Transcript Principles of Economics Third Edition by Fred Gottheil

Chapter 20
Gross Domestic Product
Accounting
© 2002 South-Western
Economic Principles
•The circular flow of resources,
goods, and services
•The circular flow of money
•The expenditure approach to
measuring GDP
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Economic Principles
•The income approach to
measuring GDP
•The relationship between GDP,
NDP, and national income
•The limitations of GDP as a
measure of economic well-being
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Gross Domestic Product
Accounting
Circular flow of goods, services,
and resources
The movement of goods and
services from firms to households,
and of resources from households
to firms.
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EXHIBIT 1
THE CIRCULAR FLOW OF GOODS,
SERVICES, AND RESOURCES
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Exhibit 1: The Circular Flow
of Goods, Services, and
Resources
1. What do households supply to
the resource market?
• Households supply their resources –
labor, capital, land, entrepreneurship – to
the firms in the resource market.
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Exhibit 1: The Circular Flow
of Goods, Services, and
Resources
2. What do firms provide to
households in the product
market?
• Firms provide households with goods and
services in the product market.
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Gross Domestic Product
Accounting
Circular flow of money
The movement of income in the
form of resource payments from
firms to households, and of
income in the form of revenue
from households to firms.
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EXHIBIT 2
THE CIRCULAR FLOW OF MONEY
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Exhibit 2: The Circular Flow
of Money
What do firms in the resource
market pay to households for
resources provided?
• Firms pay money in the form of wages,
interest, rent and profit to households
for resources supplied.
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Two Approaches to
Calculating GDP
• Economists calculate GDP in two
ways: the expenditure approach to
GDP and the income approach to
GDP.
• Regardless of which method is
used, the values should be
equivalent.
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The Expenditure Approach
Expenditure approach
A method of calculating GDP that
adds all expenditures made for
final goods and services by
households, firms and
government.
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The Expenditure Approach
When using the expenditure
approach to GDP, one must be
certain that only final goods and
services are counted. Otherwise,
goods may be double counted.
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The Expenditure Approach
Final goods
Goods purchased for final use, not
for resale.
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The Expenditure Approach
Intermediate goods
Goods used to produce other
goods.
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The Expenditure Approach
Value added
The difference between the value
of a good that a firm produces and
the value of the goods the firm
uses to produce it.
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EXHIBIT 3
MARKET VALUE AND VALUE ADDED OF
GOODS PRODUCED
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Exhibit 3: Market Value and
Value Added Goods
Produced
1. What is the total market value
of the wool sweater in Exhibit 3?
• The total market value is $94.
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Exhibit 3: Market Value and
Value Added Goods
Produced
2. Why shouldn’t the total market
value be used when calculating
GDP?
• The total market value counts the
original resource multiple times.
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Exhibit 3: Market Value and
Value Added Goods
Produced
2. Why shouldn’t the total market
value be used when calculating
GDP?
• For example, the $4 value for wool on the
sheep makes up part of the $13 value for
wool fabric and $50 value for a wool
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sweater.
The Expenditure Approach
There are four expenditure
categories of GDP:
1. Personal consumption.
2. Gross private domestic
investment.
3. Government purchases.
4. Net exports.
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The Expenditure Approach
1. Personal consumption
expenditures (C)
All goods and services bought by
households. These expenditures
are grouped into categories of
durable goods, nondurable goods,
and services.
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The Expenditure Approach
1a. Durable goods
Goods expected to last at least a
year. For example, refrigerators,
automobiles, and washing
machines.
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The Expenditure Approach
1a. Durable goods
During recessions, consumers tend
to hang on to their durable goods,
so that sales of new durable goods
are relatively weak. During times
of prosperity, consumers are more
likely to discard old durables, and
sales of new durables are strong.
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The Expenditure Approach
1b. Nondurable goods
Goods expected to last less than a
year. For example, food, clothing,
gasoline and toiletries. Households
spend more on nondurables than
on durables.
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The Expenditure Approach
1c. Services
Productive activities that are
instantaneously consumed. For
example, medical care, a lecture,
and appliance repair. Households
spend more on services than
durable and nondurable goods
combined.
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The Expenditure Approach
2. Gross private domestic
investment (I)
The purchase by firms of plant,
equipment, and inventory goods.
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The Expenditure Approach
2. Gross private domestic
investment (I)
Plant (or new structure) and
equipment purchases may either
replace worn out plants and
equipment or increase the
quantity of plants and equipment.
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The Expenditure Approach
2a. Inventory investment
Stocks of finished goods and raw
materials that firms keep in
reserve to facilitate production
and sales.
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The Expenditure Approach
3. Government purchases (G)
All goods and services bought by
government. For example, goods
such as national defense materials,
interstate highway, and post
offices, and services such as
justice and education.
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The Expenditure Approach
4. Net exports (X-M)
An economy’s exports to other
economies, minus its imports from
other economies.
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The Expenditure Approach
All final goods and services that
make up GDP, then, can be
expressed in the form:
GDP = C + I + G + (X – M).
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EXHIBIT 4
EXPENDITURE APPROACH TO 2000 GDP
($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 4: Expenditure
Approach to 2000 GDP
($ Billions)
1. What was the largest category
of GDP expenditure in 2000?
• The largest category was personal
consumption expenditures at $6,816.7
billion.
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Exhibit 4: Expenditure
Approach to 2000 GDP
($ Billions)
2. Why was the net exports
category of expenditure negative
in 2000?
• The category was negative (-$386.1
billion) because the value of US imports
was greater than the value of US exports.
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The Income Approach
Income approach
A method of calculating GDP that
adds all the incomes earned in the
production of final goods and
services.
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The Income Approach
National income
The sum of all payments made to
resource owners for the use of
their resources.
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The Income Approach
The income payments are
arranged into five categories: (1)
the compensation of employees,
(2) interest, (3) corporate profit,
(4) rental income, and (5)
proprietors’ income.
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The Income Approach
The compensation of employees is
divided into two categories: wages
and salaries and supplements.
Supplements (or fringe benefits)
include such things as bonuses,
paid vacations, and contributions
to employees’ Social Security.
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The Income Approach
Corporate profit represents the
return to owners of incorporated
firms. Corporate profit is divided
into three categories – dividends,
corporate re-investment, and
corporate taxes. All three are
included in the income approach
to GDP.
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The Income Approach
Rent is the payment for use of
property. Although most people
don’t pay themselves rent for
using their own property, the rent
is still estimated in GDP
accounting. Net rental income is
total rental income minus
depreciation.
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The Income Approach
Proprietors’ income is the income
earned by unincorporated firms
for the goods and services they
produce. Proprietors’ income is
the net income after paying such
expenses as rent, utilities, and
supplies.
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EXHIBIT 5
2000 NATIONAL INCOME ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 5: 2000 National
Income ($ Billions)
What was the largest category of
income in the US in 2000
according to Exhibit 5?
• Compensation of employees was by far
the largest category of income at $5,678.4
billion, or 70.2 percent of the national
income.
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Bringing GDP and National
Income into Accord
GDP, according to Exhibit 4, was
$10,052.2 billion in 2000. Yet
national income, according to
Exhibit 5, was only $8,091.9
billion.
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Bringing GDP and National
Income into Accord
In order to bring the two into accord, first
gross domestic product is converted to
gross national product. Then depreciation
of capital and indirect business taxes are
subtracted from gross national product.
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Bringing GDP and National
Income into Accord
Gross National Product (GNP)
The market value of all final
goods and services in an economy
produced by resources owned by
people of that economy, regardless
of where the resources are located.
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Bringing GDP and National
Income into Accord
While GDP measures location,
GNP measures ownership. For
example, the value of goods
produced by a US-owned firm in
Spain are not counted in our GDP,
but are counted in our GNP.
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Bringing GDP and National
Income into Accord
Capital depreciation
The value of existing capital stock
used up in the process of
producing goods and services.
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Bringing GDP and National
Income into Accord
Net Domestic Product (NDP)
GDP minus capital depreciation.
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EXHIBIT 6
INFLUENCE OF CAPITAL DEPRECIATION
ON THE GROWTH RATE OF NDP
($ BILLIONS)
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Exhibit 6: Influence of Capital
Depreciation on the Growth Rate
of NDP ($ Billions)
How does the rate of NDP growth
compare to the rate of GDP
growth as capital depreciation
increases in Exhibit 6?
