Measuring National Income

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					National Income Accounting

  Principles of Macroeconomics
         Professor Dalton
            ECON 201
      Boise State University
  National Income Accounting

§ National income accounting – a set of
  rules and definitions for measuring
  economic activity in the aggregate
  economy – that is, in the economy as a
§ National income accounting is a way of
  measuring total, or aggregate production.
        The National Income
        Accounting Identity
§ The equality of output and income is an
  accounting identity in the national income
§ The identity can be seen in the circular flow of
  income in an economy: for an economy as a
  whole, income must equal expenditure.
§ Supply and demand determine the market
  equilibrium price and quantity that is produced
  and exchanged in each market.
The Circular-Flow Diagram

             Product Markets
      $                             $

Households                     Businesses

      $                         $
              Factor Markets
The Circular-Flow Diagram

             Product Markets
      $                             $

Households                     Businesses

      $                         $
              Factor Markets
        The Economy’s
    Income and Expenditure

§ A measure of the income and
  expenditures of an economy is Gross
 Domestic Product (GDP).
§ Gross Domestic Product measures:
  • an economy’s total expenditure on newly
    produced goods and services or the total
    income earned from the production of these
    goods and services.
Gross Domestic Product

           § The total market
             value of all final
             goods and services
             produced during a
             given period of
             time within a
Gross National Product

           § The total market
             value of all final
             goods and services
             produced during a
             given period of
             time by a nation’s
             regardless of the
             place produced.
           Measuring Output

§ GDP is output produced within a country’s
  borders, while GNP is output produced by a
  country’s citizens.
§ The difference between GDP and GNP is net
  foreign factor income (GNP = GDP + NFFI).
  • Net foreign factor income = income from foreign
    sources of domestic factors minus income from
    domestic sources of foreign factors (foreign income
    of our citizens minus income earned in U.S. by non-
             GDP v. Wealth

§ GDP is a flow – a quantity during a certain
  time period; reported quarterly on an
  annualized basis.
§ Wealth is a stock – a quantity measured
  at a point in time.
  • Wealth accounts – balance sheet of an
    economy’s stocks of assets and liabilities.
   Important Features of GDP

§ Output is valued at market determined
  prices; Output is measured in dollar
§ GDP records only the output of final
  goods. We want to count “production”
  only once.
    What Is and What Is Not
       Counted in GDP?

§ GDP includes all items produced in the
  economy and sold legally in markets.
§ GDP does not include items produced and
  consumed at home and never enter the
§ GDP does not include items produced and
  sold illicitly, such as illegal drugs.
  GDP Measures Final Output

§ GDP does not measure total transactions
  in the economy.
  • It counts final output but not intermediate
  • Counting the sale of final goods and
    intermediate products would result in double
    and triple counting.
            Calculating GDP

§ Calculating GDP:
  • All goods and services produced by an
    economy must be weighted; each good and
    service is multiplied by its price. Once
    quantities of a particular good or service are
    multiplied by its price, we arrive at a value
    measure of the good or service. All the units
    of value are added to arrive at GDP.
   Calculating GDP: Examples

§ Selling a stock or bond does not add to GDP;
  The stock broker's commission from the sales
  does add to GDP.
§ Social security payments, welfare payments,
  and veterans' benefits are not included in GDP;
  Only the cost of transferring is included in GDP.
§ The work of unpaid house-spouses does not
  appear in GDP calculations; GDP only measures
  market activities so unpaid value added is not
  included in GDP.
  Two Methods of Computing
    An Economy’s Income

§ Expenditure Approach :
  • Sum the total expenditures by households
    (from the top portion of the circular flow).
§ Income Approach :
  • Sum the total wages and profit paid by firms
    for resources (from the bottom portion of the
    circular flow).
The Circular-Flow Diagram

             Product Markets
      $                             $

Households                     Businesses

      $                         $
              Factor Markets
   The Expenditure Approach

§ The expenditure approach measures the
  expenditures in product markets.
§ GDP is equal to the sum of the four
  categories of expenditures.

