Measuring Domestic Output and National Income
CHAPTER SEVEN
MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME
CHAPTER OVERVIEW
News headlines frequently report the status of the nation’s economic conditions, but to many citizens the
information is confusing or incomprehensible. This chapter acquaints students with the basic language
of macroeconomics and national income accounting. GDP is defined and explained. Then, the
differences between the expenditure and income approaches to determining GDP are discussed and
analyzed in terms of their component parts. The income and expenditure approaches are developed
gradually from the basic expenditure-income identity, through tables and figures.
The importance of investment is given considerable emphasis, including the nature of investment, the
distinction between gross and net investment, the role of inventory changes, and the impact of net
investment on economic growth. On the income side, nonincome charges—depreciation and indirect
business taxes—are covered in detail because these usually give students the most trouble.
Other measures of economic activity are defined and discussed, with special emphasis on using price
indexes. The purpose and procedure of deflating and inflating nominal GDP are carefully explained and
illustrated. Finally, the shortcomings of current GDP measurement techniques are examined. Global
comparisons are made with respect to size of national GDP and size of the underground economy.
The Last Word looks at the sources of data for the GDP accounts.
WHAT’S NEW
The chapter is updated and is more tightly focused than the previous edition. As reflected in the title
change, there is now less emphasis on the price level. Chapter 7 is part of a revised Part 2 that focuses
more narrowly on basic macroeconomic concepts and measurement. Macroeconomic models and fiscal
policy are now contained in Part 3 of the text. This does not affect the ordering of the chapters.
A “Consider This” box has been added to help students understand the difference between the stock and
flow variables of gross investment, depreciation, and the stock of capital (moved from the previous
edition website “Analogies, Anecdotes, and Insights”).
Two sections were moved from their positions the last edition. “The Consumer Price Index” section now
appears in the Chapter 8 discussion of inflation. In the “Shortcomings of GDP,” the section on “Per
Capita Output” was moved to the Chapter 8 discussion of measures of economic growth.
Data have been updated and web-based questions have been revised.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to
1. State the purposes of national income accounting.
2. List the components of GDP in the output (expenditures) approach and in the income approach.
3. Compute GDP using either the expenditure or income approach when given national income data.
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Measuring Domestic Output and National Income
4. Differentiate between gross and net investment.
5. Explain why changes in inventories are investments.
6. Discuss the relationship between net investment and economic growth.
7. Compute NDP, NI, PI, and DI when given relevant data.
8. Describe the system represented by the circular flow in this chapter when given a copy of the
diagram.
9. Calculate a GDP price index using simple hypothetical data.
10. Find real GDP by adjusting nominal GDP with use of a price index.
11. List seven shortcomings of GDP as an index of social welfare.
12. Explain what is meant by the underground economy and state its approximate size in the U.S. and
how that compares to other nations.
13. Give an estimate of actual 2002 (or later) U.S. GDP in trillions of dollars and be able to rank the
U.S. relative to a few other countries.
14. Define and identify terms and concepts listed at the end of the chapter.
COMMENTS AND TEACHING SUGGESTIONS
1. National income accounts are detailed and can be very time consuming for students. Some
instructors choose to treat them selectively. For example, focus only on expenditures approach to
GDP. Decide what priorities are most important and plan accordingly.
2. Encourage students to look for news items on Chapter 7 concepts. Students could be asked to keep
a weekly journal summarizing reports or follow a particular measure like unemployment.
Political cartoons are often about macroeconomic issues. Keeping a collection of them; asking
students to contribute enlivens the classroom and builds understanding.
3. Use of circular flow diagrams in this section may be helpful. The national income accounts are
built on the identity of income and output. Once a good is produced it generates a like amount of
income; this is clearly demonstrated in the sum of the transactions in the product and resource
markets.
4. Discuss the difference between the concepts of “stock” and “flows.” The national accounts are
measured over a period of time, so GDP and the related aggregates are all flow concepts. A
“stock” is a measure of a variable at a point in time. Consider these pairs of terms: income and
wealth; saving and savings; deficit and debt. Contrast the income statement of a firm with the
firm’s balance sheet. The CONSIDER THIS … Stock Answers about Flows box will help
illustrate the difference.
