components

i a. . .li +,: 1,

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ti ..:r r_r'1:,,:'1:: i t i:i i''-' . ii !,.J . !n*,. --

How do we keep track of the most complex economy in world history? what's gross

about the gross domestic product? What's domestii about it7 If you make you-rse{

a tuna Sandwich, how much does your effort add to the gross domestic product?

Becausepriceschangeovertime,howcanweComparetheeconomy,sproduction inoneyearwiththatinotheryears?Answers,totheseandotherquestionsare addressed in this chapter, whichintroduces an economic

scorecard for a $r4 trillion

*r.& * e !#*

U.S. economy. That scorecard is the

national income accounting sYs- tem, which reduces a huge network

of economic activity to a few aggre-

gate measures. As you will see, aggregate output . I should spend as much as I can, because Gonsumer spending

is measured either by the spend- keeps the economy healthy. ing on that output or by the income st,;,utv Disaqrte :lt/on9lY litr':t- de"rived from producing it. we i''-"""

"'-? -' g 4 5 s 7 examine each aPProach and learn

why they are equivalent. The major

tbmponents and imPortant equaii- ties built into the national income accounts are offered

here as another way of under-

standinghowtheeconomywolks-notasaforeignlanguagetobemasteredbefore the next exam. The emphasis is more on economic intuition

than on accounting pre-

cision. The body of tire chapter provides the background you need for later chapters'

I.ffi1 The Froduat -rn*ir< rriqrr:cse* "fopics ciscusseC iir ef a Natiore . :, .chapter /

inciucet, ,,. , . How do we ll'Ieasure the econ- e National incsfire,acesuntt I '6l Leakges'and injecliqns' omy's performance7 During imitations of national *r.h of-th" rzth ani r8;;;;: o ExpendiiureapproachtoGDP

e lrrorru..ornting

turies, when the dominant eco- Q lneomeappruachto6DP :. _ - nomic policy was mercantiiism, e C*culart*wof,inismeanO:

C eofsumer'prneindex

il::il"iff"*: t::i ;':ffi?I; - ;;;;;;";; o GDPpriceindex

ty the stock of Precious metals a natlon accumulated in the Public treasury. Mercantilism led to restrictions on international trade,

but this had the unin-

tended consequence of reducing the gains from comparative advantage' In the latter

half of the lgth century, rranEois queJ.ay became the first to measure economic activ-

ity as aflou. In r75g he published his Tatleau tconomique, which described the circular

flow ofoutput and income through different sectors of the economy' His insight was

i**r ,*s a;'

'r-*,:1:

6 U(,

=L o

CHI\PTER 7 liacilltitl 11li: ii S LlcLir:o'rlr 99

ti f i i 'i I :

:

i.

ii { E s

F :. t i ; iy

i 'a

F

t I

exDenditure ao'uroach to GDP *itiulat'utg GDP bY add- ing rtP sPer:ding on all

fina{ qoods atlri servtces prndlrcer! in the natiOr! dr"rri*g th+ Year

income aPproaeh ts GDF $alculaling GSF bY

adding uP ail *arnings fr*n1 Ytsgurees u*ed ta produee output ln the r'laiio* dirr;slS the Yea'

final.goads and servlces socds ancl servi**s ssld ta iirial, or *fid, users

intermediate goods and sen/ices aoods and servlces

[.rrchased bY iirms f or

aeiditisnal Prscesstn g

oncl re*al*

double counting the misiake el inck':ri- ing ircth the valde of i:rt*rr*eeliaie Pred*cts anql the value oJ !i*al nrotJttcts in calculatins cicss domestic Product; i**r:*ting tlr+ sanr{: Pra- .leJct!$* lilore ttratr s*c*

