National Income Accounting (Measuring Output)

I. Gross Domestic Product (GDP)

Macroeconomists are interested in total production in the economy, so it is essential that we
create a measure of total output. This measure is called GDP. GDP is the total market value of
all final goods and sevices produced in a country in a given year. Three things to note about
this definition of GDP:
total market value. We add up the dollar value of all the stuff produced in the nited
!tates. This is because producing a car is way different that producing a haircut or a can
of soup, but by converting everything to its dollar value we have a uniform measure.
final goods and services. We only count final products ready to be consumed, "#T
products used to ma$e other products. !o a car will be counted in the GDP but the steel
used to ma$e the car is not counted separately. Why% &ecause the value of the car already
reflects the value of the steel, rubber, plastic,etc. that goes into it.
produced in a country. The .!. GDP counts only those goods and services produced in
the physical borders of the nited !tates. !o Toyotas made in #hio are counted, even
though Toyota is a 'apanese company. (owever, minivans made by General Motors in
Me)ico do "#T count in GDP, even though GM is a .!. company. Where the good or
service is produced is important.
Example. !uppose our imaginary economy produces * goods: apples, computers, pi++a. The
table below shows production and prices for ,---:

year apples computers pizza
price quantity price quantity price quantity
1999 ./.0/ 0// .,/// ,// .- 1//
To caluculate GDP, we simple multiply the price and 2uanitity of each good to get the dollar
value, then add up all three values:
GDP 3 value of apples 4 value of computers 4 value of pi++a
GDP 3 5..0/650//6 4 5.,///65,//6 4 5.-651//6 3 .70/ 4 .,//,/// 4 .*8// 3 .,/*,90/
With millions of goods and services in the nited !tates, the process is a bit more complicated,
but the principle is the same.
The measurement of GDP and its components is $nown as national income accounting. The .!.
Department of :ommerce is in charge of measuring .!. GDP and measures it 2uarterly, or 1
times per year.
II. Nominal GDP s. !eal GDP
;n measuring GDP, we use prices to measure the value of good and services produced. sing the
current prices to value current production is $nown as nominal GDP. The problem with nominal
GDP is that a change in nominal GDP can be due to either 5,6 a change in the production of
goods and services, or 576 a change in the prices of those goods and services. !o an increase in
prices will cause nominal GDP to rise, even if production has not changed at all. This gives a
misleading picture of how well our economy is doing. ;t also ma$es it difficult to compare
production from year to year, since prices change every year.
To address the price problem, we also construct a measure of GDP that ta$es price changes into
account. !eal GDP values goods and services in any given year by using the prices of a set "ase
period. &y holding prices constant, real GDP measures only the changes in production from year
to year. :hanges in real GDP are used to measure economic growth.
Example. <ets continue our e)ample above. The table below has the prices and production of
apples, computers and pi++a for three years:
year apples computers pizza
price quantity price quantity price quantity
199# ./.10 1=0 .,,// =/ .= *9/
199$ ./.19 0,/ .,/0/ 90 .9 *-/
1999 ./.0/ 0// .,/// ,// .- 1//
>irst, let?s calcuate nominal GDP for each year. This means we ta$e the price for that year times
the 2uantity for that year.
nominal GDP ,--= 3 5.10651=06 4 5,,//65=/6 4 5=65*9/6 3 . =-,9=*.=0
nominal GDP ,--9 3 5.19650,/6 4 5,/0/65906 4 5965*-/6 3 . -7,8,1.9/
nominal GDP ,--- 3 5.0/650//6 4 5,///65,//6 4 5-651//6 3 .,/*,90/
>rom ,--= to ,--- nominal GDP has increased by

but this increase includes changes in &#T( price and production
"ow let?s calculate real GDP, using ,--9 as the base year. This means for each year we will
value output using ,--9 prices.
real GDP ,--= 3 (.%$)51=06 4 (1&'&)5=/6 4 ($)5*9/6 3 . =8,=98
real GDP ,--9 3 (.%$)50,/6 4 (1&'&)5906 4 ($)5*-/6 3 . -7,8,1.9/
real GDP ,--- 3 (.%$)50//6 4 (1&'&)5,//6 4 ($)51//6 3 .,/9,11/
>rom ,--= to ,--- real GDP has increased by