5. For discussion: In what sense is a hurricane or an earthquake good for the economy? How does a
divorce add to GDP? How can the depletion of a natural resource add to GDP?
6. Ask students how they think a researcher might get information about the size of the underground
economy. Obviously a drug dealer is not going to include sales information on his 1040 tax return.
Discuss how the presence of the underground economy might influence tax structure and policies.
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Measuring Domestic Output and National Income
STUDENT STUMBLING BLOCKS
1. There is a lot of memorization required to learn the various measures used in the national
accounts. In the interest of time, you might choose to have your students focus on the
expenditures approach to calculating GDP. It will prove to be the most useful in understanding
the analysis in subsequent chapters which use C + I + G + Xn formulation frequently.
2. Special Problems: Investment is a word that all of the students in the class think they understand.
The meaning of the term in ordinary conversation interferes with their ability to acquire a new
definition and use that new definition consistently.
3. Changes in business inventory is an entry that represents the difference between what has been
produced and what is sold. Although this entry is very small compared to total GDP, it is one of
the most important indicators of future business activity. It has an important role in the income
determination models presented later in the text.
4. Many of the exclusions from the GDP accounts involve financial transactions that transfer the
ownership of existing assets. The sale of stock in a corporation is a transfer of part ownership of
existing assets. New stock issues only dilute the share of ownership and are excluded as well.
The sale of corporate bonds also represents a purely financial transaction. Corporations that are
seeking to expand use the proceeds of these sales to purchase capital equipment or engage in new
construction, and this is included in GDP. To also include the purchase of the securities would
be an example of double counting. However, services are provided when these transactions are
processed, the value of which should be included in GDP.
5. Sales of secondhand goods are also excluded; however parts of the transactions may need to be
counted. The used car dealership that buys a car for $1000 and resells it for $3000 has created
$2000 worth of output, even if the entire sum is profit to the entrepreneur.
6. Remind the students that entries beginning with the word net could be negative and have been in
the case of net exports for many years in U.S.
LECTURE NOTES
I.
Assessing the Economy’s Performance
A. National income accounting measures the economy’s performance by measuring the flows of
income and expenditures over a period of time.
B. National income accounts serve a purpose for the economy similar to income statements for
business firms.
C. Consistent definition of terms and measurement techniques allows us to use the national
accounts in comparing conditions over time and across countries.
D. The national income accounts provide a basis for appropriate public policies to improve
economic performance.
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Measuring Domestic Output and National Income
II.
Gross Domestic Product
A. GDP is the monetary measure of the total market value of all final goods and services
produced within a country in one year.
1. Money valuation allows the summing of apples and oranges; money acts as the common
denominator. (See Table 7.1.)
2. GDP includes only final products and services; it avoids double or multiple counting by
eliminating any intermediate goods used in production of these final goods or services.
(Table 7.2 illustrates how including sales of intermediate goods would overstate GDP.)
3. GDP is the value of what has been produced in the economy over the year, not what was
actually sold.
B. GDP Excludes Nonproduction Transactions
1. GDP is designed to measure what is produced or created over the current time period.
Existing assets or property that was sold or transferred, including used items, are not
counted.
2. Purely financial transactions are excluded.
a. Public transfer payments, like social security or cash welfare benefits.
b. Private transfer payments, like student allowances or alimony payments.
c. The sale of stocks and bonds represent a transfer of existing assets. (However, the
brokers’ fees are included for services rendered.)
3. Secondhand sales are excluded; they do not represent current output. (However, any
value added between purchase and resale is included, e.g., used car dealers.)
C. Two Ways to Look at GDP: Spending and Income.
1. What is spent on a product is income to those who helped to produce and sell it.
2. This is an important identity and the foundation of the national accounting process.
D. Expenditures Approach (See Figure 7.1 and Table 7.3.)
1. GDP is divided into the categories of buyers in the market; household consumers,
businesses, government, and foreign buyers.
