Cf8e prs macro06

Chapter

6
Measuring National Output
and National Income

Prepared by:

Fernando & Yvonn
Quijano

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Measuring National Output
and National Income 6
Chapter Outline
Gross Domestic Product
Final Goods and Services
Exclusion of Used Goods and Paper
Transactions
Exclusion of Output Produced
Abroad by Domestically Owned
Factors of Production
e m c nI l a no t a N dna

Calculating GDP
The Expenditure Approach
The Income Approach
Nominal versus Real GDP
Calculating Real GDP
i

Calculating the GDP Deflator
The Problems of Fixed Weights
Limitations of the GDP Concept
GDP and Social Welfare
The Underground Economy
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Gross National Income Per Capita
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Looking Ahead

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MEASURING NATIONAL OUTPUT
AND NATIONAL INCOME

national income and product
accounts Data collected and published
by the government describing the
various components of national income
and output in the economy.
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GROSS DOMESTIC PRODUCT

gross domestic product (GDP) The
total market value of all final goods and
services produced within a given period
by factors of production located within a
country.
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GDP is the total market value of a country’s output. It is the market value of all final goods
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and services produced within a given period of time by factors of production located within
a country.
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FINAL GOODS AND SERVICES

final goods and services Goods
and services produced for final use.

intermediate goods Goods that are
produced by one firm for use in further
processing by another firm.

value added The difference between
the value of goods as they leave a stage
i

of production and the cost of the goods as
they entered that stage.
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To arrive at GDP, the Bureau of Economic
Analysis (BEA) counts:
a. The value of total sales, including sales to
suppliers and sales to consumers.
b. The value of final sales.
c. The value of intermediate goods and final
goods.
d. Value added plus the value of sales at the
retail level.

e. Any of the above.
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To arrive at GDP, the Bureau of Economic
Analysis (BEA) counts:
a. The value of total sales, including sales to
suppliers and sales to consumers.
b. The value of final sales.
c. The value of intermediate goods and final
goods.
d. Value added plus the value of sales at the
retail level.

e. Any of the above.
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Tires taken from that pile and mounted on the wheels of the new car
before it is sold are considered intermediate goods to the auto producer.
Tires from that pile to replace tires on your old car are considered final
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goods. If, in calculating GDP, we included the value of the tires (an
intermediate good) on new cars and the value of new cars (including the
tires), we would be double counting.
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TABLE 6.1 Value Added in the Production of a Gallon of Gasoline
(Hypothetical Numbers)
STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED
(1) Oil drilling $ 1.00 $1.00
(2) Refining 1.30 0.30
(3) Shipping 1.60 0.30
(4) Retail sale 2.00 0.40

Total value added $2.00
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In calculating GDP, we can either sum up the value added at each stage of production or
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we can take the value of final sales. We do not use the value of total sales in an economy
to measure how much output has been produced.
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EXCLUSION OF USED GOODS AND PAPER
TRANSACTIONS

GDP is concerned only with new, or current, production.

GDP ignores all transactions in which money or goods change hands but in which no new
goods and services are produced.
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EXCLUSION OF OUTPUT PRODUCED
ABROAD BY DOMESTICALLY OWNED
FACTORS OF PRODUCTION

GDP is the value of output produced by factors of production located within a country.

gross national product (GNP) The
total market value of all final goods and

services produced within a given period
by factors of production owned by a
country’s citizens, regardless of where
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the output is produced.
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11

Which of the following is counted in GDP?
a. The output produced by U.S. citizens abroad.
b. The profits earned abroad by U.S.
companies.
c. The output produced by foreigners working in
U.S. companies abroad.
d. The profits earned in the Unites States by
foreign-owned companies.
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12

Which of the following is counted in GDP?
a. The output produced by U.S. citizens abroad.
b. The profits earned abroad by U.S.
companies.
c. The output produced by foreigners working in
U.S. companies abroad.
d. The profits earned in the Unites States
by foreign-owned companies.
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13

CALCULATING GDP

expenditure approach A method of
computing GDP that measures the
amount spent on all final goods during a
given period.

income approach A method of
computing GDP that measures the

income—wages, rents, interest, and
profits—received by all factors of
i

production in producing final goods.
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CALCULATING GDP
THE EXPENDITURE APPROACH
There are four main categories of expenditure:
Expenditure Categories:
■ Personal consumption expenditures (C):
household spending on consumer goods
■ Gross private domestic investment (I):
spending by firms and households on new
capital, i.e., plant, equipment, inventory, and
new residential structures

■ Government consumption and gross
investment (G)
■ Net exports (EX - IM): net spending by the
i

rest of the world, or exports (EX) minus
imports (IM)
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GDP = C + I + G + (EX - IM)
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CALCULATING GDP