but this increase includes #"<@changes in production, because prices are held constant at their
,--9 levels. "ote how the real GDP increase is greater. This is because in calculating nominal
GDP, computer prices are falling over time even though computer production is increasing.
"ote that real GDP 3 nominal GDP in the base year, since both measures use the same prices and
same production.
When the .!. Department of :ommerce calcuates real GDP they use an average of prices in
previous years, not Aust the prices of a single year. This is $nown as a chainBweighted price
adAustment.
>igure 0., 5page -06 measures real vs. nominal GDP from ,-=0 to ,--8, using ,--7 as the base
year. Given that prices on average increase over time in the .!., the real GDP is greater than the
nominal GDP before ,--7, and less than nominal GDP after ,--7.
Ceal and nominal GDP are used to form a price inde), something we discuss in :hapter =.
III. (.). GDP Oer *ime
The graph below shows the post WW;; path of real and nominal GDP in the nited !tates, using
,--8 as a base year.
Given that prices on average increase over time in the .!., the real GDP is greater than the
nominal GDP before ,--8 and less than nominal GDP after ,--8. "ote that even after adAusting
for inflation, production in the nited !tates has risen dramatically in the past 0/ years, from
.,.0 trillion to over .- trillion.
Typically economists are more interested in the :(D"GE in real GDP rather than the <EFE< of
real GDP:
The negative percent changes in real GDP indicate recessions.
Ceal and nominal GDP are used to form a price inde), something we discuss in :hapter =.
I+. Measuring GDP, *-e ./penditure Approac-
!o how does the .!. government go about measuring such a huge 2uantity% #ne approach is to
add up e)penditures on goods and services in each sector of the economy:
Consumption (C). Ds mentioned in chapter two, this accounts for about 7G* of GDP.
nvestment (). Plants, e2uipment and inventory of businesses. This is one of the most
volatile components of GDP.
Government !pending (G): >ederal, state, and local government purchases of goods and
services are counted here. This does "#T count transfer payments, such as welfare, since
this Aust transfers income and does not represent production of goods and services.
"et Exports (# $ %). "et e)ports is e)ports minus imports. !o we add in those goods
and services produced in the .!. and sold abroad but we substract the good and services
purchased by consumers, businesses, and governments that were not made in the nited
!tates. !ince the ,-=/s, the .!. has imported more than it has e)ported, so net e)ports
are negative.
Putting all of the e)penditures together we have the identity
GDP 3 : 4 ; 4 G 4 H B ;M
+. Measuring GDP, *-e Income Approac-
The second approach to measuring GDP is to loo$ at income instead of e)penditures. ;f someone
bought it, then someone is being paid to ma$e it. The income components include
&ages and salaries
Corporate profits
Proprietors income (the profits of partnerships and solely o'ned (usinesses) like a
family restaurant)
*arm income
+ent
nterest
!ales taxes
Depreciation (the amount of capital that has 'orn out during the year)
Tables 0.0 and 0.8 5pages -9, --6 show the relationship between the income and e)penditure
approaches.
The e)penditure and income approaches should, in theory, give us the same answer. ;n reality
they are slightly different due to some measurement error. &ut spending and income are related
in a circular flow: spending by someone becomes income for someone else. >or e)ample, when
my family goes out to eat, the meal we purchase represents income for the waiter, the restaurant
owner, the suppliers, and the sales ta) on the meal is income for the government. !o to calculate
GDP we can either add up e)penditures or add up income. The flow between income and
spending is demonstrated in figure 0.* 5page ,/,6.
+I. 0-at does GDP NO* measure1
!o GDP is an important measure of the economic power and health of a nation. &ut GDP does
not tell the whole story in terms of the well being of a nation. (ere are a few things GDP leaves
out:
Ot-er social indicators. These include crime, illiteracy, life e)pectancy, infant mortality.
Dlthough these things are related to GDP, the connection is not perfect: The .!. has a
larger GDP per capita than :anada or 'apan, but also has a higher rate of crime, illiteracy,
and infant mortality.
.2uity. D large GDP per capita does not mean that the wealth of a nation is shared
e2ually. ;n some nations, the GDP is distributed for the most part among a small elite
class, leaving the rest of the nation in poverty.
.nironmental issues. D high rate of production may have disasterous environmental
conse2uences. &ra+il may increase its GDP by cutting down rain forests for the timber,
but very few of us would say that is a good thing.
*-e underground economy. The GDP actually measured will fail to capture any goods
and services that are not reported to the government. These include illegal activities, li$e
mariAuana cultivation, cocaine sales, and ta) evasion, such as underBreporting tip income,
or cashBpaid babysitting. The underground economy is estimated to be as large as ,/I of
the measured GDP in the nited !tates 5see page -,6. The underground economy in
Me)ico is relatively larger due to drug smuggling. :anada?s underground economy is
estimated to be as high as 7/I due to the higher ta)es there.
Nonmar3et 4or3. This includes transactions for which people are not paid. When ; do
my family?s laundry, that is not counted in GDP. &ut if ; paid someone to do my laundry,
it would count in GDP. The e)clusion of homema$ing really understates the services
produced in the nited !tates.
!o while GDP is a crucial measure of the si+e and health of an economy, $eep in mind it is not
the #"<@ measure of wellBbeing.