GDP

RETP A HC 18
Measuring National Output

and National Income
Prepared by: Fernando Quijano

and Yvonn Quijano
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
Gross Domestic Product
• Gross domestic product

(GDP) is the total market value
of all final goods and services
produced within a given period
by factors of production located
within a country.
A HC
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 2 of 38
National Income
and Product Accounts
• National income and product

accounts are data collected and
published by the government
describing the various components
of national income and output in the
economy.
• The U.S. Department of Commerce

is responsible for producing and
maintaining the “National Income
and Product Accounts” that keep
track of GDP.
A HC
Final Goods and Services
• The term final goods and

services in GDP refers to
goods and services produced
for final use.
• Intermediate goods are goods

produced by one firm for use in
further processing by another
firm.
A HC
Value 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.
• In calculating GDP, we can either sum
up the value added at each stage of
production, or we can take the value of
final sales.
A HC
Value Added
Value Added in the Production of a Gallon of Gasoline

(Hypothetical Numbers)
STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED
(1)Oil drilling $ .50 $ .50
(2)Refining .65 .15
(3)Shipping .80 .15
(4)Retail sale 1.00 .20
Total value added $1.00
A HC
Exclusions of Used Goods
and Paper Transactions
• GDP ignores all transactions in

which money or goods change
hands but in which no new
goods and services are
produced.
A HC
Exclusion of Output Produced Abroad
by Domestically Owned Factors of Production
• GDP is the value of output produced

by factors of production located
within a country. Output produced
by a country’s citizens, regardless of
where the output is produced, is
measured by gross national
product (GNP).
A HC
Calculating GDP
GDP can be computed in two ways:

• The expenditure approach: A method of
computing GDP that measures the total
amount spent on all final goods during a
given period.
• The income approach: A method of
computing GDP that measures the income
—wages, rents, interest, and profits—
received by all factors of production in
producing final goods.
A HC
The Expenditure Approach
Expenditure categories:
• Personal consumption
expenditures (C)—household
spending on consumer goods.
• Gross private domestic
investment (I)—spending by firms
and households on new capital:
plant, equipment, inventory, and new
residential structures.
A HC
Expenditure categories:
• Government consumption and
gross investment (G)
• Net exports (EX – IM)—net
spending by the rest of the world, or
exports (EX) minus imports (IM)
A HC
• The expenditure approach calculates

GDP by adding together the four
components of spending. In
equation form:
G D = CP + I + G + ( E X− I M )
A HC
Components of GDP, 1999:
Components of GDP, 2002: The Expenditure Approach

BILLIONS OF PERCENTAGE
DOLLARS OF GDP
Personal consumption expenditures (C) 7303.7 69.9
Durable goods 871.9 8.3
Nondurable goods 2115.0 20.2
Services 4316.8 41.3
Gross private domestic investment (l) 1543.2 14.8
Nonresidential 1117.4 10.7
Residential 471.9 4.5
Change in business inventories 3.9 0
Government consumption and gross investment (G) 1972.9 18.9
Federal 693.7 6.6
State and local 1279.2 12.2
Net exports (EX – IM) − 423.6 − 4.1
Exports (EX) 1014.9 9.8
Imports (IM) 1438.5 13.8
Total gross domestic product (GDP) 10446.2 100.0
A HC
Note: Numbers may not add exactly because of rounding.

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Personal Consumption Expenditures
• Personal consumption expenditures (C) are

expenditures by consumers on the
following:
• Durable goods: Goods that last a relatively
long time, such as cars and appliances.
• Nondurable goods: Goods that are used up
fairly quickly, such as food and clothing.
• Services: Things that do not involve the
production of physical things, such as legal
services, medical services, and education.
A HC
Gross Private Domestic Investment
• Investment refers to the purchase of

new capital.
• Total investment by the private

sector is called gross private
domestic investment. It includes
the purchase of new housing, plants,
equipment, and inventory by the
private sector.
A HC
• Nonresidential investment includes

expenditures by firms for machines, tools,
plants, and so on.
• Residential investment includes

expenditures by households and firms on
new houses and apartment buildings.
• Change in inventories computes the

amount by which firms’ inventories change
during a given period. Inventories are the
goods that firms produce now but intend to
sell later.
A HC
• Remember that GDP is not the

market value of total sales during a
period—it is the market value of total
production.
• The relationship between total

production and total sales is:
GDP = final sales + change in business inventories
A HC
Gross Investment
versus Net Investment
• Gross investment is the total value of all

newly produced capital goods (plant,
equipment, housing, and inventory)
produced in a given period.
• Depreciation is the amount by which an
asset’s value falls in a given period.
• Net investment equals gross investment
minus depreciation.
capitalendofperiod = capitalbeginningofperiod + net investment

