National Income Accounting

 National Income Accounting

Depression—Surprise! After

being blind-sided by the Great Depression, policymakers decided that they needed measures of economic activity. A Keynesian economist, Simon Kuznets, was charged with establishing the methodology for this in the late 1930s. Kuznets later received the Nobel Prize for his efforts.

 National Income Accounting The

framewo framework rk that that summari summarizes zes and catego categoriz rizes es produc productive tive activity over a specific period of time, usually a year. The National Income and Product Accounts (NIPA) is the “table of accounts” for maintaining this information in the U.S.

GDP – “Output” Gross

Domestic Product ( GDP ) is the market value of final goods and services produced within a country during a specific time pe riod, usually a year. Valued at Market Value Only Final Goods and Services Count:   Sales at intermediate stages of production are not counted as their value is embodied within the final-user good. Their inclusion would result in double counting. Excludes financial transactions and income transfers since these do not reflect production. Must be produced w ithin the geographic boundaries of the country. Net additions to inventory are current period output so are also included.

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Final Goods and Services The The term term   fi GDP refe refers rs to good goodss and and final nal goods goods and servic services es in GDP services produced for final use.  Intermediate goods are goods produced by one firm for use in further  •  Intermediate  processing by another firm. •

GDP as Output Produced includes all output sold plus sold plus all goods produced but not sold. goods . Inventory is a firm’s stock of unsold goods. GDP

 –Planned

inventory changes reflect management’s decision to add to or  to reduce its on-hand stock.  –Unplanned inventory changes reflect the results of unexpected sales variations.

GDP as Valued-Added •

Value added  is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.

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In calc calcul ulat atin ing g GDP, GDP, we can eithe eitherr sum up the valu valuee added added at each stage of production, or we can take the value of final sales.

Exclusions of Used Goods and Paper Transactions •

GDP ignore ignoress all transa transacti ctions ons in whic which h money money or goods goods chang changee hands hands  but in which no new goods and services are produced.

Exclusion of Output Produced Abroad Abroad by Domestically Owned Factors of  Production •

GDP is the value of output produced by factors of production located within a country. country. Output produced produced by a country’s country’s citizens, regardless regardless of wher wheree the the outp output ut is prod produc uced ed,, is meas measur ured ed by gros grosss nati nation onal al  product (GNP ).

The Underground Economy •

The underground economy is the the part part of an econ econom omy y in whic which h tran transa sact ctio ions ns take take plac placee and and in whic which h inco income me is gene genera rate ted d that that is unreported and therefore not counted in GDP.

Two Methods of Computing An Economy’s Income Expenditure Approach: Approach: Sum the the total total expe expend ndit itur ures es by hous househ ehol olds ds (from (from the the top top  –Sum

portion of the circular flow). Resource Cost or Income Approach:  –Sum the total wages and profit paid by firms for resources

(from the bottom portion of the circular flow).

Expenditures on Final Goods

= GDP =

Income Received for producing Final Goods

GDP as Expenditures s s

GDP is the sum of expenditures on final user goods and services by households, investors, governments, and foreigners (net). There are four components of GDP: s  personal consumption expenditures (C), s gross private domestic investment (I),

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government purchases (G) of goods and services, and,

s net exports (X) ( exports - imports ) s

GDP = C + I + G + X

GDP as Income s GDP

is the sum of the income (including profits) received received in  producing final goods and services during the period. s All of the payments made to producers are paid out to wageearn earner ers, s, busi busine ness ss owne owners rs, governm rnmen ents ts,, etc. etc. Thus Thus in tota totall the the ners, rs,, gove incomes must equal to the payments, which are equal in dollar  value to the total expenditures. s Payments include: s Wages and benefits paid to workers, s Proprietors’ income, income, s rents, s interest, s corporate profits, s Indirect business taxes s  Net factor income from abroad s Capital consumption allowance.

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Wages (including benefits) are the largest category. This category includes insurance, social security and retirement contributions. Interest is the net expense interest paid. Rent is the income earned from selling the use of real estate. Proprietors’ income is paid directly to sole proprietors. Net Factor Income from Abroad The income that foreigners earn producing goods within the borders of a country minus the income Americans earn abroad. Capital Consumption Allowance (CCA)  Depreciation is an estimate of the value of capital goods “used up” in the period’s production. It is the cost of the wear and tear on the machines and factories. CCA is depreciation, plus the value of capital lost due to accidental damage. Indirect business taxes Taxes collected by businesses and turned over to the governments.

Equality of Income and Expenditure GDP is calculated either by adding up all values of final output or by adding up the values of all earnings or income Other Measures

GDP vs. GNP Gr Gros oss s

Domes Domestic tic Produ Product ct (GDP (GDP)) is the the total total valu value e of final final good goods s and and services produced during a given period within the geographic boundaries of a country regardless regardless of by whom. The goods and services are produced domestically. Gros oss s Nati Nation onal al Prod Produc uctt (GNP) (GNP) is the total total value value of final final good goods s and and Gr services produced during a given period by the citizens of a country no matte matterr wh wher ere e they they live. live. The The good goods s and and serv service ices s are are produ produce ced d by the “nationals” of the country.

