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Chapter 5
GROSS DOMESTIC
PRODUCT ACCOUNTING1
What is Gross Domestic Product (GDP)?
How is GDP related to a nations total income and
spending?
What are the components of GDP?
Does GDP measure societys well-being?
2
Look for the answers to these questions
3
Income and Expenditure
Gross Domestic Product (GDP) measures
total income of everyone in the economy.
GDP also measures total expenditure on the
economys output of g&s.
For the economy as a whole,
income equals expenditurebecause every dollar a buyer spends
is a dollar of income for the seller.
4
The Circular-Flow Diagram
a simple depiction of the macroeconomy
illustrates GDP as spending, revenue,
factor payments, and income
Preliminaries:
Factors of production are inputs like labor,
land, capital, and natural resources.
Factor payments are payments to the factors
of production (e.g., wages, rent).
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The Circular-Flow DiagramHouseholds:
own the factors of production,sell/rent them to firms for income
buy and consume goods & services
HouseholdsFirms
Firms:
buy/hire factors of production,use them to produce goodsand services
sell goods & services
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The Circular-Flow Diagram
Markets forFactors ofProduction
HouseholdsFirms
Income (=GDP)Wages, rent,
profit (=GDP)
Factors ofproduction
Labor, land,capital
Spending (=GDP)
G & Sbought
G & Ssold
Revenue (=GDP)Markets forGoods &Services
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What This Diagram Omits
The government
collects taxes, buys g&s
The financial system
matches savers supply of funds with
borrowers demand for loans
The foreign sector
trades g&s, financial assets, and currencieswith the countrys residents
Production, Income, and the Circular-Flow Diagram
Transfer paymentsPayments by thegovernment toindividuals for which
the government doesnot receive a new goodor service in return.
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
Goods are valued at their market prices, so:
All goods measured in the same units
(e.g., dollars in the U.S.)
Things that dont have a market value are
excluded, e.g., housework you do for yourself.
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
Final goods:intended for the end user
Intermediate goods: used as components
or ingredients in the production of other goods
GDP only includes final goods they already
embody the value of the intermediate goods
used in their production.
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
GDP includes tangible goods
(like DVDs, mountain bikes, beer)
and intangible services(dry cleaning, concerts, cell phone service).
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
GDP includes currently produced goods,
not goods produced in the past.
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
GDP measures the value of production that occurs
within a countrys borders, whether done by its own
citizens or by foreigners located there.
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the market value of all final goods &
services produced within a country
in a given period of time.
Gross Domestic Product (GDP) Is
Usually a year or a quarter (3 months)
National Income Accounting System
A system of accounts developed for each country, based
on the circular flow, whose purpose is to measure the level
of economic activity in that country.
The U.S. national income accounting system (National
Income and Product Accounts) is operated by the Bureau
of Economic Analysis (BEA) in the U.S. Department of
Commerce.
3 equivalent methods of calculating GDP: Value Added,Expenditure and Income Methods.
Note: In the book, the first two methods are combined into
one method. This is fine, but for this class, we will use 3
distinct methods, as is standard practice.
The Value-Added Approach
2010 Cengage Learning16
When using this approach to GDP, one must becertain that only finalgoods and services arecounted. Otherwise, goods may be doublecounted.
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Measuring GDP by the Value-Added Method
Value added: The market value a firm adds to a product.
FIRM VALUE OF PRODUCT VALUE ADDED
Cotton
Farmer Value of raw cotton = $1
Value added by cotton
farmer = ($1-$0) = 1
Textile Mill Value of raw cotton woven
into cotton fabric = $3
Value added by cotton
textile
mill = ($3 $1) = 2
Shirt
Company Value of cotton fabric made
into a shirt = $15
Value added by shirt
manufacturer = ($15$3) = 12
L.L. Bean Value of shirt for sale on
L.L. Beans Web site = $35
Value added by L.L. Bean
= ($35 $15) = 20
Total Value Added = $35
Another example
PRODUCTION AND PRICE STATISTICS FOR 2009
(1)
PRODUCT
(2)
QUANTITY
(3)
PRICE PER
UNIT
Eye examinations 100 $50.00
Pizzas 80 10.00
Textbooks 20 100.00
Paper 2,000 0.10
PRODUCT
(1)
QUANTITY
(2)
PRICE PER
UNIT
(3)
VALUE
Eye examinations 100 $50 $5,000
Pizzas 80 10 800
Textbooks 20 100 2,000
GDP =$7800
2010 Cengage Learning 19
EXHIBIT 3 Another example:
MARKET VALUE AND VALUE ADDED OFGOODS PRODUCED
2010 Cengage Learning 20
1. What is the total market value of the woolsweater in Exhibit 3, including all thestages of production?
The total market value is $94.
