© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair National Income and Product Accounts National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy.National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy. The Department of Commerce is responsible for producing and maintaining the “National Income and Product Accounts” that keep track of GDP.The Department of Commerce is responsible for producing and maintaining the “National Income and Product Accounts” that keep track of GDP.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Gross Domestic Product Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country.Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Final Goods and Services The term final goods and services refers to goods and services produced for final use.The term final goods and services refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm.Intermediate goods are goods produced by one firm for use in further processing by another firm.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Value Added Value added is 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.Value added is 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. 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. 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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Value Added Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED (1) Oil drilling $.50$.50 (2)Refining (3)Shipping (4) Retail sale Total value added $1.00

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Exclusions from GDP GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair GDP Versus GNP 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).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).

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Calculating GDP GDP can be computed in two ways: The expenditure approach: A method of computing GDP that measures the amount spent on all final goods during a given period.The expenditure approach: A method of computing GDP that measures the amount spent on all final goods during a given period. 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.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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Expenditure Approach Expenditure categories: Personal consumption expenditures (C)—household spending on consumer goods.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.Gross private domestic investment (I)—spending by firms and households on new capital: plant, equipment, inventory, and new residential structures.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Expenditure Approach Government consumption and gross investment (G)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)Net exports (EX – IM)—net spending by the rest of the world, or exports (EX) minus imports (IM)

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Expenditure Approach The expenditure approach calculates GDP by adding together these four components of spending. In equation form:The expenditure approach calculates GDP by adding together these four components of spending. In equation form:

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Personal Consumption Expenditures Personal consumption expenditures (C) are expenditures by consumers on the following:Personal consumption expenditures (C) are expenditures by consumers on the following: Durable goods: Goods that last a relatively long time, such as cars and household appliances. 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. Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. Services: The things that we buy that do not involve the production of physical things, such as legal and medical services and education. Services: The things that we buy that do not involve the production of physical things, such as legal and medical services and education.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Components of GDP, 1999: The Expenditure Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP Total gross domestic product 9, Personal consumption expenditures (C) 6, Durable goods Nondurable goods 1, Services3, Gross private domestic investment (l) 1, Nonresidential1, Residential Change in business inventories Government consumption and gross investment (G) 1, Federal State and local 1, Net exports (EX – IM)   2.7 Exports (EX) Imports (IM) 1, Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Gross Private Domestic Investment Investment refers to the purchase of new capital.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 (or non-government) sector.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 (or non-government) sector.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Gross Private Domestic Investment Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on.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.Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Gross Investment versus Net Investment Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period.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.Depreciation is the amount by which an asset’s value falls in a given period. Net investment equals gross investment minus depreciation.Net investment equals gross investment minus depreciation. capital end of period = capital beginning of period + net investment

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Government Consumption and Gross Investment Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Net Exports Net exports (EX – IM) is 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.Net exports (EX – IM) is 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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Income Approach National income is the total income earned by the factors of production owned by a country’s citizens. The income approach to GDP breaks down GDP into four components:The income approach to GDP breaks down GDP into four components: GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Income Approach Components of GDP, 1999: The Income Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP Gross domestic product 9, National income 7, Compensation of employees 5, Proprietors’ income Corporate profits Net interest Rental income Depreciation1, Indirect taxes minus subsidies Net factor payments to the rest of the world Other  32.2  0.3 Source: See Table 17.2.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair From GDP to Disposable Income GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 1999 DOLLARS (BILLIONS) GDP9,299.2 Plus: receipts of factor income from the rest of the world Less: payments of factor income to the rest of the world  Equals: GNP 9,288.2 Less: depreciation  1,161.0 Equals: net national product (NNP) 8,127.1 Less: indirect taxes minus subsidies plus other  Equals: national income 7,469.7 Less: corporate profits minus dividends  Less: social insurance payments  Plus: personal interest income received from the government and consumers Plus: transfer payments to persons +1,011.0 Equals: personal income 7,789.6 Less: personal taxes  1,152.0 Equals: disposable personal income 6,637.7 Source: See Table 17.2.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair From GDP to Disposable 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.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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair From GDP to Disposable Income Personal income is the total income of households. Equals (national income) minus (corporate profits minus dividends) minus (social insurance payments) plus (interest income received from the government and households).Personal income is the total income of households. Equals (national income) minus (corporate profits minus dividends) minus (social insurance payments) plus (interest income received from the government and households). Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Disposable Personal Income and Personal Saving Disposable Personal Income and Personal Saving, 1999 DOLLARS (BILLIONS) Disposable personal income 6,637.7 Less: Personal consumption expenditures  6,268.7 Interest paid by consumers to business  Personal transfer payments to foreigners  26.6 Equals: personal saving Personal savings as a percentage of disposable personal income: 2.2% Source: See Table 17.2.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Disposable Personal Income and Personal Saving The personal saving rate is 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.The personal saving rate is 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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Nominal versus Real GDP Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices.Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. When a variable is measured in current dollars, it is described in nominal terms.When a variable is measured in current dollars, it is described in nominal terms.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Calculating Real GDP A weight is the importance attached to an item within a group of items.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 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.A fixed-weight procedure uses weights from a given base year.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Calculating Real GDP A Three-Good Economy (1)(2)(3)(4)(5)(6)(7)(8) GDP IN YEAR 1 YEAR 2 YEAR 1 YEAR 2 ININININ PRODUCTION PRICE PER UNIT YEAR 1 YEAR 2 YEAR 1 YEAR 2 YEAR 1 YEAR 2 PRICESPRICESPRICESPRICES Q1Q1Q1Q1 Q2Q2Q2Q2 P1P1P1P1 P2P2P2P2 P 1 x Q 1 P 1 x Q 2 P 2 x Q 1 P 2 X Q 2 Good A 611$.50 $.40 $3.00$5.50$2.40$4.40 Good B Good C Total$12.10$15.10$18.40$19.20 Nominal GDP in year 1 Nominal GDP in year 2