2. Personal Consumption Expenditures—(C)—includes durable goods (goods lasting 3
years or more), nondurable goods, and services.
3. Gross Private Domestic Investment—(Ig)
a. All final purchases of machinery, equipment, and tools by businesses.
b. All construction (including residential).
c. Changes in business inventory.
i. If total output exceeds current sales, inventories build up.
ii. If businesses are able to sell more than they currently produce, this entry will be a
negative number.
d. Net Private Domestic Investment—(In).
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Measuring Domestic Output and National Income
i.
Each year as current output is being produced, existing capital equipment is
wearing out and buildings are deteriorating; this is called depreciation or
consumption of fixed capital.
ii. Gross Investment minus depreciation (consumption of fixed capital) is called net
investment.
iii. If more new structures and capital equipment are produced in a given year than
are used up, the productive capacity of the economy will expand. (Figure 7.2)
iv. When gross investment and depreciation are equal, a nation’s productive
capacity is static.
v. When gross investment is less than depreciation, an economy’s production
capacity declines.
vi. CONSIDER THIS … Stock Answers about Flows
4. Government Purchases (of consumption goods and capital goods) – (G)
a. Includes spending by all levels of government (federal, state, and local).
b. Includes all direct purchases of resources (labor in particular).
c. This entry excludes transfer payments since these outlays do not reflect current
production.
5. Net Exports— (Xn)
a. All spending on final goods produced in the U.S. must be included in GDP, whether
the purchase is made here or abroad.
b. Often goods purchased and measured in the U.S. are produced elsewhere (Imports).
c. Therefore, net exports, (Xn) is the difference: (exports minus imports) and can be
either a positive or negative number depending on which is the larger amount.
6. Summary: GDP = C + Ig + G + Xn
E. Income Approach to GDP (See Table 7.3): Demonstrates how the expenditures on final
products are allocated to resource suppliers.
1. Compensation of employees includes wages, salaries, fringe benefits, salary and
supplements, and payments made on behalf of workers like social security and other
health and pension plans.
2. Rents: payments for supplying property resources (adjusted for depreciation it is net
rent).
3. Interest: payments from private business to suppliers of money capital.
4. Proprietors’ income: income of incorporated businesses, sole proprietorships,
partnerships, and cooperatives.
5. Corporate profits: After corporate income taxes are paid to government, dividends are
distributed to the shareholders, and the remainder is left as undistributed corporate
profits.
6. The sum of the above entries equals national income: all income earned by Americansupplied resources, whether here or abroad.
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Measuring Domestic Output and National Income
7. Adjustments required to balance both sides of the account:
a. Indirect business taxes: general sales taxes, excise taxes, business property taxes,
license fees and customs duties (the seller treats these taxes as a cost of production).
b. Depreciation/Consumption of Fixed Capital: The firm also regards the decline of its
capital stock as a cost of production. The depreciation allowance is set aside to
replace the machinery and equipment used up. In addition to the depreciation of
private capital, public capital (government buildings, port facilities, etc.), must be
included in this entry.
c. Net foreign factor income: National income measures the income of Americans both
here and abroad. GDP measures the output of the geographical U.S. regardless of
the nationality of the contributors. To make this final adjustment, the income of
foreign nationals must be added and American income earned abroad must be
subtracted. Sometimes this entry is a negative number. (Without this adjustment you
have GNP.)
III.
Other National Accounts (see Table 7.4)
A. Net domestic product (NDP) is equal to GDP minus depreciation allowance (consumption of
fixed capital).
B. National income (NI) is income earned by American-owned resources here or abroad.
Adjust NDP by subtracting indirect business taxes and adding net American income earned
abroad. (Note: This may be a negative number if foreigners earned more in U.S. than
American resources earned abroad.)
C. Personal income (PI) is income received by households. To calculate, take NI minus payroll
taxes (social security contributions), minus corporate profits taxes, minus undistributed
corporate profits, and add transfer payments.
D. Disposable income (DI) is personal income less personal taxes.
IV.
