2 National Income

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Prepared by:

Fernando & Yvonn Quijano

19Chapter

Measuring National Outputand National Income

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© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 36

Chapter Outline

19Measuring National OutputMeasuring National Outputand National Incoand National Income

Gross Domestic ProductFinal Goods and ServicesExclusion of Used Goods and Paper TransactionsExclusion of Output Produced Abroad by Domestically Owned Factors of ProductionCalculating GDPThe Expenditure ApproachThe Income ApproachNominal versus Real GDPCalculating Real GDPCalculating the GDP DeflatorThe Problems of Fixed WeightsLimitations of the GDP ConceptGDP and Social WelfareThe Underground EconomyGross National Income Per Capita

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MEASURING NATIONAL OUTPUTMEASURING NATIONAL OUTPUTAND NATIONAL INCOMEAND NATIONAL INCOME

NNational income and ational income and PProduct accountsroduct accounts

Data collected and published by the government Data collected and published by the government describing thedescribing the various components of national income various components of national income and output in the economy.and output in the economy.

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GROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCT

Gross Domestic Product (GDP)

The total market value of all final goods and services The total market value of all final goods and services produced within a given period by factors of produced within a given period by factors of production located within aproduction located within acountry.country.

GDP is the total market value of a country’s output. It is the market value of all final goods and services produced within a given period of time by factors of production located within a country.

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FFinal goods and services inal goods and services Goods and services produced for final use.

FINAL GOODS AND SERVICESFINAL GOODS AND SERVICES

IIntermediate goods ntermediate goods Goods that are produced by one firm for use in further processing by another firm.

VValue added alue added The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.

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Tires taken from that pile and mounted on the wheels of the new car before it is sold are considered intermediate goods intermediate goods to the auto producer.

Tires from that pile to replace tires on your old car are considered final final goodsgoods. .

If, in calculating GDP, we included the value of the tires the value of the tires (an intermediate good) on new cars and the value of new cars value of new cars (including the tires), we would be double countingwe would be double counting.

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In calculating GDP, we can either sum up the value added at each stage of production or we can take the value of final sales. We do not use the value of total sales in an economy to measure how much output has been produced.

TABLE 6.1 Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers)

STAGE OF PRODUCTIONSTAGE OF PRODUCTION VALUE OF SALESVALUE OF SALES VALUE ADDEDVALUE ADDED

(1)(1) Oil drillingOil drilling $$ 1.001.00 $$1.001.00

(2)(2) RefiningRefining 1.301.30 0.300.30

(3)(3) ShippingShipping 1.601.60 0.300.30

(4)(4) Retail saleRetail sale 2.002.00 0.400.40

Total value addedTotal value added $$2.002.00

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GDP ignores all transactions in which money or goods GDP ignores all transactions in which money or goods change hands but in which no new goods and services change hands but in which no new goods and services are producedare produced..

EXCLUSION OF USED GOODS AND PAPER EXCLUSION OF USED GOODS AND PAPER TRANSACTIONSTRANSACTIONS

GDP is concerned only with new, or current, production.

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GROSS DOMESTIC PRODUCT

GDP is the value of output produced by factors of production located within a country.

EXCLUSION OF OUTPUT PRODUCED ABROAD BY EXCLUSION OF OUTPUT PRODUCED ABROAD BY DOMESTICALLY OWNED FACTORS OF DOMESTICALLY OWNED FACTORS OF PRODUCTIONPRODUCTION

GGross ross NNational ational PProduct (GNP)roduct (GNP) The total market The total market value of all final goods and services produced value of all final goods and services produced within a given period by factors of production owned within a given period by factors of production owned by acountry’s citizens, by acountry’s citizens, regardless of where the regardless of where the output is produced.output is produced.

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CALCULATING GDPCALCULATING GDP

EExpenditure approachxpenditure approach A method of computing GDP that measures the amount spent on all final amount spent on all final goods during a given periodgoods during a given period.

IIncome approach ncome approach A method of computing GDP that measures the income - wages, wages, rents, interest, and profitsrents, interest, and profits - - received by all all factors of production factors of production in producing final goods.

