• National Income Accounting – measure incomes for whole economy
  • U.S. government measures performance of economy
  • Bureau of Economic Analysis (BEA) compiles national income accounts
    • Part of the U.S. Department of Commerce
  • Similar to a business
    • Businesses compile a variety of financial statements to gauge performance of the business
      • Balance sheet, cash flow statement, income statement, and changes in owner’s equity
• Gross Domestic Product (GDP) – total market value of all goods and services produced in one year
  • An aggregate (whole country)
  • Monetary measure
  • U.S. is measured in dollars
• Example:
  • 2007 U.S. Economy produced
    • 2 million pizzas
    • 10 million sodas
    • 15 million bread sticks
  • 2008 U.S. Economy produced
    • 1 million pizzas
    • 12 million sodas
    • 20 million bread sticks
  • Which year did the U.S. produce more?
• We cannot say
  • Pizza production went down, but breadsticks and soda production went up
  • Multiply the production levels by its price
  • Converts all production to dollars
  • Then add the value of production together to form one measure

2007 GDP
Item	Production	Price	Value
Pizza	2 million	$10	$20 million
Soda	10 million	$1	$10 million
Breadsticks	15 million	$5	$75 million
		Total	$105 million
2008 GDP
Item	Production	Price	Value
Pizza	1 million	$10	$10 million
Soda	12 million	$1	$12 million
Breadsticks	20 million	$5	$100 million
		Total	$122 million

• The value of production is higher in 2008
  • Note – prices did not change
  • This becomes important later
• The economy is so large, we would like to avoid multiple accounting
  • What is include and excluded from GDP
• Gross Domestic Product (GDP) is the value of all currently produced goods and services produced within the borders of an economy sold on the market during a particular time interval.
• GDP includes final goods
  • Final goods - do not have any further processing and ready to be sold to customers
    • Ignores when items are re-sold; thus they are counted once
    • Soviet Union – production managers doubled and tripled counted in order to meet production quotas, when resources were becoming scarce
• GDP excludes
  • Intermediate goods – goods require further processing and manufacturing
    • When a good is finished and sold to a customer, the price already contains the value of production from intermediate processing
    • We want to avoid multiple accounting
      • Multiple counting - where the same object is counted more than once
  • Secondhand sales – do not contribute to new production such as used houses, cars, furniture, etc.  We are just transferring assets and not creating new ones
  • Remove financial transactions – do not contribute to production
    • Public welfare payments – social security, Medicaid, etc.
    • Private transfer payments – inheritances, gifts, etc.
    • Stock market transactions – selling and buying bonds and stocks is transferring financial instruments; not creating new ones
• GDP – includes production within the borders of an economy
  • Do not distinguish between U.S. or foreign businesses
    • Japanese companies, Honda, Nissan, and Toyota produce within the U.S.
    • Examples – Sentra, Altima, Accord, CR-V, Acura RD-X, Camry, etc.
• GDP is  goods and services are valued at their market prices
  •  GDP excludes things not exchanged on the market like housework and volunteer work

2007 Ranking of GDP per capita
1	Qatar	$80,900
2	Luxembourg	$80,500
3	Bermuda	$69,900
4	Jersey	$57,000
5	Norway	$53,000
6	Brunei	$51,000
7	Singapore	$49,700
8	United States	$45,800

Source:  CIA World Fact Book

• Expenditure Approach
  • We aggregate the value of all goods and services that consumers and businesses buy
• Income Approach
  • We aggregate all incomes that were generated from production of goods and services
• Shown on Circular Flow
  • Note – simplified without government and international sector

Expenditure Approach – use the equation:  GDP = C + Ig + G + Xn

• Consumption expenditures (C) – consumers purchase nondurable goods, durable goods, and services
• Gross investment (Ig) – includes
  • Investment in machinery, equipment, and tools
  • New construction in factories, warehouses, and retail space
    • New construction in private homes
    • Owners could rent house for income
  • Change in inventory
    • If inventory increases – include in GDP; this means production increased
    • If inventory decreases – deduct from GDP; inventory was produced in previous years and avoid double counting
  • Does not include financial instruments like stocks and bonds
• Investment – can be decomposed into several types
  • Net investment – removes the impact of depreciation
  • As capital is being used, it depreciates
    • Buildings get old
    • Tools wear out
    • Equipment breaks down and becomes old
  • Depreciation is the amount the capital degraded
  • Thus, businesses invest to replace capital depreciation and in new equipment
  • Gross investment includes all investment
  • Net investment is

