Measuring Domestic Output & National Income

1. Measuring Domestic Output & National Income Chapter 6

2. In this chapter, you will learn: How gross domestic product (GDP) is defined and measured. The relationships among GDP, net domestic product, national income, personal income, and disposable income The nature & function of a GDP price index The difference between nominal GDP & real GDP Some limitations of the GDP measure

3. National Income Accounting (7.1) • Measures the economy’s overall performance • Enables economists & policymakers to • Assess the health of the economy by comparing levels of production at regular intervals • Track the long-run course of the economy to see whether it has grown, been constant, or declined • Formulate policies that will safeguard & improve the economy’s health

4. Gross Domestic Product • Total market value of all final goods & services produced within a country’s borders in a given year • Primary measure of the economy’s performance • Ex. Value of cars produced at a Toyota factory in Ohio count as U.S. GDP but not McDonald’s cheeseburgers produced in Canada.

5. Avoid multiple counting • To measure aggregate output accurately, all goods & services produced in a particular year must be counted one time only • To avoid multiple counting, GDP includes only final goods & ignores intermediate goods • Intermediate • Goods & services purchased for resale or further processing • Final • Consumption & capital goods that are purchased by their final users.

6. GDP Excludes nonproduction transactions • Must be excluded because they have nothing to do with the generation of final goods • Public transfer payments • Social security payments, welfare, veterans’ payments are excluded because they don’t contribute current production • Private transfer payments • Ex. Cash gifts • Stock market transactions • Swapping stock for money doesn’t create new production either

7. Secondhand sales (used goods) Contribute nothing to current production and are excluded from GDP

8. Two ways of looking at GDP • How is the market value measured? • How much did the final user pay for it? • Another way to measure market value: • Add up wage, rental, interest, & profit incomes that were created in producing the product

9. The Expenditures Approach • Add up all spending on final goods & services that has taken place throughout the year • Personal consumption (C) • Gross Private Domestic Investment (I) • Positive & Negative Changes in Inventories • Noninvestment Transactions • Net private domestic investment = gross investment-depreciation

10. Expenditures (cont) • Government Purchases (G) • Expenditures for goods and services that government consumes in providing public services • Expenditures for publicly owned capital such as schools and highways • Does not include government transfer payments (ex. Social security) • Net Exports (x) • Exports - Imports

11. Putting it all together Taken together, the four categories of expenditures provide a measure of the market value of a given year’s total output – its GDP GDP = C + I + G + (X-M)

12. Income • Items that make up national income • Compensation of employees • Wages & salaries paid by business and government to their employees • Rent • Income received by households & businesses that supply property resources • Include monthly payments tenants make to landlords & lease payments corporations pay for the use of office space • Interest • Money paid by private businesses to the suppliers of loans used to purchase capital • Interest households receive on savings, CD’s, & corporate bonds

13. Income Approach (cont.) • Proprietor’s income • Net income of sole proprietorships & partnerships • Corporate profits • Earnings of corporations • Corporate income taxes • Dividends • Undistributed corporate profits

14. Income Approach (cont.) • Taxes on production & imports • Includes the following: • General sales taxes • Excise taxes • Business property taxes • License fees • Customs duties

15. From National Income to GDP National income is the total of all sources of private income plus government revenue All income that flows to American-supplied resources, whether here or abroad

16. Net Foreign Factor Income When moving from national income to GDP, we must consider the income Americans gain from supplying resources abroad Income foreigners gain by supplying resources in the U.S. Difference is net foreign factor income

17. Consumption of fixed capital Huge depreciation charge made against private & publicly owned capital each year Allowance for capital that has been “consumed” in producing this year’s GDP Portion of GDP that is set aside to pay for the ultimate replacement of those capital goods

18. Other National Accounts (7.2) • Net domestic product (NDP) NDP=GDP-consumption of fixed capital (depreciation) • National income (NI) • Includes all income earned through the use of American-owned resources, (home or abroad) • Also includes taxes on production of imports • Personal income (PI)- includes all income received (earned or unearned) • Disposable income (DI)-personal income less personal taxes

19. Nominal GDP vs. Real GDP (7.3) • START HERE • Nominal • GDP based on prices that prevailed when output was produced • Real • GDP that has been deflated or inflated to reflect changes in the price level • These adjustments give us a measure of GDP for various years as if the value of the dollar had always been the same as it was in a reference year

20. GDP Price Index • Price index • Measure of the price of a specified collection of goods & services (market basket) in a given year • This # will be compared to the price of an identical collection of goods & services in a reference year (base year)

21. Calculating Real GDP (Base year=year 1) (Table 7.5)

22. Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • Underground economy • GDP & environment