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C hapter 20

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  1. Chapter 20 Gross Domestic Product Accounting

  2. Economic Principles The circular flow of resources, goods, and services The circular flow of money The expenditure approach to measuring GDP Gottheil - Principles of Economics, 4e

  3. Economic Principles The income approach to measuring GDP The relationship between GDP, NDP, and national income The limitations of GDP as a measure of economic well-being Gottheil - Principles of Economics, 4e

  4. Gross Domestic Product Accounting Circular flow of goods, services, and resources • The movement of goods and services from firms to households, and of resources from households to firms. Gottheil - Principles of Economics, 4e

  5. EXHIBIT 1 THE CIRCULAR FLOW OF GOODS, SERVICES, AND RESOURCES Gottheil - Principles of Economics, 4e

  6. Two Approaches to Calculating GDP • Economists calculate GDP in two ways: the expenditure approach to GDP and the income approach to GDP. • Regardless of which method is used, the values should be equivalent. Gottheil - Principles of Economics, 4e

  7. The Expenditure Approach Expenditure approach • A method of calculating GDP that adds all expenditures made for final goods and services by households, firms and government. Gottheil - Principles of Economics, 4e

  8. The Expenditure Approach When using the expenditure approach to GDP, one must be certain that only final goods and services are counted. Otherwise, goods may be double counted. Gottheil - Principles of Economics, 4e

  9. The Expenditure Approach Final goods • Goods purchased for final use, not for resale. • Intermediate goods • Goods used to produce other goods. Gottheil - Principles of Economics, 4e

  10. The Expenditure Approach Value added • The difference between the value of a good that a firm produces and the value of the goods the firm uses to produce it. Gottheil - Principles of Economics, 4e

  11. EXHIBIT 3 MARKET VALUE AND VALUE ADDED OF GOODS PRODUCED Gottheil - Principles of Economics, 4e

  12. The Expenditure Approach There are four expenditure categories of GDP: 1. Personal consumption 2. Gross private domestic investment 3. Government purchases 4. Net exports Gottheil - Principles of Economics, 4e

  13. The Expenditure Approach 1. Personal consumption expenditures (C) • All goods and services bought by households. These expenditures are grouped into categories of durable goods, nondurable goods, and services. Gottheil - Principles of Economics, 4e

  14. The Expenditure Approach 1a. Durable goods • Goods expected to last at least a year. For example, refrigerators, automobiles, and washing machines. Gottheil - Principles of Economics, 4e

  15. The Expenditure Approach 1a. Durable goods • During recessions, consumers tend to hang on to their durable goods, so that sales of new durable goods are relatively weak. During times of prosperity, consumers are more likely to discard old durables, and sales of new durables are strong. Gottheil - Principles of Economics, 4e

  16. The Expenditure Approach 1b. Nondurable goods • Goods expected to last less than a year. For example, food, clothing, gasoline and toiletries. Households spend more on nondurables than on durables. Gottheil - Principles of Economics, 4e

  17. The Expenditure Approach 1c. Services • Productive activities that are instantaneously consumed. For example, medical care, a lecture, and appliance repair. Households spend more on services than durable and nondurable goods combined. Gottheil - Principles of Economics, 4e

  18. The Expenditure Approach 2. Gross private domestic investment (I) • The purchase by firms of plant, equipment, and inventory goods. Gottheil - Principles of Economics, 4e

  19. The Expenditure Approach 2. Gross private domestic investment (I) • Plant (or new structure) and equipment purchases may either replace worn out plants and equipment or increase the quantity of plants and equipment. Gottheil - Principles of Economics, 4e

  20. The Expenditure Approach 2a. Inventory investment • Stocks of finished goods and raw materials that firms keep in reserve to facilitate production and sales. Gottheil - Principles of Economics, 4e

  21. The Expenditure Approach 3. Government purchases (G) • All goods and services bought by government. For example, goods such as national defense materials, interstate highway, and post offices, and services such as justice and education. Gottheil - Principles of Economics, 4e

