National Income AccountingNational Income AccountingDepression—Surprise!Depression—Surprise! After being blind-sided by the Great Depression, policymakers decided that they needed measures of economic activity. A Keynesian economist, Simon Kuznets, was charged with establishing the methodology for this in the late 1930s. Kuznets later received the Nobel Prize for his efforts.

National Income AccountingNational Income Accounting The framework that summarizes and categorizes productive activity over a specific period of time, usually a year. The National Income and Product Accounts (NIPA) is the “table of accounts” for maintaining this information in the U.S.

GDP – “Output”GDP – “Output” Gross Domestic Product (Gross Domestic Product (GDPGDP)) is the market value of final goods and services produced within a country during a specific time period, usually a year. Valued at Market Value Only Final Goods and Services Count: Sales at intermediate stages of production are not counted as their value is embodied within the final-user good. Their inclusion would result in double counting. Excludes financial transactions and income transfers since these do not reflect production. Must be produced within the geographic boundaries of the country. Net additions to inventory are current period output so are also included.

Final Goods and ServicesFinal Goods and Services• The term final goods and services in GDP refers to goods and

services produced for final use.• Intermediate goods are goods produced by one firm for use in further

processing by another firm.

GDP as Output Produced GDP as Output Produced GDP includes all output sold plus all goods produced but not sold. Inventory is a firm’s stock of unsold goods.– Planned inventory changes reflect management’s decision to add to or to reduce its on-hand stock.– Unplanned inventory changes reflect the results of unexpected sales variations.GDP as Valued-AddedGDP as Valued-Added

• Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.

• 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.

Exclusions of Used Goods and Paper Exclusions of Used Goods and Paper TransactionsTransactions

• GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.

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).

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.

Two Methods of Computing An Economy’s Two Methods of Computing An Economy’s IncomeIncome Expenditure Approach:

– Sum the total expenditures by households (from the top portion of the circular flow).

Resource Cost or Income Approach:– Sum the total wages and profit paid by firms for resources

(from the bottom portion of the circular flow).

Expenditures on Final Goods

= GDP = Income Received for producing Final Goods

GDP as Expenditures GDP as Expenditures GDP is the sum of expenditures on final user goods and services byGDP is the sum of expenditures on final user goods and services by

households, investors, governments, and foreigners (net).households, investors, governments, and foreigners (net). There are four components of GDP: There are four components of GDP:

personal consumption expenditures (C), personal consumption expenditures (C), gross private domestic investment (I), gross private domestic investment (I),

government purchases (G) of goods and services, and,government purchases (G) of goods and services, and, net exports (X) net exports (X) ( exports - imports )( exports - imports )

GDP = C + I + G + X GDP = C + I + G + X

GDP as Income GDP as Income GDP is the sum of the income GDP is the sum of the income (including profits)(including profits) received in received in

producing final goods and services during the period. producing final goods and services during the period. All of the payments made to producers are paid out to wage-All of the payments made to producers are paid out to wage-

earners, business owners, governments, etc. Thus in total theearners, business owners, governments, etc. Thus in total the incomes must equal to the payments, which are equal in dollarincomes must equal to the payments, which are equal in dollar value to the total expenditures.value to the total expenditures.

Payments include:Payments include: Wages and benefits paid to workers,Wages and benefits paid to workers, Proprietors’ income, Proprietors’ income, rents, rents, interest, interest, corporate profits,corporate profits, Indirect business taxesIndirect business taxes Net factor income from abroadNet factor income from abroad Capital consumption allowance. Capital consumption allowance.

Wages (including benefits) are the largest category. This category includes insurance, social security and retirement contributions.

Interest is the net expense interest paid. Rent is the income earned from selling the use of real estate. Proprietors’ income is paid directly to sole proprietors. Net Factor Income from Abroad

The income that foreigners earn producing goods within the borders of a country minus the income Americans earn abroad.

Capital Consumption Allowance (CCA) Depreciation is an estimate of the value of capital goods “used up” in the period’s production. It is the cost of the wear and tear on the machines and factories. CCA is depreciation, plus the value of capital lost due to accidental damage.

Indirect business taxes Taxes collected by businesses and turned over to the governments.

