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Chapter 19 Measuring National Output and National Income Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Measuring National Output and National Income 19 Chapter Outline Gross Domestic Product Final Goods and Services Exclusion of Used Goods and Paper Transactions Exclusion of Output Produced Abroad by Domestically Owned Factors of Production Calculating GDP The Expenditure Approach The Income Approach Nominal versus Real GDP Calculating Real GDP Calculating the GDP Deflator The Problems of Fixed Weights Limitations of the GDP Concept GDP and Social Welfare The Underground Economy Gross National Income Per Capita Looking Ahead P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 36 MEASURING NATIONAL OUTPUT AND NATIONAL INCOME national income and product accounts Data collected and published by the government describing the various components of national income and output in the economy. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 36 GROSS DOMESTIC PRODUCT gross domestic product (GDP) The total market value of all final goods and services produced within a given period by factors of production located within a country. P A HC e m c nI l a no t a N dna o i GDP is the total market value of a country’s output. It is the market value of all final goods and services produced within a given period of time by factors of production located within a country. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 36 GROSS DOMESTIC PRODUCT FINAL GOODS AND SERVICES final goods and services Goods and services produced for final use. intermediate goods Goods that are produced by one firm for use in further processing by another firm. value added The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 36 GROSS DOMESTIC PRODUCT P A HC e m c nI l a no t a N dna o i Tires taken from that pile and mounted on the wheels of the new car before it is sold are considered intermediate goods to the auto producer. Tires from that pile to replace tires on your old car are considered final goods. If, in calculating GDP, we included the value of the tires (an intermediate good) on new cars and the value of new cars (including the tires), we would be double counting. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 36 GROSS DOMESTIC PRODUCT TABLE 6.1 Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED (1)Oil drilling (2)Refining (3)Shipping $ 1.00 1.30 1.60 2.00 $1.00 0.30 0.30 0.40 $2.00 P A HC e m c nI l a no t a N dna o i (4)Retail sale Total value added 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. We do not use the value of total sales in an economy to measure how much output has been produced. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 36 GROSS DOMESTIC PRODUCT EXCLUSION OF USED GOODS AND PAPER TRANSACTIONS GDP is concerned only with new, or current, production. GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 36 GROSS DOMESTIC PRODUCT EXCLUSION OF OUTPUT PRODUCED ABROAD BY DOMESTICALLY OWNED FACTORS OF PRODUCTION GDP is the value of output produced by factors of production located within a country. P A HC e m c nI l a no t a N dna o i gross national product (GNP) The total market value of all final goods and services produced within a given period by factors of production owned by a country’s citizens, regardless of where the output is produced. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 36 CALCULATING GDP expenditure approach A method of computing GDP that measures the amount spent on all final goods during a given period. 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. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 36 CALCULATING GDP THE EXPENDITURE APPROACH There are four main categories of expenditure: P A HC e m c nI l a no t a N dna o i Expenditure Categories: ■ Personal consumption expenditures (C): household spending on consumer goods ■ Gross private domestic investment (I): spending by firms and households on new capital, i.e., plant, equipment, inventory, and new residential structures ■ Government consumption and gross investment (G) ■ Net exports (EX - IM): net spending by the rest of the world, or exports (EX) minus imports (IM) GDP = C + I + G + (EX - IM) © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 36 CALCULATING GDP TABLE 6.2 Components of U.S. GDP, 2004: The Expenditure Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP P A HC e m c nI l a no t a N dna o i Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories Government consumption and gross investment (G) Federal State and local Net exports (EX – IM) Exports (EX) Imports (IM) Gross domestic product (GDP) Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis. 8,214.3 987.8 2,368.3 4,858.2 1,928.1 1,198.8 673.8 55.4 2,215.9 827.6 1,388.3 − 624.0 1,173.8 1,797.8 11,734.3 70.0 8.4 20.2 41.4 16.4 10.2 5.7 0.5 18.9 7.1 11.8 − 5.3 10.0 15.3 100.0 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 36 CALCULATING GDP Personal Consumption Expenditures (C) personal consumption expenditures (C) A major component of GDP: expenditures by consumers on goods and services. P A HC e m c nI l a no t a N dna o i There are three main categories of consumer expenditures: durable goods, nondurable goods, and services. