1. The market value of all final goods and services produced in the domestic economy during the year is measured by the gross domestic product (GDP).
a. GDP is a monetary measure that is calculated in dollar terms rather than in terms of physical units of output
b. GDP includes in its calculation only the value of final goods (consumption goods, capital goods, and services purchased by final users and that will not be resold or processed further during the current year)
(1) GDP excludes the value of intermediate goods (ones that are purchased for resale or further processing) because including both final goods and intermediate goods would result in multiple counting of the goods and overstate GDP
(2) Another way to avoid multiple counting is to measure and add only the value added at each stage of the production process. Value added is the market value of a firm’s output minus the value of the inputs the firm bought from others to produce the output
c. Nonproduction transactions are not included in GDP
(1) Purely financial transactions such as public transfer payments, private transfer payments, and stock market transactions are simply exchanges of money or paper assets and do NOT create output
(2) sales of secondhand or used goods are excluded because they were counted in past production and do not contribute to current production
d. Measurement of GDP can be accomplished by either the expenditures approach or the income approach, but the same result is obtained by the two methods
2. Computation of the GDP by the expenditures approach requires the summation of the total amounts of the four types of spending for final goods and services
a. Personal consumption expenditures (C) are the expenditures of households for durable goods and nondurable goods and for services
b. Gross private domestic investment (Ig) is the sum of the spending by business firms for machinery, equipment, and tools; spending by firms and households for new construction (building); and the changes in the inventories of business firms
(1) an increase in inventories in a given year increases investment that year because it is part of the output of the economy that was produced but not sold that year; a decrease in inventories in a given year decreases investment that year because it was included as part of the output from a prior year
(2) investment does not include expenditures for stocks or bonds (a transfer of paper assets) or for used or secondhand capital goods (because they were counted as part of investment in the year they were new capital goods)
(3) gross investment exceeds net investment by the value of the capital goods worn out during the year. An economy in which net investment is positive is one with an expanding production capacity
c. Government purchases (G) are the expenditures made by all levels of governments (Federal, state, and local) for final goods from businesses, and for the direct purchases of resources, including labor
(1) the government purchases are made to provide public goods and services, and for spending on publicly owned capital (for example, highways or schools)
(2) transfer payments made by the government to individuals, such as Social Security payments, are not included in government purchases because they simply transfer income to individuals and do not generate production
d. Net exports (Xn) in an economy is calculated as the difference between exports (X) and imports (M). It is equal to the expenditures made by foreigners for goods and services produced in the economy minus the expenditures made by the consumers, governments, and investors of the economy for goods and services produced in foreign nations.
e. in equation form, C + Ig + G + Xn = GDP
3. Computation of GDP by the income approach requires adding the income derived from the production and sales of final goods and services. The six income items are:
a. compensation of employees (the sum of wages and salaries and wage and salary supplements, such as social insurance and private pension or health funds for workers)
b. rents (the income received by property owners). This rent is a net measure of the difference between gross rent and property depreciation.
c. interest (only the interest payments made by financial institutions or business firms are included; interest payments made by government are excluded)
d. proprietors’ income (the profits or net income of sole proprietors or unincorporated business firms)
e. corporate profits (the earning of corporations). They are allocated in the following three ways: as corporate income taxes, dividends paid to stockholders, and undistributed corporate profits retained by corporation
f. taxes on production and imports are added because they are initially income for households that later gets paid to government in the form of taxes. This category includes general sales taxes, excise taxes, business property taxes, license fees, and custom duties
g. the sum of all of the above six categories equal national income. To obtain GDP from national income, three adjustments must be made
(1) net foreign factor income is subtracted from national income because it reflects income earned from production outside the United States. Net foreign factor income is income earned by American-owned resources abroad minus income earned by foreign-owned resources in the United States
(2) a statistical discrepancy is added to national income to make the income approach match the expenditure approach
(3) the consumption of fixed capital is added to national income to get to GDP because it is a cost of production that does not add to anyone’s income. It covers depreciation of private capital goods and publicly owned capital goods such as roads or bridges.
4. Four other national accounts are important in evaluating the performance of the economy. Each has a distinct definition and can be computed by making additions to or deductions from another measure.
a. Net domestic products (NDP) is the annual output of final goods and services over and above the privately and publicly owned capital goods worn out during the year. It is equal to the GDP minus depreciation (consumption of fixed capital).
b. National income (NI) is the total income earned by U.S land owners of land and capital and by the U.S. suppliers of labor and entrepreneurial ability during the year plus taxes on production and imports. It equals NDP minus a statistical discrepancy and plus net foreign factor income.
c. Personal income (PI) is the total income received (whether earned or unearned) by the households of the economy before the payment of personal taxes. It is found by taking national income and adding transfer payments and then subtracting taxes on production and imports, Social Security contributions, corporate income taxes, and undistributed corporate profits.
d. Disposable income (DI) is the total income available to households after the payment of personal taxes. It is calculated by taking personal income and then subtracting personal taxes. It is also equal to personal consumption expenditures plus personal savings.
5. Nominal GDP is the total output of final goods and services produced by an economy in one year multiplied by the market prices when they were produced. Prices, however, change each year. To compare total output over time, nominal GDP is converted to real GDP to account for these price changes.
a. There are two methods for deriving real GDP from nominal GDP. The first method involves computing a price index.
(1) this price index is a ratio of the price of a market basket in a given year to the price of the same market basket in a base year, with the ratio multiplied by 100. If the market basket of goods in the base year was $10 and the market basket of the same goods in the next year was $15, then the price index would be 150 ($15/10*100).
(2) To obtain real GDP, divide nominal GDP by the price index expressed in hundredths. If nominal GDP was $14,000 billion and the price index was 120, then real GDP would be $11,667 billion ($14,000 billion/1.2).
b. in the second method, nominal GDP is broken down into prices and quantities for each year. Real GDP is found by using base-year prices and multiplying them by each year’s physical quantities. The GDP price index for a particular year is the ratio of nominal GDP to real GDP for that year. If nominal GDP was $14,000 billion and real GDP was $11,667 billion, the GDP index would be 1.2 ($14,000 billion/$11,667 billion)
c. For years when the price index is below 100, dividing GDP by the price index (in hundredths) inflates nominal GDP to obtain real GDP. For years when the price index is greater than 100, dividing nominal GDP by the index (in hundredths) deflates nominal GDP to obtain real GDP
6. GDP has shortcomings as a measure of total output and economic well-being
a. it excludes the value of nonmarket final goods and services that are not bought and sold in the markets, such as the unpaid work done by people on their houses
b. it excludes the amount of increased leisure enjoyed by the participants in the economy
c. it does not fully account for the value of improvements in the quality of products that occur over the years
d. it does not measure the market value of the final goods and services produced in the underground sector of the economy because that income and activity is not reported
e. it does not record the pollution or environmental costs of producing final goods and services
f. it does not measure changes in the composition and the distribution of the domestic output
g. it does not measure noneconomic sources of well-being such as a reduction in crime, drug or alcohol abuse, or better relationships among people and nations
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