Principles of Economics

Twelfth Edition

Chapter 21
Measuring National
Output and National
Income

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Chapter Outline and Learning Objectives

21.1 Gross Domestic Product

• Describe GDP fundamentals and differentiate between GDP and GNP.

21.2 Calculating GDP

• Explain two methods for calculating GDP.

21.3 Nominal versus Real GDP

• Discuss the difference between real GDP and nominal GDP.

21.4 Limitations of the GDP Concept

• Discuss the limitations of using GDP to measure well-being.

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Chapter 21 Measuring National Output
and National Income
Looking Ahead
• national income and product accounts Data collected
and published by the government describing the various
components of national income and output in the economy.
• Data are complied by the Bureau of Economic Analysis
(BEA) of the U.S. Department of Commerce.
• While there are literally thousands of variables in the
national income and product accounts, in this chapter we
discuss only those that are most important.

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Gross Domestic Product
• gross domestic product (GDP) The total market value of
all final goods and services produced within a given period
by factors of production located within a country.
• GDP is the total market value of a country’s output. It is the
market value of all final goods and services produced
within a given period of time by factors of production
located within a country.

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Final Goods and Services (1 of 2)
• final goods and services Goods and services produced
for final use.
• intermediate goods Goods that are produced by one firm
for use in further processing or for resale by another firm.
• value added 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.

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Final Goods and Services (2 of 2)
• In calculating GDP, we can sum up the value added at
each stage of production or we can take the value of final
sales.
• We do not use the value of total sales in an economy to
measure how much output has been produced.

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TABLE 21.1 Value Added in the Production of a Gallon of Gasoline
(Hypothetical Numbers)

Stage of Production Value of Sales Value Added

(1) Oil drilling $ 3.00 $ 3.00
(2) Refining 3.30 0.30
(3) Shipping 3.60 0.30
(4) Retail sale 4.00 0.40
Total value added $ 4.00

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Exclusion of Used Goods and Paper
Transactions
• GDP is concerned only with new, or current, production.
Old output is not counted in current GDP because it was
already counted when it was produced.
• GDP does not count transactions in which money or goods
change hands but in which no new goods and services are
produced.

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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.
• gross national product (GNP) The total market value of
all final goods and services produced within a given period
by factors of production owned by a country’s citizens,
regardless of where the output is produced.

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Calculating GDP
• expenditure approach A method of computing GDP that
measures the total amount spent on all final goods and
services during a given period.
• 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 and services.

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The Expenditure Approach (1 of 7)
• There are four main categories of expenditure:
– Personal consumption expenditures (C): household
spending on consumer goods
– Gross private domestic investment (I): spending by
firms and households on new capital—that is, plant,
equipment, inventory, and new residential structures
– Government consumption and gross investment (G)

– Net exports (EX – IM): net spending by the rest of the

world, or exports (EX) minus imports (IM)

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TABLE 21.2 Components of U.S. GDP, 2014: The Expenditure
Approach
Billions of Dollars ($) Percentage of GDP (%)

Personal consumption expenditures (C) 11,930.3 68.5

Durable goods 1,302.5 7.5
Nondurable goods 2,666.2 15.3
Services 7,961.7 45.7
Gross private domestic investment (l) 2,851.6 16.4
Nonresidential 2,210.5 12.7
Residential 559.1 3.2
Change in business inventories 82.0 0.5
Government consumption and gross investment (G) 3,175.2 18.2
Federal 1,219.2 7.0
State and local 1,956.1 11.2
Net exports (EX – IM) −538.2 −3.1
Exports (EX) 2,337.0 13.4
Imports (IM) 2,875.2 16.5
Gross domestic product 17,418.9 100.0

Source: U.S. Bureau of Economic Analysis, March 27, 2015.

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The Expenditure Approach (2 of 7)
Personal Consumption Expenditures (C)
• personal consumption expenditures (C) Expenditures
by consumers on goods and services.
• durable goods Goods that last a relatively long time,
such as cars and household appliances.
• nondurable goods Goods that are used up fairly quickly,
such as food and clothing.
• services The things we buy that do not involve the
production of physical things, such as legal and medical
services and education.

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ECONOMICS IN PRACTICE
Where Does eBay Get Counted?
eBay’s business is to provide a marketplace
for exchange. In doing so, it uses labor and
capital and creates value.

In return for creating this value, eBay charges

fees to the sellers that use its site. The value
of these fees enter into GDP.

Items that people sell on eBay do not

contribute to current GDP. The cost of finding
an interested buyer for those goods, however,
does get counted.

