Measuring Domestic Output and National Income

Assessing the Economy’s Performance

• National income accounting measures the economy’s overall performance.

• The Bureau of Economic Analysis compiles National Income and Product Accounts to:

  • Assess health of the economy.

  • Track the long-run course of the economy.

  • Adjust economic policy according to economic indicators.

Gross Domestic Product (GDP)

• Gross Domestic Product (GDP): Measure of aggregate output.

  • Avoid Multiple Counting:

  • Only market value of final goods and services is considered.

  • Intermediate goods and services are ignored.

  • Only the value added at each stage is counted.

• Domestic Output Only: Reflects the nation’s economic activities.

Transactions Excluded in GDP Calculation

• Exclusions from GDP include:

  • Financial transactions:

  • Public transfer payments (e.g., social security).

  • Private transfer payments (e.g., gifts).

  • Financial asset transactions (e.g., stock sales).

  • Secondhand sales, for example:

  • Selling a used car to a friend is not included.

Two Ways of Looking at GDP

• Expenditures Approach:

  • Counts the sum of money spent on final goods.

  • Focuses on the buyers of the goods.

• Income Approach:

  • Counts the income derived from production, including:

  • Wages, rental income, interest income, profit.

The Expenditures and Income Approaches to GDP Compared

• Comparative analysis of both approaches helps understand the GDP formulae from different perspectives.

Accounting Statement for the U.S. Economy (2021 Data)

• Expenditures Approach (in billions):

  • Personal consumption expenditures (C): $15,742

  • Gross private domestic investments (Ig): $4,120

  • Government purchases (G): $4,053

  • Net exports (Xn): -$918

  • Total GDP: $22,996

Expenditures Approach Components

1. Personal Consumption Expenditures (C):

   • Includes durable goods, nondurable goods, and consumer expenditures for services.

2. Gross Private Domestic Investment (Ig):

   • Comprises machinery, equipment, tools, residential construction, R&D, creation of new works of art and music, and changes in inventories.

   • Financial investment transactions are excluded.

3. Government Purchases (G):

   • Expenditures for goods and services, publicly owned capital, and R&D are included.

   • Transfer payments are excluded.

4. Net Exports (Xn):

   • Add exported goods and subtract imported goods.

   • Calculation: Xn = X - M where X = Exports, M = Imports.

5. Total GDP Formula: GDP = C + Ig + G + Xn

Accounting Statement for U.S. Economy Using the Income Approach (2021 Data)

• Income Approach (in billions):

  • Compensation of employees: $12,581

  • Rents: $726

  • Interest: $686

  • Proprietors’ income: $1,822

  • Corporate profits: $2,806

  • Taxes on production and imports: $1,299

  • Total National Income: $19,920

  • Less: Net foreign factor income: $252

  • Plus: Consumption of fixed capital: $3,848

  • Plus: Statistical discrepancy: -$520

  • Total GDP: $22,996

Breakdown of the Income Approach

• Key components include:

  1. Compensation of Employees: Wages paid to workers.

  2. Rents: Income received from rented property.

  3. Interest: Received on investments.

  4. Proprietor’s Income: Earnings of self-employed individuals and businesses.

  5. Corporate Profits:

  • Includes corporate income taxes, dividends paid to shareholders, and undistributed corporate profits.

  1. Taxes on Production and Imports: Taxes levied on production activities.

• From National Income to GDP formula:

  • National Income - Net Foreign Factor Income + Consumption of Fixed Capital + Statistical Discrepancy = GDP.

Other National Accounts

• Key national accounts include:

  • Net Domestic Product (NDP): Measures the net value of all goods produced.

  • National Income (NI): Total income earned by residents of a nation.

  • Personal Income (PI): Income received by individuals.

  • Disposable Income (DI): Income available for spending after taxes.

