NATIONAL INCOME ACCOUNTING

How do we measure the nation’s income; the value of its output of goods and services?

Gross Domestic Product (GDP) – the total market value of all final goods and services produced in the economy in one year.

Points to note:

1) To measure, we need a measuring stick. How do we measure value? For GDP, we use dollars—current market prices measured in current dollars.

2) “in one year”—what does that phrase tell about the type of variable GDP is?

But GDP comes out quarterly. How can it be production in one year if the numbers come out each quarter?

3) Final goods and services – Is that the

same as finished?

No !

Final goods are those that are NOT “intermediate”.

So what is “intermediate” ?

Rule: Anything purchased for resale, either directly or indirectly, with or without further processing in the physical sense, are classified “intermediate” and as such are excluded from GDP.

But, how do the national income accountants know what is bought for resale?

Their rule: Anything charged to current cost is defined as intermediate. (Meaning: anything that is NOT expensed.)

Final vs. Intermediate Sales

Consider the case of a $400 wool suit:

Stage of Production Sale Price Value Added

Firm A.

Sheep Ranch $100 $100

Firm B.

Wool Processing Firm $150 50

Firm C.

Suit Manufacturer $200 50

Firm D.

Clothing Wholesaler $280 80

Firm E.

Clothing Retail Store $400 120

________ ________

$1,130 $400

Note that if we simply add in every expenditure, then the value of the suit would appear to be $1,130. Yet we know that that is not the case. The value of the suit is the $400 that the customer pays at the store—the current market price. Adding in all the other transactions would amount to double and triple counting the same item.

So, what does go into GDP?

Spending and Income.

Look at spending first:

Who spends?

Households

Businesses

Governments

Foreigners

Households

“Personal Consumption Expenditures”

pizzas, beer, shirts, caps, CDs,

new tires, pencils, ……

computers, cars, refrigerators, microwave ovens, stereos ……..

haircuts, unclogged drains, movie tickets, music concert tickets, appendectomies, shelter*, …..

ie., consumer nondurables

durables

services

Businesses

“Gross Private Domestic Investment”

What’s “gross”

Hint: it ain’t net

What’s “private”?

And “domestic”?

And finally, what’s investment?

Investment is Business Sector Spending for:

v Plant and equipment

(Business fixed investment)

v Construction

(Both Residential and non…

v Changes in inventories

Investment is NOT:

stocks and bonds

shares of stock

stamp collections

Government

Govt Purchases of Goods/Services

Which governments?

U.S. federal government

state governments

city governments

county governments

Purchases???

Not government giveaways

Not welfare payments

Not social security benefits

Not food stamps

Foreigners (Rest of world)

What they spend on our output minus what we spend on their output

Total Exports minus Total Imports

X – M = X_n

Thus, to obtain GDP

C

+ I

+ G

+ X_n

= GDP

And what does GDP NOT include?

Intermediate transactions*

Most nonmarket transactions*

Illegal transactions

Purely financial transactions

capital gains, losses

purchases of securities

secondhand sales

transfers, subsidies