Measuring Domestic Output, 7 C H A P T E R Measuring Domestic Output, National Income, and the Price Level

Macroeconomic Measurement The Importance of Macroeconomic Measurement National Income Accounting: Health of the Economy Comparisons Over Time Formulation of Public Policy What Are These Accounting Measures? Health – measure health by comparing production levels @ regular intervals. Has economy grown, been constant or declined. Establish policy that safeguard and improve health

Avoid Multiple Counting Final Goods Intermediate Goods Value Added GROSS DOMESTIC PRODUCT The total market value of all final goods and services produced in a given year A Monetary Measure Avoid Multiple Counting Final Goods Intermediate Goods Value Added MONEY MEASURE = Quantity times price MULTIPLE COUNTING - only final, finished goods and services are counted. Intermediate goods are included in final good. Auto includes tires, CD player etc. VALUE ADDED method. Hence, Multiple counting is avoided.

Excludes Nonproduction Transactions Financial Transactions GROSS DOMESTIC PRODUCT Excludes Nonproduction Transactions Financial Transactions Public Transfer Payments Private Transfer Payments Stock Market Transactions Secondhand Sales Two Approaches Expenditures Approach Income Approach more… Exclusions = Public transfer payments – Social Security, welfare & veterans’ payments. Private transfer payments – Allowance, gifts to children. Stock Market transactions. Buying & selling of securities is simply “swapping paper”. Secondhand Sales – anything used has been counted in a previous years GDP. Expenditures = C + Ig + G + Xn = W + R + I + P + #’s adjustments C = personal consumption – durable/non-durable goods. Ig = Gross private domestic investment – machinery, all construction, the changes in inventory. Government purchases = 1) $ spent on G/S, & 2) projects, hwy, i.e. long term. Fed., State, Local inc. Xn = exports – imports (M) can be negative number.

EXPENDITURES APPROACH Personal Consumption Expenditure ( C ) Durable Consumer Goods Nondurable Consumer Goods Consumer Expenditures for Services

EXPENDITURES APPROACH Personal Consumption Expenditure ( C ) Gross Private Domestic Investment ( Ig ) Machinery, Equipment, and Tools All Construction Changes in Inventories Noninvestment Transactions Gross vs. Net Investment Net Private Domestic Investment Gross vs. Net = Gross – depreciation (consumption on fixed capital)

EXPENDITURES APPROACH Personal Consumption Expenditure ( C ) Gross Private Domestic Investment ( Ig ) Government Purchases ( G ) G & S = labor, weapons etc Social Captial = long term purchases = highways, schools, etc. Transfer payments = SS, Vets, Welfare Expenditures for Goods & Services Expenditures for Social Capital Does NOT include Government Transfer Payments

EXPENDITURES APPROACH Personal Consumption Expenditure ( C ) Gross Private Domestic Investment ( Ig ) Government Purchases ( G ) Net investment = Gross - depreciation Net Exports ( Xn) Net Exports (Xn) = Exports (X) – Imports (M)

GDP = C + Ig + G + Xn Putting it all together: EXPENDITURES APPROACH Putting it all together: GDP = C + Ig + G + Xn Next: The Income Approach

Compensation of Employees Rents Interest Proprietors’ Income THE INCOME APPROACH Compensation of Employees Rents Interest Proprietors’ Income Corporate Profits Corporate Income Taxes Dividends Undistributed Corporate Profits Compensation = Wages Rents = income from property resources Interest = money paid to lenders (financial institutions savings and investments) and money paid by private businesses to lenders Proprietors’ Income = 1) sole proprietorship, partnership and unincorporated businesses. 2) corporate profits Corporate profits. Taxes levied on net earnings like personal income tax Dividends are portions of profits paid to shareholders Undistributed profits = profits used for capital investment

From National Income to GDP Indirect Business Taxes THE INCOME APPROACH From National Income to GDP Indirect Business Taxes Consumption of Fixed Capital (Depreciation) Net Foreign Factor Income National Income = all income that flows to U.S. supplied resources whether here or abroad. Indirect business taxes = general sales, excise, business property taxes, license fees and customs duties. Net Foreign Factor Income = Money earned abroad – foreign income earned in the U.S.

U.S. GDP, NDP, NI, PI, & DI, 2000 OTHER NATIONAL ACCOUNTS Gross Domestic Product (GDP) $9966 Consumption of fixed capital -1257 Net Domestic Product (NDP) $8709 Net foreign factor income earned in the U.S. - 9 Indirect business taxes -682 National Income (NI) $8018 Social security contributions -706 Corporate income taxes -286 Undistributed corporate profits -274 Transfer payments +1530 Personal Income (PI) $8282 Personal Taxes 1292 Disposable Income (DI) $6990

Deflate GDP when prices rise Inflate GDP when Prices fall Nominal GDP NOMINAL GDP vs. REAL GDP Nominal Values Deflate GDP when prices rise Inflate GDP when Prices fall Nominal GDP Calculating Real GDP (4) (2) Unadjusted, (1) Price (3) or Nominal, (5) Units of Pizza Price Index GDP, Adjusted, or Year Output Per Unit Year 1 = 100 (1)x(2) Real, GDP 1 5 $10 100 $ 50 $50 2 7 20 200 140 70 3 8 25 250 80 4 10 30 - 11 28

= = = x 100 NOMINAL GDP vs. REAL GDP An Alternative Method Adjustment Process GDP Price Index Price Index in a given year = Price of market basket in specific year Price of same market basket in base year x 100 Real GDP = Nominal GDP Price Index (in hundredths) An Alternative Method Price Index (in hundredths) = Nominal GDP Real GDP

= CPI x 100 Consumer Price Index NOMINAL GDP vs. REAL GDP Price of the same market basket in 1982-1984 x 100 CPI Price of 1993-1995 market basket in any given year

SHORTCOMINGS OF GDP Nonmarket Transactions Leisure Improved Product Quality The Underground Economy GDP and the Environment Composition and Distribution of Output Per Capita Output Noneconomic Sources of Well-Being Homemaker services, self home improvement Dollar value isn’t placed on leisure time Computer enhancement $1K in 1985 not = $1K 2003 Illegal activity, under the table, non-reported tips Costs of pollution Mix of goods not necessarily representative of GDP. Guns vs. books. Per capita output – considered most meaningful measure of performance. Divide GDP by population. Measure of standard of living. Save Madagascar. GDP grows by 1.3% and population grows by 2.8% = decline in per capita GDP.

GLOBAL PERSPECTIVE The Underground Economy as a Percent of GDP 0 5 10 15 20 25 30 Greece Italy Spain Portugal Belgium Sweden Germany France Holland United Kingdom Japan United States Switzerland Source: The Journal of Economic Literature, 2000

Chapter Conclusions

Key Terms national income accounting gross domestic product intermediate goods final goods multiple counting value added expenditures approach income approach personal consumption expenditures (C) gross private domestic investment (Ig) net private domestic investment government purchases (G) net exports (Xn) national income indirect business taxes consumption of fixed capital net domestic product (NDP) personal income (PI) disposable income (DI) nominal GDP price index real GDP consumer price index (CPI) per capita output BACK END Copyright McGraw-Hill/Irwin, 2002

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