THINKING PRACTICALLY

1. John has a 2009 Honda Civic. In 2013, he sells it to Mary for $10,000. Is that $10,000
counted in the GDP for 2013?

2. If John is an automobile dealer, does that change your answer to Question 1 at all?

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The Expenditure Approach (3 of 7)
Gross Private Domestic Investment (I)
• gross private domestic investment (I) Total investment
in capital—that is, the purchase of new housing, plants,
equipment, and inventory by the private (or
nongovernment) sector.
• nonresidential investment Expenditures by firms for
machines, tools, plants, and so on.
• residential investment Expenditures by households and
firms on new houses and apartment buildings.

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The Expenditure Approach (4 of 7)
Gross Private Domestic Investment (I)
• change in business inventories The amount by which
firms’ inventories change during a period. Inventories are
the goods that firms produce now but intend to sell later.
GDP = final sales + change in business inventories

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The Expenditure Approach (5 of 7)
Gross Private Domestic Investment (I)
• depreciation The amount by which an asset’s value falls
in a given period.
• gross investment The total value of all newly produced
capital goods (plant, equipment, housing, and inventory)
produced in a given period.
• net investment Gross investment minus depreciation.
capitalend of period = capitalbeginning of period + net investment

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The Expenditure Approach (6 of 7)
Government Consumption and Gross Investment (G)
• government consumption and gross investment (G)
Expenditures by federal, state, and local governments for
final goods and services.

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The Expenditure Approach (7 of 7)
Net Exports (EX – IM)
• net exports (EX – IM) The difference between exports
(sales to foreigners of U.S.-produced goods and services)
and imports (U.S. purchases of goods and services from
abroad). The figure can be positive or negative.

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The Income Approach (1 of 4)
• national income The total income earned by the factors
of production owned by a country’s citizens.
• compensation of employees Includes wages, salaries,
and various supplements—employer contributions to social
insurance and pension funds, for example—paid to
households by firms and by the government.
• proprietors’ income The income of unincorporated
businesses.
• rental income The income received by property owners
in the form of rent.

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The Income Approach (2 of 4)
• corporate profits The income of corporations.
• net interest The interest paid by business.
• indirect taxes minus subsidies Taxes such as sales
taxes, customs duties, and license fees less subsidies that
the government pays for which it receives no goods or
services in return.
• net business transfer payments Net transfer payments
by businesses to others.
• surplus of government enterprises Income of
government enterprises.

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TABLE 21.3 National Income, 2014

Billions of Dollars Percentage of

($) National Income (%)

National income 15,070.4 100.0

Compensation of employees 9,221.6 61.2
Proprietors’ income 1,380.2 9.2
Rental income 640.2 4.2
Corporate profits 2,089.8 13.9
Net interest 486.3 3.2
Indirect taxes minus subsidies 1,145.8 7.6
Net business transfer payments 140.6 0.9
Surplus of government enterprises −34.2 −0.2

Source: U.S. Bureau of Economic Analysis, March 27, 2015.

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The Income Approach (3 of 4)
• net national product (NNP) Gross national product
minus depreciation; a nation’s total product minus what is
required to maintain the value of its capital stock.
• statistical discrepancy Data measurement error.
• personal income The total income of households.

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TABLE 21.4 GDP, GNP, NNP, and National Income, 2014

Dollars
($, Billions)
GDP 17,418.9
Plus: Receipts of factor income from the rest of the world +827.7
Less: Payments of factor income to the rest of the world −616.0
Equals: GNP 17,630.6
Less: Depreciation −2,736.2
Equals: Net national product (NNP) 14,894.4
Less: Statistical discrepancy
−176.0
Equals: National income 15,070.4

Source: U.S. Bureau of Economic Analysis, March 27, 2015.

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The Income Approach (4 of 4)
• disposable personal income or after-tax income
Personal income minus personal income taxes. The
amount that households have to spend or save.
• personal saving The amount of disposable income that is
left after total personal spending in a given period.
• personal saving rate 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.

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TABLE 21.5 National Income, Personal Income, Disposable
Personal Income, and Personal Saving, 2014

Dollars
(Billions, $)
National income 15,070.4
Less: Amount of national income not going to households
−341.8
Equals: Personal income 14,728.6
Less: Personal income taxes −1,742.9
Equals: Disposable personal income 12,985.8
Less: Personal consumption expenditures −11,930.3
Personal interest payments −256.8
Transfer payments made by households −170.3
Equals: Personal saving 628.3
Personal saving as a percentage of disposable personal income: 4.8%

Source: U.S. Bureau of Economic Analysis, March 27, 2015.

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ECONOMICS IN PRACTICE
GDP: One of the Great Inventions of the 20th Century
The United States and the rest of the world
rely on GDP to tell where we are in the
business cycle and to estimate long-run
growth.
It is the centerpiece of an elaborate and
indispensable system of social accounting, the
national income, and product accounts.
This is surely the single most innovative
achievement of the Commerce Department in
the 20th century.
Source: U.S. Department of Commerce, Bureau of
Economics, “GDP: One of the Great Inventions of
the 20th Century,” Survey of Current Business,
January 2000, pp. 6–9.

