6 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business...

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Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijano and Yvonn Quijano

© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair

Measuring National Output and National Income

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2 of 38© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair

Gross Domestic Product (GDP)

• Is the most important concept in macroeconomics, because it measure the total value of goods and services produced in the country.

• GDP is part of the national income and product accounts or national account.

• GDP is useful in determining whether the economy is expanding or contracting. GDP give an overall picture of the state of the economy.

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Gross Domestic Product

• What is the GDP?

• (GDP) is the total market value of all final goods and services produced within a nation during a given year, by factors of production located within a country.

• Therefore GDP is very important in measuring the overall performance of the economy.

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National Incomeand Product Accounts

• National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy.

• The U.S. Department of Commerce is responsible for producing and maintaining the “National Income and Product Accounts” that keep track of GDP.

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Tow measures of national product

How do economist measure GDP?

GDP can be measured in two entirely independent ways.

• The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period.

• National accountants use market prices as weights in valuing different commodities because market prices reflect the relative economic of diverse goods and services.

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The Expenditure Approach

Expenditure categories:

• Personal consumption expenditures (C)—household spending on consumer goods.

• Gross private domestic investment (I)—spending by firms and households on new capital: plant, equipment, inventory, and new residential structures.

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• Government consumption and gross investment (G)

Expenditure categories:

• Net exports (EX – IM)—net spending by the rest of the world, or exports (EX) minus imports (IM)

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• The expenditure approach calculates GDP by adding together the four components of spending. In equation form:

GDP C I G EX IM ( )

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Components of GDP, 1999:The Expenditure Approach

Components of GDP, 2002: The Expenditure ApproachBILLIONS OF

DOLLARSPERCENTAGE

OF GDPPersonal consumption expenditures (C) 7303.7 69.9

Durable goods 871.9 8.3Nondurable goods 2115.0 20.2Services 4316.8 41.3

Gross private domestic investment (l) 1543.2 14.8Nonresidential 1117.4 10.7Residential 471.9 4.5Change in business inventories 3.9 0

Government consumption and gross investment (G) 1972.9 18.9Federal 693.7 6.6State and local 1279.2 12.2

Net exports (EX – IM) 423.6 4.1Exports (EX) 1014.9 9.8Imports (IM) 1438.5 13.8

Total gross domestic product (GDP) 10446.2 100.0Note: Numbers may not add exactly because of rounding.Source: U.S. Department of Commerce, Bureau of Economic Analysis.

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Personal Consumption Expenditures

• Personal consumption expenditures (C) are expenditures by consumers on the following:

• Durable goods: Goods that last a relatively long time, such as cars and appliances.

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

• Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

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Gross Private Domestic Investment

• Investment refers to the purchase of new capital.

• Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector.

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Gross Private Domestic Investment

• Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on.

• Residential investment includes expenditures by households and firms on new houses and apartment buildings.

• Remember that GDP is not the market value of total sales during a period—it is the market value of total production.

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Gross Investmentversus Net Investment

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

• Depreciation is the amount by which an asset’s value falls in a given period.

• Net investment equals gross investment minus depreciation.

capitalend of period = capitalbeginning of period + net investment

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Government Consumptionand Gross Investment

• Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

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Net Exports

• Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative.

• Exports (EX) are sales to foreigners of U.S.-produced goods and services.

• Imports (IM) are U.S. purchases of goods and services from abroad).

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The Income or cost Approach

•The 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.

•National income is the total income earned by factors of production owned by a country's citizens.

GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other

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Who Gets the Income?

• The income that flows to the private The income that flows to the private sector is the sector is the national incomenational income which which is the net national product less is the net national product less indirect taxes.indirect taxes.

• To measure national income, To measure national income, economists must make three economists must make three adjustments to gross domestic adjustments to gross domestic product (GDP).product (GDP).

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Who Gets the Income?

• The three adjustments to GDP are as follows:The three adjustments to GDP are as follows:

• Add the net income earned by U.S. firms Add the net income earned by U.S. firms and residents abroad; subtract income and residents abroad; subtract income earned in the U.S. by foreign firms to arrive earned in the U.S. by foreign firms to arrive at at gross national product (GNP)gross national product (GNP)..

• Subtract depreciation from GNP to arrive at Subtract depreciation from GNP to arrive at net national product (NNP)net national product (NNP). .

• Subtract Subtract indirect taxesindirect taxes, which are sales , which are sales taxes on products to arrive at national taxes on products to arrive at national income (NI).income (NI).