• Regardless of the value of capital
depreciation, the rate of GDP growth
remains unchanged.
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Exhibit 6: Influence of Capital
Depreciation on the Growth Rate
of NDP ($ Billions)
How does the rate of NDP growth
compare to the rate of GDP
growth as capital depreciation
increases in Exhibit 6?
• The rate of NDP growth declines,
however, as capital depreciation increases
from $900 to $1100 billion.
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Bringing GDP and National
Income into Accord
Indirect business taxes include
general sales taxes, excise taxes,
customs duties and license fees.
They are indirect because they are
taxes levied not on the firms
directly, but on the goods and
services.
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EXHIBIT 7
THE RELATIONSHIP BETWEEN GROSS
DOMESTIC PRODUCT, GROSS NATIONAL
PRODUCT, NET NATIONAL PRODUCT, AND
NATIONAL INCOME: 2000 ($ BILLIONS)
Note: Net domestic product = $8,767.7 billion. The use of NNP instead of NDP to derive national incomes conforms to the derivation of national
income used by government sources. Note also that because GDP and GNP are almost identical, NDP and NNP are almost identical.
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 7: The Relationship
Between GDP, GNP, Net National
Product, and National Income:
2000
How is national income derived
from gross domestic product?
• First, GDP is converted to GNP. This is
done by subtracting factor payments to the
rest of the world and adding factor
payments from the rest of the world.
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Exhibit 7: The Relationship
Between GDP, GNP, Net National
Product, and National Income:
2000
How is national income derived
from gross domestic product?
• Second, capital depreciation is subtracted
from GNP. The result is net national
product.
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Exhibit 7: The Relationship
Between GDP, GNP, Net National
Product, and National Income:
2000
How is national income derived
from gross domestic product?
• Third, indirect business taxes are
subtracted from net national product. The
result is national income.
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Personal Income and Personal
Disposable Income
Personal income
National income, plus income
received but not earned, minus
income earned but not received.
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Personal Income and Personal
Disposable Income
Transfer payments
Income received but not earned. For
example, government-supplied
income from retirement benefits,
veteran benefits, unemployment
insurance benefits, disability
payments and subsidies to farmers.
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Personal Income and Personal
Disposable Income
Transfer payments
The government transfers income
from taxpayers (who earned the
income in the first place) to those
receiving benefits.
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Personal Income and Personal
Disposable Income
Disposable personal income
Personal income minus direct
taxes.
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How Comprehensive
is GDP?
GDP tries to measure everything
that appears on the market. Yet,
not everything produced in the
economy gets onto the market,
and some things that contribute to
our economic well-being aren’t
even produced.
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How Comprehensive
is GDP?
The value of housework is one
example of an important service
that is usually not included in
GDP. The work is only included if
it is performed by someone
outside the household, such as a
housekeeper, nanny, or cook.
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How Comprehensive
is GDP?
Underground economy
The unreported or illegal
production of goods and services
in the economy that is not counted
in GDP.
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How Comprehensive
is GDP?
Illegal unreported activities may
include drug trafficking, money
laundering, bribery, prostitution,
illegal gambling, fraud and
burglary.
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How Comprehensive
is GDP?
Tax avoidance is the main reason
why legal activities may go
unreported. Swapping services or
simply understating the value of
income earned are two ways to
avoid paying taxes.
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How Comprehensive
is GDP?
Finally, legal and illegal
immigrants may work for less
than minimum wage at off-thebooks entry-level jobs.
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How Comprehensive
is GDP?
The quality of goods and services
produced may not be included in
GDP. For example, a good may be
of higher quality, but cost less,
than a similar good. The economic
value of the improved quality
good is not recorded.
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How Comprehensive
is GDP?
The costs of environmental
damage are another factor not
taken into account in GDP.
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How Comprehensive
is GDP?
While the expense associated with
cleaning up the pollution we
create contributes to GDP, the
actual pollution created is not
subtracted from GDP.
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How Comprehensive
is GDP?
Many economists agree that
despite the exclusion of some
forms of economic value, our
measure of GDP is sufficiently
comprehensive to be a reliable
indicator of changes in the overall
performance of the economy.
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