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 36 CALCULATING GDP durable goods Goods that last a relatively long time, such as cars and household appliances. nondurable goods Goods that are used up fairly quickly, such as food and clothing. services The things we buy that do not involve the production of physical things, such as legal and medical services and education. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 36 P A HC e m c nI l a no t a N dna o i CALCULATING GDP Gross Private Domestic Investment (I) P A HC e m c nI l a no t a N dna o i gross private domestic investment (I) Total investment in capital—that is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector. nonresidential investment Expenditures by firms for machines, tools, plants, and so on. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 36 CALCULATING GDP residential investment Expenditures by households and firms on new houses and apartment buildings. Change in Business Inventories P A HC e m c nI l a no t a N dna o i change in business inventories The amount by which firms’ inventories change during a period. Inventories are the goods that firms produce now but intend to sell later. GDP = final sales + change in business inventories © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 36 CALCULATING GDP Gross Investment versus Net Investment depreciation The amount by which an asset’s value falls in a given period. gross investment The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. net investment Gross investment minus depreciation. capitalend of period = capitalbeginning of period + net investment © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 36 P A HC e m c nI l a no t a N dna o i CALCULATING GDP Government Consumption and Gross Investment (G) government consumption and gross investment (G) Expenditures by federal, state, and local governments for final goods and services. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 36 CALCULATING GDP Net Exports (EX - IM) P A HC e m c nI l a no t a N dna o i net exports (EX - IM) The difference between exports (sales to foreigners of U.S.- produced goods and services) and imports (U.S. purchases of goods and services from abroad). The figure can be positive or negative. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 36 CALCULATING GDP THE INCOME APPROACH national income The total income earned by the factors of production owned by a country’s citizens. TABLE 6.3 National Income, 2004 P A HC e m c nI l a no t a N dna o i BILLIONS OF DOLLARS PERCENTAGE OF NATIONAL INCOME National Income Compensation of employees Proprietors’ income Corporate profits Net interest Rental income 10,275.9 6,687.6 889.6 134.2 1,161.5 505.5 809.3 91.1 − 3.0 100.0 65.1 8.7 1.3 11.3 4.9 7.9 0.9 − 0.0 Indirect taxes minus subsidies Net business transfer payments Surplus of government enterprises Source: See Table 6.2. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 36 CALCULATING GDP compensation of employees Includes wages, salaries, and various supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government. P A HC e m c nI l a no t a N dna o i proprietors’ income The income of unincorporated businesses. rental income The income received by property owners in the form of rent. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 36 CALCULATING GDP corporate profits The income of corporate businesses. net interest The interest paid by business. indirect taxes minus subsidies Taxes such as sales taxes, customs duties, and license fees, less subsidies that the government pays for which it receives no goods or services in return. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 36 CALCULATING GDP net business transfer payments Net transfer payments by businesses to others. surplus of government enterprises Income of government enterprises. TABLE 6.4 GDP, GNP, NNP and National Income, 2004 P A HC e m c nI l a no t a N dna o i DOLLARS (BILLIONS) GDP Plus: Receipts of factor income from the rest of the world Less: Payments of factor income to the rest of the world 11,734.3 + 415.4 − 361.7 11,788.0 − 1,435.3 10,352.8 − 76.9 10,275.9 23 of 36 Equals: GNP Less: Depreciation Equals: Net national product (NNP) Less: Statistical discrepancy Equals: National income Source: See Table 6.2. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair CALCULATING GDP net national product (NNP) Gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock. TABLE 6.5 National Income, Personal Income, Disposable Personal Income, and Personal Saving, 2004 P A HC e m c nI l a no t a N dna o i DOLLARS (BILLIONS) National income Less: Amount of national income not going to households Equals: Personal income Less: Personal income taxes Equals: Disposable personal income Personal consumption expenditures Personal interest payments Transfer payments made by households Equals: Personal saving Personal saving as a percentage of disposable personal income: Source: See Table 6.2. 