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THE EXPENDITURE APPROACHTHE EXPENDITURE APPROACH

There are four main categories of expenditureThere are four main categories of expenditure:

Expenditure CategoriesExpenditure Categories:■ Personal consumption expenditures Personal consumption expenditures (C): household

spending on consumer goods■ Gross private domestic investment Gross private domestic investment (I): spending by

firms and households on new capital, i.e., plant, equipment, inventory, and new residential structures

■ Government consumption Government consumption and gross investment (G)■ Net exports Net exports (EX - IM): net spending by the rest of the

world, or exports (EX) minus imports (IM)

GDP GDP = = CC + + I I ++ G G ++ ((EX EX -- IM IM))

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TABLE 6.2 Components of U.S. GDP, 2004: The Expenditure ApproachBILLIONS OFBILLIONS OF

DOLLARSDOLLARSPERCENTAGEPERCENTAGE

OF GDPOF GDP

Personal consumption expenditures (C) 8,214.38,214.3 70.0 %Durable goods 987.8 8.4Nondurable goods 2,368.3 20.2

Services 4,858.2 41.4

Gross private domestic investment (l) 1,928.11,928.1 16.416.4 % %

Nonresidential 1,198.8 10.2

Residential 673.8 5.7

Change in business inventories 55.4 0.5

Government consumption and gross investment (G)

2,215.92,215.9 18.918.9 % %

Federal 827.6 7.1

State and local 1,388.3 11.8

Net exports (EX – IM) 624.0624.0 5.3%

Exports (EX) 1,173.8 10.0

Imports (IM) 1,797.8 15.3

Gross domestic product (GDP) 11,734.311,734.3 100.0 %Note: Numbers may not add exactly because of rounding.Source: U.S. Department of Commerce, Bureau of Economic Analysis.

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CALCULATING GDP

personal consumption expenditures personal consumption expenditures (C) A major component of GDP: expenditures by consumers on goods and services.

Personal Consumption Expenditures (C)

There are three main categories of consumer expenditures: durable goods, nondurable goods, and durable goods, nondurable goods, and services.services.

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CALCULATING GDP

Durable goods Goods that last a relatively long time, such as carscars, TV set, Refrigerator, TV set, Refrigerator and and other other household appliances.household appliances.

Nondurable goods Goods that are used up fairly quickly, such as food and clothing.food and clothing.

Services The things we buy that do not involve the production of physical things, such as legal and medical services and education.

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CALCULATING GDP

Gross private domestic investment (I) Total investment in capital—that is,the purchase of new housingnew housing, , plantsplants, equipment, and inventory by the private (or nongovernment) sector.

Gross Private Domestic Investment Gross Private Domestic Investment (I)

Nonresidential investment Expenditures by firms for machines, tools, plantsmachines, tools, plants, and so on.

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CALCULATING GDP

Residential investment Expenditures by households and firms on new houses and apartment buildings.

Change in business inventories The amount by which firms’ inventories change during a period. Inventories arethe goods that firms produce now but intend to sell later.

Change in Business Inventories

GDP = final sales + change in business inventories

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CALCULATING GDP

Depreciation The amount by which an asset’s value falls in a given period.

Gross Investment versus Net Investment

Gross investment The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period.

Net investment Gross investment minus depreciation.

capitalend of period = capitalbeginning of period + net investment

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CALCULATING GDP

Government consumption and grossinvestment (G) Expenditures by federal, state, and local governments for final goods and services.

Government Consumption and Gross Investment (G)

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CALCULATING GDP

NNet exports (et exports (EXEX - - IMIM) ) The difference between exports (sales to foreigners of the country - produced

goods and services) and imports (country’s purchases of goods and services from abroad).

The figure can be positive or negative.

Net Exports (Net Exports (EXEX - - IMIM))

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CALCULATING GDP

national income national income The total income earned by the factors of production owned by a country’s citizens.