GDP and NDP the sum sum of cons consum umpt ptio ion n expe expend ndit itur ures es,,   Net Net domes domestic tic produc product  t  ( NDP   NDP ) – the governm government ent expend expenditu itures, res, net foreign foreign expend expenditu itures res,, and investm investment ent less less depreciation s  Net domestic product is GDP adjusted for depreciation: GDP = C + I + G + (X - M)  NDP = C + I + G + (X - M) - depreciation

 Net National Product Net Net

Nati Nation onal al Prod Produc uctt (NNP (NNP)) is GDP that that is net  of depreci depreciatio ation— n— depreciation has been substracted from it. That is, NNP includes net investment instead of gross investment.  –Gross

investment is total investment, which includes investment expenditures that simply replace worn out capital goods. Such replacement investment does not add to the total capital stock. investmentt excludes excludes replacement replacement investmen investment. t. That That is, it is gross gross investment investment  –Net investmen minus CCA.

 National Income National

Income (NI) is NNP less business taxes, plus or minus some other minor factors. NI is a measure of the income payments that actually go to resources.

Personal Income and Personal Disposable Income Personal

Income (PI) is national income plus current year. It is:

 –Net

income that is received but not earned (transfer payments like social security), and  –Net income earned but not received (like retained corporate earnings).  –PI is the income with which individuals pay personal taxes, save, and consume. Disposable

Personal Income is PI minus personal taxes. It is “after-tax” personal income.  –DPI

is the income that individuals have at their disposal for spending or saving.

Qualifications to the Income Accounting Identity s

To go from GDP to national income: q Add net foreign factor income. x  National income is all income earned by citizens of a nation and is equal to GNP. x To move from "domestic" to "national" we add net foreign factor income. q Subtract depreciation from GDP. DP. q Subtract indirect business taxes from G DP.

Real and Nominal GDP term "real" means "real" means adjusted for inflation. Nominal GDP is a measure of national output based on the current prices of goods and services. It is also called “money GDP”. The

Real

GDP is a measure of the quantity of final goods and services produced, obtained by eliminating the influence of price changes from nominal nomin al GDP G DP..

GDP Price Deflator  GDP Price Deflator is Deflator is a price index that uses a bundle of all final goods and services.

The

 –It tells us the rise in nominal GDP that is attributable to a rise in

prices. Converting

Nominal GDP to Real GDP: Real GDP20xx =

(Nominal GDP20xx ) ÷ (GDP deflator 20xx 20xx)X100

Real GDP Growth in 7 Countries

What Increased?

GDP and Economic Well-Being GDP GDP Per Per Pers Person on tell tells s us the the inco income me and and expe expend ndit itur ure e of the the

average person in the economy econo my.. well-being  of the economy as  –It is a good measure of the material well-being of a whole.  –More Real GDP means we have a higher material standard of  living by being able to consume more goods and services.  –It is NOT intended NOT intended to be a measure of happiness or quality of life.

GDP and Economic Well-Being Some factors and issues not in not  in GDP that lead to the “well-being” of 

the economy:  –Factors that contribute to a good life such as leisure.  –Factors that lead to a quality environment.  –The value of almost all activity that takes place outside of the markets, e.g. volunteer work and child-rearing.

Some Limitations of National Income Accounting s

Limitations of national income accounting accounting include include the the following: q Measurement problems exist. q GDP measures economic activity, not welfare.

q Subcategories are often interdependent interdependent.

GDP Measures Market M arket Activity, Not Welfare s s

GDP does not measure happiness, nor does it measure economic welfare. Welfare is a complicated idea, very difficult to measure.

Measurement Errors s

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GDP figures leave out the following: f ollowing: q Illegal drug sales. q Under-the-counter sales of goods to avoid income and sales taxes. q Work performed and paid for in cash. q Unreported sales. q Prostitution, loan sharking, extortion, and other illegal activities A second type of measurement error occurs in adjusting GDP for  inflation. q If the price and the quality of a product go up together, has the  price really gone up? Is it possible to measure the value of quality increases?

Price Indexes  The value of a price index in any particular year indicates how prices

have changed relative to a base year.  The base year is the year against which all other years are compared.

The index is 100 ± the percent change in prices from the base year.  This type of index index suffers suffers from substitution suffers substitut subst itution ion bias as some some buyers buyers will will

change the mix of goods that they buy in response to price changes.  Chain-type Chain-type indexes indexes of real GDP GDP were were created created to to correct correct for for this this bias. bias. Such an index uses the mean of the growth rates using beginning and ending year prices.

Circular Flow Diagram