Measuring Domestic Output and National Income

1. 6 Measuring Domestic Output and National Income

2. Chapter Objectives • How GDP is Defined and Measured • Relationships Between GDP, Net Domestic Product, National Income, Personal Income, and Disposable Income • The Nature and Function of a GDP Price Index • The Difference Between Nominal GDP and Real GDP • Some Limitations of the GDP Measure

3. Assessing Economy’s Performance • National Income Accounting • Bureau of Economic Analysis • Gross Domestic Product (GDP) • A Monetary Measure • Avoid Multiple Counting • Intermediate Goods • Final Goods • Value Added • Exclude Nonproduction Transactions

4. Assessing Economic Performance • National income accounting – measure’s overall econ. Performance • Bureau of Economic Analysis compiles the NIPA accounts for economy • Allows for: • Assessment of economic health • Tracking long-run health • Policy-making decisions

5. Gross Domestic Product • Total market value of all final g/s produced in a country in a given year • By either citizen-supplied or foreign supplied sources • Does not include production by U.S. companies overseas • GDP is a monetary measure

6. Avoiding Multiple Counting • INCLUDES final goods, EXCLUDES intermediate goods • Intermediate goods – purchased for resale or further processing • Final goods – purchased for final use by consumer • Prevents multiple counting, which would distort GDP

7. Assessing Economy’s Performance • Financial Transactions Excluded • Public Transfer Payments • Private Transfer Payments • Stock (and Bond) Market Transactions • Second Hand Sales

8. GDP Excludes Nonproduction Transactions • Two types of nonproduction transactions: financial transactions and secondhand sales • Financial Transactions include: • Public transfer payments – gov uses tax dollars to provide g/s to recipients who provide nothing in return • Ex. Welfare, SS, Medicare/Medicaid, etc…

9. Types of Financial Transactions Continued • Private transfer payments – Ex. Parent gives kid $$, xmas gifts • Stock market transactions excluded as well

10. Secondhand Sales • Old or resold items excluded

11. Two Approaches to GDP • Income Approach • Wages • Rental Incomes • Interest Incomes • Profits • Expenditure Approach • Final-Product or Value-Added • The Sum of the Money Spent to Buy the Output

12. Two Approaches to GDP Expenditure Approach Income Approach Consumption by Households Wages + + Rents Investment by Businesses + G D P + = = Interest + Government Purchases + Profits + Expenditures By Foreigners Statistical Adjustments

13. Two Ways of Looking at GDP • 1. expenditures approach (output approach)-views GDP as sum of $$ spent in buying it • 2. income approach (earnings or allocation approach) – views GDP in terms of the income derived or created from producing it

14. Expenditures Approach • Add up all spending on final g/s that has taken place throughout the year • C+IG+G+XN • See Figure 6.1 • Sums personal consumption expenditures, gross private domestic investment, government purchases, and net exports

15. Expenditure Approach C Personal Consumption Expenditures • Durable Consumer Goods (Ex. Cars, computers, IPODS) • Nondurable Consumer Goods (Ex. Bread, veggies, milk, pencils) • Consumer Expenditures for Services (lawyer, accountant, doctor, barber, restaurant) • Accountants used symbol C to represent this Ig

16. Gross Private Domestic Investment Gross Private Domestic Investment • Final purchases of Machinery, Equipment, and Tools by businesses • All Construction (factories, warehouse, stores) • Changes in Inventories (unsold goods) – these can inc/dec over time

17. Noninvestment Transactions • Investment does NOT include paper assets (stocks, bonds) or resale of tangible items such as cars, houses, boats, etc. • Investment has to do with creation of new capital assets that create jobs and income

18. Gross Investment vs. Net Investment • Gross Private Domestic Investment • “gross” refers to all investment goods, including those that replace machines, equipment, buildings used up and added capital (investment in replacement capital and added capital)

19. Net Private Domestic Investment • Net private domestic investment – includes only investment in form of added capital • Depreciation – amount of capital used up over a year • Net investment = gross investment – depreciation • GROSS investment is used in determining GDP

20. Expenditure Approach Gross Investment - Depreciation = Net Investment Net Investment Gross Investment Depreciation Increased Consumption & Government Spending Stock of Capital Stock of Capital January 1 Year’s GDP December 31

21. Expenditure Approach G Government Purchases • Expenditures for Goods and Services • Expenditures for Social Capital (Ex. Schools, highways) • Fed, state, local include all gov expenditures on resource purchase, including labor • EXCLUDES transfer payments

22. Net Exports: Xn Net Exports: exports less imports Xn = Exports (X) – Imports (M) Putting It All Together: GDP = C + I + G + Xn GDP= $8,746 + 2,105 + 2,363 - 727 = $12,487 in 2005

23. $ 8746 2105 2363 -727 $ 12,487 GDP Approaches Compared Accounting Statement for the U.S. Economy, 2005 in Billions Receipts Expenditures Approach Allocations Income Approach Personal Consumption (C) Gross Private Domestic Investment (Ig) Government Purchases (G) Net Exports (Xn) Gross Domestic Product Compensation Rents Interest Proprietor’s Income Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income Statistical Discrepancy Consumption of Fixed Capital Gross Domestic Product $ 7125 73 498 939 1352 917 $10,904 -34 43 1574 $ 12,487