THE INCOME APPROACHTHE INCOME APPROACH

TABLE 6.3 National Income, 2004

BILLIONS OFDOLLARS

PERCENTAGEOF NATIONAL INCOME

National Income 10,275.9 100.0

Compensation of employees 6,687.6 65.1

Proprietors’ income 889.6 8.7

Corporate profits 134.2 1.3

Net interest 1,161.5 11.3

Rental income 505.5 4.9

Indirect taxes minus subsidies 809.3 7.9

Net business transfer payments 91.1 0.9

Surplus of government enterprises 3.0 0.0

Source: See Table 6.2.

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CALCULATING GDP

Compensation of employees Includes wages, salaries, and various supplements -employer contributions to social insurance and pension funds, for example - paid to households by firms and by the government.

Proprietors’ income The income of unincorporated businesses.

Rental income The income received by property owners in the form of rent.

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CALCULATING GDP

Corporate profits The income of corporate businesses.

Net interest The interest paid by business.

Indirect taxes minus subsidies Taxes such as sales taxes, customs duties, and license fees, less subsidies that the government pays for which it receives no goods or services in return.

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CALCULATING GDP

Net business transfer payments Net transfer payments by businesses toothers.

Surplus of government enterprises Income of government enterprises.

TABLE 6.4 GDP, GNP, NNP and National Income, 2004

DOLLARS(BILLIONS)

GDP 11,734.3

Plus: Receipts of factor income from the rest of the world + 415.4

Less: Payments of factor income to the rest of the world 361.7

Equals: GNP 11,788.0

Less: Depreciation 1,435.3

Equals: Net national product (NNP) 10,352.8

Less: Statistical discrepancy 76.9

Equals: National income 10,275.9


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CALCULATING GDP

Net national product (NNP) Gross national product minus depreciationdepreciation; a nation’s total product minus what is required to maintain the value of its capital stock.

TABLE 6.5 National Income, Personal Income, Disposable Personal Income, and Personal Saving, 2004

DOLLARS(BILLIONS)

National income 10,275.9

Less: Amount of national income not going to households 562.6

Equals: Personal income 9,713.3

Less: Personal income taxes 1,049.1

Equals: Disposable personal income 8,664.2

Personal consumption expenditures 8,214.3

Personal interest payments 186.7

Transfer payments made by households 111.5

Equals: Personal saving 151.8

Personal saving as a percentage of disposable personal income: 1.8%


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CALCULATING GDP

Statistical discrepancy (inconsistency) Data measurement error.

Personal income The total income of households before paying personal income taxes.

Disposable personal income or after-tax income Personal income minus personal income taxes. The amount that households have to spend or save.

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CALCULATING GDP

Personal saving The amount of disposable income that is left after total personal spending in a given period.

Personal saving rate The percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously.

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NOMINAL VERSUS REAL GDP

Current dollars The current prices that one pays for goods and services.

Nominal GDP Gross domestic product measured in current dollars.

Weight The importance attached to an item within a group of items.

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TABLE 6.6 A Three-Good Economy

(1) (2) (3) (4) (5) (6) (7) (8)

GDP IN GDP IN GDP IN GDP IN

YEAR 1 YEAR 2 YEAR 1 YEAR 2

IN IN IN IN

PRODUCTION PRICE PER UNIT YEAR 1 YEAR 1 YEAR 2 YEAR 2

YEAR 1 YEAR 2YEAR 2 YEAR 1 YEAR 2YEAR 2 PRICES PRICES PRICES PRICES

Q1 QQ22 P1 PP22 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2

Good Good AA 6 1111 $.50 $ .40$ .40 $3.00 $5.50$5.50 $2.40 $4.40$4.40

Good Good BB 7 44 .30 1.001.00 2.10 1.201.20 7.00 4.004.00

Good Good CC 10 1212 .70 .90.90 7.00 8.408.40 9.00 10.8010.80

Total $12.10 $15.10$15.10 $18.40 $19.20$19.20

Nominal GDPin year 1

Nominal GDPin year 2

CALCULATING REAL GDP

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Base year The year chosen for the weights in a fixed-weight procedure.

Fixed-weight procedure A procedure that uses weights from a given base year.