TABLE 6.2 Components of U.S. GDP, 2004: The Expenditure
Approach
BILLIONS OF PERCENTAGE
DOLLARS OF GDP
Personal consumption expenditures (C) 8,214.3 70.0
Durable goods 987.8 8.4
Nondurable goods 2,368.3 20.2
Services 4,858.2 41.4
Gross private domestic investment (l) 1,928.1 16.4
Nonresidential 1,198.8 10.2
Residential 673.8 5.7
Change in business inventories 55.4 0.5
Government consumption and gross 2,215.9 18.9

investment (G)
Federal 827.6 7.1
State and local 1,388.3 11.8
Net exports (EX – IM) −624.0 − 5.3
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Exports (EX) 1,173.8 10.0
Imports (IM) 1,797.8 15.3
Gross domestic product (GDP) 11,734.3 100.0
Note: Numbers may not add exactly because of rounding.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
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For the year 2004, the percentages of C, I, G, and
(EX – IM) in U.S. aggregate expenditure were
roughly as follows:
a. 70%, 16%, 19%, and –5%.
b. 40%, 18%, 25%, and 17%.
c. 24%, 35%, 45%, and –4%
d. 35%, 27%, 41%, and –3%.
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For the year 2004, the percentages of C, I, G, and
(EX – IM) in U.S. aggregate expenditure were
roughly as follows:
a. 70%, 16%, 19%, and –5%.
b. 40%, 18%, 25%, and 17%.
c. 24%, 35%, 45%, and –4%
d. 35%, 27%, 41%, and –3%.
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CALCULATING GDP

Personal Consumption Expenditures ( C)

personal consumption
expenditures (C) A major
component of GDP: expenditures by
consumers on goods and services.

There are three main categories of consumer
expenditures: durable goods, nondurable goods, and
services.
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CALCULATING GDP

durable goods Goods that last a
relatively long time, such as cars and
household appliances.

nondurable goods Goods that are
used up fairly quickly, such as food and
clothing.

services The things we buy that do not involve
the production of physical things,
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such as legal and medical services and
education.
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The largest component of Personal Consumption
Expenditures (C) is:
a. Durable goods.
b. Nondurable goods.
c. Services.
d. Residential Investment.
e. Imports.
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The largest component of Personal Consumption
Expenditures (C) is:
a. Durable goods.
b. Nondurable goods.
c. Services.
d. Residential Investment.
e. Imports.
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CALCULATING GDP

Gross Private Domestic Investment ( I)

gross private domestic investment
(I) Total investment in capital—that is,
the purchase of new housing, plants,
equipment, and inventory by the private
(or nongovernment) sector.

nonresidential investment
Expenditures by firms for machines,
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tools, plants, and so on.
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CALCULATING GDP

residential investment Expenditures
by households and firms on new houses
and apartment buildings.

Change in Business Inventories

change in business inventories
The amount by which firms’ inventories

change during a period. Inventories are
the goods that firms produce now but
i

intend to sell later.

GDP = final sales + change in business inventories
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CALCULATING GDP

Gross Investment versus Net Investment

depreciation The amount by which an
asset’s value falls in a given period.

gross investment The total value of
all newly produced capital goods (plant,
equipment, housing, and inventory)

produced in a given period.

net investment Gross investment
i

minus depreciation.

capitalend of period = capitalbeginning of period + net investment
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CALCULATING GDP

Government Consumption and Gross
Investment (G)

government consumption and gross
investment (G) Expenditures by federal,
state, and local governments for final goods
and services.
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CALCULATING GDP

Net Exports (EX - IM)

net exports (EX - IM) The difference
between exports (sales to foreigners of
U.S.- produced goods and services) and
imports (U.S. purchases of goods and
services from abroad). The figure can

be positive or negative.
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27

Which of the following statements about exports
and imports is correct?
a. Exports must be subtracted out of GDP to
obtain the correct figure.
b. Imports must be subtracted out of GDP to
c. The difference between exports and imports
is negative when the country is a net
exporter.

d. Before 1976, the United States was generally
a net importer. Only after 1976, exports
began to exceed imports.
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28

Which of the following statements about exports
and imports is correct?
a. Exports must be subtracted out of GDP to
b. Imports must be subtracted out of
GDP to obtain the correct figure.
c. The difference between exports and imports
is negative when the country is a net
exporter.

d. Before 1976, the United States was generally
a net importer. Only after 1976, exports
began to exceed imports.
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CALCULATING GDP

THE INCOME APPROACH

national income The total income
earned by the factors of production
owned by a country’s citizens.

