7 - 1 Measuring Domestic Output, and National Income Measuring Domestic Output, and National Income

7 - 2 Assessing the Economy’s Performance Performance National Income Accounting: Health of the EconomyHealth of the Economy Comparisons Over TimeComparisons Over Time Formulation of Public PolicyFormulation of Public Policy

7 - 3 √ The idea was created by Simon Kuznets ( ) beginning in 1930 shortly after the beginning of the Great Depression. He received the Nobel Prize in Economics in 1971 for his effort. √ The tools of collection of the data were developed by the team led by Dr. Kuznets. √ The Bureau of Economic Analysis (part of the Commerce Department) compiles the numbers ( National Income accounting: measuring overall performance of the economy

7 - 4 GROSS DOMESTIC PRODUCT Market Value of the total goods and services produced within the boundaries of the US whether by Americans or foreigners in one year. Defining…

7 - 5 uses monetary measure uses monetary measure √ attach a “price tag” to products produced √ use market value of FINAL goods and services avoid multiple counting- avoid multiple counting- √ ignore transactions involving intermediate goods. GROSS DOMESTIC PRODUCT

7 - 6 Excludes Non-productive Transactions Financial Transactions Public Transfer Payments Private Transfer Payments Security Transactions Secondhand Sales GROSS DOMESTIC PRODUCT

GROSS DOMESTIC PRODUCT Consumption by Households Investment by Businesses GovernmentPurchases Expenditures by Foreigners Expenditures Approach Income Approach Wages Rents Interest Profits StatisticalAdjustments = = GDPGDP

7 - 8 GDP = C + G + I g + X n Consumption Spending Government Spending Investment Spending Net Export Spending

7 - 9 C for Consumption Spending Largest portion of GDP — about 65% √ Durables consumption (more than 3 yrs use) √ Non durable consumption (less than 3 yrs use) √ Services

G for Government Spending Federal Spending State and Local Spending

I g for Investment Spending 4. change in business inventories 2. new commercial construction 3. tools and machines 1. new residential construction

Net Investment Gross Investment Depreciation — = Stock of Capital ConsumptionandGovernmentSpending Capital Depreciation NetInvestment January 1 Year’s GDP December 31 Increased GrossInvestment

X n for Net Export Spending √ Imports (goods and services from other countries purchased by American citizens) √ Exports (goods and services from America purchased by citizens of other countries. X n = Exports-Imports

United States JapanGermany United Kingdom FranceChinaItalyCanadaMexicoSpainBrazilIndia Korea, Rep. NetherlandsAustralia GLOBAL PERSPECTIVE Comparative GDPs in Trillions, 2001 Source: World Bank

Compensation of Employees Compensation of Employees Rents Rents Interest Interest Proprietors’ Incomes Proprietors’ Incomes Corporate Profits Corporate Profits Corporate Income TaxesCorporate Income Taxes DividendsDividends Undistributed Corporate ProfitsUndistributed Corporate Profits THE INCOME APPROACH National Income

From National Income, subtract: Indirect Business Taxes Consumption of Fixed Capital (Depreciation) Net Foreign Factor Income THE INCOME APPROACH From National Income to GDP

Net Domestic Product By subtracting DEPRECIATION or Consumption of Fixed Capital from the GDP, a figure for the true amount of new goods and services can be determined.

Personal Income Subtracting losses to income (Social Security contribution, corporate profits and retained earnings) and adding a source of income (transfer payments) to the National Income, a figure is determined that shows the personal income available to the nation.

Disposable Income By subtracting from Personal Income, the dollars lost to taxes, we have the Disposable Income. This is the “bottom” line of national income accounting. This figure of Disposable Income gives us the funds available for spending and/or saving.

Gross Domestic Product $10,446 (GDP) Consumption of fixed capital -1,393 Net Domestic Product $9,053 (NDP) Net foreign factor income earned in the U.S Indirect business taxes -695 National Income $8,348 (NI) Social security contributions -748 Corporate income taxes -213 Undistributed corporate profits -141 Transfer payments +1,683 Personal Income $8,929 (PI) Personal Taxes -1,113 Disposable Income $7,816 (DI) U.S. GDP, NDP, NI, PI, & DI, 2002

NOMINAL GDP vs. REAL GDP Nominal GDP … reflects the current price level of goods and services and ignores the effect of inflation on the growth of GDP. … this measure is called Current Dollar GDP.

Real GDP … measures the value of goods and services adjusted for change in the price level. It will reflect the real change in output. … This measure is called the Constant Dollar GDP. … indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The government currently uses 2000 as its base year for Real GDP measurement. NOMINAL GDP vs. REAL GDP

Nominal Values Deflate GDP when prices rise Inflate GDP when prices fall NOMINAL GDP vs. REAL GDP $ $ (2)PricePizza Per Unit (1) Units of Output Year (3) Price Index Year 1 = 100 (4)Unadjusted, or Nominal, GDP,(1)x(2) (5)Adjusted, Or Real, GDP Calculating Real GDP

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) Price Index (in hundredths) = Nominal GDP Real GDP An Alternative Method NOMINAL GDP vs. REAL GDP

GDP Index Numbers Year GDP Index Q