Net investment = Ig – depreciation

• Why this distinction?
  • If gross investment is growing at 5% per year and capital is depreciating at 6% per year, then net investment is decreasing 1%
  • Country is using up its stock of capital?
• Government purchases (G) – include all government purchases
  • Gov. buys goods and services
  • Gov. invests in schools, highways, airports, etc.
  • Includes all three levels: Federal, state, and local
• Net Exports (Xn) – is exports minus imports
  • Exports – produced here and sold abroad
  • Imports – produced outside the country and sold here
  • Net exports – add directly to GDP
  • The net impact on production
    • If net exports > 0, net increase in production here in U.S.
    • If net exports < 0 , net decrease in production here in U.S.

Income Approach - aggregate income that came from production of goods and services

• Employee Compensation - wages and salaries paid to workers
  • Includes wages paid by businesses and government
  • Largest source
• Interest - earnings
  • households save money in financial institutions; financial institutions lend money to businesses for capital
  • In turn, businesses pay interest to the financial institutions and financial institutions pay the savers for their investments
    • households earn interest from savings deposits, certificates of deposits (CDs), and corporate bonds
• Profits
  • Proprietor's profits - as a proprietor earns profits, he can pay himself some of the profits and invest the rest into more capital for his business
  • Partnerships are similar; the profits is divided among partners as income and the rest is invested back into capital for the business
  • Corporations - are more complicated
    • Corporations pay taxes on its income
    • Corporations divide their capital into two accounts
      • contributed capital - corporation directly sells stocks to investors
        • provides funding so corporation can acquire buildings, machines, and equipment
      • retained earnings - a corporation's profits (minus taxes) are placed in this account
        • if board of directors approve dividends, then dividends are paid from this account and funds left over can be used to invest more into corporation
• Rents - income earned from renting or leasing property
  • Includes leasing office space and rent paid to landlords
  • Government looks at net rent
    • Net rent = gross rent - depreciation
    • gross rent is cash received for rental income
    • depreciation - rental property wears out and degrades over time
• Taxes -
  • these taxes increase the price of goods and services
    • if you bought a can of Pepsi for $1 and the store charges 6% sales tax, you pay a total of $1.06
      • The $1 only includes income for producing that can of Pepsi, but $0.06 reflects the tax and the higher price.
  • these taxes are added to income accounts
    • sales taxes
    • excise taxes
    • business property taxes
    • license fees
    • customs duties
• Adjustments - several adjustments are made creating GDP from national income accounts
  • Foreign income - GDP is production within the borders of the U.S.
    • Deduct foreign income earned by Americans
    • Add foreigners income that is earned within the United States
  • Depreciation - buildings, machines, and equipment depreciated over time
    • Businesses are allowed to claim depreciation expenses on their income statements, thus lowering their profits and income
    • Add depreciation expenses back in
  • Statistical discrepancy - the income approach and expenditure approach are never equal, thus add a number to the national income account, so it equals total expenditures
    • Apparently the income approach always yields a smaller estimate of GDP than the expenditure approach

1. Net Domestic Product (NDP) - remove the impact of depreciation of capital
   • Determine how the economy is doing and growing, even though businesses and government are replacing worn out equipment.
   • Example - GDP can be growing, but NDP could be falling
     • Economy is using up its capital stock and not replacing it
     • Hinders future growth in the economy
2. National Income - how much households are earning from supplying resources like land, labor, capital, and entrepreneurs.
   • Aggregate all forms of income
     • salaries, wages, rent, interest, profits (from all businesses), and taxes on production
     • We can get National Income from adjusting GDP from expenditures or income approaches
3. Personal Income - includes all household income
   • Earned income - salaries, wages, interest, rent, and profits (from all businesses)
     • Some taxes are not included
   • Unearned income - transfer payments
     • Social Security
     • Unemployment insurance
     • Food stamps
     • Medicare/Medicaid
4. Disposable Income (DI) - income households has left over after they pay their taxes 
   • Households choose how much to consume (C) and save (S)
   • DI = C + S