TABLE 6.3 National Income, 2004
PERCENTAGE
BILLIONS OF OF NATIONAL
DOLLARS

INCOME
National Income 10,275.9 100.0
Compensation of employees 6,687.6 65.1
Proprietors’ income 889.6 8.7
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Corporate profits 134.2 1.3
Net interest 1,161.5 11.3
Rental income 505.5 4.9
Indirect taxes minus subsidies 809.3 7.9
Net business transfer payments 91.1 0.9
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Surplus of government enterprises −3.0 −0.0
Source: See Table 6.2.
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CALCULATING GDP

compensation of employees
Includes wages, salaries, and various
supplements—employer contributions to
social insurance and pension funds, for
example—paid to households by firms
and by the government.

proprietors’ income The income of
unincorporated businesses.
i

rental income The income received
by property owners in the form of rent.
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CALCULATING GDP

corporate profits The income of
corporate businesses.

net interest The interest paid by
business.

indirect taxes minus subsidies
Taxes such as sales taxes, customs

duties, and license fees, less subsidies
that the government pays for which it
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receives no goods or services in return.
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32

Which of the following statements is/are correct
about the components of GDP using the
income approach?
a. Compensation of employees is the largest
item in national income.
b. Proprietor’s income refers to the profits
earned by corporations.
c. Net interest refers to interest paid by
households, business firms, and the
government.

d. Rental income is a major component of
national income.
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33

Which of the following statements is/are correct
about the components of GDP using the
income approach?
a. Compensation of employees is the
largest item in national income.
b. Proprietor’s income refers to the profits
earned by corporations.
c. Net interest refers to interest paid by
households, business firms, and the
government.

d. Rental income is a major component of
national income.
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CALCULATING GDP

net business transfer payments Net
transfer payments by businesses to
others.

surplus of government enterprises
Income of government enterprises.

TABLE 6.4 GDP, GNP, NNP and National Income, 2004

DOLLARS
(BILLIONS)
GDP 11,734.3
Plus: Receipts of factor income from the rest of the world + 415.4
i

Less: Payments of factor income to the rest of the world − 361.7
Equals: GNP 11,788.0
Less: Depreciation − 1,435.3
Equals: Net national product (NNP) 10,352.8
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Less: Statistical discrepancy − 76.9
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Equals: National income 10,275.9
Source: See Table 6.2. 35

CALCULATING GDP
net national product (NNP) Gross
national product minus depreciation; a
nation’s total product minus what is
required to maintain the value of its
capital stock.
TABLE 6.5 National Income, Personal Income, Disposable
Personal Income, and Personal Saving, 2004
DOLLARS
(BILLIONS)

National income 10,275.9
Less: Amount of national income not going to households − 562.6
Equals: Personal income 9,713.3
Less: Personal income taxes − 1,049.1
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Equals: Disposable personal income 8,664.2
Personal consumption expenditures − 8,214.3
Personal interest payments −186.7
Transfer payments made by households −111.5
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Equals: Personal saving 151.8
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Personal saving as a percentage of disposable personal income: 1.8%
Source: See Table 6.2. 36

The difference between gross national product
(GNP) and net national product (NNP) is:
a. Net exports.
b. The surplus of government enterprises.
c. Net interest.
d. Depreciation.
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The difference between gross national product
(GNP) and net national product (NNP) is:
a. Net exports.
b. The surplus of government enterprises.
c. Net interest.
d. Depreciation.
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CALCULATING GDP

statistical discrepancy Data
measurement error.

personal income The total income of
households before paying personal
income taxes.

disposable personal income or after-tax
income Personal income minus personal income
i

taxes. The amount that households have to spend
or save.
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CALCULATING GDP

personal saving The amount of
disposable income that is left after total
personal spending in a given period.

personal saving rate The percentage of
disposable personal income that is saved. If the
personal saving rate is low,

households are spending a large amount
relative to their incomes; if it is high, households
are spending cautiously.
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Fill in the blanks. Saving rates tend to ________
during recessionary periods and ________
during boom times.
a. rise; rise
b. rise; fall
c. fall; fall
d. fall; rise
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Fill in the blanks. Saving rates tend to ________
during recessionary periods and ________
during boom times.
a. rise; rise
b. rise; fall
c. fall; fall
d. fall; rise
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NOMINAL VERSUS REAL GDP

current dollars The current prices
that one pays for goods and services.

nominal GDP Gross domestic product
measured in current dollars.

weight The importance attached to an
item within a group of items.
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CALCULATING REAL GDP

TABLE 6.6 A Three-Good Economy
(1) (2) (3) (4) (5) (6) (7) (8)

GDP IN GDP IN GDP IN GDP IN
Y EAR 1 Y EAR 2 Y EAR 1 Y EAR 2
IN IN IN IN
PRODUCTION PRICE PER UNIT Y EAR 1 Y EAR 1 Y EAR 2 Y EAR 2
Y EAR 1 Y EAR 2 Y EAR 1 Y EAR 2 PRICES PRICES PRICES PRICES
Q1 Q2 P1 P2 P1 x Q1 P1 x Q2 P2 x Q1 P2 X Q2

