Measuring National Output and National Income

1. Measuring National Output and National Income

2. Gross Domestic Product (GDP) • Is the most important concept in macroeconomics, because it measure the total value of goods and services produced in the country. • GDP is part of the national income and product accounts or national account. • GDP is useful in determining whether the economy is expanding or contracting. GDP give an overall picture of the state of the economy.

3. Gross Domestic Product • What is the GDP? • (GDP) is the total market value of all final goods and services produced within a nation during a given year, by factors of production located within a country. • Therefore GDP is very important in measuring the overall performance of the economy.

4. National Incomeand Product Accounts • National income and product accountsare 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.

5. Tow measures of national product How do economist measure GDP? GDP can be measured in two entirely independent ways. • The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. • National accountants use market prices as weights in valuing different commodities because market prices reflect the relative economic of diverse goods and services.

6. 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.

7. The Expenditure Approach • Government consumption and gross investment (G) Expenditure categories: Net exports (EX – IM)—net spending by the rest of the world, or exports (EX) minus imports (IM)

8. The Expenditure Approach • The expenditure approach calculates GDP by adding together the four components of spending. In equation form:

9. Components of GDP, 1999:The Expenditure Approach

10. 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.

11. 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.

12. Gross Private Domestic Investment • 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. • Remember that GDP is not the market value of total sales during a period—it is the market value of total production.

13. Gross Investmentversus 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 asset’s value falls in a given period. • Net investment equals gross investment minus depreciation. capitalend of period = capitalbeginning of period + net investment

14. Government Consumptionand Gross Investment • Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

15. 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).

16. The Income or cost Approach • The income approach: • A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods. • National income is the total income earned by factors of production owned by a country's citizens. GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other

17. Who Gets the Income? • The income that flows to the private sector is the national income which is the net national product less indirect taxes. • To measure national income, economists must make three adjustments to gross domestic product (GDP).

18. Who Gets the Income? • The three adjustments to GDP are as follows: • Add the net income earned by U.S. firms and residents abroad; subtract income earned in the U.S. by foreign firms to arrive at gross national product (GNP). • Subtract depreciation from GNP to arrive at net national product (NNP). • Subtract indirect taxes, which are sales taxes on products to arrive at national income (NI).

19. The Income Approach

20. Final Goods and Services • A final product is one that is sold for consumption purposes or is an investment good. The point here is that the product is not changed or modified and sold again to someone else. The product has reached its final stage and is now being used either as a consumption good or a piece of capital equipment.

21. Intermediate goods • Intermediate goods are goods produced by one firm for use in further processing by another firm. • Intermediate goods are not added separately in order to avoid double counting. Double counting can also be avoided by adding up national income using the value added approach.

22. Value Added • Value added : • Value added is the difference between a firm’s total revenue and what it pays other firms for intermediate goods. • Value added includes wages and salaries, rent, interest, and profits. • 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.

23. Value Added

24. Exclusions of Used Goodsand Paper Transactions • Old output is not counted in current GDP because it was already counted back at the time it was produced. It would be double counting to count sales of used goods in current GDP.

25. Paper Transactions • Sales of stocks and bonds are not counted in GDP. These sales are exchanges of paper assets and do not correspond to current production. However, what if I sell the stock or bond for more than I originally paid for it? • Profits from the stock or bond market have nothing to do with current production, so they are not counted in GDP. What about stock market dealers?

26. Exclusion of Output Produced Abroadby Domestically Owned Factors of Production • GDP is the value of output produced by factors of production located within a country. Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP). • GNP =GDP + Net Factor Income From Abroad

27. From GDP to Disposable Personal Income • Net national product equals gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock. • NNP = GNP - Depreciation • Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.

28. From GDP to Disposable Personal Income

29. Disposable Personal Income and Personal Saving • .disposable personal income is the amount of income that households can spend or save. • The personal saving rate is the percentage of disposable personal income that is saved, this is an important indicator of household behaviour. • If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending carefully.

30. Disposable PersonalIncome and Personal Saving

31. Real versus Nominal GDP • Because prices change over time, as inflation generally sends prices upward year after year. Economists have to solve the problem of changes prices by using a reliable measure. • We can measure GDP for a particular year using the actual market prices of that year, this gives us the Nominal GDP, or GDP at Current prices. • but we are usually more interested in determining what has happened to the Real GDP.

32. Real GDP is calculated by tracking the volume or quantity of production after removing the rate of inflation. • Hence, Nominal GDP is calculated using changing prices, while Real GDP represent the change in the volume of total output after price changes are removed.

33. When we evaluate the nation’s current output at current market prices, we measure nominal GDP. This is equivalent to multiplying output by price, for all units of every commodity that is produced, and then adding all these numbers up. • So, nominal GDP is a huge sum of prices times quantities. Therefore, if nominal GDP changes from one year to the next it could be due to a change in P, or Q, or both. • Since we are very interested in the growth of the economy over time, we need to know which component of GDP is (are) changing.

34. Suppose, for example, that prices increase from one year to the next, and output decreases .In fact, this economy has a couple of new problems. Prices are higher, so there is an increase in inflation. Output is lower, so there is probably an increase in unemployment, too. • When both inflation and unemployment increase together, economists refer to this situation as stagflation. (The economy slows down or stagnates at the same time that prices increase.)

35. Calculating Real GDP • In order to accurately assess the real growth of the economy over time, we need to measure output with a constant set of prices. One year is chosen as the base year and then every year’s output is evaluated in terms of the prices in the base year. • 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.

36. Calculating Real GDP

37. Calculating the CPI,GDP Deflator and PPI • The most widely used measure of inflation is the consumer price index ( CPI). • CPI is a measure of the average change over time in the prices paid by consumes for a market basket of consumer goods and services. • If we divide nominal GDP by real GDP (and multiply by 100), we get the overall price index which we call the GDP Deflator. • PPI measures the level of prices at the wholesale or producer stage.

38. The Problems of Fixed Weights • Structural changes in the economy. • Supply shifts, which cause large decreases in price and large increases in quantity supplied. • The substitution effect of price increases. The use of fixed price weights to estimate real GDP leads to problems because it ignores:

39. 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. • Tax evasion is usually thought to be the major incentive for people to participate in the underground economy

40. 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.

41. Gross National Income per Capita

42. 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 expenditure approach final goods and services fixed-weight procedure 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 intermediate goods national income national income and product accounts

43. Review Terms and Concepts net exports (EX – IM) net factor payments to the rest of the world net interest net investment net national product (NNP) nominal GDP nondurable goods nonresidential investment personal consumption expenditures (C) personal income personal saving personal saving rate proprietors’ income rental income residential investment services subsidies underground economy value added weight