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Chapter 15 Gross Domestic Product

• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2000 South-Western College Publishing

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In this chapter, you will learn to solve these economic puzzles:

Why doesn’t economic growth include increases in

spending for welfare, Social Security, and

unemployment programs?

Can one newscaster report that the economy grew,

while another reports for the same year that the

economy declined, and both reports be correct?

How is the calculation of national output affected by

environmental damage?

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Who was Simon Kuznets?Published a report in 1934

titled National Income, 1929 -32, which explained the first national accounting system

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What is Gross Domestic Product? GDP is the most widely

reported measure of a nation’s economic performance

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What does GDP measure?

The market value of all final goods and services produced in a nation during a period of time, usually a year

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What is Gross National Product (GNP)?

GNP measures the market value of all final goods and services produced by a nation’s residents, no matter where they are located

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What is an advantage of using GDP?

GDP measures value using dollars, rather than a list of the number of goods and services

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Does GDP measure secondhand transactions?No, Current GDP does not

include the sale of a used car or the sale of a home constructed some years ago

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What areIntermediate Goods?Goods and services used

as inputs for production of final goods

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Does GDP count Intermediate Goods?

No, to avoid double counting, GDP only measures final goods and services

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What are Final Goods?Finished goods and

services produced for the ultimate user

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Does GDP measure nonproductive

financial transactions?No, GDP does not count

purely private or public financial transactions such as giving gifts, stocks, bonds, or transfer payments

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What is aTransfer Payment?

A government payment to individuals, not in exchange for goods or services currently produced

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Does GDP measure the whole economy?

Yes, GDP consists of many puzzle pieces to fit together, including markets for products, resources, consumers, workers, and businesses

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What is aCircular Flow Model?A model that show us

how all the pieces of the puzzle fit together

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Productmarkets

Households

Factormarkets

Businesses

Basic Circular

Flow Model

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What is a Flow?A rate of change in a

quantity during a given time period

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What is a Stock?A quantity measured

at one point in time

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What additional sectors does a complex Circular

Flow Model contain?• Financial markets• Government• Foreign markets

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What Leakages are present in the more

Complex Model?• Household saving• Household taxes paid• Income spent on imports

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What Injections are present in the more

Complex Model?• Business spending• Government spending• Foreign spending

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What point is the Economy tending toward?

Where the dollar value of leakages equals the dollar value of injections

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What are the two approaches we use to

measure GDP?Expenditure

Income

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What is theExpenditure Approach? The national income

accounting method that measures GDP by adding all the spending for final goods and services

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What are the four sectors of GDP?• Consumption• Investment• Government• Foreign (X - M)

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GDP = C + I + G + (X - M)

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GDP using the Expenditure Approach1998

National Income Accounts

Percentage of GDP

ConsumptionInvestmentGovernmentExports - Imports

68%15%19%-2%

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What is theIncome Approach?

The method that measures GDP by adding all incomes

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What are the Income components of GDP?

GDP = Compensation of employees + rents + profits + net interest + nonincome adjustments

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What areNonincome Adjustments?

• Capital consumption allowances

• Indirect business taxes

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GDP using the Income Approach1998

National Income Accounts

Percentage of GDP

Employee compensationRental income of persons

Net interestDepreciation

59%2%

16%5%

Indirect business taxes

Profits

11%7%

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What is Compensation of Employees?

Income earned from wages, salaries, and certain supplements paid to labor

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What is Rental Income of Persons?

Rent and royalties received by property owners who permit others to use their assets

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What are Profits?Proprietors incomeCorporate profits

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What is Net Interest?Interest earned from

loans to businesses

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What is Depreciation?An allowance for the

capital worn out producing GDP

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What are Indirect Business Taxes?