24. GLOBAL PERSPECTIVE Comparative GDPs Select Nations GDPs - 2005 GDP in Trillions of Dollars 0 1 2 3 4 5 6 7 8 9 10 12 United States Japan Germany China United Kingdom France Italy Spain Canada Brazil Korea, Rep. India Mexico Russian Fed. Australia $12.4 $4.5 $2.8 $2.2 $2.2 $2.1 $1.7 $1.1 $1.1 $.79 $.79 $.78 $.77 $.76 $.70 Source: World Bank

25. The Income Approach • Compensation of Employees • Rents • Interest • Proprietor’s Income • Corporate Profits • Corporate Income Taxes • Dividends • Undistributed Corporate Profits • Taxes on Production and Imports

26. The Income Approach • Compensation of Employees – largest share of nat’l income: wages and salaries paid by businesses and gov. to employees • Also includes wage and salary supplements (pension, insurance, etc…)

27. Rents • Income received by households and businesses that supply property resources • Ex. Payments received by landlords, lease payment company pays for office space • Figure used is net rents: gross rental income – depreciation of rental property

28. Interest • Interest – money paid by private businesses to suppliers of money capital • Includes the interest households receive on bonds, CDs, etc…

29. Proprietors’ Income and Corporate Profits • Proprietors’ income – net income of sole proprietorship, partnership, and other unincorporated businesses • Corporate profits – earnings of owners of corporations • 3 categories: • Corporate income taxes – tax levied on corp earnings • Dividends – part of profits paid to shareholder • Undistributed corporate profits(retained earnings)

30. Taxes on Production and Imports • Includes sales tax, excise taxes, business property taxes, license fees, customs duties

31. W 6.1 The Income Approach • From National Income to GDP • National income – all income that flows to American-supplied resources, plus taxes on production and imports • Net Foreign Factor Income – NI includes income of Americans worldwide, GDP only measures domestic output; must subtract NNFI from NI to determine domestic output • Statistical Discrepancy – b.w the two approaches • Consumption of Fixed Capital – allowance for depreciation

32. Other National Accounts • Net Domestic Product = GDP – consumption of fixed capital (depreciation) (Simply GDP adjusted for depreciation National Income - how much Americans earned for their resource contributions =NDP - statistical discrepancy + net foreign factor income

33. Other National Accounts • Personal Income – all income received whether earned or unearned; includes transfer payments; See page 114 • Disposable Income – personal income less personal taxes; amount of income households have left over after paying personal taxes; free to divide b/w saving and consumption

34. $ 12,487 -1,574 $ 10,913 -43 34 $ 10,904 -917 -871 -378 -460 +1,970 $ 10,248 -1,210 $ 9,038 The Income Approach Income Relationships – United States, 2005 Gross Domestic Product (GDP) Consumption of Fixed Capital Net Domestic Profit (NDP) Statistical Discrepancy Net Foreign Factor Income National Income (NI) Taxes on Production and Imports Social Security Contributions Corporate Income Taxes Undistributed Corporate Profits Transfer Payments Personal Income (PI) Personal Taxes Disposable Income (DI)

35. Circular Flow Revisited U.S. Domestic Output and the Flows of Expenditure and Income

36. Nominal vs. Real GDP • Nominal GDP – based on prices prevailing in year output was produced; unadjusted GDP • Real GDP – GDP that has been deflated or inflated to reflect changes in price level; adjusted GDP

37. Adjustment Process • Price index – measure of the price of a specified collection of g/s in a specific year (“market basket”) as compared to same/similar collection of g/s in reference year • Formula on next slide

38. O 6.1 Price of Market Basket In Specific Year Price Index In Given Year = x 100 Price of Same Basket In Base Year Nominal GDP Real GDP = Price Index (in hundredths) W 6.2 Nominal Versus Real GDP • Nominal GDP • Real GDP • Price Index • GDP Price Index

39. Shortcomings of GDP • Nonmarket Activities • Leisure • Improved Product Quality • The Underground Economy • GDP and the Environment • Composition and Distribution of the Output • Noneconomic Sources of Well-Being

40. Shortcomings of GDP • Nonmarket activity – homemaker, home repair, understates output • Leisure – GDP does not account for increase in leisure time • Improved product quality – GDP is not qualitative, does not account for this

41. Shortcomings of GDP • Underground economy- drugs, prostitution, cash-only jobs excluded • Environment – GDP does not account for environmental damage • Composition and distribution of output are not revealed from GDP data • Does not measure noneconomic sources of well-being

42. GLOBAL PERSPECTIVE Shortcomings of GDP Underground Economy as a Percentage of GDP - Select Nations Percentage of GDP 0 5 10 15 20 25 30 Greece Italy Spain Portugal Belgium Sweden Germany France Holland United Kingdom Japan United States Switzerland Source: Journal of Economic Literature

43. Magical Mystery Tour Last Word BEA Sources of Data for Analysis • Consumption • Census Bureau’s Retail Trade Survey • Census Bureau’s Survey of Manufacturers • Census Bureau’s Service Survey • Investment • All Consumption Data Sources • Survey of Manufacturers • Service Survey • Industry Sources • Census Bureau’s Housing Starts Survey and Housing Sales Survey • Retail Trade Survey • Wholesale Trade Survey • Survey of Manufacturing

44. Magical Mystery Tour Last Word • 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

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