Measuring National Output and National Income: Fernando & Yvonn Quijano

Chapter
19
Measuring National Output and National Income
Prepared by:
Fernando & Yvonn Quijano
2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 19: Measuring National Output and National Income
Measuring National Output and National Income
19
Chapter Outline
Gross Domestic Product Final Goods and Services Exclusion of Used Goods and Paper Transactions Exclusion of Output Produced Abroad by Domestically Owned Factors of Production Calculating GDP The Expenditure Approach The Income Approach Nominal versus Real GDP Calculating Real GDP Calculating the GDP Deflator The Problems of Fixed Weights Limitations of the GDP Concept GDP and Social Welfare The Underground Economy Gross National Income Per Capita
2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 36
MEASURING NATIONAL OUTPUT AND NATIONAL INCOME

National income and Product accounts
Data collected and published by the government describing the various components of national income and output in the economy.
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GROSS DOMESTIC PRODUCT
Gross Domestic Product (GDP)

The total market value of all final goods and services produced within a given period by factors of production located within a country.
GDP is the total market value of a countrys 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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FINAL GOODS AND SERVICES
Final goods and services Goods and services produced for final use.
Intermediate goods Goods that are produced by one firm for use in further processing by another firm. Value 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 to the auto producer. Tires from that pile to replace tires on your old car are considered final goods. If, in calculating GDP, we included the value of the tires (an intermediate good) on new cars and the value of new cars (including the tires), we would be double counting.

TABLE 6.1 Value Added in the Production of a Gallon of Gasoline
(Hypothetical Numbers)
STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED
(1) Oil drilling (2) Refining (3) Shipping
$ 1.00 1.30 1.60
$ 1.00 0.30 0.30
(4) Retail sale

Total value added
2.00
0.40
$ 2.00
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.

EXCLUSION OF USED GOODS AND PAPER TRANSACTIONS
GDP is concerned only with new, or current, production.

GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.
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EXCLUSION OF OUTPUT PRODUCED ABROAD BY DOMESTICALLY OWNED FACTORS OF PRODUCTION GDP is the value of output produced by factors of production located within a country.
Gross National Product (GNP) The total market value of all final goods and services produced within a given period by factors of production owned by acountrys citizens, regardless of where the output is produced.
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CALCULATING GDP
Expenditure approach A method of computing GDP that measures the amount spent on all final goods during a given period. Income approach A method of computing GDP that measures the income - wages, rents, interest, and profits - received by all factors of production in producing final goods.
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CALCULATING GDP
THE EXPENDITURE APPROACH There are four main categories of expenditure: Expenditure Categories: Personal consumption expenditures (C): household spending on consumer goods Gross private domestic investment (I): spending by firms and households on new capital, i.e., plant, equipment, inventory, and new residential structures Government consumption and gross investment (G) Net exports (EX - IM): net spending by the rest of the world, or exports (EX) minus imports (IM)
GDP = C + I + G + (EX - IM)
CALCULATING GDP
TABLE 6.2 Components of U.S. GDP, 2004: The Expenditure Approach
BILLIONS OF DOLLARS PERCENTAGE OF GDP
Personal consumption expenditures (C) Durable goods Nondurable goods Services Gross private domestic investment (l) Nonresidential Residential Change in business inventories Government consumption and gross investment (G) Federal State and local Net exports (EX IM) Exports (EX)
8,214.3 987.8 2,368.3 4,858.2 1,928.1 1,198.8 673.8 55.4 2,215.9 827.6 1,388.3 -624.0 1,173.8
70.0 % 8.4 20.2 41.4 16.4 % 10.2 5.7 0.5 18.9 % 7.1 11.8 - 5.3% 10.0
Imports (IM) Gross domestic product (GDP)

Note: Numbers may not add exactly because of rounding. Source: U.S. Department of Commerce, Bureau of Economic Analysis.
1,797.8
11,734.3 100.0 %
15.3
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CALCULATING GDP
Personal Consumption Expenditures (C) personal consumption expenditures (C) A major component of GDP: expenditures by consumers on goods and services.
There are three main categories of consumer expenditures: durable goods, nondurable goods, and services.
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CALCULATING GDP
Durable goods Goods that last a relatively long time, such as cars, TV set, Refrigerator and other household appliances. Nondurable goods Goods that are used up fairly quickly, such as 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) Gross private domestic investment (I) Total investment in capitalthat is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector. Nonresidential investment Expenditures by firms for machines, 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
Change in business inventories The amount by which firms inventories change during a period. Inventories are the goods that firms produce now but intend to sell later.
GDP = final sales + change in business inventories
CALCULATING GDP
CHAPTER 19: Measuring National Output and National Income Gross Investment versus Net Investment
Depreciation The amount by which an assets value falls in a given period.