Good A 6 11 $.50 $ .40 $3.00 $5.50 $2.40 $4.40

Good B 7 4 .30 1.00 2.10 1.20 7.00 4.00

Good C 10 12 .70 .90 7.00 8.40 9.00 10.80
Total $12.10 $15.10 $18.40 $19.20
i

Nominal GDP Nominal GDP
in year 1 in year 2
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base year The year chosen for the
weights in a fixed-weight procedure.

fixed-weight procedure A procedure
that uses weights from a given base
year.
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The difference between nominal GDP and real
GDP comes from:
a. Changes in the level of income.
b. Changes in purchasing power of the dollar
caused by changes in the exchanger rate.
c. Changes in prices.
d. Differences in the value of GDP depending on
whether the income approach or the
expenditure approach is chosen to compute

GDP.
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46

The difference between nominal GDP and real
GDP comes from:
a. Changes in the level of income.
b. Changes in purchasing power of the dollar
caused by changes in the exchanger rate.
c. Changes in prices.
d. Differences in the value of GDP depending on
whether the income approach or the
expenditure approach is chosen to compute

GDP.
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CALCULATING THE GDP DEFLATOR

The GDP deflator is one measure of the overall price level.
The GDP deflator is computed by the Bureau of Economic
Analysis (BEA).

Overall price increases can be sensitive to the choice of
the base year. For this reason, using fixed-price weights

to compute real GDP has some problems.
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THE PROBLEMS OF FIXED WEIGHTS

The use of fixed-price weights to estimate real GDP leads
to problems because it ignores:

• Structural changes in the economy.

• Supply shifts, which cause large decreases in

price and large increases in quantity supplied.

• The substitution effect of price increases.
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LIMITATIONS OF THE GDP CONCEPT

GDP AND SOCIAL WELFARE

Society is better off when crime decreases; however, a
decrease in crime is not reflected in GDP.

An increase in leisure is an increase in social welfare, but
not counted in GDP.

Nonmarket and household activities are not counted in
GDP even though they amount to real production.
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THE UNDERGROUND ECONOMY

underground economy The part of
the economy in which transactions take
place and in which income is generated
that is unreported and therefore not
counted in GDP.

Whenever sellers looking for a
i

profit come into contact with
buyers willing to pay, markets
will arise, often “underground.”
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Legalizing all forms of illegal activities would:
a. Reduce both the underground economy and
GDP.
b. Increase both the underground economy and
GDP.
c. Increase the underground economy but
reduce the value of GDP.
d. Reduce the underground economy and
increase the value of GDP.
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52

Legalizing all forms of illegal activities would:
a. Reduce both the underground economy and
GDP.
b. Increase both the underground economy and
GDP.
c. Increase the underground economy but
reduce the value of GDP.
d. Reduce the underground economy and
increase the value of GDP.
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GROSS NATIONAL INCOME PER CAPITA

gross national income (GNI) GNP
converted into dollars using an average
of currency exchange rates over several
years adjusted for rates of inflation.
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TABLE 6.7 Per Capita Gross National Income for Selected
Countries, 2004
COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS
Norway 52,030 Portugal 14,350
Switzerland 48,230 South Korea 13,980
United States 41,400 Czech Republic 9,150
Denmark 40,650 Mexico 6,770
Japan 37,180 Argentina 3,720
Sweden 35,270 Turkey 3,750
Ireland 34,280 South Africa 3,630
United Kingdom 33,940 Brazil 3,090
Finland 32,790 Romania 2,920

Austria 32,300 Jordan 2,140
Netherlands 31,700 Colombia 2,000
Belgium 31,030 Philippines 1,170
Germany 30,120 China 1,290
France 30,090 Indonesia 1,140
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Canada 28,390 India 620
Australia 26,900 Pakistan 600
Italy 26,120 Nepal 260
Spain 21,210 Rwanda 220
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Greece 16,610 Ethiopia 110
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Source: World Bank, 2005.
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REVIEW TERMS AND CONCEPTS

base year net business transfer payments
change in business inventories net exports (EX - IM)
compensation of employees net interest
corporate profits net investment
current dollars net national product (NNP)
depreciation nominal GDP
disposable personal income, or after-tax nondurable goods
income nonresidential investment
durable goods personal consumption expenditures (C)
expenditure approach personal income
final goods and services personal saving
fixed-weight procedure personal saving rate
government consumption and gross proprietors’ income

investment (G) rental income
gross domestic product (GDP) residential investment
gross investment services
gross national income (GNI) statistical discrepancy
gross national product (GNP) surplus of government enterprises
i

gross private domestic investment (I) underground economy
income approach value added
indirect taxes minus subsidies weight
intermediate goods Expenditure approach to GDP: GDP = C + I + G + (EX - IM)
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national income GDP = final sales - change in business inventories
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national income and product accounts net investment = capital end of period - capital beginning of
period 56

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