Equality of Income and ExpenditureGDP is calculated either by adding up all values of final output or by adding up the values of all earnings or income

Other MeasuresOther Measures

GDP vs. GNPGDP vs. GNP Gross Domestic Product (GDP) is the total value of final goods and services produced during a given period within the geographic boundaries of a country regardless of by whom. The goods and services are produced domestically. Gross National Product (GNP) is the total value of final goods and services produced during a given period by the citizens of a country no matter where they live. The goods and services are produced by the “nationals” of the country.

GDP and NDPNet domestic product (NDP) – the sum of consumption expenditures, government expenditures, net foreign expenditures, and investment less depreciation

Net domestic product is GDP adjusted for depreciation:GDP = C + I + G + (X - M)NDP = C + I + G + (X - M) - depreciation

Net National ProductNet National Product Net National Product (NNP) is GDP that is net of depreciation—depreciation has been substracted from it. That is, NNP includes net investment instead of gross investment.– Gross investment is total investment, which includes investment expenditures that simply replace worn out capital goods. Such replacement investment does not add to the total capital stock.– Net investment excludes replacement investment. That is, it is gross investment minus CCA.

National IncomeNational Income National Income (NI) is NNP less business taxes, plus or minus some other minor factors. NI is a measure of the income payments that actually go to resources.

Personal Income and Personal Income and Personal Disposable IncomePersonal Disposable Income Personal Income (PI) is national income plus current year. It is:– Net income that is received but not earned (transfer payments like social security), and – Net income earned but not received (like retained corporate earnings).– PI is the income with which individuals pay personal taxes, save, and consume. Disposable Personal Income is PI minus personal taxes. It is “after-tax” personal income.– DPI is the income that individuals have at their disposal for spending or saving.

Qualifications to the Income Accounting Identity

To go from GDP to national income: Add net foreign factor income.

National income is all income earned by citizens of a nation and is equal to GNP.

To move from "domestic" to "national" we add net foreign factor income.

Subtract depreciation from GDP. Subtract indirect business taxes from GDP.

Real and Nominal GDPReal and Nominal GDP The term "real" means adjusted for inflation. Nominal GDP is a measure of national output based on the current prices of goods and services. It is also called “money GDP”.

Real GDP is a measure of the quantity of final goods and services produced, obtained by eliminating the influence of price changes from nominal GDP.

GDP Price DeflatorGDP Price Deflator The GDP Price Deflator is a price index that uses a

bundle of all final goods and services. – It tells us the rise in nominal GDP that is attributable to a rise in

prices. Converting Nominal GDP to Real GDP:

Real GDP20xx = (Nominal GDP20xx ) ÷ (GDP deflator20xx)X100

Real GDP Growth in 7 Countries

What Increased?

GDP and Economic Well-BeingGDP and Economic Well-Being GDP Per Person tells us the income and expenditure of the

average person in the economy.– It is a good measure of the material well-being of the economy

as a whole.– More Real GDP means we have a higher material standard of

living by being able to consume more goods and services.

– It is NOT intended to be a measure of happiness or quality of life.

GDP and Economic Well-BeingGDP and Economic 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 leisure.– Factors that lead to a quality environment.– The value of almost all activity that takes place outside of the

markets, e.g. volunteer work and child-rearing.

Some Limitations of National Income Some Limitations of National Income AccountingAccounting

Limitations of national income accounting include the following:Limitations of national income accounting include the following: Measurement problems exist.Measurement problems exist. GDP measures economic activity, not welfare.GDP measures economic activity, not welfare. Subcategories are often interdependentSubcategories are often interdependent..

GDP Measures Market Activity, Not Welfare 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

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 increases?

Price Indexes Price Indexes

The value of a price index in any particular year indicates how pricesThe value of a price index in any particular year indicates how prices have changed relative to a base year.have changed relative to a base year.

The base year is the year against which all other years are compared.The base year is the year against which all other years are compared. The index is 100 The index is 100 ±± the percent change in prices from the base year. the percent change in prices from the base year. This type of index suffers from substitution bias as some buyers willThis type of index suffers from substitution bias as some buyers will

change the mix of goods that they buy in response to price changes.change the mix of goods that they buy in response to price changes. Chain-type indexes of real GDP were created to correct for this bias.Chain-type indexes of real GDP were created to correct for this bias.

Such an index uses the mean of the growth rates using beginning andSuch an index uses the mean of the growth rates using beginning and ending year prices.ending year prices.

Circular Flow DiagramCircular Flow Diagram