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NOMINAL VERSUS REAL GDPNOMINAL VERSUS REAL GDPCALCULATING THE GDP DEFLATOR

The GDP deflator The GDP deflator is one measure of the overall price level. In other words, in order to determine how much prices have changed we can compare the growth rates of nominal GDP and real GDP. nominal GDP and real GDP. This is GDP deflator.

The GDP deflator is computed by the state statistics bureau.

Overall price increases can be sensitive to the choice of the base year.

For this reason, using fixed-price weights to compute real GDP has some problems.

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THE PROBLEMS OF FIXED WEIGHTS

The use of fixed-price weights to estimate real GDP leads to problems because it ignores:

• Structural chStructural changes in the economy.

• Supply shiftsSupply shifts, which cause large decreases in price and large increases in quantity supplied.

• The substitution effect The substitution effect of price increases.

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LIMITATIONS OF THE GDP CONCEPTLIMITATIONS OF THE GDP CONCEPT

GDP AND SOCIAL WELFAREGDP AND SOCIAL WELFARE

Society is better off when crime decreases; however, a decrease in crime is not reflected in GDP.

An increase in leisure is an increase in social welfare, but not counted in GDP.

Nonmarket and household activities are not counted in GDP even though they amount to real production.

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LIMITATIONS OF THE GDP CONCEPT

THE UNDERGROUND ECONOMY

Underground economy The part of the economy in which transactions take place and in which income is generated that is unreported and therefore notcounted in GDP.

Whenever sellers looking for a profit come into contact with buyers willing to pay, markets will arise, often “underground.”

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GROSS NATIONAL INCOME PER CAPITA

Gross National Income (GNI) GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation.

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TABLE 6.7 Per Capita Gross National Income for Selected Countries, 2010 (IMF)

COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS

Qatar 98.870 Australia 40,900Luxembourg 80.260 Italy 30,120Singapore 59.600 Spain 30,210Norway 53,400 Greece 26,610Switzerland 44,452 Portugal 23,350United States 48,328 South Korea 31,980Denmark 37,008 Czech Republic 27,150Japan 34,748 Mexico 14,770Sweden 40,705 Argentina 17,720Ireland 40,838 Turkey 11,750United Kingdom 36,940 South Africa 10,630Finland 35,790 Brazil 11,090Austria 42,500 Romania 12,920Netherlands 42,700 Poland 20,170Belgium 37,030 China 8,390Germany 38,120 Russia 16,740France 35,090 India 3.620Canada 40,390 Ethiopia 1.100

Source: IMF, 2010

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change in business inventoriescompensation of employeescorporate profitscurrent dollarsdepreciationdisposable personal income, or after-

tax incomedurable goodsexpenditure approachfinal goods and servicesfixed-weight proceduregovernment consumption and gross investment (G)gross domestic product (GDP)gross investmentgross national income (GNI)gross national product (GNP) gross private domestic investment (I)income approachintermediate goodsnational income

net exports (EX - IM)net interestnet investmentnet national product (NNP)nominal GDPnondurable goodsnonresidential investmentpersonal consumption expenditures (C)personal incomepersonal savingpersonal saving rateproprietors’ incomerental incomeresidential investmentsurplus of government enterprisesunderground economyvalue addedWeightGDP = final sales - change in business inventoriesNet investment = capital end of period - capital

beginning of period

REVIEW TERMS AND CONCEPTSREVIEW TERMS AND CONCEPTS

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© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Chapter end QuestionsDuring 2002 real GDP in Japan rose about 1.3 %. During the same

period, retail sales in Japan fell 1.8 % in real terms. What are some possible explanations for retail sales to consumers falling when GDP rises (expenditure approach)?

Which of the following transactions would not be counted in GDP? Which of the following transactions would not be counted in GDP? Explain your answer.Explain your answer.

• Toyota motors issues new shares of stock to finance the construction of a plant

• Firm (A) builts a new plant• Company (A) successfully launches a hostile takeover of company

(B), in which it purchases all the assests of company (B).• Your grandmother wins TL 5 million in the lottery• You buy a new copy of textbook.• You buy a used copy of textbook• The Government pays out social security benefits• You spend the weekend cleaning your apartment

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2 National Income