Circular Flow Revisited (see Figure 7.3)
A. Compare to the simpler model presented in earlier chapters. Now both government and
foreign trade sectors are added.
B. Note that the inside covers of the text contain a useful historical summary of national income
accounts and related statistics.
V.
Nominal versus Real GDP
A. Nominal GDP is the market value of all final goods and services produced in a year.
1. GDP is a (P x Q) figure including every item produced in the economy. Money is the
common denominator that allows us to sum the total output.
2. To measure changes in the quantity of output, we need a yardstick that stays the same
size. To make comparisons of length, a yard must remain 36 inches. To make
comparisons of real output, a dollar must keep the same purchasing power.
3. Nominal GDP is calculated using the current prices prevailing when the output was
produced, but real GDP is a figure that has been adjusted for price level changes.
B. The adjustment process in a one-good economy (Table 7.5). Valid comparisons cannot be
made with nominal GDP alone, since both prices and quantities are subject to change. Some
method to separate the two effects must be devised.
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Measuring Domestic Output and National Income
1. One method is to first determine a price index, (see Equation 1) and then adjust the
nominal GDP figures by dividing by the price index (in hundredths) (see Equation 2).
2. An alternative method is to gather separate data on the quantity of physical output and
determine what it would sell for in the base year. The result is Real GDP. The price
index is implied in the ratio: Nominal GDP/Real GDP. Multiply by 100 to put it in
standard index form (see Equation 3).
C. Real World Considerations and Data
1. The actual GDP price index in the U.S. is called the chain-type annual-weights price
index, and is more complex than can be illustrated here.
2. Once nominal GDP and the GDP price index are established, the relationship between
them and real GDP is clear (see Table 7.7).
3. The base year price index is always 100, since Nominal GDP and Real GDP use the
same prices. Because the long-term trend has been for prices to rise, adjusting Nominal
GDP to Real GDP involves inflating the lower prices before the base year and deflating
the higher prices after the base year.
4. Real GDP values allow more direct comparison of physical output from one year to the
next, because a “constant dollar” measuring device has been used. (The purchasing
power of the dollar has been standardized at the base-year level.)
VI.
Shortcomings of GDP
A. GDP doesn’t measure some very useful output because it is unpaid (homemakers’ services,
parental child care, volunteer efforts, home improvement projects).
B. GDP doesn’t measure improvements in product quality or make allowances for increased
leisure time.
C. GDP doesn’t measure improved living conditions as a result of more leisure.
D. GDP makes no value adjustments for changes in the composition of output or the distribution
of income.
1. Nominal GDP simply adds the dollar value of what is produced; it makes no difference if
the product is a semiautomatic rifle or a jar of baby food.
2. Per capita GDP may give some hint as to the relative standard of living in the economy;
but GDP figures do not provide information about how the income is distributed.
E. The Underground Economy
1. Illegal activities are not counted in GDP (estimated to be around 8% of U.S. GDP).
2. Legal economic activity may also be part of the “underground,” usually in an effort to
avoid taxation.
F. GDP and the environment
1. The harmful effects of pollution are not deducted from GDP (oil spills, increased
incidence of cancer, destruction of habitat for wildlife, the loss of a clear unobstructed
view).
2. GDP does include payments made for cleaning up oil spills and the cost of health care
for cancer victims.
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Measuring Domestic Output and National Income
G. Noneconomic Sources of well-being like courtesy, crime reduction, etc., are not covered in
GDP.
VII.
LAST WORD: Feeding the GDP Accounts
A. GDP is compiled by the Bureau of Economic Analysis (BEA) in the U.S. Commerce
Department. Where does it get its data? Explanation follows.
B. Consumption data comes from
1. Census Bureau’s “Retain Trade Survey” from a sample of 22,000 firms.
2. Census Bureau’s “Survey of Manufacturers,” which gets information on consumer goods
shipments from 50,000 firms.
