c hapter 20 gross domestic product accounting © 2002 south-western
TRANSCRIPT
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Economic PrinciplesEconomic Principles
•The circular flow of resources, goods, and services
•The circular flow of money
•The expenditure approach to measuring GDP
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Economic PrinciplesEconomic Principles
•The income approach to measuring GDP
•The relationship between GDP, NDP, and national income
•The limitations of GDP as a measure of economic well-being
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Gross Domestic Gross Domestic Product AccountingProduct Accounting
Circular flow of goods, services, and resources
The movement of goods and services from firms to households, and of resources from households to firms.
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Exhibit 1: The Exhibit 1: The Circular Flow of Circular Flow of
Goods, Services, and Goods, Services, and ResourcesResources
1. What do households supply to the resource market?
• Households supply their resources – labor, capital, land, entrepreneurship – to the firms in the resource market.
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Exhibit 1: The Exhibit 1: The Circular Flow of Circular Flow of
Goods, Services, and Goods, Services, and ResourcesResources
2. What do firms provide to households in the product market?• Firms provide households with goods and services in the product market.
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Gross Domestic Gross Domestic Product AccountingProduct Accounting
Circular flow of money
The movement of income in the form of resource payments from firms to households, and of income in the form of revenue from households to firms.
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Exhibit 2: The Exhibit 2: The Circular Flow of Circular Flow of
MoneyMoneyWhat do firms in the resource market pay to households for resources provided?
• Firms pay money in the form of wages, interest, rent and profit to households for resources supplied.
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Two Approaches to Two Approaches to Calculating GDPCalculating GDP
• Economists calculate GDP in two ways: the expenditure approach to GDP and the income approach to GDP.
• Regardless of which method is used, the values should be equivalent.
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The Expenditure The Expenditure ApproachApproach
Expenditure approach
A method of calculating GDP that adds all expenditures made for final goods and services by households, firms and government.
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The Expenditure The Expenditure ApproachApproach
When using the expenditure approach to GDP, one must be certain that only final goods and services are counted. Otherwise, goods may be double counted.
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The Expenditure The Expenditure ApproachApproach
Final goods
Goods purchased for final use, not for resale.
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The Expenditure The Expenditure ApproachApproach
Intermediate goods
Goods used to produce other goods.
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The Expenditure The Expenditure ApproachApproach
Value added
The difference between the value of a good that a firm produces and the value of the goods the firm uses to produce it.
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Exhibit 3: Market Exhibit 3: Market Value and Value Value and Value
Added Goods Added Goods ProducedProduced
1. What is the total market value of the wool sweater in Exhibit 3?
• The total market value is $94.
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Exhibit 3: Market Exhibit 3: Market Value and Value Value and Value
Added Goods Added Goods ProducedProduced
2. Why shouldn’t the total market value be used when calculating GDP?
• The total market value counts the original resource multiple times.
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Exhibit 3: Market Exhibit 3: Market Value and Value Value and Value
Added Goods Added Goods ProducedProduced
2. Why shouldn’t the total market value be used when calculating GDP?
• For example, the $4 value for wool on the sheep makes up part of the $13 value for wool fabric and $50 value for a wool sweater.
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The Expenditure The Expenditure ApproachApproach
There are four expenditure categories of GDP:
1. Personal consumption.
2. Gross private domestic investment.
3. Government purchases.
4. Net exports.
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The Expenditure The Expenditure ApproachApproach
1. Personal consumption expenditures (C)
All goods and services bought by households. These expenditures are grouped into categories of durable goods, nondurable goods, and services.
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The Expenditure The Expenditure ApproachApproach
1a. Durable goods
Goods expected to last at least a year. For example, refrigerators, automobiles, and washing machines.
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The Expenditure The Expenditure ApproachApproach
1a. Durable goods
During recessions, consumers tend to hang on to their durable goods, so that sales of new durable goods are relatively weak. During times of prosperity, consumers are more likely to discard old durables, and sales of new durables are strong.
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The Expenditure The Expenditure ApproachApproach
1b. Nondurable goods
Goods expected to last less than a year. For example, food, clothing, gasoline and toiletries. Households spend more on nondurables than on durables.
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The Expenditure The Expenditure ApproachApproach
1c. Services
Productive activities that are instantaneously consumed. For example, medical care, a lecture, and appliance repair. Households spend more on services than durable and nondurable goods combined.
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The Expenditure The Expenditure ApproachApproach
2. Gross private domestic investment (I)
The purchase by firms of plant, equipment, and inventory goods.
