National Income Accounting (NIA)Outline:

1. Functions of NIA

2. Gross Domestic Product (GDP)

3. The Value Added approach to GDP

4. The Expenditure Approach to GDP

5. The Factor Payments Approach to GDP

6. Real versus Nominal GDP

7. Problems with GDP

National income accounting (NIA) is the measurement of aggregate or total economic activity.

NIA is useful for assessing the performance of the

macroeconomy. NIA is also helpful in evaluating the

effectiveness of policy initiatives such as the Reagan tax cuts.

We measure stockvariables at a

specific point intime; whereas

flows are measuredper unit of time.

Flows include:

•Income

•Sales revenue

•OutputStocks include:

•Checking account balance

•Balance owed on student loans

•Inventories

We measure economic

activity as aflow.

Stocks vs. Flows

GDP is the market value of new goods and services produced in the economy in one year within the nation’s borders.

Gross Domestic Product (GDP)

GDP is our basicmeasure of economic

activity

Three approaches to measuring GDP

The value-added approachThe expenditure approachThe factor payments approach

Value-added is the increasein the market value of a good

that takes place at each stage of the production

-distribution process.

Stage 1: Farmer grows wheat, sells it to the Miller for 55 cents.

Stage 2: Miller mills the wheat, sells it to the Baker for 85 cents--hence value-added at the milling stage is 30 cents.

Stage 3: Baker bakes the bread--sells it to the supermarket for $1.45--hence value-added at the baking stage is 60 cents.

Stage 4: Supermarket sells the bread to the consumer for $1.65--hence value added at the retailing stage is 20 cents.

$1.00Wood Chips

$1.50Raw Paper

$2.25Notebook

Paper

$3.50Notebook

Paper

$5.00Notebook

Paper

Lumber Mill

Paper Mill

Office SuppliesManufacturer

Wholesaler Retailer

Summing the value-added at each stage

Stage Value Added

Lumber milling $1.00Paper processing

.50

Office Supply Manufacturing

.75

Wholesaling 1.25Retailing 1.50Total $5.00

To count the notebook in GDP, we count the final transaction only. Otherwise, we would be counting value added twice.

Here we simplyadd up all

expenditures fornew goods

and services in oneyear

GDP = C + I + G + NX

Where,

C is personal consumption expenditure;I is gross private domestic investment;G is government expenditure (local, state, and federal); andNX is net exports, or Exports minus Imports

The expenditure approach

ConsumptionHousehold spending for newly-produced goods and services is defined as consumption. We distinguish between 3 categories or types:

Spending for consumer durables

Spending for consumer nondurables

Spending for consumer services.

Category

Spending in 1999

(billions)

Percent of Total

Durables $759 12

Nondurables 1,842 29 Services 3,656 59

Source: Economic Report of the President

Consumer Spending by Type, 1999 (in billions)

Total spending byU.S. households

in 1999 was astaggering $6.3

trillion

0

1000

2000

3000

4000

5000

6000

7000

76 78 80 82 84 86 88 90 92 94 96 98

Consumption in current dollars

www.bls.gov

All spending by business firms for newly built equipment and business structures.

All changes in business inventories of raw materials, semifinished articles, and finished goods.

All spending by households for newly constructed residential housing

What is investment?

Investment does NOT include

•The purchase of stocks, bonds, or other financial assets.

•Secondhand salesRemember that

investment only happens when there is production of new tangible capital

goods

Components of Business Fixed Investment, 1982-97

billions of chain-weighted 1992 dollars

Source: Economic Report of the President

Year

199719941991198819851982

billi

ons

of 1

992

dolla

rs

700

600

500

400

300

200

100

0

Structures

Durable equipment

Computers

DefinitionsCapital consumption allowance (CCA):A monetary measure of the depreciation of the capital stock in a year due to normal wear and tear, fires, or other accidents.

Net Investment: Gross Investment minus CCA.