10,275.9 − 562.6 9,713.3 − 1,049.1 8,664.2 − 8,214.3 − 186.7 − 111.5 151.8 1.8% 24 of 36 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair CALCULATING GDP statistical discrepancy Data measurement error. personal income The total income of households before paying personal income taxes. P A HC e m c nI l a no t a N dna o i disposable personal income or aftertax income Personal income minus personal income taxes. The amount that households have to spend or save. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 36 CALCULATING GDP personal saving The amount of disposable income that is left after total personal spending in a given period. personal saving rate The percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 36 NOMINAL VERSUS REAL GDP current dollars The current prices that one pays for goods and services. nominal GDP Gross domestic product measured in current dollars. P A HC e m c nI l a no t a N dna o i weight The importance attached to an item within a group of items. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 36 NOMINAL VERSUS REAL GDP CALCULATING REAL GDP TABLE 6.6 A Three-Good Economy (1) (2) (3) (4) (5) GDP IN YEAR 1 IN YEAR 1 PRICES P1 x Q1 $3.00 2.10 7.00 $12.10 Nominal GDP in year 1 (6) GDP IN YEAR 2 IN YEAR 1 PRICES P1 x Q2 $5.50 1.20 8.40 $15.10 (7) GDP IN YEAR 1 IN YEAR 2 PRICES P2 x Q1 $2.40 7.00 9.00 $18.40 (8) GDP IN YEAR 2 IN YEAR 2 PRICES P2 X Q2 $4.40 4.00 10.80 $19.20 Nominal GDP in year 2 PRODUCTION YEAR 1 YEAR 2 Q1 Q2 PRICE PER UNIT YEAR 1 YEAR 2 P1 P2 $.50 .30 .70 $ .40 1.00 .90 P A HC e m c nI l a no t a N dna o i Good A Good B Good C Total 6 7 10 11 4 12 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 28 of 36 NOMINAL VERSUS REAL GDP base year The year chosen for the weights in a fixed-weight procedure. fixed-weight procedure A procedure that uses weights from a given base year. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 29 of 36 NOMINAL VERSUS REAL GDP CALCULATING THE GDP DEFLATOR The GDP deflator is one measure of the overall price level. The GDP deflator is computed by the Bureau of Economic Analysis (BEA). Overall price increases can be sensitive to the choice of the base year. For this reason, using fixed-price weights to compute real GDP has some problems. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 30 of 36 NOMINAL VERSUS REAL GDP THE PROBLEMS OF FIXED WEIGHTS The use of fixed-price weights to estimate real GDP leads to problems because it ignores: • Structural changes in the economy. P A HC e m c nI l a no t a N dna o i • Supply shifts, which cause large decreases in price and large increases in quantity supplied. • The substitution effect of price increases. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 31 of 36 LIMITATIONS OF THE GDP CONCEPT GDP AND SOCIAL WELFARE Society is better off when crime decreases; however, a decrease in crime is not reflected in GDP. An increase in leisure is an increase in social welfare, but not counted in GDP. P A HC e m c nI l a no t a N dna o i Nonmarket and household activities are not counted in GDP even though they amount to real production. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 32 of 36 LIMITATIONS OF THE GDP CONCEPT THE UNDERGROUND ECONOMY underground economy The part of the economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP. P A HC e m c nI l a no t a N dna o i Whenever sellers looking for a profit come into contact with buyers willing to pay, markets will arise, often “underground.” © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 33 of 36 LIMITATIONS OF THE GDP CONCEPT GROSS NATIONAL INCOME PER CAPITA gross national income (GNI) GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation. P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 34 of 36 LIMITATIONS OF THE GDP CONCEPT TABLE 6.7 Per Capita Gross National Income for Selected Countries, 2004 COUNTRY Norway Switzerland United States Denmark Japan Sweden Ireland United Kingdom Finland Austria Netherlands Belgium Germany France Canada Australia Italy Spain Greece Source: World Bank, 2005. U.S. DOLLARS 52,030 48,230 41,400 40,650 37,180 35,270 34,280 33,940 32,790 32,300 31,700 31,030 30,120 30,090 28,390 26,900 26,120 21,210 16,610 COUNTRY Portugal South Korea Czech Republic Mexico Argentina Turkey South Africa Brazil Romania Jordan Colombia Philippines China Indonesia India Pakistan Nepal Rwanda Ethiopia U.S. DOLLARS 14,350 13,980 9,150 6,770 3,720 3,750 3,630 3,090 2,920 2,140 2,000 1,170 1,290 1,140 620 600 260 220 110 P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 35 of 36 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 minus subsidies intermediate goods national income national income and product accounts net business transfer payments net exports (EX - IM) 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 statistical discrepancy surplus of government enterprises underground economy value added weight Expenditure approach to GDP: GDP = C + I + G + (EX - IM) GDP = final sales - change in business inventories net investment = capital end of period - capital beginning of period 36 of 36 P A HC e m c nI l a no t a N dna o i © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair