Chapter 7: Measuring Domestic Output, National Income and Price Level

1. Assessing the Economy’s Performance

a. Nat’l income accounting measures econ’s overall performance asses
health of econ
b. Track long-run course of econ
c. Formulate policies to safeguard and improve

2. Gross Domestic Product

a. Aggregate output---annual total output of goods and services
b. GDP—total mkt value of all final goods and services produced in a given
year, both domestic and foreign – owned by US = GDP
c. A Monetary Measure
i. GDP= monetary measure (needs prices to be measured)
d. Avoiding multiple counting
i. All goods and services produced in a particular year must be
counted only ONCE
ii. GDP includes only the mkt value of final goods; ignores
intermediate goods
iii. Intermediate goods: purchased for resale or further processing
iv. Multiple counting: distorts value of GDP
v. Value added-- $ added to value after each process
e. GDP Excludes Nonproduction Transactions
i. Nonproduction transactions must be excluded, are purely financial
and secondhand sales
1. Financial Transactions:
a. Public Transfer Payments-social security, welfare
payments, vets payments
b. Private Transfer payments-Christmas cash
c. Stock Mkt transactions: buy/selling of stocks/bonds
2. Secondhand sales: contribute nothing to current production
f. two ways of Looking at GDP: Spending and Income
i. Final product approach; value added approach
ii. Expenditures approach—output/sum of all $ spent
iii. Income approach—earnings or allocation
3. The expenditures Approach: add up all the spending on final goods and services
a. Personal Consumption expenditures (c)
i. Consumption expenditures by households
ii. Personal consumption expenditures: durable consumer goods (cars,
fridge, etc), nondurable consumer goods (pencils, toothpaste,
milk), consumer expenditures for services (lawyers, doctors)
b. Gross Private Domestic Investment (Iq)
i. All final purachases of machinery, equipment, and tools by
business enterprises
ii. All construction
iii. Changes in inventories
 1. positive and negative changes in inventories: count all
output produced even if it’s unsold at end of year “drawing
down of inventories” sold goods produced in prior
years=negative investment
2. Noninvestment transaction: investments NOT transfer of
paper assets or resale of tangible assets, merely transfer
ownership of existing assets. Investment—creation of new
capital assets
3. Gross Investment vs Net Investment:
a. GDP investment: all final purchases, construction,
changes in inventories. “Private” “gross”: all
domestic goods.
b. Net private domestic investment: only investment in
the form of added capital amt of capital used up
over year = depreciation
c. Net investment=gross investment-depreciation
d. GI=d net is 0
e. GI>d net is neg, econ is disinvesting
c. Government Purchases (G)
i. Expenditures for goods/services govt uses in providing public
servicer
ii. Expenditures for social capital (schools/highways)
iii. Gov purchases: all expenditures on final goods all direct purchases
of resources, including labor
d. net Exports (Xn)
i. Exports less imports
ii. Net exports
iii. Net exports (Xn) = exports (X) – imports (m)
e. Putting it all Together: GDP = G + Ig+ G + Xn
i. Four categories provide a measure of the mkt value of a given
year’s output
4. Income approach: not just wages and rent and interest and profit, 1st look at natl
income
a. Compensation of Employees:
i. Wages and salaries by businesses and govt to employees
ii. Private pension, health and welfare funds
b. Rents
i. Income received by the households and businesses that supply
property resources (monthly payments tenants make)
c. Interest
i. Money paid by private businesses to the suppliers of money capital
(interest on savings, CoD and Corporate bonds)
d. Proprietor’s Income:
i. Profits: proprietor’s income and corporate profits
ii. PI: flows to proprietors
e. Corporate profits: earnings of owners of corporations
 i. Corporate Income Taxes: levied on net earnings flow to govt
ii. Dividends: paid to stockholders: households
iii. Undistributed corporate profits: $ saved to be invested later (aka
returned earnings
f. From Natl Income to GDP
i. Natl income: all the income that flows to Am-supplied resources;
here or abroad
ii. Natl income < GDP (balanced by adding…)