A HC
Government Consumption
and Gross Investment
• Government
consumption and gross
investment (G) counts
expenditures by federal,
state, and local
governments for final
goods and services.
A HC
Net Exports
• Net exports (EX – IM) is the

difference between exports and
imports. The figure can be positive
or negative.
• Exports (EX) are sales to foreigners of
U.S.-produced goods and services.
• Imports (IM) are U.S. purchases of
goods and services from abroad).
A HC
The Income Approach
• National income is the total income

earned by the factors of production
owned by a country’s citizens.
• The income approach to GDP
breaks down GDP into four
components:
GDP = national income + depreciation + (indirect
taxes – subsidies) + net factor payments to the rest
of the world + other
A HC
The Income Approach
Components of GDP, 2002: The Income Approach

BILLIONS OF PERCENTAGE
DOLLARS OF GDP
National income 8,199.9 80.3

Compensation of employees 6,010.0 58.9
Proprietors’ income 943.5 7.3
Corporate profits 748.9 7.3
Net interest 554.8 5.4
Rental income 142.7 1.4
Depreciation 1,351.3 13.2
Indirect taxes minus subsidies 739.4 7.2
Net factor payments to the rest of the world 11.1 0.1
Other − 96.1 − 0.9
Gross domestic product 10,205.6 100.0
A HC
Source: See Table 18.2.
From GDP to Disposable Personal Income
GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2002
DOLLARS
(BILLIONS)
GDP 10,205.6
Plus: receipts of factor income from the rest of the world + 342.1
Less: payments of factor income to the rest of the world − 353.2
Equals: GNP 10,194.5
Less: depreciation − 1,351.3
Equals: net national product (NNP) 8,843.2
Less: indirect taxes minus subsidies plus other − 643.3
Equals: national income 8,199.9
Less: corporate profits minus dividends − 332.6
Less: social insurance payments − 731.2
Plus: personal interest income received from the government and consumers + 439.1
Plus: transfer payments to persons +1,148.7
Equals: personal income 8,723.9
Less: personal taxes − 1,306.2
Equals: disposable personal income 7,417.7
A HC
From GDP to Disposable Personal Income
• Net national product equals gross

national product minus depreciation;
a nation’s total product minus what is
required to maintain the value of its
capital stock.
• Personal income is the income

received by households after paying
social insurance taxes but before
paying personal income taxes.
A HC
Disposable Personal
Income and Personal Saving
Disposable Personal Income and Personal Saving, 2002

DOLLARS
(BILLIONS)
Disposable personal income 7,417.7
Less:
Personal consumption expenditures − 7063.5
Interest paid by consumers to business − 204.3
Personal transfer payments to foreigners − 31.3
Equals: personal saving 118.6
Personal savings as a percentage of disposable personal income: 1.6%
A HC
Disposable Personal Income and
Personal Saving
• The personal saving rate is the

percentage of disposable personal
income that is saved.
• If the personal saving rate is low,

households are spending a large
amount relative to their incomes; if it
is high, households are spending
cautiously.
A HC
Nominal Versus Real GDP
• Nominal GDP is GDP measured in

current dollars, or the current prices
we pay for things. Nominal GDP
includes all the components of GDP
valued at their current prices.
• When a variable is measured in

current dollars, it is described in
nominal terms.
A HC
Calculating Real GDP
• A weight is the importance attached

to an item within a group of items.
• A base year is the year chosen for

the weights in a fixed-weight
procedure.
• A fixed-weight procedure uses

weights from a given base year.
A HC
Calculating Real GDP
A Three-Good Economy
(1) (2) (3) (4) (5) (6) (7) (8)
GDP IN GDP IN GDP IN GDP IN
YEAR 1 YEAR 2 YEAR 1 YEAR 2
IN IN IN IN
PRODUCTION PRICE PER UNIT YEAR 1 YEAR 1 YEAR 2 YEAR 2
YEAR 1 YEAR 2 YEAR 1 YEAR 2 PRICES PRICES PRICES PRICES
Q1 Q2 P1 P2 P 1 x Q1 P 1 x Q2 P2 x Q1 P2 X Q 2
Good A 6 11 $.50 $ .40 $3.00 $5.50 $2.40 $4.40
Good B 7 4 .30 1.00 2.10 1.20 7.00 4.00
Good C 10 12 .70 .90 7.00 8.40 9.00 10.80
Total $12.10 $15.10 $18.40 $19.20
Nominal GDP Nominal GDP
in year 1 in year 2
A HC
Calculating the GDP Deflator
• The GDP deflator is one measure of

the overall price level. The GDP
deflator is computed by the Bureau
of Economic Analysis (BEA).
• Overall price increases can be

sensitive to the choice of the base
year. For this reason, using fixed-
price weights to compute real GDP
has some problems.
A HC
The Problems of Fixed Weights
The use of fixed price weights to

estimate real GDP leads to problems
because it ignores:
1. Structural changes in the
economy.
2. Supply shifts, which cause large