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Calculating the GDP Price Index The GDP price index is one measure of the overall price level.The GDP price index is one measure of the overall price level. The old procedure used by the Bureau of Economic Analysis (BEA) to estimate changes in the overall price level used the quantities produced in a chosen year (the base year) as weights. But overall price increases are sensitive to the choice of the base year. The new procedure, known as the chained price index, avoids the problems associated with the use of fixed weights.The old procedure used by the Bureau of Economic Analysis (BEA) to estimate changes in the overall price level used the quantities produced in a chosen year (the base year) as weights. But overall price increases are sensitive to the choice of the base year. The new procedure, known as the chained price index, avoids the problems associated with the use of fixed weights.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Problems of Fixed Weights 1.Structural changes in the economy. 2.Supply shifts, which cause large decreases in price and large increases in quantity supplied. 3.The substitution effect of price increases. The use of fixed price weights to estimate real GDP leads to problems because it ignores:

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Limitations of the GDP Concept Society is better off when crime decreases, but a decrease in crime is not reflected in GDP.Society is better off when crime decreases, but a decrease in crime is not reflected in GDP. An increase in leisure is an increase in social welfare, not counted in GDP.An increase in leisure is an increase in social welfare, not counted in GDP. Nonmarket and domestic activities are not counted even though they amount to real production.Nonmarket and domestic activities are not counted even though they amount to real production.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Limitations of the GDP Concept GDP accounting rules do not adjust for production that pollutes the environment.GDP accounting rules do not adjust for production that pollutes the environment. GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP.GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. GDP is neutral to the kinds of goods an economy produces.GDP is neutral to the kinds of goods an economy produces.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair 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.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.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Per Capita GDP/GNP Per capita GDP or GNP measures a country’s GDP or GNP divided by its population.Per capita GDP or GNP measures a country’s GDP or GNP divided by its population. Per capita GDP is a better measure of well-being for the average person that its total GDP or GNP.Per capita GDP is a better measure of well-being for the average person that its total GDP or GNP.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Per Capita GDP/GNP Per Capita GNP for Selected Countries, 1998 COUNTRY U.S. DOLLARS COUNTRY Switzerland40,080Portugal10,690 Norway34,330Argentina8,970 Denmark33,260 South Korea 7,970 Japan32,380 Czech Republic 5,040 United States 29,340Brazil4,570 Austria26,850Mexico3,970 Germany25,850Turkey3,160 Sweden25,620 South Africa 2,880 Belgium25,380Colombia2,600 France24,940Jordan1,520 Netherlands24,760Romania1,390 Finland24,110Philippines1,050 United Kingdom 21,400China750 Australia20,300Indonesia680 Italy20,250Pakistan480 Canada20,020India430 Ireland18,340Rwanda230 Israel15,940Nepal210 Spain14,080Ethiopia100 Greece11,650 Source: The World Bank Atlas, 2000.