Chapter 25: Measuring Domestic Output and National Income

Nominal GDP (unadjusted GDP)

A GDP based on the prices that prevailed when the output was produced Output valued at current prices

Real GDP (adjusted GDP)

A GDP that has been deflated or inflated to reflect changes in the price level - makes the use of reference years USEFUL (same value of the dollar) Real GDP = (nominal GDP)/(price index [in hundredths]) *The most direct method of deflating is to express the index numbers as hundredths - in decimal for, - and divide them into corresponding nominal GDP Output valued at constant base-year prices

Price index

A measure of the price of a specified collection of goods and services, called a "market basket," in a given year as compared to the price of an identical (or highly similar) collection of goods and services in a reference year Price index in a given year = (price of a market basket in a specific year/price of same market basket in base year) x 100 Price index (in hundredths) = (nominal GDP)/(real GDP) *This approach is essentially determining the price index for a given year by dividing the nominal GDP by the real GDP for that year

Gross domestic product (GDP)

Aggregate output as the dollar value of all final goods and services produced within the borders of a country during a specific period of time, typically a year. Note: the value of cars produced at a Toyota factory in Ohio count as part of the U.S. GDP rather than that of Japan (produced within American borders). Excludes non production/financial transactions such as public transfer payments (ex. welfare), private transfer payments (ex. cash gifts), and stock market transactions (ex. purchasing of bonds and stocks) GDP = C + I + G + Xn GDP = (total output) x (market prices) Whether there is a 5% increase in output with no change in prices or a 5% increase in prices with no change in output, the change in value of GDP will be the same - the quantity of goods and services that get produced and distributed to households affects our standard of living, not the prices of those goods and services When prices fall, inflate GDP When prices rise, deflate GDP These adjustments give measures as if the value of the dollar has remained the same

Personal consumption expenditures (C)

All expenditures by households on goods and services (10% durable goods, 30% nondurable goods, 60% services)

Gross private domestic investment (I)

All final purchases of machinery, equipment, and tools by business enterprises, all construction (apartments/houses can earn income when rented or leased = investment!), changes in inventories (depend on nature of economy), money spent on R&D - does not include non-investment transactions such as the selling/purchasing of stocks and bonds or resale of tangible assets (houses, jewelry, boats)

Consumption of fixed capital (depreciation allowance)

Because the useful lives of private capital equipment extend far beyond the year in which they were produced, the cost of such capital must be allocated over its lifetime (to avoid understating profit and income in the year of purchase and overstating these factors in future years). The amount allocated is an estimate of how much of the capital is being used up each year = depreciation. The huge depreciation made against private and publicly owned capital each year is called consumption of fixed capital because it is the allowance for capital that has been consumed in producing the year's GDP - it is the portion of the GDP that is set aside to pay for the ultimate replacement of those capital goods. The money allocated to consumption of fixed capital is a cost of production and is included in the gross value of output*

Disposable income (DI)

DI = PI - personal taxes (personal income taxes, personal property taxes, and inheritance taxes) The amount of income that household have left over after paying their personal taxes- free to divide their income between consumption and saving

Expenditures approach (output approach)

Determining the GDP by adding up all the spending on final goods and services that has taken place throughout the year.

Income approach (earnings/allocations approach)

Determining the GDP by looking at the income derived or created through the production of goods and services over the course of a year

Statistical discrepancy

Difficulties in accuracy of calculating inputs arise due to factors including people misreporting their incomes on tax returns and the difficulty involved with accurately estimating depreciation. Therefore, the GDP number produced by the income method always differs a small percentage from the GDP number produced by the expenditures method

Net exports (Xn)

Goods and services produced within the borders of the United States In order to count only what goes to purchasing domestically produced goods and services, we must subtract the spending that goes to imports Net exports (Xn) = exports (X) - imports (M)

Government purchases (G)

Government consumption expenditures and gross investment - (1) expenditures for goods and services that government consumes in providing public services; (2) expenditures for publicly owned capital such as schools and highways which have long lifetimes; and (3) government expenditures on R&D and other activities that increases the economy's stock of know-how. Government purchases include all government expenditures on final goods and all direct purchases of resources, including labor - does not include government transfer payments (ex. welfare payments, Social Security)

Net private domestic investment

Gross investment refers to all investment goods (both those that replace older capital and add to capital) - BUT net private domestic investment includes only investment in the form of added capital Net investment = gross investment - depreciation

National income (NI)

Includes all income earned through the use of American-owned resources, whether they are located home or abroad (also includes taxes on production and imports) NI = NDP - statistical discrepancy + net foreign factor income (income earned by Americans overseas - income earned by foreigners in the U.S.)

