Students Again

National Income Accounting:

Gross Domestic Product – This is a physical measure of the market value (using what the prices of each item is) of all final goods and services (products that are sold to the final consumers) produced within a country (regardless of who produced it, if it was produced IN the country, then it counts) within a year.

Avoiding Multiple Counting – why we use “final goods and services” and not all goods and services

Intermediate goods – goods used in the manufacturing process to create another good, like wheat s used up to make flour. But also like a broom, used by a manufacturing company to clean up. Since the value of that broom is used up and then included in the price of the firm’s output, it would be double-counting to include both the broom and the output of the firm.

Final goods – goods used by the final consumer.

Value Added – an alternative approach to getting GDP by adding up the value that each level of the production process together instead of using the total value of all final goods. Given a simple industry – like the production of bread. Let’s assume that the farmer has no start up costs (unrealistic, I know, but we have to start somewhere). He produces 100 bushels of wheat (column 2) and sells it to a miller for $1 per bushel. He added $100 of value to the production process (started with nothing and produced $100 worth of wheat).

The miller takes that $100 of wheat (starting value) and grinds it into 200 lbs of flour. He sells it for $150 per lb to a bakery. That gives him revenue of $300 (column 4) but he didn’t add $300 of value – only the increase in value ($300 – the $100 he started with). The baker takes that flour and produced 300 loaves of bread, which he sells to final consumers for $2.00 per loaf.

Adding up final goods (the wheat is used up in producing the flour, the flour is used up in producing the bread – so only the bread is a final good and service), we get $600 of bread. Adding up Values added (the alternative approach to getting GDP) we add the $100 the farmer added to the $200 the miller added, to the $300 the baker added = and we get $600 as well.

Some of the complications: If the miller sells some flour directly to consumers – then it’s a final good and service, even if the consumer then makes the same bread with it that the baker would have. That production is not “market” production (it never gets sold). If the baker (or anyone else in the process) produces it but doesn’t sell it – it still gets added in as if it were sold, because we are measuring production – not sales.

GDP excludes non-Productive Transactions – many transactions merely change who owns something – but do not represent new production.

Financial Transactions:

Public transfers – government taking money from one group and giving it to another. There is no good that government is buying with this transaction – just money moving around.

Private transfer payments – same idea, but this time it’s people moving money around without a product being included. Like you giving allowance to a child – or getting $20 from your grandmother for your birthday. Now, if the child rakes leaves to earn the  allowance – then it isn’t a private transfer – it’s “income” in return for production. In that raking example, we should be adding that allowance in as GDP (although we know it isn’t since we have no way to find that transaction to include it).

Stock market transactions – transactions by the stock market do not increase the amount of capital in the economy, it only changes who owns it.

Secondhand Sales – This would be if you bought a car in January and then sold it in August. This car has been sold before, and the re-sale would not be included because the product was already included as GDP once. Its secondary sale does not represent any new production – just a changing of hands.

Another complication: When a person re-sells a good for a living, part of the costs of the product to the second person is the value the salesman added by matching product and secondary customer. I.e. the value of a used car is not included prior production) but the income of the car salesman is included in GDP (new production). The same goes true for the value added by a stockbroker in re-selling stock. The value of the stock is not counted as GDP, but the income of the stockbroker is included.

Two other ways of looking at GDP: Spending and Income:

Expenditures approach – if it was produced, then someone paid for it to be produced (the customer if it was sold, the firm if it was added to inventory). In total, it should add up to the same value as if we added the value of all final goods and services or if we added all value-added.

Income approach – If a product was produced, someone earned income by producing it. If we add up all the ways that people earn money – it should equal the value of all goods produced in the economy.

The Expenditures Approach – this is the approach we use in economics the most –not only is it the easiest (only 4 categories to keep track of)

Personal Consumption Expenditures (-C-) the spending by all households for goods and services

• Durables – products that are expected to last for a while (at least 3 years, but that’s a squishy cut-off). If is a product we expect to use over time, then it’s durable.
• Non-durables – Products that are consumed relatively quickly
• Services – this would include all the things you buy where you don’t get a physical asset or product for it – from medical exams, to tax preparing service to the lawn mowing service.

Gross Private Domestic Investment (Ig) – The amount of spending done by all businesses Positive and Negative Changes in Inventories – If businesses sell more than they produce, then inventories must have decreased. If they produce more than they sell, then inventories must be increasing. We measure production with “Investment” – not sales. Gross Investment (Ig) versus Net Investment (In) – This is defining the difference between the additions to new value (gross investment) and the increase in value (net
investment). The difference is what is called depreciation – and it is the value of lost capital (the wearing out of capital, machines, building etc) and the loss of value of products (shrinkage, spoilage etc).

Government purchases (G) – The spending by government for goods and services. This does not include the total government  budget – since a large portion of the official budget is just transfer payments – and does not represent the purchase of anything. This means that Social Security payments, Unemployment Insurance, Medicare and Medicaid reimbursements etc – are not government “expenditures” the way we use the term in macro economics.