  22. The Expenditure Approach 4. Net exports (X - M) • An economy’s exports to other economies, minus its imports from other economies. Gottheil - Principles of Economics, 4e

  23. The Expenditure Approach All final goods and services that make up GDP, then, can be expressed in the form: GDP = C + I + G + (X – M). Gottheil - Principles of Economics, 4e

  24. EXHIBIT 4 EXPENDITURE APPROACH TO 2003 GDP ($ BILLIONS) Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003. Gottheil - Principles of Economics, 4e

  25. The Income Approach Income approach • A method of calculating GDP that adds all the incomes earned in the production of final goods and services. Gottheil - Principles of Economics, 4e

  26. The Income Approach National income • The sum of all payments made to resource owners for the use of their resources. Gottheil - Principles of Economics, 4e

  27. The Income Approach Corporate profit represents the return to owners of incorporated firms. Corporate profit is divided into three categories—dividends, corporate reinvestment, and corporate taxes. All three are included in the income approach to GDP. Gottheil - Principles of Economics, 4e

  28. The Income Approach Proprietors’ income is the income earned by unincorporated firms for the goods and services they produce. Proprietors’ income is the net income after paying such expenses as rent, utilities, and supplies. Gottheil - Principles of Economics, 4e

  29. EXHIBIT 5 2003 NATIONAL INCOME ($ BILLIONS) Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003. Gottheil - Principles of Economics, 4e

  30. Bringing GDP and National Income into Accord Gross National Product (GNP) • The market value of all final goods and services in an economy produced by resources owned by people of that economy, regardless of where the resources are located. Gottheil - Principles of Economics, 4e

  31. Bringing GDP and National Income into Accord While GDP measures location, GNP measures ownership. For example, the value of goods produced by a U.S.-owned firm in Spain are not counted in our GDP, but are counted in our GNP. Gottheil - Principles of Economics, 4e

  32. EXHIBIT 7 THE RELATIONSHIP BETWEEN GROSS DOMESTIC PRODUCT, GROSS NATIONAL PRODUCT, NET NATIONAL PRODUCT, AND NATIONAL INCOME: 2003 ($ BILLIONS) Note: Net domestic product = $8,767.7 billion. The use of NNP instead of NDP to derive national incomes conforms to the derivation of national income used by government sources. Note also that because GDP and GNP are almost identical, NDP and NNP are almost identical. Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2003. Gottheil - Principles of Economics, 4e

  33. Relationship Between GDP and GNP • GDP is converted to GNP. This is done by subtracting factor payments to the rest of the world and adding factor payments from the rest of the world. Gottheil - Principles of Economics, 4e

  34. Personal Income and Personal Disposable Income Disposable personal income • Personal income minus direct taxes. Gottheil - Principles of Economics, 4e

  35. How Comprehensive Is GDP? GDP tries to measure everything that appears on the market. Yet, not everything produced in the economy gets onto the market, and some things that contribute to our economic well-being aren’t even produced. Gottheil - Principles of Economics, 4e

  36. How Comprehensive Is GDP? The value of housework is one example of an important service that is usually not included in GDP. The work is only included if it is performed by someone outside the household, such as a housekeeper, nanny, or cook. Gottheil - Principles of Economics, 4e

  37. How Comprehensive Is GDP? Underground economy • The unreported or illegal production of goods and services in the economy that is not counted in GDP. • Illegal unreported activities may include drug trafficking, money laundering, bribery, prostitution, illegal gambling, fraud and burglary. • Tax avoidance is the main reason why legal activities may go unreported. Swapping services or simply understating the value of income earned are two ways to avoid paying taxes. Gottheil - Principles of Economics, 4e

  38. How Comprehensive Is GDP? The costs of environmental damage are another factor not taken into account in GDP. While the expense associated with cleaning up the pollution we create contributes to GDP, the actual pollution created is not subtracted from GDP. Gottheil - Principles of Economics, 4e

  39. How Comprehensive Is GDP? Many economists agree that despite the exclusion of some forms of economic value, our measure of GDP is sufficiently comprehensive to be a reliable indicator of changes in the overall performance of the economy. Gottheil - Principles of Economics, 4e