# Methods of Measuring the National Income - PowerPoint

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```					     ECON2301 - Principles of
Macroeconomics

Instructor: Patrick M. Crowley

Lecture 8 – Measuring the Economy’s
Performance

1
Chapter Outline
   The Simple Circular Flow
   National Income Accounting
   Two Main Methods of Measuring GDP
   Other Components of National
Income Accounting
   Distinguishing Between Nominal and
Real Values
   Comparing GDP Throughout the World

2
The Simple Circular Flow
   Two observations
1.   In every economic exchange, the seller receives
exactly the same amount that the buyer spends.
2.   Goods and services flow in one direction and money
payments flow in the other.

   Understanding these two observations lies
behind how we construct our nation’s accounts.
   Every market-based economy in the world
constructs it’s national accounts in a similar
manner.
3
Figure 8-1 The Circular Flow
of Income and Product

4
The Simple Circular Flow (cont'd)
   Product Markets
   Transactions in which households buy goods

5
The Simple Circular Flow (cont'd)
   Factor Markets

6
The Simple Circular Flow (cont'd)
   Total Income
   Wages, rent, interest, profits

7
The Simple Circular Flow (cont'd)
   Question
   Why must total
income be identical
to the dollar value of
total output?
   Every transaction
simultaneously
involves an
expenditure and
a receipt.

8
National Income Accounting
   National Income Accounting
   A measurement system used to estimate national income
and its components

   Total Income
   The yearly amount earned by the nation’s resources (factors
of production)
   National income accounting identity:
Value of (new) production ≡ total income ≡ total expenditures

9
National Income Accounting (cont'd)
Defn: Gross Domestic Product (GDP) =
The total market value of all final goods and
services produced by factors of production
located within a nation’s borders in a given
period of time
   Observations
   Has to go through a market
   Final, not intermediate goods
   Goods produced abroad not counted in GDP
10
National Income Accounting (cont'd)

   Stress on final output
   What is a final good?
   Wheat?
   Steel?
   Oil?
   Automobile?
   Gasoline?
National Income Accounting (cont'd)
   Intermediate Goods
   Goods used up entirely in the production of final
goods

   The dollar value of an industry’s sales minus the
value of intermediate goods (for example, raw
materials and parts) used in production

12
Table 8-1 Sales Value and Value Added at
Each Stage of Donut Production

13
National Income Accounting (cont'd)
   Exclusion of financial transactions, transfer
payments, and secondhand goods
   Numerous transactions occur that have nothing to do
with final goods and services being produced.

   Note we exclude anything produced abroad as our
factors of production didn’t get paid any income for
producing it
   But we include all US exports as even though we
don’t consume these, our factors of production get
paid for producing them
   We exclude any work that doesn’t go through a legal       14
market (e.g. charity work, homemaker work in the
house, black market activities)
International Example: Greece Pays a Price for

 Greece’s government recently announced that its
official tabulation of GDP would include
production in black market industries.
 Consequently, GDP rose by about 25% for every
year since 2000, which reduces the amount of EU
payments Greece is eligible for by almost \$600
million annually.
 Why is it harder now to compare Greek GDP to
the levels of other nations?
National Income Accounting (cont'd)
   GDP’s limitations
   Excludes non-market production
   It is not necessarily a good measure of the well-being
of a nation.

   GDP is a measure of the value of production in
terms of market prices, and an indicator of
economic activity.
   GDP is not a measure of a nation’s overall
welfare.
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Two Main Methods
of Measuring GDP
   From national income accounting identity, we
can either value our production (output) in terms
of spending (expenditure approach) or in terms of
income (income approach)
   Expenditure approach
   Computing GDP by adding up the dollar value at
current market prices of all final goods and services
purchased

   Expenditure approach is simpler than income
approach, but considered less accurate
17
Two Main Methods
of Measuring GDP (cont'd)

Expenditure Approach   18
Two Main Methods
of Measuring GDP (cont'd)

Income Approach

19
Two Main Methods
of Measuring GDP (cont'd)
   Deriving GDP by the expenditure approach

   Consumption Expenditure (C)
   Durable Consumer Goods
   Life span of more than three years
   Nondurable Consumer Goods
   Goods that are used up in three years
   Services
   e.g. doctors, dentists, lawyers, real estate
agents, private tuition                        20
Two Main Methods
of Measuring GDP (cont'd)
   Gross Private Domestic Investment (I)
   The creation of capital goods, such as factories and
machines, that can yield production and hence consumption
in the future
   Also included: changes in business inventories and
repairs made to machines, new buildings
   Capital Goods
   Life span of more than three years – used to
make/produce something else
   Fixed Investment
   Purchases by business of newly produced producer
durables or capital goods
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   Inventory Investment
   Changes in stocks of finished goods and goods in process
Two Main Methods
of Measuring GDP (cont'd)
   Deriving GDP by the
expenditure approach
   Government Expenditures (G)
   State, local, and federal current and capital spending
   Valued at cost
   Deriving GDP by the
expenditure approach
   Net Exports (Foreign Expenditures)