Net exports Xn – the difference between what we sell to the rest of the world (exports) and what we buy from the rest of the world (imports). This is a correction to get expenditure by Americans to match production by Americans. Some of what we produce (and therefore should include in GDP) isn’t bought by Americans – it’s bought by the rest of the world. We have to add that in. Some of  what we buy (as households, businesses or government) isn’t produced here, so it shouldn’t count as GDP. This category takes
care of both problems simultaneously.

GDP = C + Ig + G + Xn … Usually, we call GDP measured this way (added up this way) Aggregate Expenditures (AE). Later we will use this AE abbreviation when we mean GDP added up by the expenditures approach. This equation will become an essential part of a model.

Income Approach – another way to add up GDP by adding up the incomes earned by producing everything in the economy. It’s  messier than the expenditure approach and we don’t use it as much – but it is another way to do it.

Compensation of Employees – wages, tips, perks like insurance etc

Rents – money earned from renting out property you own

Interest – money earned by lending money to others either directly (lending money to someone) or through a financial intermediary (bank, credit union, savings and loan, etc)

Proprietor’s Income – money earned by owners of sole proprietorship's and partnerships (any non-corporation)

Corporate Profits – money earned by corporations for its owners. It does not require that the profits be distributed to stockholders –  but it was earned so it must be included to get GDP.

• Corporate income taxes – some of the value of the goods corporations produced never make it to the owners of the corporation, but are absorbed by government in taxes.
• Dividends – if the corporation distributes profits to their owners (stockholders) it is called a dividend.
• Undistributed corporate profits – if a corporation does not distribute profits to stockholders, but instead retains it to re-invest in the corporation, then it is called “retained earnings”

Other income measures – and how they differ from GDP. These are measuring different things (not “production”), so these are not like the income and expenditure approaches we were talking about. These are wholly different things we are measuring.

From national income to GDP:

Indirect business taxes – taxes collected by businesses for government. This isn’t taxes on businesses – just ones collected by  businesses – like sales taxes and excise taxes.

Consumption of Fixed Capital – another term for depreciation

Net Foreign Factor Income – This is subtracting off income earned by foreigners in the country and adding on income earned by citizens abroad

Other National Accounts:

Net Domestic Product – The same measure as GDP but using (In) instead of (Ig) – i.e. we are subtracting out depreciation.

National Income – the difference between GDP and this (which is GNP) is the former is “produced within the country” and the latter is “produced by citizens”

Personal Income – Income received by the citizens – not businesses or government.

Disposable Income – Income citizens can choose how to spend

Nominal GDP vs Real GDP: “nominal” uses prices from the same period as the product was produced to determine GDP, but “real” uses an inflation corrected set of price

GDP Price Index – the measure of the level of prices using a “market basket” of all the goods in the economy.

Dividing Nominal GDP by the Price Index to get Real GDP.

Nom GDP

Real GDP = --------------- X 100

Price Index

Real-World Considerations and Data: There are some complications in determining real GDP – but the book does a pretty good job explaining those, so I won’t repeat them here.

Shortcomings of GDP:

Non-Market Activities – like the raking the leaves example, there are many transactions that we don’t count because we don’t have the data. In a perfect world, they would be included, but we have no effective way of measuring them.

Leisure – the value of output is often reduced as we progress because it frees us to take more time off. i.e. if we used to have to work 80 hours a week to produce enough goods and now we can do it in 40 hours per week, we probably don’t continue to work 80 hours
per week. Some of what is “produced” now is more time off. That time off has value – but it isn’t included in GDP.

Improved Product Quality: a computer today is better than a computer was a few years ago. Even though the product is better today, it probably is also cheaper. This makes it look like GDP is falling, but the value of the good is more than it was before. The Underworld Economy – illegal activities (black market, under-the-table production, etc) represent production, but never make it to the bottom line of GDP since they are not reported.

GDP and the Environment – improvements to the environment often go hand-in-hand with decreased production. This means that  improvements to the environment (which are good) look like a decrease in the value of our economy. On the other hand, pollution  and clean-up get counted more as GDP than avoiding pollution in the first place. For example, if we never let the Exxon Valdez leave full of oil, there would be less GDP. Since it did, the value of the oil is counted (production that wasn’t sold), then the price of oil went up when it spilled all over prince Edwards Sound (driving up the price we use to value all the oil that made it to market), and then we  cleaned it up (people going to Alaska to wipe oil off of ducks etc). Most would agree that the economy would have been better off  without the spill – as would the environment, but GDP is higher with the spill and clean-up than it would have been without the  pollution in the first place.

Composition and Distribution of Output – just because GDP goes up, doesn’t mean people are all better off. It’s possible that only a few have their quality of life increase when GDP rises. How it gets spread around matters, but GD can’t (or at least, doesn’t) measure that.

Non-economic Sources of Well-Being – other things improve our quality of life but are not included in GDP –like peace, family unity,  good new music etc.