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
CALCULATING GDP
Government Consumption and Gross Investment (G) Government consumption and gross investment (G) Expenditures by federal, state, and local governments for final goods and services.
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CALCULATING GDP
Net Exports (EX - IM)

Net exports (EX - IM) The difference between exports (sales to foreigners of the country - produced goods and services) and imports (countrys purchases of goods and services from abroad).
The figure can be positive or negative.
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CALCULATING GDP
THE INCOME APPROACH national income The total income earned by the factors of production owned by a countrys citizens.
TABLE 6.3 National Income, 2004
BILLIONS OF DOLLARS PERCENTAGE OF NATIONAL INCOME
National Income Compensation of employees Proprietors income Corporate profits Net interest Rental income
10,275.9 6,687.6 889.6 134.2 1,161.5 505.5 809.3 91.1 -3.0
100.0 65.1 8.7 1.3 11.3 4.9 7.9 0.9 -0.0
Indirect taxes minus subsidies

Net business transfer payments Surplus of government enterprises
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 to others. Surplus of government enterprises Income of government enterprises.
TABLE 6.4 GDP, GNP, NNP and National Income, 2004
DOLLARS (BILLIONS) 11,734.3 + 415.4 - 361.7 11,788.0 - 1,435.3 10,352.8 - 76.9 10,275.9 23 of 36
GDP
Plus: Receipts of factor income from the rest of the world Less: Payments of factor income to the rest of the world
Equals: GNP
Less: Depreciation
Equals: Net national product (NNP)

Less: Statistical discrepancy
Equals: National income

CALCULATING GDP
Net national product (NNP) Gross national product minus depreciation; a nations 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) 10,275.9 - 562.6 9,713.3 - 1,049.1 8,664.2 - 8,214.3 -186.7 -111.5 151.8 1.8%
National income Less: Amount of national income not going to households Equals: Personal income Less: Personal income taxes Equals: Disposable personal income Personal consumption expenditures Personal interest payments Transfer payments made by households Equals: Personal saving Personal saving as a percentage of disposable personal income:
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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 aftertax 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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CALCULATING REAL GDP

TABLE 6.6 A Three-Good Economy
(1) (2) (3) (4) (5)
GDP IN YEAR 1 IN PRODUCTION PRICE PER UNIT YEAR 1
(6)
GDP IN YEAR 2 IN YEAR 1
(7)
(8)
YEAR 1 Q1
YEAR 2 Q2
YEAR 1 P1
YEAR 2 P2
PRICES P1 x Q1
PRICES P1 x Q2
PRICES P2 x Q1
PRICES P2 X Q2
Good A
Good B Good C
6
7 10
11
4 12
$.50
.30 .70
$ .40
1.00 .90
$3.00
2.10 7.00 $12.10
Nominal GDP in year 1
$5.50
1.20 8.40 $15.10
$2.40
7.00 9.00 $18.40
$4.40
4.00 10.80 $19.20
Nominal GDP in year 2
Total
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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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CALCULATING 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. 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.

THE PROBLEMS OF FIXED WEIGHTS The use of fixed-price weights to estimate real GDP leads to problems because it ignores: Structural changes in the economy. Supply shifts, which cause large decreases in price and large increases in quantity supplied.
The substitution effect of price increases.
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LIMITATIONS OF THE GDP CONCEPT

GDP 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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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 not counted in GDP.
Whenever sellers looking for a profit come into contact with buyers willing to pay, markets will arise, often underground.

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 Luxembourg Singapore Norway Switzerland United States Denmark Japan Sweden Ireland United Kingdom Finland Austria Netherlands Belgium Germany France Canada
Source: IMF, 2010
98.870 80.260 59.600 53,400 44,452 48,328 37,008 34,748 40,705 40,838 36,940 35,790 42,500 42,700 37,030 38,120 35,090 40,390
Australia Italy Spain Greece Portugal South Korea Czech Republic Mexico Argentina Turkey South Africa Brazil Romania Poland China Russia India Ethiopia
40,900 30,120 30,210 26,610 23,350 31,980 27,150 14,770 17,720 11,750 10,630 11,090 12,920 20,170 8,390 16,740 3.620 1.100
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REVIEW TERMS AND CONCEPTS

change in business inventories compensation of employees corporate profits current dollars depreciation disposable personal income, or aftertax income durable goods expenditure approach final goods and services fixed-weight procedure government consumption and gross investment (G) gross domestic product (GDP) gross investment gross national income (GNI) gross national product (GNP) gross private domestic investment (I) income approach intermediate goods national income
net exports (EX - IM) net interest net investment net national product (NNP) nominal GDP nondurable goods nonresidential investment personal consumption expenditures ( C) personal income personal saving personal saving rate proprietors income rental income residential investment surplus of government enterprises underground economy value added Weight GDP = final sales - change in business inventories Net investment = capital end of period - capital beginning of period
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Chapter end Questions

During 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? 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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Fernando & Yvonn Quijano

CHAPTER 19: Measuring National Output and National Income