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The Income Approach

Components of GDP, 2002: The Income Approach

BILLIONS OFDOLLARS

PERCENTAGEOF GDP

National income 8,199.9 80.3Compensation of employees 6,010.0 58.9

Proprietors’ income 943.5 7.3

Corporate profits 748.9 7.3

Net interest 554.8 5.4

Rental income 142.7 1.4

Depreciation 1,351.3 13.2

Indirect taxes minus subsidies 739.4 7.2

Net factor payments to the rest of the world 11.1 0.1

Other 96.1 0.9

Gross domestic product 10,205.6 100.0Source: See Table 18.2.

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Final Goods and Services

• A final product is one that is sold for consumption purposes or is an investment good. The point here is that the product is not changed or modified and sold again to someone else. The product has reached its final stage and is now being used either as a consumption good or a piece of capital equipment.

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Intermediate goods

• Intermediate goods are goods produced by one firm for use in further processing by another firm.

• Intermediate goods are not added separately in order to avoid double counting. Double counting can also be avoided by adding up national income using the value added approach.

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Value Added

• Value added :

• Value added is the difference between a firm’s total revenue and what it pays other firms for intermediate goods.

• Value added includes wages and salaries, rent, interest, and profits.

• 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.

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Value Added

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

STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED

(1) Oil drilling $ .50 $ .50

(2) Refining .65 .15

(3) Shipping .80 .15

(4) Retail sale 1.00 .20

Total value added $1.00

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Exclusions of Used Goodsand Paper Transactions

• Old output is not counted in current GDP because it was already counted back at the time it was produced. It would be double counting to count sales of used goods in current GDP.

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Paper Transactions

• Sales of stocks and bonds are not counted in GDP. These sales are exchanges of paper assets and do not correspond to current production. However, what if I sell the stock or bond for more than I originally paid for it?

• Profits from the stock or bond market have nothing to do with current production, so they are not counted in GDP. What about stock market dealers?

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Exclusion of Output Produced Abroadby Domestically Owned Factors of Production

• GDP is the value of output produced by factors of production located within a country. Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP).

• GNP =GDP + Net Factor Income From Abroad

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From GDP to Disposable Personal Income

• Net national product equals gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock.

• NNP = GNP - Depreciation

• Personal income is the income received by households after paying social insurance taxes but before paying personal income taxes.

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From GDP to Disposable Personal Income

GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2002

DOLLARS(BILLIONS)

GDP 10,205.6Plus: receipts of factor income from the rest of the world + 342.1Less: payments of factor income to the rest of the world 353.2

Equals: GNP 10,194.5Less: depreciation 1,351.3

Equals: net national product (NNP) 8,843.2Less: indirect taxes minus subsidies plus other 643.3

Equals: national income 8,199.9Less: corporate profits minus dividends 332.6Less: social insurance payments 731.2Plus: personal interest income received from the government and consumers + 439.1Plus: transfer payments to persons +1,148.7

Equals: personal income 8,723.9Less: personal taxes 1,306.2

Equals: disposable personal income 7,417.7

Source: See Table 18.2.

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Disposable Personal Income and Personal Saving

• .disposable personal income is the amount of income that households can spend or save.

• The personal saving rate is the percentage of disposable personal income that is saved, this is an important indicator of household behaviour.

• If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending carefully.

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Disposable PersonalIncome and Personal Saving

Disposable Personal Income and Personal Saving, 2002

DOLLARS(BILLIONS)

Disposable personal income 7,417.7

Less:

Personal consumption expenditures 7063.5

Interest paid by consumers to business 204.3

Personal transfer payments to foreigners 31.3

Equals: personal saving 118.6

Personal savings as a percentage of disposable personal income: 1.6%Source: See Table 18.2.

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Real versus Nominal GDP

• Because prices change over time, as inflation generally sends prices upward year after year. Economists have to solve the problem of changes prices by using a reliable measure.

• We can measure GDP for a particular year using the actual market prices of that year, this gives us the Nominal GDP, or GDP at Current prices.

• but we are usually more interested in determining what has happened to the Real GDP.

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• Real GDP is calculated by tracking the volume or quantity of production after removing the rate of inflation.

• Hence, Nominal GDP is calculated using changing prices, while Real GDP represent the change in the volume of total output after price changes are removed.

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• When we evaluate the nation’s current output at current market prices, we measure nominal GDP. This is equivalent to multiplying output by price, for all units of every commodity that is produced, and then adding all these numbers up.