• Nominal GDP - has no adjustment for inflation
  • If nominal GDP increases:
    • Could be from more production of goods and services
    • And/or inflation causes all prices to be higher, increasing GDP
• Note – GDP could decrease by decreasing production and/or deflation
  • Deflation - prices in the economy on average decrease
    • Occurred in the United States when we were on the gold standard
• Real GDP - removes the effect of inflation
  • If real GDP increases:
    • Economy is producing more goods and services
• Example - Shows the calculation of GDP for an economy with 3 products
  • Pizza
  • Breadsticks
  • Soda

Nominal GDP increases, but economy does not expand production

How is inflation measured?

• Inflation - continuously rise in prices over time
  • measured as a percentage
• Economists create a basket of goods
  • Basket contains goods like bread, milk, and many other products and services
    1. Consumer Price Index (CPI)
       • Includes thousands of consumer products
       • Products are grouped into 224 categories
    2. Producer Price Index (PPI)
       • Similar to CPI but a price index for producers
    3. GDP Deflator
       • Index of all prices for final goods and services
       • The actual price index to deflate nominal GDP
  • Economists chose one year to be the base year
  • Each year, economists calculate the average price of each good in the basket
  • price index - the average price for the basket
    • It is not a simple average
    • Notice - pizzas, sodas, and breadsticks are produced in different levels

Calcuation of price index

Example:  If prices for the base year are 2,000 and the prices for Year t is 3,000, then the price index is 1.50
Calculating real GDP is simple, use the formula:

Continuing with our example and using the same price index, if nominal GDP in Year t is $14 trillion, then take nominal GDP and divide by the price index of 1.5, which yields  $9.333 trillion.

Calculating inflation - take two price indices that are adjacent to each other in time and calculate the percentage change.  For example, in 2008 the price index is 1.78 and in 2009 it is 1.90, then the inflation rate is: 

Below is GDP for the United States since 1929

BEA calls real GDP "Chained GDP" and nominal GDP "Current GDP"  Also note that 200 is the base year.  Real and nominal GDP are equal.  Also nominal GDP is lower than real before 2000 and higher after 2000.

GDP is not a perfect measure of economic well-being

• Problems with GDP
  • GDP does not include volunteer work and housework
  • GDP does not include more leisure
    • During 1900s, Americans worked 53 hours per week
    • Currently Americans work 40 hours per week
  • Does not include quality improvements
    • All electronic devices are better than predecessors
    • T.V. – Now they are digital; during 1950s, TVs used vacuum tubes
    • Cell phones – Small and have many features; during 1980s they were big as a took box
• GDP does not include underground economy
  • Also called hidden economy or black markets
  • Markets for illegal products and services
  • Hide income from tax authorities
  • Avoid regulations and price controls
  • Declining civic loyalty to government
• Economists estimated size of underground economy
  • Economists are guessing (estimating)

Estimated Size of Underground Economy
Country	% of Real GDP
Nigeria	68 to 76%
Mexico	40 to 60%
Russia	20 to 27%
Hong Kong	13%
United States	8 to 10%
Japan	8 to 10%

Source:  Schneider, Friedrich and Dominik H. Enste. March 2000. "Shadow Economies: Size, Causes, and Consequences." Journal of Economic Literature 38(1): 77-114.

Note - Participants in the underground economy will not be honest about their activities; further, some activities may be crimes in country but not another.  Hong Kong is lax on copyright laws.

• GDP does not contain changes in the:
  • Environment
  • Noise
  • Congestion
  • Waste
  • Example - Asian countries like China and Kazakhstan are lax on environmental laws
• GDP does not specify who earns the income
  • Example - what if a country’s leader get 99% of the GDP and everyone else gets the 1%
• The government publishes statistics
  • The top leaders in the federal government are elected
  • May be some biases to appease the public and voters
  • Example - U.S. government published the Gross National Product (GNP), which is a slightly different definition
    • GDP had a better growth rate than GNP and the federal government dropped the GNP series in the early 1990s.
    • Not the first the federal government did this