U.S. Income Relationships (2021 Data)

• Breakdown of relationships in billions:

  • Gross domestic product (GDP): $22.996

  • Less: Consumption of fixed capital: $3,848

  • Equals: Net domestic product (NDP): $19,148

  • Less: Statistical discrepancy: -$520

  • Plus: Net foreign factor income: $252

  • Equals: National income (NI): $19,920

  • Less Taxes on production and imports: $1,148

  • Less Corporate Income Tax: $381

  • Less Social Security contributions: $1,591

  • Less Undistributed corporate profits: $1,006

  • Plus: Transfer payments: $5,284

  • Equals: Personal income (PI): $21,077

  • Less: Personal taxes: $2,583

  • Equals: Disposable income (DI): $18,495

Nominal GDP vs. Real GDP

• Nominal GDP: Measures production in current dollar values.

  • Reflects the prices that prevailed when the output was produced.

• Real GDP: Adjusted for changes in price level.

  • Uses base year prices to remove the effects of inflation.

GDP Price Index

• The price index is used to determine Real GDP:

  • Formula: ext{Price Index in given year} = rac{ ext{Price of market basket in specific year}}{ ext{Price of same basket in base year}} imes 100

  • Real GDP calculation: ext{Real GDP} = rac{ ext{Nominal GDP}}{ ext{Price Index (in hundredths)}}

Calculating Real GDP (Example)

• Table example illustrates how to calculate Real GDP based on nominal figures:

  • Table Breakdown:

  1. Year 1:

     • Units of Output: 5

     • Price of Pizza per Unit: $10

     • Price Index: 100

     • Nominal GDP: $50

     • Real GDP: $50

  2. Year 2:

     • Units of Output: 7

     • Price of Pizza per Unit: $20

     • Price Index: 200

     • Nominal GDP: $140

     • Real GDP: $70

  3. Year 3:

     • Units of Output: 8

     • Price of Pizza per Unit: $25

     • Price Index: 250

     • Nominal GDP: $200

     • Real GDP: $80

  4. Year 4:

     • Units of Output: 10

     • Price of Pizza per Unit: $30

     • Price Index: ___

     • Nominal GDP: ___

     • Real GDP: ___

  5. Year 5:

     • Units of Output: 11

     • Price of Pizza per Unit: $28

     • Price Index: ___

     • Nominal GDP: ___

     • Real GDP: ___

Steps for Deriving Real GDP from Nominal GDP

1. Method 1:

   • Find nominal GDP for each year.

   • Compute a GDP price index.

   • Divide each year’s nominal GDP by that year’s price index (in hundredths) to determine Real GDP.

2. Method 2:

   • Break down nominal GDP into physical quantities of output and prices for each year.

   • Determine Real GDP for each year using base-year prices for valuation.

   • The GDP price index can be calculated by dividing nominal GDP by real GDP.

Real World Considerations

• Table presents historical nominal GDP, real GDP, and GDP price index (base year = 2012).

• Notable Years:

  • 2000: Nominal GDP: $10,251.0 billion; Real GDP: $13,138.0 billion; Price Index: N/A.

  • 2005: Nominal GDP: $13,039.2 billion; Real GDP: N/A; Price Index: 87.5.

  • 2010: Nominal GDP: $15,049.0 billion; Real GDP: $15,649.0 billion; Price Index: 96.2.

  • 2012: Nominal GDP: $16,254.0 billion; Real GDP: N/A; Price Index: 100.0.

  • 2015: Nominal GDP: $18,206.0 billion; Real GDP: $17,390.3 billion; Price Index: 104.7.

  • 2020: Nominal GDP: $20,893.7 billion; Real GDP: $18,384.7 billion; Price Index: 113.6.

Shortcomings of GDP

• GDP has several limitations, including:

  • Nonmarket activities that are not accounted for.

  • Values leisure and psychic income inaccurately.

  • Improvement in product quality is often ignored.

  • The underground economy is not represented.

  • Environmental considerations are often omitted.

  • Composition and distribution of output are not analyzed.

  • Other non-economic sources of well-being are unconsidered.

Global Perspective on the Underground Economy

• Discussion of the underground economy's representation as a percentage of GDP across selected nations, emphasizing its impact on economic indicators.