• So, nominal GDP is a huge sum of prices times quantities. Therefore, if nominal GDP changes from one year to the next it could be due to a change in P, or Q, or both.

• Since we are very interested in the growth of the economy over time, we need to know which component of GDP is (are) changing.

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• Suppose, for example, that prices increase from one year to the next, and output decreases .In fact, this economy has a couple of new problems. Prices are higher, so there is an increase in inflation. Output is lower, so there is probably an increase in unemployment, too.

• When both inflation and unemployment increase together, economists refer to this situation as stagflation. (The economy slows down or stagnates at the same time that prices increase.)

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Calculating Real GDP

• In order to accurately assess the real growth of the economy over time, we need to measure output with a constant set of prices. One year is chosen as the base year and then every year’s output is evaluated in terms of the prices in the base year.

• A weight is the importance attached to an item within a group of items.

• A base year is the year chosen for the weights in a fixed-weight procedure.

• A fixed-weight procedure uses weights from a given base year.

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Calculating Real GDP

A Three-Good Economy(1) (2) (3) (4) (5) (6) (7) (8)

GDP IN GDP IN GDP IN GDP INYEAR 1 YEAR 2 YEAR 1 YEAR 2

IN IN IN INPRODUCTION PRICE PER UNIT YEAR 1 YEAR 1 YEAR 2 YEAR 2

YEAR 1 YEAR 2 YEAR 1 YEAR 2 PRICES PRICES PRICES PRICESQ1 Q2 P1 P2 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2

Good A 6 11 $.50 $ .40 $3.00 $5.50 $2.40 $4.40

Good B 7 4 .30 1.00 2.10 1.20 7.00 4.00

Good C 10 12 .70 .90 7.00 8.40 9.00 10.80

Total $12.10 $15.10 $18.40 $19.20

Nominal GDP

in year 1

Nominal GDP

in year 2

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Calculating the CPI,GDP Deflator and PPI

• The most widely used measure of inflation is the consumer price index ( CPI).

• CPI is a measure of the average change over time in the prices paid by consumes for a market basket of consumer goods and services.

• If we divide nominal GDP by real GDP (and multiply by 100), we get the overall price index which we call the GDP Deflator.

• PPI measures the level of prices at the wholesale or producer stage.

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The Problems of Fixed Weights

1. Structural changes in the economy.

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

3. The substitution effect of price increases.

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

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The Underground Economy

• The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

• Tax evasion is usually thought to be the major incentive for people to participate in the underground economy

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Gross National Income per Capita

• To make comparisons of GNP between countries, currency exchange rates must be taken into account.

• Gross National Income (GNI) is a measure used to make international comparisons of output. GNI is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation.

• GNI divided by population equals gross national income per capita.

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Gross National Income per Capita

Per Capita Gross National Income for Selected Countries, 2002

COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARSSwitzerland 36,970 Portugal 10,670Japan 35,990 South Korea 9,400Norway 35,530 Argentina 6,860United States 34,870 Mexico 5,540Denmark 31,090 Czech Republic 5,270Ireland 28,880 Brazil 3,060Sweden 25,400 South Africa 2,900United Kingdom 24,230 Turkey 2,540Netherlands 24,040 Colombia 1,910Austria 23,940 Jordan 1,750Finland 23,840 Romania 1,710Germany 23,700 Philippines 1,050Belgium 23,340 China 890France 22,640 Indonesia 680Canada 21,340 India 460Australia 18,770 Pakistan 420Italy 18,470 Nepal 250Spain 14,860 Rwanda 220Greece 11,780 Ethiopia 100

Source: The World Bank Atlas, 2002.

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Review Terms and Concepts

base year

change in business inventories

compensation of employees

corporate profits

current dollars

depreciation

disposable personal income, or after-tax 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

indirect taxes

intermediate goods

national income

national income and product accounts

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Review Terms and Concepts

personal savingpersonal saving

personal saving ratepersonal saving rate

proprietors’ incomeproprietors’ income

rental incomerental income

residential investmentresidential investment

servicesservices

subsidiessubsidies

underground economyunderground economy

value addedvalue added

weightweight

net exports (EX – IM)

net factor payments to the rest of the world

net interest

net investmentnet investment

net national product (net national product (NNPNNP))

nominal GDPnominal GDP

nondurable goodsnondurable goods

nonresidential investmentnonresidential investment

personal consumption expenditures (personal consumption expenditures (CC))

personal incomepersonal income

6 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business...

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Transcript of 6 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business...