Net exports (NX) = Total exports – Total imports
22
Two Main Methods
of Measuring GDP (cont'd)
   Presenting the expenditure approach
   Where
   C   = consumption expenditures
   I   = investment expenditures
   G   = government expenditures
   X   = exports
   M   =   imports

GDP = C + I + G + X-M
23
Figure 8-2
GDP and Its Components

24
Two Main Methods
of Measuring GDP (cont'd)
   Depreciation and net domestic product
   Deducting for depreciation (capital consumption
allowance)
   Reduction in the value of capital goods over a one-year
period due to physical wear and tear, and also to
obsolescence

NDP = GDP – Depreciation
25
Figure 8-3 Gross Domestic Product and Gross
Domestic Income, 2009 (in billions of 2009 dollars
per year)

Sources: U.S. Department of Commerce and author’s estimates.
Figure 8-3 Gross Domestic Product and Gross
Domestic Income, 2009 (in billions of 2009 dollars
per year)

Sources: U.S. Department of Commerce and author’s estimates.
Other Components of
National Income Accounting
   National Income (NI)
   The total of all factor payments to resource owners

   Personal Income (PI)
   The amount of income that households actually
receive before they pay personal income taxes

   Disposable Personal Income (DPI)
   Personal income after personal income taxes have
been paid

28
Distinguishing Between Nominal
and Real Values
   Nominal Values
   Measurements in terms of the actual market prices
at which goods are sold; expressed in current dollars,
also called money values
   Real Values
changes in the average of prices between years;
expressed in constant dollars

   Constant Dollars
   Dollars expressed in terms of real purchasing power
29
Example: Correcting GDP
for Price Index Changes
   Correcting GDP for price index changes
   Nominal (current) dollars GDP
   Real (constant) dollars GDP

Nominal GDP
Real GDP =               x 100
Price level*
*Price level: measured by the GDP deflator

30
Table 8-3 Correcting GDP for Price
Index Changes
Distinguishing Between Nominal
and Real Values (cont'd)
   Per capita GDP

Real GDP
Per capita real GDP =
Population

32
Figure 8-4 Nominal and Real GDP

Source: U.S. Department of Commerce
Comparing GDP throughout the world
   Foreign Exchange Rate
   The price of one currency in terms
of another

   Foreign exchange rate
   \$1.25 = 1 euro, or \$1 = 0.80 euros
   French per capita income = 23,168.80 euros
   French per capita income in terms of dollars equals
23,168.80 euros x \$1.25 = \$28,961

   Adjustments in exchange rate conversions that takes
into account differences in the true cost of living       34
across countries
Table 8-4 Comparing GDP
Internationally
Comparisons of World Incomes

 The International Monetary Fund accepted the
purchasing power parity approach a few years
ago.
 It started presenting the statistics on each
country’s GDP relative to others and based on the
purchasing power parity relative to the dollar.
 Why is China’s per capita GDP higher based on
Issues and Applications: The Art of Estimating
GDP often Requires Touch-Ups
   The Bureau of Economic Analysis gives an advance
estimate of quarterly GDP.
   The estimate receives considerable attention from the news
media.
   Nevertheless, the estimate is updated at least two times.
   How different is the final result?

37
Figure 8-5 Effects of Revisions
in GDP Estimates on Measured
GDP Growth Rates

38
Issues and Applications: QoQ or YoY?

Purple plot is   20.0
real GDP
change on        15.0

QoQ basis,       10.0
and blue line
is real GDP       5.0

change on
0.0
YoY basis.               1947   1954   1961   1968   1975   1982   1989   1996   2003

Which is more     -5.0

volatile?
-10.0

39
-15.0
Summary
   The circular flow of income and output
   National income accounting identity
   Gross domestic product (GDP)
   Expenditure vs income method
   Distinguishing between nominal GDP and real GDP
   Limitations of GDP
   Foreign exchange rates
   International comparisons of GDP
   Revisions and different ways of measuring growth

40

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