E

likely insPired bY his k-nor1l- i edge of blood's circular Jtow in i the bodY-Quesnay was court

ff,ysician to King Louis XV of

France. Rough measures of

national income were devel-

oped inEngland two centuries

ago, Uut detailed calcuiations

Uuitt uP from microeco- nomic data were refined in

the United States during the

Great DePression' The result-

ing national income accounling

svstem organizes huge quan-

tities of data coiiected from a variety of sources across America' These data were summarized, assembled into

u .oh"rurrt framework' and reported bY the federal gov-

.rrr*"trr. The conception and imPlementation of these

t..orrni, has been hailed as one of the greatest achieve- ments of the zoth century' The U'S' national income accounts are the most widely

copied and most highlY

regatded jn the rr''orid a::g ta::ei rlreir riere -cper' Simon Kuznets, the Nobei ?dze in r97r for

"giving

q"""iio,*" precision lo economic entities "

National lncome Aecounts

How do the national income accounts keep track

oftheeconomy'sincrediblevarietyofgoodsand services, from hiking boots to Pilates

classes? The

gt"tt-J".tt, ic produci, or GfP' m1as1t::^tl" market

value of all final goods and services produced dur-

ing a year by resources located in the United States'

,*E"rii"r, ot,^,t'o owns the resources' For example'

GDP includes production in the United States by for-

"ign nr*r, .,,th "'

a Toyota nlant-i1 Kentucky' but

excludes forelgn produciion by U'S' firms' such as a

Ford Plant in Mexico' The national income accounts

are based on the

simple fact that one person's spendingis another person's

income. GDP canbe *"*"""d eitherby total spending

on U.S. production or by total income received from

;;;;;;".tion' rhe expenditure approach adds up

;;";il;g on all n'.'"i gooat and services produced

;;;;; tfre year' the iniorne approach adds up earn-

ings during the y91r by those whl nrod-1ce all that

output' ln the douote' eitry bookkeeping system r1.11t.:

ir".'r. rr-t" economy, spending on aggregate output ls

recordedononesideoftheledgerandincomefrom producing that aggregate output

is recorded on the

other side. Gross domestic product includes ":ty li:]

noo,i, nttd seruices, which are goods and servlces

:;ffi";; in"t, ot end, user' A toothbrush' a pair of

contact ienses, and a bus ride are examples of final

*""at ""a services' Whether a sale is to the

final

ir", a"p"rlas on who buys the pTg-Y:' When vou

i"u .iiit"", that's reflectld in GDP' when KFC buys

;iJ;;;",r",, th"t'' not counted in GDP because

KFC is not the final consumer' Only "ft"t-:|"

chicken

is cooked and sold by KFC is the transaction counted

in GDP. Intermediate goods and serviees

are those pur-

chasedforadditionalprocessing.a'.dresale,iike *iZ;. .r.i.ten. This cr'ange may b3 imperceptible' as when a grocer buys cained

goods to.restock the

shelves. or the inter'mediat" goodr can be dramati-

. "uv "t,"'"

a Tl;J,iJ :?:1 :i::Jfin :,,: 1:: canvas and $3o In olIS lnfo a wur

L!' -' '. .*

;;:;";. sales of intermediate goods and servrces are

excluded from GDP io avoid ihe problem of double

-^,rnting which is counting an item's value more

Lv s.. !^- -a t

thanonce.Forexampl"''Jppot"the,grocerbuys il;;;;;"a for $o'ot ana ieits it for$:'oo'

If GDP

counted both the intermediate transaction of $o'6o

and the final transaltion of $r 'oo' the recorded value

!,.. :

fl

ii t:,.,,

i,r €' x,{t: gi&

i*:x':* iE]tr& =i*

OI Ui('t <t >E cH IJgFN Ft -l

aa U* EA JN FT OE EE

ixilaA l3Elat

lEt

l:E

lil

Ig

1OO PART z Frlndanentals of Macroec0tt0tlltcs

- -:$reciiale goods

9 ,'i

&

- : : :: 5o would exceed its final value by $o.6o. Hence, : .ll counts only the final value. As another exam- . - .= ::r zoo8 Wal-Mart paid $z8Z billion for products ; . -:.C for $:ZS billion. If GDP counted intermedi- ] =-= ::ansactions and final transactions, it would be-"-:-: cil]ion too high. GDP also ignores most of the 'r r":,:'idhand value of used goods, such as existing

= .,.,,.at, used cars, and used textbooks. These goods

: ., '=:. counted in GDP when they were produced. But *. - as the services provided by the grocer and by

''-a--l,,lart are captured in GDR so are the services :::-.--ied by real estate agents, used-car dealers, and -==i-book sellers.