Taxes levied as a percentage of the prices of goods sold and therefore become a part of the revenue received by firms

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What are Shortcomings of GDP?• Nonmarket transactions• Distribution, kind, &

quality of products• Neglect of leisure time• Underground economy• Economic bads

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What other national accounts measure

economic performance?• Net National Product• National Income• Personal Income • Disposable Personal Income• Nominal and Real GDP• GDP Chain Price Index

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What is Net Domestic Product?

NDP is GDP minus depreciation of the capital worn out in producing output

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What isNational Income?

NI is the total earned by resource owners, including wages, rents, interest, and profits

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What isPersonal Income?

PI is the total income received by households that is available for consumption, saving, and payment of personal taxes

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What is Disposable Personal Income?

DI is the amount of income that households have to spend or save after payment of personal taxes

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What is Nominal GDP?The value of all final goods

based on the prices existing during the time period of production

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What is Real GDP?The value of all final goods

produced during a given time period based on the prices existing in a selected base year

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Real GDP =nominal GDP x 100

GDP price index

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What is theChain Price Index?

A measure that compares changes in the prices of all final goods during a given period to the prices of those goods in a base year

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Key Concepts

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Key Concepts• Who was Simon Kuznets?

• What is Gross Domestic Product?

• What does GDP measure?

• What is an advantage of using GDP?

• Does GDP measure the whole economy?

• What are the two approaches we use to measure GDP?

• What is the Expenditure Approach?

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Key Concepts cont.

• What are the four sectors of GDP?

• What is the Income Approach?

• What are the Income components of GDP?

• What are Nonincome Adjustments?

• What are Shortcomings of GDP?

• What is Net Domestic Product?

• What is National Income?

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Summary Key Concepts cont.

• What is Personal Income?

• What is Disposable Personal Income?

• What is Nominal GDP?

• What is Real GDP?

• What is the Chain Price Index?

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Summary

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GDP is the most widely used measure of a nation’s economic performance. GDP is the market value of all final goods produced in the U.S. during a period of time regardless of who owns the factors of production. Secondhand and financial transactions are not counted in GDP. To avoid double counting, GDP also does not include intermediate goods. GDP is calculated by either the expenditure approach or the income approach.

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GNP is the market value of final goods and services produced by U.S. residents, no matter where they are located. To reflect the increasing integration of the U.S. into the global economy, the Department of Commerce changed its emphasis to GDP in 1991.

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The circular flow model is a diagram representing the flow of products and resources between businesses and households in exchange for money payments. Flows must be distinguished from stocks. Flows are measured in units per time period, for example, dollars per year. Stocks are quantities that exist at a given point in time measured in dollars.

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Productmarkets

Households

Factormarkets

Businesses

Basic Circular

Flow Model

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The expenditure approach sums the four major spending components of GDP: consumption, investment, government, and net exports. Algebraically, GDP = C + I + G + (X-M), where X equals foreign spending for domestic exports and M equals domestic spending for foreign products.

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The income approach sums the major income components of GDP, consisting of compensation of employees, rents, profits net interest and nonincome expenses for depreciation and indirect business taxes. Indirect business taxes are levied as a percentage of product prices and include sales taxes, excise taxes, and customs duties.

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Net domestic product (NDP) is GDP minus depreciation

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National income (NI) is total income earned by households and is calculated as NDP minus indirect business taxes.

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Personal income (PI) is the total income received by households and is calculated as NI minus corporate taxes and Social Security taxes plus transfer payments, net interest, and dividends.

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Disposable personal income (DI) is personal income minus personal taxes. DI is the amount of income a household has available to consume or save.

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Nominal GDP measures all final goods and services produced in a given time period of production.

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Real GDP measures all final goods and services produced in a given time period, valued at the prices existing in a base year.

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The GDP chain price index is a broad price index used to convert nominal GDP to real GDP. The GDP chain price index measures changes in the prices of consumer goods, business investment, government spending, exports, and imports. Real GDP is computed by dividing nominal GDP for year X by year X’s GDP chain price index and then multiplying the result by 100.

