Chapter 7 deals with how we measure output/production in the U.S. economy.  We use a monetary measure known as Gross Domestic Product or GDP.  GDP is the market value of all final goods and services produced in the United States during a year. It is measured monthly, but expressed as an annual value.

Two approaches to measuring GDP:

          There are two ways to look at GDP.  One is to see GDP as the sum of all expenditures on final goods and services.  This is the output or expenditures approach.  The other approach views GDP in terms of the income derived or created from producing that output.  This is the income approach.  In other words, this year’s GDP can be determined either by adding up all that is spent on this year’s total output or by summing the incomes derived from the production of this year’s total output.  What is spent on a product is income to those who have contributed their human and property resources to getting that product produced and to market.

Expenditure approach:    The expenditure approach to measuring GDP simply sums total expenditures on final goods and services made by the four spending groups:  

        GDP  =  C  +  Ig  +  G  +  Xn    

Consumption (C) makes up about 2/3 of all spending.  Consumption spending is divided into three categories:

1.    Consumer durables (goods expected to last three years or more)

2.    Consumer non-durables (expected to last less then three years)

3.    Consumer services

Gross Private Domestic Investment (Ig) - For simplicity, we will simply refer to this as Gross Investment spending.  It is made up of three(3) categories of spending:    

1.    Fixed business investment (spending on capital goods)

2.    Residential construction    

3.    Changes in business inventories (This is a difficult one for most students, so read carefully the explanation on page 130.  

Government  -  There are two important things to remember about the Government component of aggregate spending:

1.    It includes all levels of government (federal, state & local)

2.    It only applies to spending on final goods and services, not to income expenditures (transfer payments).

Net Exports - ($Exports - $Imports)

Income Approach

It would be simple if we could say that all expenditures on the economy’s annual output flowed to households as rent, wages, interest, profits and taxes on production and imports. If this were the case, then National Income would be equal to GDP.  But the picture is complicated by three adjustments which are necessary to balance the expenditure and income sides of the national accounting statement.  In other words, we can balance both sides of the account by subtracting Net Foreign Factor Income and adding two non-income items to National Income.  Those items are (1) depreciation or an allowance for the consumption of fixed capital, and (2) a small statistical adjustment.

  $GDP  =  $National Income (NI)  -  $NFF + $CCA(depreciation) + Statistical Adjustment

  Therefore:

          $NI  =  $Rents + $Wages & Salaries + $Interest + $Profits + Taxes on Production and Imports

                             or

          $NI  =  $GDP + $NFF – ($CCA + $STAT. ADJ.)

  Recall from class discussion that National Income is income earned by the factors of production, but not necessarily income received during the period.  Income received, whether earned or unearned is known as Personal Income.

          $PI  =  $NI – $Taxes on Production and Imports - ($CIT + $SSC + $UCP) + $Transfer Payments, where

                    $CIT = $ Corporate Income Taxes

                    $SSC = $ Social Security Contributions

                    $UCP = $ Undistributed Corporate Profits

$Transfer Payments are income payments that do not reflect the use of productive resources during the period (Social Security, AFDC, etc.)   

Distinguishing Gross Domestic Product and Net Domestic Product:

One of the spending components in GDP is Gross Private Domestic Investment or what I will refer to simply as Gross Investment (Ig).  Ig includes all business expenditures on "new" capital goods.  However, in producing any year's GDP, we use up or consume some part of our existing capital stock.  The monetary measure of that consumption of our stock of capital is depreciation or the Capital Consumption Allowance(CCA).  The difference between the value of new capital produced (Ig) and depreciation (CCA) is Net Investment (In).

                Net Investment (In)  =  Ig  -  depreciation (CCA)

Net Domestic Product is no more than the GDP calculation substituting Net Investment for Ig.

                NDP  =  C  +  In  +  G  +  Xn

                                    or

                NDP  =  GDP  -  depreciation (CCA)         

Price Index  - A Price Index is simply the ratio of the average price of a "basket" of goods and services in the year in question to the price of the same basket of goods in some reference year (base year).  We will be concerned with two of the many price indices calculated by the government.  One is the Consumer Price Index (CPI) and the other is the GDP Price Index which is used to calculate Real GDP.

Nominal GDP versus Real GDP

Real GDP, sometimes referred to as Adjusted GDP or Constant dollar (price) GDP is simply the current year's output of final goods and services valued at Base Year prices.  For adjustment purposes, we currently are using year 2000 as the base or reference year.  After valuing or recalculating each year's GDP using year 2000 prices we can compare one year's GDP with previous year, the difference being changes in real output.

Real GDP₂₀₀₅     =     

Shortcomings of GDP