1. indirect business taxes: general sales tax, excise tax,
business property tax, license fees, custom duties
2. Consumption of fixed capital: cost of durable items must be
allocated over its lifetime, amount allocated is estimate of
how much capital is used (depreciation, NOT included in
natl income b/c it doesn’t add to anyone’s income
3. Net foreign factor income: natl income: all US here or
aborad. GDP= domestic regardless of nationally producing,
must add it to natl income. Foreign-owned resources—Am-
owned resources (aborad)
5. Other Natl Accounts
a. Net Domestic Product
i. GDP does not make allowances for replacing capital goods used up
in each year’s production
ii. NDP= GDP – consumption of fixed capital (depreciation)
b. Natl Income: To derive
i. Subtract net foreign factor income from NDP
ii. Subtract indirect business taxes from NDP
iii. NI=NDP–Net foreign factor income earned – indirect business tax
c. personal income: all income received whether it was earned or unearned
i. some income earned is not received by households (taxes
ii. some income is not earned (social security benefits)
iii. NIPI: subtracted earned/net received and received/not earned
iv. Corporate profits and transfer payments
d. disposable income
i. DI= PI – personal taxes
ii. PT= income, property, inheritance
iii. DI= $ left over after taxes
iv. DI= consumption + savings
6. Nominal GDP vs Real GDP: how can we compare mkt value of GDP if value of $
changes in response to inflation/deflation? To fix thisdeflate GDP when prices go
up, inflate GDP when prices go down (Nominal is the unadjusted GDP)
a. Adjustment process in a one-product econ: 2 ways to adjust nominal GDP
to reflect price changes
i. GDP Price index:
1. assemble data on the price changes that occurred over
various years
 2. price index—measure of the price of a specified collection
of goods/services ina given year as compared to the price of
an identical collection of goods/services in a reference year
3. Price index in a given year = (price of mkt basket in
specified year/ price of same mkt in base year) * 100
ii. Dividing Nominal GDP by the Price index
1. Real GDP= Nominal GDP / price index (in hundredths)
b. an alternative method
i. price index (in hundredths) = nominal GDP / real GDP
c. Real world considerations and data
i. Determining GDP = way complex
ii. Chain-type annual wights price index
7. The Consumer Price Index
a. CPI: compiled by Bureau of Labor statistics, used by govt to measure rate
of inflation from month to month
b. CPI = ( price in current mkt / price in old mkt ) * 100
8. Shortcomings of GDP: reasonably accurate, but total output and well-being
a. Nonmkt transactions
i. Certain transactions never show up in GDP
ii. GDP understates nations total output
b. Leisure
i. Understantes well-being by ignoring leisure’s value; does not
accommodate satisfaction ppl derive from work
c. improved product quality
i. fails to take into account the value of improvements in product
quality
d. the underground econ
i. some illegal
ii. some perfectly legal: ex: bellman only report par of his tips
iii. value: estimated to be about 8% of recorded GDP
e. GDP and the environment
i. Growth of GDP accompanied by byproducts dirty air and water,
toxic waste
ii. GDP overstates our natl well-being
f. composition and distribution of output
i. GDP does not tell whether the mix of services will be helpful or
harmful to society’s well-being
ii. Reveals nothing about how output is distributed
g. per capita output
i. PCO = Real GDP / popn
h. Nonecon sources of well-being
i. GDP doesn’t measure it’s total well-being
ii. many things to raise well-being w/out raising GDP (reduction of
crime, reduction of drugs/alcohol abuse)
9. Last word: Feeding the GDP accounts
a. The Bureau of Econ Analysis (BEA) an agency of the Dep of Commerce
compiles the GDP accounts. Where does it get the Actual Data?
i. Consumption: The census Bureau’s Retail Trade Survey, Survey of
Manufactures, Service Survey, industry trade sources
ii. Investment: all sources above, census construction surveys
iii. Govt purchases: US office of Personal Management surveys,
census construction surveys, cnsus bureau’s survey of Govt
finance
iv. Net exports:US customs services, BEA surveys of potential
domestic exporters to importers of services