THINKING PRACTICALLY

1. The article above emphasizes the importance of being able to measure an economy’s
output to improve government policy. Looking at recent news, can you identify one
economic policy debate or action that referenced GDP?

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Nominal versus Real GDP
• current dollars The current prices that we pay for goods
and services.
• nominal GDP Gross domestic product measured in
current dollars.
• weight The importance attached to an item within a group
of items.

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Calculating Real GDP
• base year The year chosen for the weights in a fixed-
weight procedure.
• fixed-weight procedure A procedure that uses weights
from a given base year.

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TABLE 21.6 A Three-Good Economy

(1) (2) (3) (4) (5) (6) (7) (8)

Prod Price GDP in GDP in GDP in GDP in Year 2
ucti per Year 1 in Year 2 in Year 1 in in Year 2
on Unit Year 1 Year 1 Year 2 Prices
Prices Prices Prices
Q1 Q2 P1 P2 P1 × Q1 P1 × Q2 P2 × Q1 P2 × Q2
Good A 6 11 $ 0.50 $ 0.40 $ 3.00 $ 5.50 $ 2.40 $ 4.40
Good B 7 4 0.30 1.00 2.10 1.20 7.00 4.00
Good C 10 12 0.70 0.90 7.00 8.40 9.00 10.80
Total $ 12.10 $ 15.10 $ 18.40 $ 19.20
Nominal Nominal
GDP in GDP in
year 1 year 2

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Calculating the GDP Deflator
• Policy makers need not only good measures of how real
output is changing but also good measures of how the
overall price level is changing.
• The GDP deflator is one measure of the overall price level.

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The Problems of Fixed Weights
• Many structural changes took place in the U.S. economy
between the 1950s and 1987.
• The use of fixed-price weights does not account for the
responses in the economy to supply shifts.
• The fixed-weight procedure ignores the substitution away
from goods whose prices are increasing and toward goods
whose prices are decreasing or whose prices are
increasing less rapidly.

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Limitations of the GDP Concept (1 of 2)
GDP and Social Welfare
• If crime levels went down, society would be better off, but a
decrease in crime is not an increase in output and is not
reflected in GDP.
• An increase in leisure is also an increase in social welfare,
sometimes associated with a decrease in GDP.
• Most nonmarket and domestic activities, such as
housework and child care, are not counted in GDP.
• GDP also has nothing to say about the distribution of
output among individuals in a society.

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ECONOMICS IN PRACTICE
An alternative to GDP: The Human Development Index
GDP and GNI indicate economic welfare
but do not measure the nation’s overall
well-being.

As a result of discussions about the multiple

dimensions of economic development, a
new indicator-the Human Development
Index was created by the United Nations in
1990 to compare well-being across nations.

However, it neglects important aspects of a

county’s well-being such as human rights or
political participation.

THINKING PRACTICALLY

1. What are the other aspects of a nation’s well-being you think are missing from
both HDI and GDP (or GNI) measures?

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Limitations of the GDP Concept (2 of 2)
The Informal Economy
• informal economy The part of the economy in which
transactions take place and in which income is generated
that is unreported and therefore not counted in GDP.

Gross National Income per Capita

• gross national income (GNI) GNP converted into dollars
using an average of currency exchange rates over several
years adjusted for rates of inflation.

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FIGURE 21.1 Per Capita Gross National Income for Selected
Countries, 2013

Source: Data from GNI per capita, PPP (current international $), The World Bank Group, Retrieved from
http://data.worldbank.org/indicator/NY.GNP.PCAP.PP.CD/countries/1W?display=default

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REVIEW TERMS AND CONCEPTS (1 of 2)
• base year • gross domestic product (GDP)
• change in business inventories • gross investment
• compensation of employees • gross national income (GNI)
• corporate profits • gross national product (GNP)
• current dollars • gross private domestic
• depreciation investment (I)
• disposable personal income, or • income approach
after-tax income • indirect taxes minus subsidies
• durable goods • informal economy
• expenditure approach • intermediate goods
• final goods and services • national income
• fixed-weight procedure • national income and product
• government consumption and gross accounts
investment (G) • net business transfer payments

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REVIEW TERMS AND CONCEPTS (2 of 2)
• net exports (EX – IM) • rental income
• net interest • residential investment
• net investment • services
• net national product (NNP) • statistical discrepancy
• nominal GDP • surplus of government enterprises
• nondurable goods • value added
• nonresidential investment Weight
• personal consumption • Equations:
expenditures (C) • expenditure approach to GDP: GDP
• personal income = C + I + G + (EX - IM)
• personal saving • GDP = final sales + change in
• personal saving rate business inventories

• proprietors’ income • capitalend of period = capitalbeginning of period +

net investment

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