National Income Accounting (NIA) Outline: 1.Functions of NIA 2.Gross Domestic Product (GDP) 3.The Value Added approach to GDP 4.The Expenditure Approach to GDP 5.The Factor Payments Approach to GDP 6.Real versus Nominal GDP 7.Problems with GDP

National income accounting (NIA) is the measurement of aggregate or total economic activity. NIA is useful for assessing the performance of the macroeconomy. NIA is also helpful in evaluating the effectiveness of policy initiatives such as the Reagan tax cuts.

We measure stock variables at a specific point in time; whereas flows are measured per unit of time. Flows include: Income Sales revenue Output Stocks include: Checking account balance Balance owed on student loans Inventories We measure economic activity as a flow. Stocks vs. Flows

GDP is the market value of new goods and services produced in the economy in one year within the nation’s borders. Gross Domestic Product (GDP) GDP is our basic measure of economic activity

Three approaches to measuring GDP The value-added approach The expenditure approach The factor payments approach

Value-added is the increase in the market value of a good that takes place at each stage of the production -distribution process.

àStage 1: Farmer grows wheat, sells it to the Miller for 55 cents. àStage 2: Miller mills the wheat, sells it to the Baker for 85 cents--hence value-added at the milling stage is 30 cents. àStage 3: Baker bakes the bread--sells it to the supermarket for $1.45--hence value-added at the baking stage is 60 cents. àStage 4: Supermarket sells the bread to the consumer for $1.65--hence value added at the retailing stage is 20 cents.

$1.00 Wood Chips $1.50 Raw Paper $2.25 Notebook Paper $3.50 Notebook Paper $5.00 Notebook Paper Lumber Mill Paper Mill Office Supplies Manufacturer Wholesaler Retailer

Summing the value-added at each stage StageValue Added Lumber milling$1.00 Paper processing.50 Office Supply Manufacturing.75 Wholesaling1.25 Retailing1.50 Total$5.00

 To count the notebook in GDP, we count the final transaction only. Otherwise, we would be counting value added twice.

Here we simply add up all expenditures for new goods and services in one year GDP = C + I + G + NX Where, C is personal consumption expenditure; I is gross private domestic investment; G is government expenditure (local, state, and federal); and NX is net exports, or Exports minus Imports The expenditure approach

Consumption Household spending for newly-produced goods and services is defined as consumption. We distinguish between 3 categories or types: ñSpending for consumer durables ñSpending for consumer nondurables ñSpending for consumer services.

Source: Economic Report of the President Consumer Spending by Type, 1999 (in billions) Total spending by U.S. households in 1999 was a staggering $6.3 trillion

ï All spending by business firms for newly built equipment and business structures. ï All changes in business inventories of raw materials, semifinished articles, and finished goods. ï All spending by households for newly constructed residential housing What is investment?

Investment does NOT include The purchase of stocks, bonds, or other financial assets. Secondhand sales Remember that investment only happens when there is production of new tangible capital goods

Definitions áCapital consumption allowance (CCA):A monetary measure of the depreciation of the capital stock in a year due to normal wear and tear, fires, or other accidents. áNet Investment: Gross Investment minus CCA. áIndirect business taxes: taxes collected by businesses for government units, such as taxes on entertainment, motels, groceries, liquor, cigarettes, or gasoline taxes. Also called excise taxes. áNet income earned abroad: Income earned by domestic residents in foreign factor markets minus income earned by foreigners in domestic factor markets.

This mainly involves summing up income earned in factor markets GDP = Employee compensation + interest + rent + profits - net income earned abroad + CCA + indirect business taxes The Factor Payments Approach

1 Includes the capital consumption allowance and statistical discrepancy Two Approaches to U.S. GDP, 1999 Source: Bureau of Economic Analysis (

All data in billions of current dollars Relation of GDP to GNP, NNP, National Income, and Personal Income, 1999

All data in billions of dollars From National Income to Personal Income

Personal disposable income (PDI) Personal income $7,792 Less: Personal tax payments 1,152 Equals: PDI $6,640 PDI is the obviously one measure of ready spending power of the household sector

Real versus Nominal GDP We use money to measure the market value of new goods and services produced produced in the economy. The value (or purchasing power) of money is subject to change over time. Hence we need to adjust nominal GDP (that is, GDP measured at current prices) for changes in the value of money. GDP adjusted for changes in the value of money is called real GDP.

Price  Quantity = Market Value of Output oranges coconuts ,000 pizzas $16,350 Year 1 (base year) Nominal GDP = Real GDP oranges coconuts 8.002,200 pizzas $17,985 Year 2 (quantities increase 10%) Nominal GDP increases, Real GDP increases

Price  Quantity = Market Value of Output oranges coconuts ,000 pizzas $17,985 Year 3 (prices increase by 10%) Nominal GDP increases, Real GDP remains constant

Goods & Services Produced in 1990 (in units) Market Prices in 1990 $5,748.3 billion Goods & Services Produced in 1991 (in units) Market Prices in 1991 $5,916.7 billion Nominal GDP in 1990 is computed by: Nominal GDP in 1991 is computed by:

The problem is this: How do we know if the change in GDP (from ’90 to ’91) is due to a change in actual production of goods and services? That is, the increase in nominal GDP might be explained by an increase in prices.

GDP in the United States (in millions)

GDP per Person in the United States

Notice that real GDP decreased in 1991 Recessions are shaded GDP in the U.S. (millions of chained 1996 dollars)

GDP does not take full account of qualitative changes in output. GDP does not take account of the underground economy. GDP does not account for nonmarket production— that is, goods produced but not sold in the marketplace.