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

§ Consumption (C) :
  • Is the spending by on goods and services
    § e.g. buying clothing, food, movie tickets
§ Investment (I) :
  • Is the purchases of capital equipment and
    § e.g. factories, houses, etc.

§ When individuals receive income, they can
  spend it on domestic goods, save it, pay taxes,
  or buy foreign goods.
§ Personal consumption expenditures –
  payments by households for goods and services.
§ Consumption is the largest and most important
  of the flows.
§ It is also the most obvious way in which income
  received is returned to firms.

§ The portion of income that individuals save
  leaves the income stream and goes into
  financial markets; in financial markets,
  businesses acquire resources for investment.
§ Gross private investment – business
  spending on equipment, structures, and
  • Depreciation – the decrease in an asset's value due
    to it wearing out.
  • Net private investment – gross private investment
    minus depreciation.
        Components of GDP

§ Government Purchases (G) :
  • Includes spending on goods and services by
    local, state and federal governments (e.g.
    roads, police, etc.).
  • Does not include transfer payments.
§ Net Exports (NX) or (X – M ) :
  • Exports minus imports.

§ Taxes are either spent by government on goods
  and services or are returned to individuals in the
  form of transfer payments.
§ Government consumption expenditures
  and gross investment – government
  payments for goods and services or investment
  in equipment and structures.
§ If the government runs a deficit, it must borrow
  from financial markets to make up the
  difference, competing with businesses for saving
  of households.
               Net Exports

§ Spending on imports are subtracted from total
  expenditures because spending on imports
  “leaks from the system” and does not add to
  domestic production.
§ Exports to foreign nations are added to total
  expenditures because spending on exports is
  “injected into the system” and adds to domestic
§ These two flows are usually combined into net
           GDP by Expenditures

    Consumption                                 $8,282.5
    Investment                                  $1,947.0
    Government Purchases                        $2,197.2
    Plus Exports                                $1,189.5
    Minus Imports                               $1,801.2
    GDP                                        $11,814.9
2004:3 Current Dollar GDP (Billions) For updated information, contact
   FRED or the Bureau of Economic Analysis.
 The Relative Size
of GDP Components

                               Net Exports -5.2%
   Investment     18.6%

           Consumption 70.1%

                                    2004:3 GDP
      The Income Approach

§ The income approach measures the factor
  payments by businesses in factor markets.
§ National income (NI) is the total
  income earned by households; employee
  compensation, rent, interest, and profits.

       GDP = w + r + i + π
The Circular-Flow Diagram

             Product Markets
      $                             $

Households                     Businesses

      $                         $
              Factor Markets
Components of National Income

§ Employee compensation (w) consists of
  payments for labor such as salaries and wages.
§ Rent (r) consists of payments for use of land
  and buildings.
§ Interest (i) includes payments for loans by
  households to firms.
§ Profits (π) are payments to the owners of
Components of National Income

Actual national income accounts are:
  Compensation of Employees
  Proprietor’s Income
  Rental Income
  Corporate Profits
  Net Interest and miscellaneous
      Expenditure = Income

§ Income and expenditures must be equal
  because of the rules of double-entry
  bookkeeping. Profit is the balancing item.
§ To go from GDP to national income:
  • GDP + net foreign factor income = GNP
  • GNP – minus depreciation – indirect business
    taxes = National Income
Expenditure = Income

                       Net foreign               Depreciation
                     factor income
 Net exports                               Indirect business taxes
Government                                          Rents
               GDP                                               National
Consumption                                                      Income


    (1)                 (2)                         (3)
Expenditures    =      Output        =            Income
                  GDP by Incomes
                            (and adjustments)