Indirect business taxes: taxes collected by businesses for government units, such as taxes on entertainment, motels, groceries, liquor, cigarettes, or gasoline taxes. Also called excise taxes.

Net income earned abroad: Income earned by domestic residents in foreign factor markets minus income earned by foreigners in domestic factor markets.

This mainly involves summing up income

earned in factor markets

GDP =

Employee compensation

+ interest

+ rent

+ profits

- net income earned abroad

+ CCA

+ indirect business taxes

The Factor Payments Approach

Expenditure Approach Factor payments ApproachConsumption $6,257 Employee compensation $5,331Investment 1,623 Profits, rent, interest, etc.(see note 1) 3,209Government expenditure 1,630 Indirect business taxes 716Exports 998Imports -1,252

Total $9,256 Total $9,2561Includes the capital consumption allowance and statistical discrepancy

Two Approaches to U.S. GDP, 1999

Source: Bureau of Economic Analysis (www.bea.gov

Gross domestic product $9,256 Plus: Net income earned abroad (20) Equals: Gross national product 9,236 Less: consumption of fixed capital 1,136 Equals: Net national product 8,100 Less: Indirect business taxes 716 Plus: Subsidies less current surplus of government enterprises

27

Plus: Statistical discrepancy 85 Equals: National income $7,496

All data in billions of current dollars

Relation of GDP to GNP, NNP, National Income, and Personal Income, 1999

National Income $7,496

Less: Corporate profits 893

Less: Net interest 468

Less: contributions for social insurance

658

Plus: transfer payments 1019

Plus: Dividend income 364

Plus: Personal interest income

932

Equals: Personal Income $7,792

All data in billions of dollars

From National Income to Personal Income

Personal disposable income (PDI)

Personal income $7,792Less: Personal tax payments 1,152Equals: PDI $6,640

PDI is the obviously one measure

of ready spending powerof the household sector

Real versus Nominal GDP

•We use money to measure the market value of new goods and services produced produced in the economy.

•The value (or purchasing power) of money is subject to change over time.

•Hence we need to adjust nominal GDP (that is, GDP measured at current prices) for changes in the value of money.

•GDP adjusted for changes in the value of money is called real GDP.

Price Quantity = Market Value of Output

.50 100 oranges

1.00 300 coconuts

8.00 2,000 pizzas

$16,350Year 1(base year)

Nominal GDP = Real GDP

.50 110 oranges

1.00 330 coconuts

8.00 2,200 pizzas

$17,985Year 2(quantities increase 10%)

Nominal GDP increases, Real GDP increases

Price Quantity = Market Value of Output

.55 100 oranges

1.10 300 coconuts

8.80 2,000 pizzas

$17,985Year 3(prices increase by 10%)

Nominal GDP increases, Real GDP remains constant

Goods & ServicesProduced in 1990 (in units)

Market Prices in 1990 $5,748.3

billion

Goods & ServicesProduced in 1991 (in units)

Market Prices in 1991 $5,916.7 billion

Nominal GDP in 1990 is computed by:

Nominal GDP in 1991 is computed by:

The problem is this: How do we know if the change in GDP (from ’90 to ’91) is due to a

change in actual production of goods and services? That is, the increase in nominal GDP might be explained by an increase in

prices.

0

2000

4000

6000

8000

60 65 70 75 80 85 90 95

Nominal GDP Chained 1996 dollars

GDP in the United States (in millions)

www.bea.gov

0

5000

10000

15000

20000

25000

30000

35000

60 65 70 75 80 85 90 95

Nominal Chained 1996 dollars

GDP per Person in the United States

www.economagic.com

2000

3000

4000

5000

6000

7000

70 75 80 85 90 95

Notice that real GDP decreased in 1991

Recessions are shaded

GDP in the U.S. (millions of chained 1996 dollars)

www.bea.gov

•GDP does not take full account of qualitative changes in output.•GDP does not take account of the underground economy.•GDP does not account for nonmarket production—that is, goods produced but not sold in the marketplace.