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Chapter 20. The Measurement of National Income. In this chapter you will learn to. 1. Use the concept of value added to solve the problem of “double counting” when measuring national income. 2. Describe the income approach and the expenditure approach to measuring national income.
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Chapter 20 The Measurement of National Income
In this chapter you will learn to 1. Use the concept of value added to solve the problem of “double counting” when measuring national income. 2. Describe the income approach and the expenditure approach to measuring national income. 3. Explain the difference between real and nominal GDP and the meaning of the GDP deflator. 4. Describe the important omissions from official measures of GDP. 5. Explain why real per capita GDP is a good measure of average “material” living standards but an incomplete measure of overall “well-being.”
National Output and Value Added Production occurs in stages — most firms produce outputs that are other firms’ inputs - intermediate products - final products Each firm’s contribution to total output is its value added = revenues – cost of intermediate goods = income to factors of production
National Output and Value Added Intermediate goods: Outputs that are used as inputs by other producers in a further stage of production. Final goods: Goods that are not used as inputs by other firms but are produced to be sold for consumption, investment, government, or exports. Value added: The value of a firm’s output minus the value of the inputs that it purchases from other firms
Gross Domestic Product Summing value added avoids the problem of double counting when measuring total output. Total value added in the economy is called Gross Domestic Product(GDP). APPLYING ECONOMIC CONCEPTS 20.1 Value Added Through Stages of Production
National Income Accounting: The Basics Three methods for measuring national income (output): • total value added from domestic production • total expenditureson domestic output • total income generated by domestic production Because of the circular flow of income, these three measures yield the same total — GDP.
GDP from the Expenditure Side Consider adding up the expenditures needed to purchase the final output produced in any given year. There are four broad expenditure categories: - consumption - investment - government purchases - net exports
GDP from the Expenditure Side Actual consumption expenditure (Ca)includes expenditure on all final goods during the year. • Actual investment expenditure (Ia) is expenditure on the production of goods not for present consumption, including: • inventories • plant and equipment • residential housing
GDP from the Expenditure Side • Actual government purchases (Ga) are the purchases of currently produced goods and services by the government • only purchases of goods and services count, so that • a great deal of government “expenditure” does not count • excluding transfer payments • Actual net exports (NXa) is the difference between exports and imports: NXa = (Xa - IMa) • exports are purchases of U.S.-produced goods and services by foreigners. • imports are subtracted because they are not produced in the U.S.
Total Expenditures Since total domestic output must equal total expenditure on domestic output, we have: GDP = Ca + Ia + Ga + NXa
GDP from the Income Side GDP is also the sum of factor incomes and other claims on the value of output. Factor incomes include: - wages - rent, interest,andprofits net domestic income Nonfactor payments include: - indirect taxes (net of subsidies) - depreciation of existing physical capital
GDP from the Income Side GDP from the income side is therefore equal to: GDP = Net domestic income + Indirect taxes (less subsidies) + Depreciation EXTENSIONS IN THEORY 20.1 Arbitrary Decisions in National Income Accounting
National Income Accounting: Some Further Issues GDP and GNP A measure of national output closely related to GDP is Gross National Product(GNP). The difference between GDP and GNP is the difference between income produced and income received.
National Income Accounting: Some Further Issues GDP is superior as a measure of domestic economic activity. GNP is superior as a measure of living standards of residents. A more “refined” measure is disposable personal income: It equals GNP minus: - any part not actually paid to households - personal income taxes - plus transfer payments received by households
Real and Nominal GDP GDP that is valued at constant (base-period) dollars is real national income. Nominal GDP GDP Deflator = x 100 Real GDP The GDP deflator is a very comprehensive index of prices because it includes the prices of all goods and services produced in the country.
Real and Nominal GDP Do the CPI and the GDP Deflator Move Together? Broadly, the two price indexes move together, due to underlying inflationary forces. But because one tracks consumer prices and the other tracks the prices of goods produced in the country, there will be some differences. APPLYING ECONOMIC CONCEPTS 20.2 Calculating Nominal and Real GDP
Table 20.3 Nominal and Real GDP: Selected Years (billions of dollars)
Omissions from GDP National income accountants cannot measure economic activity that takes place outside of regular, legal markets: • illegal activities • leisure • the underground economy • Nonmarket activities • economic “bads”
GDP and Living Standards Unless the unmeasured economic activity changes rapidly, changes in GDP will do a reasonable job of measuring changes in material living standards. “Well-being” is a broader concept than material living standards: - GDP is not a complete measure of economic well- being - but income is a very important part of well-being and GDP is a good measure of income.
Table 20.5 Value of Production Using Current Year Prices: Nominal GDP
Table 20.6 Value of Production Using Year 1 Prices: Traditional Real GDP
Table 20.7 An Alternative Traditional Measure: Real GDP Based on Year 2 Prices
