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Chapter 05 National Income Accounting
Principles of MacroEconomics Econ101
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Measuring the Economy

• Measurement of aggregate economic activity helps
  answer such questions as
• How much output is being produced? What is it
  being used for?
• How much income is being generated?
• Whats happening to prices and wages?

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Gross Domestic Product (GDP)

• Gross domestic product (GDP) The total market
  value of final output produced within a nations
  borders in a given time period
• Each good and service produced and brought to
  market has a price which serves as a measure of
  value for calculating total output

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The Measurement of Output
Last Years Output Amount   This Years Output Amount
 
In physical terms     In physical terms  
Oranges 2 billion   Oranges 3 billion
Bicycles 2 million   Bicycles 4 million
Rock concerts 700   Rock concerts 600
Total ?   Total ?
 
In monetary terms     In monetary terms  
2 billion oranges _at_ 0.20 each 400 million   3 billion oranges _at_ 0.20 each 600 million
2 million bicycles _at_ 50 each 100 million   4 million bicycles _at_ 50 each 200 million
700 rock concerts _at_ 1 million each 700 million   600 rock concerts _at_ 1 million each 600 million
Total 1200 million   Total 1400 million
It is impossible to add up all output when output
is counted in physical terms. Accordingly, total
output is measured in monetary terms, with each
good or service valued at its market price.
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GDP per Capita

• GDP per capita Total GDP divided by total
  population average GDP
• GDP per capita is commonly used as a measure of a
  countrys standard of living
• Measures of per capita GDP tell us nothing about
  how GDP is actually distributed or used

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Measurement Problems

• Methods of calculating GDP entail measurement
  problems in accounting for all economic activity
• Non-Market Activities - Goods and services
  produced that are not sold in a market
• Unreported Income - Market activities not
  reported to tax or census authorities

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Value Added

• The production of most goods and services
  involves a series of stages
• To accurately measure GDP we must distinguish
  between intermediate goods and final goods

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Value Added

• Intermediate goods Goods or services purchased
  for use as input in the production of final goods
  or services
• Value added The increase in the market value of
  a product that takes place at each stage of the
  production process

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Value Added in Various Stages of Production
Stages of Production Value of Transactions Value Added
1.  Farmer grows wheat, sells it to miller 0.12 0.12
2.  Miller converts wheat to flour, sells it to baker 0.28 0.16
3.  Baker bakes bagel, sells it to bagel store 0.60 0.32
4.  Bagel store sells bagel to consumer 0.75 0.15
Total 1.75 0.75
The value added at each stage represents a
contribution to total output.
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Real Versus Nominal GDP

• Nominal GDP The value of final output produced
  in a given period, measured in the prices of that
  period (current prices)
• Real GDP The value of final output produced in a
  given period, adjusted for changing prices

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Computing Real GDP

• Inflation An increase in the average level of
  prices of goods and services
• Inflation tends to obscure actual declines in
  real output
• Base year The year used for comparative
  analysis the basis for indexing price changes

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Computing Real GDP

• The general formula for computing real GDP is
• The price index represents a price level change
  as an index with a base of 100

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Computing Real GDP
  2005 2006
1.  Nominal GDP (in billions) 12,456 13,245
2.  Change in nominal GDP   789
3.  Change in the price level, 2005 to 2006   3.30
4.  Real GDP in 2005 dollars 12,456 12,822
5.  Change in real GDP   366
Real GDP is the inflation-adjusted value of
nominal GDP.
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Changes in GDP Nominal Versus Real
Increases in nominal GDP reflect higher prices as
well as more output. Increases in real GDP
reflect more output only.
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The Uses of Output

• The major uses of total output conform to the
  four sets of market participants
• Households ? consumption
• Business Firms ? investment
• Government ? government spending
• International participants ? net exports

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GDP Components

• The value of GDP can be computed by adding up
  these expenditures
• where
• C Consumption expenditure X exports
• I investment expenditure M imports
• G government expenditure

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Consumption

• Goods and services used by households are called
  consumption goods, which includes all household
  purchases made in product markets
• Consumer spending claims over two-thirds of
  annual output in the U.S.

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Investment

• Investment goods are the plant, machinery, and
  equipment that we produce
• Also includes net inventory changes and new
  residential construction
• Investment spending claims about one-sixth of our
  annual output.

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Government Spending

• Resources purchased by the public sector are
  unavailable for consumption or investment
  purposes
• Government spending on goods and services claims
  about one-fifth of our annual output
• This does not include income transfers

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Net Exports

• Net exports The value of exports minus the value
  of imports
• Exports Goods and services sold to international
  buyers
• Imports Goods and services purchased from
  international sources

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Measures of Income

• Instead of looking at whos buying the output
  (the demand side), we can look at whos being
  paid to produce it (the supply side)
• The total value of market incomes must equal the
  total value of final output, or GDP

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The Equivalence of Expenditure and Income (In
billions of dollars)
Expenditure Expenditure Expenditure Income
C Consumer goods and services Wages and salaries 8,062
Consumer goods and services 10,057 Corporate profits 1,092
I Investment in plant, equipment, and inventory Proprietors income 1,072
Investment in plant, equipment, and inventory Rents 64
Investment in plant, equipment, and inventory 1,994 Interest 929
G Government goods and services Taxes on output and imports 1,034
Government goods and services 2,882 Depreciation 1,832
X Exports 1,859 Miscellaneous 46
M Imports (2,529) Statistical discrepancy 136
GDP Total value of output 14,265 Total value of income 14,265
Source U.S. Department of Commerce (2008 data)
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Income and Expenditure

• The flow of income that starts with GDP
  ultimately returns to the market in the form of
  new consumption (C), investment (I), and
  government purchases (G)

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Circular Flow of Spending and Income