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2010 Cengage Learning 21
2. Why shouldnt the total market value of allthe goods used in production be used whencalculating GDP?
The total market value ($94) counts the originalresource multiple times.
2010 Cengage Learning 22
2. Why shouldnt the total market value beused when calculating GDP?
For example, the $4 value for wool on thesheep makes up part of the $13 value forwool fabric and $50 value for a wool sweater.
2010 Cengage Learning 23
3. What shouldbe used when calculatingGDP?
Only the market value of the final good beingproduced, which is the sweater worth $50.
Notice that the Market value of finalgood=$50=Total Value Added
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Recall: GDP is total spending.
Four components:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
These components add up to GDP (denotedY):
Y = C + I + G + NX
Measuring GDP by the Expenditure Method
The Components of GDP
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Personal Consumption (C) is total spending by households on durable
goods, nondurable goods, and services.
Note on housing costs:
For renters,
consumption includes rent payments.
For homeowners,
consumption includes the imputed rental value
of the house, but not the purchase price or
mortgage payments.
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Gross Private Domestic Investment (I) is total spending on goods that will be used in the
future to produce more goods.
includes spending on
capital equipment (e.g., machines, tools)
structures (factories, office buildings, houses)
inventories (goods produced but not yet sold)
Note:Investmentdoes not
mean the purchase of financial
assets like stocks and bonds.
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Government Purchases (G)
is all spending on the g&s purchased by govt
at the federal, state, and local levels.
G excludes transfer payments, such as
Social Security or unemployment insurance
benefits. They are not purchases of g&s.
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Net Exports (NX)
NX= exports imports
Exports represent foreign spending on the
economys g&s.
Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
Adding up all the components of GDP gives:
Y = C + I + G + NX
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2010 Cengage Learning 29
EXHIBIT 4 EXPENDITURE APPROACH TO 2008 GDP($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008. 2010 Cengage Learning 30
1. What was the largest category of GDPexpenditure in 2008?
The largest category was personal consumptionexpenditures at $10,053.7 billion.
2010 Cengage Learning 31
2. Why was the net exports category ofexpenditure negative in 2008?
The category was negative ($717.9 billion)because the value of U.S. imports wasgreater than the value of U.S. exports.
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U.S. GDP and Its Components, 2009
1,307
9,608
5,059
32,940
$46,299
per capita
2.8
20.8
10.9
71.1
100.0
% of GDP
402
2,955
1,556
10,133
$14,242
billions
NX
G
I
C
Y
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In each of the following cases, determine how much
GDP and each of its components is affected (if at all).
A.Debbie spends $200 to buy her husband dinner
at the finest restaurant in Boston.
B.Sarah spends $1800 on a new laptop to use in her
publishing business. The laptop was built in China.
C.Jane spends $1200 on a computer to use in her
editing business. She got last years model on sale
for a great price from a local manufacturer.
D.General Motors builds $500 million worth of cars,
but consumers only buy $470 million worth ofthem.
GDP and its components
A. Debbie spends $200 to buy her husband dinner
at the finest restaurant in Boston.
Consumption and GDP rise by $200.
B.Sarah spends $1800 on a new laptop to use in
her publishing business. The laptop was built in
China.
Investment rises by $1800, net exports fall
by $1800, GDP is unchanged.
Answers
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C.Jane spends $1200 on a computer to use in her
editing business. She got last years model on
sale for a great price from a local manufacturer.
Current GDP and investment do not change,
because the computer was built last year.
D.General Motors builds $500 million worth of cars,but consumers only buy $470 million of them.
Consumption rises by $470 million, inventory
investment rises by $30 million, and GDP rises by
$500 million.
Answers
35 2010 Cengage Learning
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We can measure GDP in terms the total incomereceived by households.
The income payments are arranged into five maincategories:
(1) the compensation of employees,
(2) interest,(3) corporate profit,
(4) rental income, and
(5) proprietors income.
Measuring GDP by the Income Method
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The Income Approach
2010 Cengage Learning37
The compensation of employees is divided intotwo categories:
wages and salaries and supplements.
Supplements (or fringe benefits) include suchthings as bonuses, paid vacations, andcontributions to employees Social Security.
2010 Cengage Learning38
Corporate profit represents the return to owners ofincorporated firms.
Corporate profit is divided into three categories-dividends, corporate reinvestment, and corporatetaxes.
All three are included in the income approach toGDP.
The Income Approach
2010 Cengage Learning39
Rent is the payment for use of property.