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The Expenditure The Expenditure ApproachApproach
2. Gross private domestic investment (I)
Plant (or new structure) and equipment purchases may either replace worn out plants and equipment or increase the quantity of plants and equipment.
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The Expenditure The Expenditure ApproachApproach
2a. Inventory investment
Stocks of finished goods and raw materials that firms keep in reserve to facilitate production and sales.
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The Expenditure The Expenditure ApproachApproach
3. Government purchases (G)
All goods and services bought by government. For example, goods such as national defense materials, interstate highway, and post offices, and services such as justice and education.
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The Expenditure The Expenditure ApproachApproach
4. Net exports (X-M)
An economy’s exports to other economies, minus its imports from other economies.
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The Expenditure The Expenditure ApproachApproach
All final goods and services that make up GDP, then, can be expressed in the form:
GDP = C + I + G + (X – M).
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EXHIBIT 4 EXPENDITURE APPROACH TO 2000 GDP ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 4: Exhibit 4: Expenditure Expenditure
Approach to 2000 Approach to 2000 GDP GDP
($ Billions)($ Billions)1. What was the largest category of GDP expenditure in 2000?
• The largest category was personal consumption expenditures at $6,816.7 billion.
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Exhibit 4: Exhibit 4: Expenditure Expenditure
Approach to 2000 Approach to 2000 GDP GDP
($ Billions)($ Billions)2. Why was the net exports category of expenditure negative in 2000? • The category was negative (-$386.1 billion) because the value of US imports was greater than the value of US exports.
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The Income ApproachThe Income Approach
Income approach
A method of calculating GDP that adds all the incomes earned in the production of final goods and services.
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The Income ApproachThe Income Approach
National income
The sum of all payments made to resource owners for the use of their resources.
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The Income ApproachThe Income Approach
The income payments are arranged into five categories: (1) the compensation of employees, (2) interest, (3) corporate profit, (4) rental income, and (5) proprietors’ income.
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The Income ApproachThe Income Approach
The compensation of employees is divided into two categories: wages and salaries and supplements. Supplements (or fringe benefits) include such things as bonuses, paid vacations, and contributions to employees’ Social Security.
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The Income ApproachThe Income Approach
Corporate profit represents the return to owners of incorporated firms. Corporate profit is divided into three categories – dividends, corporate re-investment, and corporate taxes. All three are included in the income approach to GDP.
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The Income ApproachThe Income Approach
Rent is the payment for use of property. Although most people don’t pay themselves rent for using their own property, the rent is still estimated in GDP accounting. Net rental income is total rental income minus depreciation.
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The Income ApproachThe Income Approach
Proprietors’ income is the income earned by unincorporated firms for the goods and services they produce. Proprietors’ income is the net income after paying such expenses as rent, utilities, and supplies.
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EXHIBIT 5 2000 NATIONAL INCOME ($ BILLIONS)
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 5: 2000 Exhibit 5: 2000 National Income ($ National Income ($
Billions)Billions)What was the largest category of income in the US in 2000 according to Exhibit 5?
• Compensation of employees was by far the largest category of income at $5,678.4 billion, or 70.2 percent of the national income.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordGDP, according to Exhibit 4, was $10,052.2 billion in 2000. Yet national income, according to Exhibit 5, was only $8,091.9 billion.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordIn order to bring the two into accord, first gross domestic product is converted to gross national product. Then depreciation of capital and indirect business taxes are subtracted from gross national product.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordGross National Product (GNP)
The market value of all final goods and services in an economy produced by resources owned by people of that economy, regardless of where the resources are located.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordWhile GDP measures location, GNP measures ownership. For example, the value of goods produced by a US-owned firm in Spain are not counted in our GDP, but are counted in our GNP.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordCapital depreciation
The value of existing capital stock used up in the process of producing goods and services.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordNet Domestic Product (NDP)
GDP minus capital depreciation.
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Exhibit 6: Influence of Exhibit 6: Influence of Capital Depreciation on Capital Depreciation on the Growth Rate of NDP the Growth Rate of NDP
($ Billions)($ Billions)How does the rate of NDP growth compare to the rate of GDP growth as capital depreciation increases in Exhibit 6?• Regardless of the value of capital depreciation, the rate of GDP growth remains unchanged.
