Chapter 24 Measuring Domestic Output and National Income McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Define and measure GDP GDP and income relationships The GDP price index Nominal GDP vs. real GDP Limitations of the GDP measure

National Income Accounting Bureau of Economic Analysis compiles National Income and Product Accounts Assess health of economy Track long run course Formulate policy

Gross Domestic Product Measure of aggregate output Monetary measure Avoid multiple counting Market value final goods Ignore intermediate goods Count value added

Gross Domestic Product Exclude financial transactions Public transfer payments Private transfer payments Stock (and bond) market transactions Second hand sales Sell used car to a friend

Two Approaches to GDP Income approach Expenditure approach Count income derived from production Wages, rental income, interest income, profit Expenditure approach Count sum of money spent buying the final goods Who buys the goods?

+ + + + + + + Two Approaches to GDP G D P = = Consumption by Wages Households Wages + + Rents Investment by Businesses + G D P + = = Interest + Government Purchases + Profits + Statistical Adjustments Expenditures By Foreigners

Expenditure Approach Personal consumption expenditures (C) Durable consumer goods Nondurable consumer goods Consumer expenditures for services Domestic plus foreign produced

Expenditure Approach Gross private domestic investment (I) Machinery, equipment, and tools All construction Changes in inventories Creation of new capital asset Noninvestment transactions

- Expenditure Approach = Gross Investment Depreciation Net Investment Increase Consumption & Government Spending Stock of Capital Stock of Capital January 1 Year’s GDP December 31

Expenditure Approach Government purchases (G) Net exports (Xn) Expenditures for goods and services Expenditures for social capital Excludes transfer payments Net exports (Xn) Add exported goods Subtract imported goods NX = exports - imports GDP = C+Ig+G+Xn

U.S. Economy 2007 in Billions Receipts Expenditures Approach Allocations Income Approach Personal Consumption (C) Gross Private Domestic Investment (Ig) Government Purchases (G) Net Exports (Xn) Gross Domestic Product $ 9734 2125 2690 -708 $ 13,841 Compensation Rents Interest Proprietor’s Income Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income (-) Statistical Discrepancy (+) Consumption of Fixed Capital (+) Gross Domestic Product $ 7874 65 603 1043 1627 1009 $12,221 96 29 1687 $ 13,841

Comparative GDP Selected Nations GDPs, 2007 GDP in Trillions of Dollars 0 1 2 3 4 5 6 7 8 9 10 12 13 United States Japan Germany China United Kingdom France Italy Canada Spain Brazil Russia India South Korea Mexico Australia Source: World Bank

Components of National Income Compensation of employees Rents Interest Proprietor’s income Corporate profits Corporate income taxes Dividends Undistributed corporate profits Taxes on production and imports

Income Approach From national income to GDP Other national accounts Net foreign factor income Statistical discrepancy Consumption of fixed capital Other national accounts Net domestic product (NDP) National income (NI) Personal income (PI) Disposable income (DI) DI = C + S

U.S. Income Relationships 2007 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) $ 13,841 1687 $ 12,154 29 96 $ 12,221 1009 979 467 344 2237 $ 11,659 1482 $ 10,177

Nominal vs. Real GDP GDP is a dollar measure of production Using dollar values creates problems Nominal GDP Use prevailing price Real GDP Reflect changes in price Use base year price

GDP Price Index Use price index to determine real GDP = x 100 = In Given Year = x 100 Price of Market Basket In Specific Year Price of Same Basket In Base Year Real GDP = 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 output Noneconomic sources of well-being

Underground Economy As a percentage of GDP, Selected Nations, 2007 0 5 10 15 20 25 30 Mexico South Korea India Italy Spain China Sweden Germany France United Kingdom Japan Switzerland United States Source: Open Assessment, E-Journal

Sources of BEA Data Consumption Investment Census Bureau’s Retail Trade Survey Census Bureau’s Survey of Manufacturers Census Bureau’s Service Survey Investment All Consumption data sources Census Bureau’s Housing Starts Survey and Housing Sales Survey Retail Trade Survey Wholesale Trade Survey Survey of Manufacturing

Sources of BEA Data Government Purchases Net Exports Office of Personnel Management Construction Surveys Census Bureau’s Survey of Government Finance Net Exports U.S. Customs Service BEA Surveys and Analysis

Key Terms government purchases national income accounting net exports taxes on production and imports national income consumption of fixed capital net domestic product personal income disposable income nominal GDP real GDP price index national income accounting gross domestic product intermediate goods final goods multiple counting value added expenditures approach income approach personal consumption expenditures gross and net private domestic investment

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