7 Measuring Domestic Output and National Income Mc

7 Measuring Domestic Output and National Income Mc. Graw-Hill/Irwin Copyright © 2012 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Assessing the Economy’s Performance • National Income Accounting • LO 1 • Assess health of economy • Track long run course • Formulate policy Gross Domestic Product (GDP): Total market value of all final goods and services produced within a country within a year

Gross Domestic Product • Monetary measure • Avoid multiple counting • Market value final goods • Exclude intermediate goods • Value added counted LO 1

Gross Domestic Product • Exclude financial transactions • Public transfer payments • Private transfer payments • Stock (and bond) market • LO 1 transactions Exclude second hand sales

Circular Flow RESOURCE MARKET • Households sell • Businesses buy BUSINESSES • buy resources • sell products HOUSEHOLDS • sell resources • buy products PRODUCT MARKET • Businesses sell • Households buy LO 1

Circular Flow Revisited LO 2

Two Approaches to GDP • Income approach • Count income derived from • LO 2 production Expenditure approach • Count sum of money spent buying the final goods

Two Approaches to GDP • GDP, output, and income all refer to the same thing and can be used interchangeably. LO 2

Expenditures Approach • Personal consumption expenditures • LO 2 (C) • Durable goods • Nondurable goods • Services • Spending on houses is not included Largest component of GDP

Expenditures Approach • Gross private domestic investment (Ig) • Machinery, equipment, and tools • All construction • Changes in inventories LO 2

Changes in Inventories Changes in inventories represent the difference between what was produced during the year, and what was purchased. LO 2

Changes in Inventories • If inventories increase, more was produced than purchased, so the increase in inventories must be added to Ig and GDP. • Vice versa if inventories fell. LO 2

Net Investment • Net Investment includes only added capital during the year. • In = Ig – Depreciation • Consumption of Fixed Capital (Depreciation) – amount of capital goods used during the year. LO 2

Net Investment • Ig > CFC; therefore In > 0 and economy is growing. • Ig = CFC; therefore In = 0 and economy is stagnant. • Ig < CFC; therefore In < 0 and economy is experiencing negative growth. LO 2

• • • LO 2 Expenditures Approach Government purchases (G) • Goods and services • Publicly owned capital • Excludes transfer payments Net exports (Xn) • Add exported goods • Subtract imported goods • Xn = exports - imports GDP = C+Ig+G+Xn

U. S. Economy 2015 in Billions Receipts Expenditures Approach Allocations Income Approach Personal Consumption (C)$12, 272 Compensation Gross Private Domestic Rents 657 Interest 524 Investment (Ig) 3, 021 $ 9, 655 Government Purchases (G) 3, 183 Proprietor’s Income 1, 388 Net Exports (Xn) Corporate Profits 2, 009 -529 Taxes on Production and Imports 1, 302 National Income $15, 535 Net Foreign Factor Income (-) Consumption of Fixed 214 2, 821 Capital (+) Statistical Discrepancy (+) Gross Domestic Product $ 17, 947 Gross Domestic Product -195 $ 17, 947 Source: Bureau of Economic Analysis, www. bea. gov LO 2

Comparative GDP LO 2

Other National Accounts • Net Domestic Product (NDP) • Measures what has been added to • LO 2 the stock of capital and the new output National Income (NI) • Includes all income earned by U. S. -owned resources whether they are located in the United States or abroad

Other National Accounts • Personal Income (PI) • Includes all income received • LO 2 whether it was earned or unearned Disposable Income (DI) • Income that households receive and able to spend as they desire DI = C + S

U. S. Income Relationships 2015 Gross Domestic Product (GDP) Less: Consumption of Fixed Capital Equals: Net Domestic Product (NDP) Less: Statistical Discrepancy Plus: Net Foreign Factor Income Equals: National Income (NI) Less: Taxes on Production and Imports Less: Social Security Contributions Less: Corporate Income Taxes Less: Undistributed Corporate Profits Plus: Transfer Payments Equals: Personal Income (PI) Less: Personal Taxes Equals: Disposable Income (DI) LO 2 $ 17, 947 2, 821 $ 15, 126 -195 214 $ 15, 535 1, 177 1, 203 530 591 3, 306 $ 15, 340 1, 945 $ 13, 395

Nominal vs. Real GDP • Nominal GDP • Uses current prices • Real GDP • Adjusted for inflation • Use base year’s prices LO 3

GDP Price Index • Use price index to determine real GDP Price Index In Given Year Real GDP LO 3 Price Good in Specific Year =Price of Good In Base Year x 100 = Nominal GDP Price Index (in hundredths)

Shortcomings of GDP • Nonmarket activities • Leisure • Improved product quality • The underground economy • GDP and the environment • Composition and distribution of the • LO 4 output Noneconomic sources of well-being

Underground Economy LO 4