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Exhibit 6: Influence of Exhibit 6: Influence of Capital Depreciation on Capital Depreciation on the Growth Rate of NDP the Growth Rate of NDP
($ Billions)($ Billions)How does the rate of NDP growth compare to the rate of GDP growth as capital depreciation increases in Exhibit 6?• The rate of NDP growth declines, however, as capital depreciation increases from $900 to $1100 billion.
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Bringing GDP and Bringing GDP and National Income into National Income into
AccordAccordIndirect business taxes include general sales taxes, excise taxes, customs duties and license fees. They are indirect because they are taxes levied not on the firms directly, but on the goods and services.
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EXHIBIT 7 THE RELATIONSHIP BETWEEN GROSS DOMESTIC PRODUCT, GROSS NATIONAL PRODUCT, NET NATIONAL PRODUCT, AND NATIONAL INCOME: 2000 ($ BILLIONS)
Note: Net domestic product = $8,767.7 billion. The use of NNP instead of NDP to derive national incomes conforms to the derivation of national income used by government sources. Note also that because GDP and GNP are almost identical, NDP and NNP are almost identical.
Source: Bureau of Economic Analysis, U.S. Department of Commerce, November 29, 2000.
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Exhibit 7: The Exhibit 7: The Relationship Between Relationship Between
GDP, GNP, Net National GDP, GNP, Net National Product, and National Product, and National
Income: 2000Income: 2000How is national income derived from gross domestic product?
• First, GDP is converted to GNP. This is done by subtracting factor payments to the rest of the world and adding factor payments from the rest of the world.
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Exhibit 7: The Exhibit 7: The Relationship Between Relationship Between
GDP, GNP, Net National GDP, GNP, Net National Product, and National Product, and National
Income: 2000Income: 2000How is national income derived from gross domestic product?
• Second, capital depreciation is subtracted from GNP. The result is net national product.
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Exhibit 7: The Exhibit 7: The Relationship Between Relationship Between
GDP, GNP, Net National GDP, GNP, Net National Product, and National Product, and National
Income: 2000Income: 2000How is national income derived from gross domestic product?
• Third, indirect business taxes are subtracted from net national product. The result is national income.
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Personal Income and Personal Income and Personal Disposable Personal Disposable
IncomeIncomePersonal income
National income, plus income received but not earned, minus income earned but not received.
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Personal Income and Personal Income and Personal Disposable Personal Disposable
IncomeIncomeTransfer payments
Income received but not earned. For example, government-supplied income from retirement benefits, veteran benefits, unemployment insurance benefits, disability payments and subsidies to farmers.
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Personal Income and Personal Income and Personal Disposable Personal Disposable
IncomeIncomeTransfer payments
The government transfers income from taxpayers (who earned the income in the first place) to those receiving benefits.
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Personal Income and Personal Income and Personal Disposable Personal Disposable
IncomeIncomeDisposable personal income
Personal income minus direct taxes.
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How Comprehensive How Comprehensive is GDP?is GDP?
GDP tries to measure everything that appears on the market. Yet, not everything produced in the economy gets onto the market, and some things that contribute to our economic well-being aren’t even produced.
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How Comprehensive How Comprehensive is GDP?is GDP?
The value of housework is one example of an important service that is usually not included in GDP. The work is only included if it is performed by someone outside the household, such as a housekeeper, nanny, or cook.
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How Comprehensive How Comprehensive is GDP?is GDP?
Underground economy
The unreported or illegal production of goods and services in the economy that is not counted in GDP.
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How Comprehensive How Comprehensive is GDP?is GDP?
Illegal unreported activities may include drug trafficking, money laundering, bribery, prostitution, illegal gambling, fraud and burglary.
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How Comprehensive How Comprehensive is GDP?is GDP?
Tax avoidance is the main reason why legal activities may go unreported. Swapping services or simply understating the value of income earned are two ways to avoid paying taxes.
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How Comprehensive How Comprehensive is GDP?is GDP?
Finally, legal and illegal immigrants may work for less than minimum wage at off-the-books entry-level jobs.
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How Comprehensive How Comprehensive is GDP?is GDP?
The quality of goods and services produced may not be included in GDP. For example, a good may be of higher quality, but cost less, than a similar good. The economic value of the improved quality good is not recorded.
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How Comprehensive How Comprehensive is GDP?is GDP?
The costs of environmental damage are another factor not taken into account in GDP.
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How Comprehensive How Comprehensive is GDP?is GDP?
While the expense associated with cleaning up the pollution we create contributes to GDP, the actual pollution created is not subtracted from GDP.