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Chapter 15 Quiz

©2000 South-Western College Publishing

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1. The dollar value of all final goods and services produced within the borders of a nation is the a. GNP deflator.b. gross national product.c. net national product.d. gross domestic product.

D. GDP is the most widely reported measure of a nation’s economic performance. GDP excludes production abroad by U.S. firms.

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2. Based on the circular flow model, money flows from businesses to households in a. factor markets.b. product markets.c. neither factor nor product markets.d. both factor and product markets.

A. Money flows from household to businesses in product markets. The reverse is true for factor markets.

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3. The circular flow model does not include which of the following?a. The quantity of shoes in inventory on

January 1.b. The total wages paid per month.c. The percentage of profits paid out as

dividends each year. d. The total profits earned per year in

the U.S. economy.

A. The quantity of shoes in inventory is a stock at one point in time rather than a flow over a period of time.

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4. The expenditure approach measures GDP by adding all the expenditures for final goods made by a. households.b. businesses.c. government.d. foreigners.e. all of the above.

E. One method national income accountants use to calculate CDP is to add all spending for the four sectors of the economy during a period of time.

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5. GDP is a less-than-perfect measure of the nation’s economic pulse because it a. excludes nonmarket transactions.b. does not measure the quality of goods

and services.c. does not report illegal transactions.d. all of the above.

D. GDP only measures legal market transactions and adjustments for quality changes are very difficult or impossible.

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6. Subtracting an allowance for depreciation of fixed capital from gross domestic product yields a. real GDP.b. nominal GDP.c. national income.d. net domestic product.

D. Real GDP and nominal GDP include an estimate of depreciation. National income is equal to net national product less indirect business taxes (e.g. sales taxes, federal excise taxes).

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7. Adding all incomes earned by households from the sale of resources yields a. intermediate goods.b. indirect business taxes.c. national income.d. personal income.

C. Intermediate goods and indirect business taxes have nothing to do with adding incomes. Personal income is the total income received by households. For example, PI includes transfer payments and NI does not.

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8. Personal income equals disposable income plusa. personal savings.b. transfer payments.c. dividend payments.d. personal taxes.

D. Disposable income is the amount of income that households actually have to spend or save after payment of personal taxes.

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9. Disposal personal income a. is the income people spend for

personal items such as homes and cars.b. includes transfer payments.c. excludes transfer payments.d. includes personal taxes.

B. DPI equals PI minus personal taxes. Since PI includes transfer payments, DPI also includes transfer payments.

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10. Which of the following statements is true? a. Leakages in an economy equal savings plus taxes plus

imports. b. National income is total income earned by

households, whereas personal income is total income received by households.

c. Disposable personal income equals personal income minus personal taxes.

d. The expenditures approach and the income approach yield the same GDP figure.

e. all of the above are true. E. When money leaves the system, a leakage occurs.

Personal income is both earned and unearned income. Disposable income is income left over after taxes. Expenditures will always equal income.

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11. Gross domestic product data that reflect actual prices as they exist in a given year are expressed in terms of a. fixed dollars.b. current dollars.c. constant dollars.d. real dollars.

B. Nominal GDP is also referred to as current dollar or money GDP and is not adjusted for inflation.

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12. The GDP chain price index is a. widely reported in the news.b. broadly based.c. adjusted for government spending.d. a measure of changes in consumer prices.

B. The GDP chain price index not only measures price changes of consumer goods, but also price changes of business investment, government consumption expenditures, exports and imports.

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13. Which of the following statements is true? a. The inclusion of intermediate goods and

services in GDP calculations would underestimate our nation’s production level.

b. The expenditures approach sums the compensation of employees, rents, profits, net interest, and non-income expenses for depreciation and indirect business taxes.

c. Real GDP has been adjusted for inflation or deflation.

d. Real GDP equals nominal GDP multiplied by the GDP deflator.

C. The word real in front of any term means that the value has been adjusted.

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