Although most people dont pay themselves rentfor using their own property, the rent is stillestimated in GDP accounting. Net rental incomeis total rental income minus depreciation.
The Income Approach
2010 Cengage Learning40
Proprietors income is the income earned byunincorporated firms for the goods andservices they produce.
Proprietors income is the net income afterpaying such expenses as rent, utilities, and
supplies.
The Income Approach
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EXPANDED CIRCULAR FLOW: INCOME ANDEXPENDITURE APPROACHES TO GDP Equivalence of Expenditure and Income Methods
Components of GDP in 2007
NXGICY Expenditure Method
Observations from the Expenditure method
Consumer spending on services is greater than thesum of spending on durable and non-durable goods.
Business fixed investment is the largest componentof investment.
Purchases made by state and local governments aregreater than purchases made by the federal
government (since education and law enforcementare usually funded at the state/local level).
Imports are greater than exports, so net exports arenegative.
The Division of Income in 2007
The largest component of income received by households is wages,which are about three times as large as the profits received by soleproprietors and the profits received by corporations combined.
Income MethodEquivalence of Expenditure and Income Methods
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2010 Cengage Learning 45
Gross National Product (GNP)
The market value of all final goods and servicesin an economy produced by resources ownedby people of that economy, regardless of wherethe resources are located.
2010 Cengage Learning 46
While GDP measures location, GNP measuresownership.
For example, the value of goods produced by aU.S.-owned firm in Spain are not counted in ourGDP, but are counted in our GNP.
Gross National Product (GNP)
National Income
2010 Cengage Learning 47
The sum of all payments made to resource ownersfor the use of their resources.
2010 Cengage Learning 48
EXHIBIT 5 2008 NATIONAL INCOME ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008.
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2010 Cengage Learning 49
What was the largest category of income inthe U.S. in 2008 according to Exhibit 5?
Compensation of employees was by far thelargest category of income at $8,110.7 billion,or 64.9 percent of the national income.
Bringing GDP and National Incomeinto Accord
2010 Cengage Learning 50
GDP, according to Exhibit 4, was $14,201 billion in2008.
Yet national income, according to Exhibit 5, wasonly $12,481.3 billion.
2010 Cengage Learning 51
How is national income derived from grossdomestic product?
First, GDP is converted to GNP.
This is done by subtracting factor payments tothe rest of the world and adding factor
payments from the rest of the world.
2010 Cengage Learning 52
How is national income derived from grossdomestic product?
Second, capital depreciation is subtracted fromGNP. The result is Net National Product (NNP).
Capital depreciationThe value of existingcapital stock used up in the process ofproducing goods and services.
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2010 Cengage Learning 53
How is national income derived from grossdomestic product?
Third, indirect business taxes are subtractedfrom NNP. The result is National Income.
Indirect business taxesinclude general salestaxes, excise taxes, customs duties and licensefees. They are indirect because they are taxeslevied not on the firms directly, but on thegoods and services.
2010 Cengage Learning 54
EXHIBIT 6 THE RELATIONSHIP BETWEEN GROSSDOMESTIC PRODUCT, GROSS NATIONALPRODUCT, NET NATIONAL PRODUCT, ANDNATIONAL INCOME: 2008 ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008.
Other Important Terms
2010 Cengage Learning 55
Net Domestic Product (NDP)
GDP minus capital depreciation.
Personal Income andPersonal Disposable Income
2010 Cengage Learning 56
Personal income
National income, plus income received butnot earned, minus income earned but notreceived.
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Personal Income andPersonal Disposable Income
2010 Cengage Learning 57
Transfer payments
Income received but not earned.
For example, government-supplied incomefrom retirement benefits, veteran benefits,unemployment insurance benefits, disabilitypayments and subsidies to farmers.
Personal Income andPersonal Disposable Income
2010 Cengage Learning 58
Transfer payments
The government transfers income fromtaxpayers (who earned the income in the firstplace) to those receiving benefits.
Personal Income andPersonal Disposable Income
2010 Cengage Learning 59
Disposable personal income
Personal income minus direct taxes.
2010 Cengage Learning 60
EXHIBIT 7 U.S. ECONOMIC PERFORMANCE, 19982005(CURRENT AND CONSTANT $, BASE YEAR 2000; AND PERCENT)
Source:Economic Report of the President, Washington, D.C., 2006, Statistical Tables. Except for the per capita data, all otherdata are in billion of U.S. dollars.
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2010 Cengage Learning 61
1. Looking at GDP, national income,personal income, or personal disposableincome, the annual rate of growth is?
Over 6 percent. Adjusting for price changesover the 25 years reduces GDP growth rate3.1 percent per year.