&*P Based &ffi the *xpenditure Approaelt ..-: :,::ed already, one way to measure GDP is to add r:=:-,iing on all final goods and services produced .:- ::re economy during the year. The easiest way :: *::Cerstand the spending approach is to divide :r-=gate expenditure into its components: con-

sumption, investment, government purchases, and net exports. Consurnption, or more specifically, per- sonal consumption expenditures, consists of purchases of final goods and services by households during the year. Consumption is the iargest spending cat- egory averaging about two-thirds of U.S. GDP during the last decade. Along with seruices like dry cleaning, haircuts, and air travel, consumption includes nondu- rable goods,like soap and soup, and durable goods, like furniture and kitchen appliances. Durabie goods are expected to last at least three years.

Investmer:t, or more specifically, gross private domestic investment, consists of spending on new cap- ital goods and on net additions to inventories. The most important investment is p'hysicai eapitai, such as new buildings and new machinery. investment also includes new residentiai construction. Although it fluctuates from year to year, investment averaged about one-sixth of U.S. GDP during the last decade. More generally, investment consists of spending on current production that is not used for current con- sumption. A net increase to inventories also counts as investment because it represents current production not used for current consumption. Inventsries are stocks of goods in process, such as computer parts, and stocks offinished goods, such as new computers awaiting sale. Inventories help manufacturers cope with unexpected changes in the supply of their resources or in the demand for their products.

Although investment inciudes purchasing a new residence, it excludes pur- chases of exisling buildings and machines and pur- chases of financial assets, such as stocks and bonds. Existing buildings and machines were counted in GDP when they were pro- duced. Stocks and bonds are not investments themselves but simply indications of ownership.

Covernment purehases, or more specifically, govern- ment consumption and gross investment, inciude govern- ment spending for goods and services-from clear- ing snowy roads to clearing court dockets, from buy- ing library books to paying

c*nsurr:pti*n h*uc*fu {,ki pur *}lat*,r: t:f {in*i gi:::e!* and s*v"ric*t" *Ei:+fit !*l **vT ?'is,!ni::iilt*5, trviri+l: r:r:urti ;!i ;r]rii;:slfi1*!'r i

investr:renl ilr* ;:i.;r':iias* *i :rr-ror'; 3:1i:r:t*, c*v.; +'.lir ip,rriittt, r';eiv i:*i!rttng::, ,rlirrJ ::*v; r*r;it**n**:s. i:ltts ti;:l ;:1:i- {f iL!*:1:i t$ i}}v*ill*ril}{i

pl'rysicai capital r *anil i:;*i;rr*r.! it+rrrs :;:+::d t* *l*riL:;*: 1;*i:*: c ;l'! ;;*r* i*es ; ir"l*ii:,i*g !-1&',rV i.]lii*ts irr-!d ii*';f *til:ix?rt,rn'1;

residential construetion liu i! riiltl nt*. lltrt!;rt,q r.ji' iw*i!!:';i; p:ar;r::

inr;entsries 1:r*rJ i:**l s' st.J+:ra: {:f ii*i*h*ci ariil !* "pr*+*s': 9.1*:'rd:;

gBVernment purchascs :i;.r*lr *ir;g +$l fi ,t],rt.ili ;,t-l{i **:r.j'!:*:: h"d aii ievi:i:; li i:*,,i*i{!!nf ?:i; ii*?*:'l:. rrir:ri t *i: f !a7s i-ilin *s tra:: r*i*i il,ii yirl*i1i!i

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