discrepancy −520
Plus: Net foreign factor income 252
Equals: National income (NI) $19,920

National income (NI) $19,920

Less: Taxes on production and imports 1,148
Less: Corporate income taxes 381
Less: Social Security contributions 1,591
Less: Undistributed corporate profits 1,006
Plus: Transfer payments 5,284
Equals: Personal income (PI) $21,077
*
Personal income (PI) $21,077
Less: Personal taxes 2,583
Equals: Disposable income (DI) $18,495

*Some of the items combine categories that appear in the more detailed accounts. 27-20
LO27.4
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 U.S. Domestic Output and the Flows of Expenditure
and Income

27-21
LO27.4
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 Nominal GDP vs. Real GDP
GDP is a dollar measure of production.
Using dollar values creates problems.
Nominal GDP: Based on prices that prevailed when
output was produced.
Real GDP:
• Reflects changes in the price level.
• Uses base year price.
27-22
LO27.5
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 GDP Price Index
Use price index to determine real GDP.

Price Price of market basket

in specific year
index
in given
= Price of same basket × 100
year in base year

Real Nominal GDP

GDP =
Price index (in hundredths)

27-23
LO27.5
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 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 Real,
Year Output per Unit (Year 1 = 100) (1) × (2) 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 --- --- ---

27-24
LO27.5
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 Steps for Deriving Real GDP from Nominal GDP
Method 1
1. Find nominal GDP for each year.
2. Compute a GDP price index.
3. Divide each year’s nominal GDP by that year’s price index (in hundredths) to
determine real GDP.
Method 2
1. Break down nominal GDP into physical quantities of output and prices for each year.
2. Find real GDP for each year by determining the dollar amount that each year’s
physical output would have sold for if base-year prices had prevailed. (The GDP price
index can then be found by dividing nominal GDP by real GDP.)

LO27.5 27-25

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 Real World Considerations
Nominal GDP, Real GDP, and GDP Price Index for the United States, Selected Years

(1) Year (2) Nominal GDP, (3) Real GDP, (4) GDP Price Index
Billions Billions (2012 = 100)
2000 10,251.0 13,138.0 –––––
2005 13,039.2 ––––– 87.5
2010 15.049.0 15,649.0 96.2
2012 16,254.0 ––––– 100.0
2015 18,206.0 17,390.3 104.7
2020 20,893.7 18,384.7 113.6

27-26

LO27.5 Source: U.S. Bureau of Economic Analysis.

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 Shortcomings of GDP
Nonmarket activities
Leisure and psychic income
Improved product quality
The underground economy
GDP and the environment
Composition and distribution of output
Noneconomic
LO27.6
sources of well-being 27-27

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 Global Perspective 27.2
THE UNDERGROUND ECONOMY AS A PERCENTAGE OF
GDP, SELECTED NATIONS

27-28

Source: Leandro Medina and Friedrich Schneider. Shadow

LO27.6 Economies Around the World: What Did We Learn Over the Last
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 Gross Output
Sum of:
• Production
• Distribution
• Final output (GDP)
Larger than GDP.
Better reflection of productive side of economy.
27-29
LO27.6
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 Last Word: Measuring Quality to Price the
Priceless
GDP more difficult to measure in digital age.
How do you:
• Account for quality improvements?
• Internet products that are free of charge?
Hedonic adjustment.
Dollar value on time. 27-30

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