Personal income (PI)

Includes all income received, whether earned or unearned PI = NI - income earned but not received (taxes) + income received but not earned (private pension payments, welfare payments, Social Security payments, unemployment compensation payments, and disability and education payments to veterans)

Taxes on production and imports

Includes general sales taxes, excise taxes, business property taxes, license fees, and customs duties. Counting these as national income is important in order to account for expenditures that are diverted to the government as "government income"

Net domestic product (NDP)

NDP = GDP - consumption of fixed capital (depreciation) Unlike GDP, NDP makes allowances for replacing the capital goods used up in each year's production and tells us how much new output was available for consumption and for additions to the stock of capital Essentially, NDP is GDP adjusted for depreciation - it measures the total annual output that the entire economy (households, businesses, government, and foreigners) can consume without impairing its capacity to produce in ensuing years

Final goods

Products purchased by their end users. Ex. Gasoline used for personal transportation. The value of final goods is included in GDP - includes intermediate goods used in their production

Intermediate goods

Products that are purchased for resale or further processing or manufacturing. Ex. lettuce, carrots, and vinegar in restaurant salads (while the restaurant salad itself is a final good). The value of intermediate goods is not included in GDP because the value of final goods already includes the value of all intermediate goods used in producing them

Durable goods

Products that have expected lives of three years or more. Ex. New cars, furniture, refrigerators

Nondurable goods

Products with less than three years of expected life. Ex. Food, clothing, and gasoline

Depreciation

The amount of capital that is used up over the course of a year

Value added

The market value of a firm's output minus the value of the inputs the firm has bought from others.

Base year

The point of reference used in a price index (also known as the benchmark, base period, or reference year)

Deflating

The process of using a price index to decrease (deflate) a given year's nominal gross domestic product down to the smaller value of its real gross domestic product; only applicable if the given year's price level is higher than the price level that prevailed during the price index's base year

Inflating

The process of using a price index to increase (inflate) a given year's nominal gross domestic product up to the larger value of its real gross domestic product; only applicable if the given year's price level is lower than the price level that prevailed during the price index's base - making everything RELATIVE

National income accounting

The techniques used to measure the overall production of a country's economy as well as other related variables - measures economy's overall performance

National income

The total of all sources of private income (employee compensation, rents, interest, proprietor's income, and corporate profits) plus government revenue from taxes on production and imports. National income is all the income that flows to American-supplied resources, whether here or abroad, plus taxes on production and imports

Services

The work done by lawyers, hair stylists, doctors, mechanics, and other service providers - U.S. spends so much on these that it is often referred to as a service economy

WIRP

Wages: wages and salaries paid by business and government to their employees. Also includes payments by employers into social insurance and into a variety of private pension, health, and welfare funds for workers Interest: money paid by private businesses to the suppliers of loans used to purchase capital. Includes interest households receive on savings deposits, certificates of deposit, and corporate bonds Rent: the income received by the households and businesses that supply property resources (Ex. monthly payments tenants make to landlords and lease payments corporations pay for the use of office space) [Net rent = gross rental income - depreciation of rental property) Profits (proprietor's income and corporate profits): Proprietor's income: the net income of sole proprietorships, partnerships, and other unincorporated businesses - flows to proprietors Corporate profits: earnings of corporations, which is divided into... (1) Corporate income taxes: taxes levied on corporations' profits which flow to the government (2) Dividends: part of after-tax profits that corporations choose to pay out/distribute to their stockholders - flow to households (the owners of all corporations) (3) Undistributed corporate profits: any after-tax profits that are not distributed to shareholders are saved, or retained, by corporations to be invested later in new plants and equipment - also called retained earnings

Multiple counting

Wrongly including the value of intermediate goods in the GDP; counting the same good or service more than once (why we don't count intermediate goods in GDP)