decreases in price and large
increases in quantity supplied.
3. The substitution effect of price

increases.
A HC
GDP and Social Welfare
• Society is better off when crime

decreases, however, a decrease in
crime is not reflected in GDP.
• An increase in leisure is an increase

in social welfare, but not counted in
GDP.
• Nonmarket and household activities

are not counted in GDP even though
they amount to real production.
A HC
GDP and Social Welfare
• GDP accounting rules do not adjust

for production that pollutes the
environment.
• GDP has nothing to say about the

distribution of output. Redistributive
income policies have no direct
impact on GDP.
• GDP is neutral to the kinds of goods

an economy produces.
A HC
The Underground Economy
• The underground economy is

the part of an economy in
which transactions take place
and in which income is
generated that is unreported
and therefore not counted in
GDP.
A HC
Gross National Income per Capita
• To make comparisons of GNP between

countries, currency exchange rates must
be taken into account.
• Gross National Income (GNI) is a

measure used to make international
comparisons of output. GNI is GNP
converted into dollars using an average of
currency exchange rates over several
years adjusted for rates of inflation.
• GNI divided by population equals gross

national income per capita.
A HC
Gross National Income per Capita
Per Capita Gross National Income for Selected Countries, 2002

COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS
Switzerland 36,970 Portugal 10,670
Japan 35,990 South Korea 9,400
Norway 35,530 Argentina 6,860
United States 34,870 Mexico 5,540
Denmark 31,090 Czech Republic 5,270
Ireland 28,880 Brazil 3,060
Sweden 25,400 South Africa 2,900
United Kingdom 24,230 Turkey 2,540
Netherlands 24,040 Colombia 1,910
Austria 23,940 Jordan 1,750
Finland 23,840 Romania 1,710
Germany 23,700 Philippines 1,050
Belgium 23,340 China 890
France 22,640 Indonesia 680
Canada 21,340 India 460
Australia 18,770 Pakistan 420
Italy 18,470 Nepal 250
Spain 14,860 Rwanda 220
A HC
Greece 11,780 Ethiopia 100

Source: The World Bank Atlas, 2002.
Review Terms and Concepts
base year government consumption and gross investment

G)
change in business inventories
gross domestic product (GDP)
compensation of employees
gross investment
corporate profits
gross national income (GNI)
current dollars
gross national product (GNP)
depreciation
gross private domestic investment (I)
disposable personal income, or after-tax income
income approach
durable goods
indirect taxes
expenditure approach
intermediate goods
final goods and services
national income
fixed-weight procedure
national income and product accounts
A HC
Review Terms and Concepts
net exports (EX – IM) personal saving

net factor payments to the rest of the world personal saving rate
net interest proprietors’ income
net investment rental income
net national product (NNP) residential investment
nominal GDP services
nondurable goods subsidies
nonresidential investment underground economy
personal consumption expenditures (C) value added
personal income weight
A HC

GDP

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RETP A HC 18

Measuring National Output

Prepared by: Fernando Quijano

• Gross domestic product

• National income and product

• The U.S. Department of Commerce

• The term final goods and

• Intermediate goods are goods

• Value added is the difference

Value Added in the Production of a Gallon of Gasoline

• GDP ignores all transactions in

• GDP is the value of output produced

GDP can be computed in two ways:

• The expenditure approach calculates

Components of GDP, 2002: The Expenditure Approach

Note: Numbers may not add exactly because of rounding.

• Personal consumption expenditures (C) are

• Investment refers to the purchase of

• Total investment by the private

• Nonresidential investment includes

• Residential investment includes

• Change in inventories computes the

• Remember that GDP is not the

• The relationship between total

• Gross investment is the total value of all

capitalendofperiod = capitalbeginningofperiod + net investment

• Net exports (EX – IM) is the

• National income is the total income

Components of GDP, 2002: The Income Approach

National income 8,199.9 80.3

Source: See Table 18.2.

Source: See Table 18.2.

• Net national product equals gross

• Personal income is the income

Disposable Personal Income and Personal Saving, 2002

• The personal saving rate is the

• If the personal saving rate is low,

• Nominal GDP is GDP measured in

• When a variable is measured in

• A weight is the importance attached

• A base year is the year chosen for

• A fixed-weight procedure uses

• The GDP deflator is one measure of

• Overall price increases can be

The use of fixed price weights to

2. Supply shifts, which cause large

3. The substitution effect of price

• Society is better off when crime

• An increase in leisure is an increase

• Nonmarket and household activities

• GDP accounting rules do not adjust

• GDP has nothing to say about the

• GDP is neutral to the kinds of goods

• The underground economy is

• To make comparisons of GNP between

• Gross National Income (GNI) is a

• GNI divided by population equals gross

Per Capita Gross National Income for Selected Countries, 2002

Greece 11,780 Ethiopia 100

base year government consumption and gross investment

net exports (EX – IM) personal saving

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