2010 Cengage Learning 62
2. But does GDP really measure everythingproduced in the national economy?
It is a quite legitimate means of measurement.The point is knowing and understanding whatmeasure we are using and why we use it.
Does GDP MeasureWhat We Want It to Measure?
MEASURING A NATIONS INCOME 64
GDP and Economic Well-Being
Real GDP per capita is the main indicator of
the average persons standard of living.
But GDP is not a perfect measure of
well-being.
Robert Kennedy issued a very eloquent
yet harsh criticism of GDP:
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Gross Domestic Product
does not allow for the health of our
children, the quality of their education,
or the joy of their play. It does not
include the beauty of our poetry or
the strength of our marriages, the
intelligence of our public debate or
the integrity of our public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures everything,
in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are
proud that we are Americans.
- Senator Robert Kennedy, 196865
How Comprehensive Is GDP?
2010 Cengage Learning66
GDP tries to measure everything that appearson the market.
Yet, not everything produced in the economygets onto the market, and some things thatcontribute to our economic well-being arenteven produced.
How Comprehensive Is GDP?
2010 Cengage Learning67
The value of housework is one example of animportant service that is usually not included inGDP.
The work is only included if it is performed by
someone outside the household, such as ahousekeeper, nanny, or cook.
How Comprehensive Is GDP?
2010 Cengage Learning68
Underground economy
The unreported or illegal production ofgoods and services in the economy that isnot counted in GDP.
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2010 Cengage Learning69
EXHIBIT 8 UNDERGROUND ECONOMIES, SELECTEDCOUNTRIES (PERCENT OF GDP)
Source: The Tax Foundation,Washington, D.C., 2006. Datacompiled by Friedrich Schneider,Johannes Kelper University(Linz, Austria).
2010 Cengage Learning70
Why would socially conscious and law-abidingsocieties such as Sweden and Switzerland havelarger underground economies?
Taxes and other government regulation maycreate an irresistible temptation.
How Comprehensive Is GDP?
2010 Cengage Learning71
Illegal unreported activities may include drugtrafficking, money laundering, bribery,prostitution, illegal gambling, fraud andburglary.
How Comprehensive Is GDP?
2010 Cengage Learning72
Tax avoidance is the main reason why legalactivities may go unreported.
Swapping services or simply understating thevalue of income earned are two ways to avoidpaying taxes.
Finally, legal and illegal immigrants may workfor less than minimum wage at off-the-booksentry-level jobs.
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How Comprehensive Is GDP?
2010 Cengage Learning73
The quality of goods and services producedmay not be included in GDP.
For example, a good may be of higher quality,but cost less, than a similar good. Theeconomic value of the improved quality good isnot recorded.
How Comprehensive Is GDP?
2010 Cengage Learning74
The costs of environmental damage areanother factor not taken into account in GDP.
While the expense associated with cleaning upthe pollution we create contributes to GDP, theactual pollution created is not subtracted fromGDP.
How Comprehensive Is GDP?
2010 Cengage Learning75
Many economists agree that despite the exclusion ofsome forms of economic value, our measure of GDPis sufficiently comprehensive to be a reliable indicatorof changes in the overall performance of theeconomy.
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Recap: GDP Does Not Value:
the quality of the environment
leisure time
non-market activity, such as the child care
a parent provides his or her child at home
an equitable distribution of income
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Then Why Do We Care About GDP? Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.
Many indicators of the quality of life are
positively correlated with GDP. For example
GDP and Life Expectancy in 12 countries
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Lifeexpectancy(years)
Real GDP per capita
U.S.Germany
Japan
Mexico
Russia
Brazil
China
India
Indonesia
Pakistan
Bangladesh
Nigeria
GDP and Literacy in 12 countries
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AdultLiteracy
(%o
fpopulation)
Real GDP per capita
U.S.Germany Japan
Mexico
Russia
Brazil
China
India
Indonesia
Nigeria
Pakistan
Bangladesh
GDP and Internet Usage in 12 countries
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InternetUsage
(
%o
fpopulation)
Real GDP per capita
U.S.
Germany
Japan
Mexico
Russia
Brazil
ChinaIndia
Indonesia
Nigeria
Bangladesh
Pakistan
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Gross Domestic Product (GDP) measures acountrys total income and expenditure.
The four spending components of GDP include:
Consumption, Investment, Government Purchases,
and Net Exports.
Nominal GDP is measured using current prices.
Real GDP is measured using the prices of a
constant base year and is corrected for inflation.
GDP is the main indicator of a countrys economic
well-being, even though it is not perfect.
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SUMMARY
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