7 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Measuring Domestic Output and National Income

National Income Accounting Assess health of economy Compares levels of production Track long run course Grown, constant, or declined Formulate policy Safeguard and improve economy’s health Assessing the Economy’s Performance LO1

Gross Domestic Product (GDP) -- Total value of final goods and services produced in a country in a given year. (Aggregate Output) As long as a company is within a country’s border, their numbers go into the country’s GDP (even if they are foreign-owned). Gross Domestic Product 2-3

Gross Domestic Product (GDP): Total market value of all final goods and services produced within a country within a year Gross Domestic Product (GDP) LO1

2-5 Total value of final goods and services produced by a country in a given year. Gross National Product (GNP)

Gross Domestic Product Monetary measure Avoids multiple counting Excludes intermediate goods Counts market value of final goods Value added counted LO1

Gross Domestic Product Intermediate Goods Purchased for resale Further processing Manufacturing Final Goods Purchased by end user LO1

Gross Domestic Product Value added counted Sum of value added = GDP LO1

Excludes Non-Production Transactions Excludes financial transactions Public transfer payments Private transfer payments Stock (and bond) market transactions Excludes second hand sales LO1

2-10 GDP 2014: $17.4T Source: World Development Indicators database, World Bank, 1 July 2015 Gross Domestic Product

Circular Flow LO1 RESOURCEMARKET Households sell Businesses buy PRODUCTMARKET Businesses sell Households buy BUSINESSES buy resources sell products HOUSEHOLDS sell resources buy products

Circular Flow Revisited LO2

Two Approaches to GDP Income approach (earnings or allocation) Count income derived from production Expenditure approach (output) Count sum of money spent buying the final goods LO2

Two Approaches to GDP GDP, output, and income all refer to the same thing and can be used interchangeably. LO2

Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2

Income or Allocations Approach Wages Plus Rents Plus Interest Plus Profits Plus Statistical Adjustments LO2

Expenditures Approach LO2

Expenditures or Output Approach Consumption Expenditures by Households (C) Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2

Expenditures Approach Personal consumption expenditures (C) Durable goods (3 years +, 10%) Nondurable goods (< 3 years, 30%) Services (60%) Spending on houses is not included Largest component of GDP LO2

Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses (G) Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2

Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners LO2

Expenditures Approach Gross private domestic investment (I g ) Machinery, equipment, and tools All construction (includes residential) R & D Creation of music, art, film, software, etc. Changes in inventories LO2

Changes in Inventories Changes in inventories represent the difference between what was produced during the year, and what was purchased. LO2

Positive and Negative Changes in Inventories LO2

Changes in Inventories If inventories increase, more was produced than purchased, so the increase in inventories must be added to I g and GDP. (unconsumed output) Vice versa if inventories fell. LO2

Net Investment ( I n ) LO2

Net Investment Net Investment includes only added capital during the year. (Gross Investment minus Depreciation) I n = I g – Depreciation Depreciation (Consumption of Fixed Capital - CFC) = amount of capital goods used during the year. LO2

Net Investment I g > CFC; therefore I n > 0 and economy is growing. I g = CFC; therefore I n = 0 and economy is stagnant. I g < CFC; therefore I n < 0 and economy is experiencing negative growth (disinvesting). LO2

Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services (G) Plus Expenditures by Foreigners LO2

Expenditures Approach Government purchases (G) 1.Goods and services to provide public services 2.Publicly owned capital 3.R&D + other to increase economy know-how Excludes transfer payments LO2

Expenditures or Output Approach Consumption Expenditures by Households Plus Investment Expenditures by Businesses Plus Government Purchases of Goods and Services Plus Expenditures by Foreigners (Net Exports = X n ) LO2

Expenditures Approach Net exports (X n ) Add exported goods (X) Subtract imported goods (M) X n = exports (X) – imports (M) LO2

Expenditures or Output Approach Consumption Expenditures by Households (C) Plus Investment Expenditures by Businesses (I g ) Plus Government Purchases of Goods and Services (G) Plus Expenditures by Foreigners (X n ) LO2

Expenditures Approach GDP = C+I g +G+X n LO2

Compensation Rents Interest Proprietor’s Income Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income (-) Consumption of Fixed Capital (+) Statistical Discrepancy (+) Gross Domestic Product $ 8, ,225 2,031 1,123 $13, , $ 16,245 Personal Consumption (C) Gross Private Domestic Investment (I g ) Government Purchases (G) Net Exports (X n ) Gross Domestic Product in Billions Receipts Expenditures Approach Allocations Income Approach $11,150 2,475 3, $ 16,245 U.S. Economy 2012 LO2 Source: Bureau of Economic Analysis,

Comparative GDP LO2

Other National Accounts Net Domestic Product (NDP) Measures what has been added to the stock of capital and the new output = replacement of capital goods used up in production of output. NDP = GDP – consumption of fixed capital LO2

Other National Accounts National Income (NI) Includes all income earned by U.S.-owned resources whether they are located in the United States or abroad LO2

Other National Accounts Personal Income (PI) Includes all income received whether it was earned or unearned LO2

Other National Accounts Disposable Income (DI) Income that households receive (personal income minus taxes) and able to spend as they desire (consumption or savings) DI = C + S LO2

U.S. Income Relationships 2012 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) $ 16,245 2,543 $ 13, $ 13,972 1, ,766 $ 13,744 1,498 $ 12,246 LO2

Nominal vs. Real GDP LO2

Nominal vs. Real GDP Nominal GDP Uses current prices year produced Real GDP Adjusted for inflation Use base year’s prices LO3

CPI Market Basket

GDP Price Index Use price index to determine real GDP Price Index In Given Year =x100 Price Good in Specific Year Price of Good In Base Year Real GDP = Nominal GDP Price Index (in hundredths) LO3

Real-World Considerations More complicated than the “one-good scenario Assigns a “weight” to several categories of goods and services based on the relative proportion of each category in total output The U.S. GDP PI is “chain-type- annual-weights price index” LO4

Shortcomings of GDP Nonmarket activities Leisure Improved product quality The underground economy LO4

Underground Economy LO4

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 LO4