Wages & Salaries                                         $ 6,657.4
Rent                                                     $    153.8
Interest                                                 $    546.7
Profits & Proprietor’s Income                            $ 2,020.9
= National Income                                        $ 9,378.8
Plus Depreciation                                        $ 1,497.9
Plus Indirect Business Taxes                             $    885.9
Minus Net Foreign Factor Income                          $     38.2
(Plus Statistical Discrepancy)                           $     90.4
= GDP                                                    $ 11,814.9
2004:3 Current Dollar GDP (Billions) For updated information, contact FRED or
    the Bureau of Economic Analysis.
               Relative Size of National
                Income Components
                Corporate Profits = 11.9%
                                              Net Interest = 5.8%
Rental Income = 1.6%

Income =

                                     Wages and Salaries = 71.0%

                                                                    2004:3 GDP
    Real versus Nominal GDP

§ GDP is the market value of the economy’s
  current production, referred to as
  Nominal GDP.
§ Real GDP measures any given year’s
  total output in “constant” prices.
§ An accurate view of the economy requires
  adjusting nominal to real GDP, using the
  GDP Price Deflator.
         GDP Price Deflator

§ The GDP Price Deflator is a price index
  that uses a bundle of all final goods and
  • The GDP Price Deflator tells us the rise in
    nominal GDP that is attributable to a rise in
      Real and Nominal GDP

§ Real GDP is arrived at by dividing nominal
  GDP by the GDP deflator.

  Real GDP =      Nominal GDP x 100
                  GDP Deflator
          Real and Nominal GDP

               1998                       2004
        Price Quantity $ Value   Price   Quantity   $ Value
CD’s    $15    1,000   $15,000   $30      1,300     $39,000
Tapes    $5    2,000   $10,000   $10      2,600     $26,000

Nominal GDP            $25,000                      $65,000
          Real and Nominal GDP

               1998                        2004
        Price Quantity $ Value    Price   Quantity   $ Value
CD’s    $15    1,000   $15,000   $30$15    1,300 $39,000$19,500
Tapes    $5    2,000   $10,000   $10$5     2,600 $26,000$13,000

Nominal GDP            $25,000                    $65,000$32,500
      Limitations of National
        Income Accounting

§ Limitations of national income accounting
  include the following:
  • Measurement problems exist.
  • GDP measures economic activity, not welfare.
  • Subcategories are often interdependent.
         GDP and Well-Being

§ GDP per person (GDP per capita) tells us
  the income of the average person in the
  • It is a good measure of the material well-being of the
    economy as a whole.
  • More real GDP means being able to consume more
    goods and services.
  • It is not intended to be a measure of happiness or
    quality of life.
        GDP and Well-Being

§ Some factors and issues not in GDP that
  lead to the “well-being” of the economy:
  • Factors that contribute to a good life such as
  • Factors that lead to a quality environment.
  • The value of almost all activity that takes
    place outside of organized markets, e.g.
    volunteer work and child-rearing.
GDP Measures Market Activity

§ GDP does not measure happiness, nor
  does it measure economic welfare.
§ Welfare is a complicated idea, very
  difficult to measure.
        Measurement Errors

§ GDP figures leave out the following:
  • Illegal drug sales.
  • Under-the-counter sales of goods to avoid
    income and sales taxes.
  • Work performed and paid for in cash.
  • Unreported sales.
  • Prostitution, loan sharking, extortion, and
    other illegal activities.
        Measurement Errors

§ A second type of measurement error
  occurs in adjusting GDP for inflation.
  • If the price and the quality of a product go up
    together, has the price really gone up?
  • Is it possible to measure the value of quality
  Other Measures of Income

§ Net domestic product (NDP )
 • GDP minus depreciation (capital consumption
§ Net National Product (NNP)
 • GNP minus depreciation.
   Other Measures of Income

§ Personal income (PI)
  • national income plus net transfer payments
    from government minus amounts attributed
    but not received.

PI = NI + Transfer payments from government
     + Net non-business interest income
     – Corporate retained earnings
     – Social security taxes
   Other Measures of Income

§ Disposable personal income (DPI)
  • personal income minus personal income taxes
    and payroll taxes.
§ Disposable personal income is what
  people have readily available to spend.
         DPI = PI - Personal taxes

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