3. Census Bureau’s “Service Survey” of 30,000 service businesses.
4. Industry trade sources like auto and aircraft sales.
C. Investment data comes from
1. All the consumption sources listed above.
2. Census construction surveys.
D. Government purchase data is obtained from
1. U.S. Office of Personnel Management, which collects data on wages and benefits.
2. Census construction surveys of public projects.
3. Census Bureau’s “Survey of Government Finance.”
E. Net export information comes from
1. U.S. Customs Service data on exports and imports.
2. BEA surveys on service exports and imports.
ANSWERS TO END-OF-CHAPTER QUESTIONS
7-1
In what ways are national income statistics useful?
National income accounting does for the economy as a whole what private accounting does for
businesses. Firms measure income and expenditures to assess their economic health.
The national income accounting system measures the level of production in the economy at some
particular time and helps explain the significance at that level. By comparing national accounts
over a number of years, we can track the long-run course of the economy. Information supplied
by national accounts provide a basis for designing and applying public policies to improve the
performance of the economy. Without national accounts, economic policy would be guesswork.
National income accounting allows us to assess the health of an economy and formulate policies
to maintain and improve that health.
7-2
Explain why an economy’s output is also its income?
Everything that is produced is sold, even if the “selling,” in the case of inventory, is to the
producing firm itself. Since the same amount of money paid out by the buyers of the economy’s
output is received by the sellers as income (looking only at a private-sector economy at this
point), “an economy’s output is also its income.”
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Measuring Domestic Output and National Income
7-3
(Key Question) Why do national income accountants include only final goods in measuring GDP
for a particular year? Why don’t they include the value of stocks and bonds sold? Why don’t
they include the value of used furniture bought and sold?
The dollar value of final goods includes the dollar value of intermediate goods. If intermediate
goods were counted, then multiple counting would occur. The value of steel (an intermediate
good) used in autos is included in the price of the auto (a final product).
This value is not included in GDP because such sales and purchases simply transfer the
ownership of existing assets; such sales and purchases are not themselves (economic) investment
and thus should not be counted as production of final goods and services.
Used furniture was produced in some previous year; it was counted as GDP then. Its resale does
not measure new production.
7-4
What is the difference between gross private domestic investment and net private domestic
investment? If you were to determine net domestic product (NDP) through the expenditures
approach, which of these two measures of investment spending would be appropriate? Explain.
Gross private domestic investment less depreciation is net private domestic investment.
Depreciation is the value of all the physical capital—machines, equipment, buildings—used up
in producing the year’s output.
Since net domestic product is gross domestic product less depreciation, in determining net
domestic product through the expenditures approach it would be appropriate to use the net
investment measure that excludes depreciation, that is, net private domestic investment.
7-5
Why are changes in inventories included as part of investment spending? Suppose inventories
declined by $1 billion during 2003. How would this affect the size of gross private domestic
investment and gross domestic product in 2003? Explain.
Anything produced by business that has not been sold during the accounting period is something
in which business has invested—even if the “investment” is involuntary, as often is the case with
inventories. But all inventories in the hands of business are expected eventually to be used by
business—for instance, a pile of bricks for extending a factory building—or to be sold—for
instance, a can of beans on the supermarket shelf. In the hands of business both the bricks and
the beans are equally assets to the business, something in which the business has invested.
If inventories declined by $1 billion in 2003, $1 billion would be subtracted from both gross
private domestic investment and gross domestic product. A decline in inventories indicates that
goods produced in a previous year have been used up in this year’s production. If $1 billion is
not subtracted as stated, then $1 billion of goods produced in a previous year would be counted
as having been produced in 2003, leading to an overstatement of 2003’s production.
7-6
Use the concepts of gross and net investment to distinguish between an economy that has a rising
stock of capital and one that has a falling stock of capital. “In 1933 net private domestic
investment was minus $6 billion. This means in that particular year the economy produced no
capital goods at all.” Do you agree? Why or why not? Explain: “Though net investment can be
positive, negative, or zero, it is quite impossible for gross investment to be less than zero.”
When gross investment exceeds depreciation, net investment is positive and production capacity
expands; the economy ends the year with more physical capital than it started with. When gross
investment equals depreciation, net investment is zero and production capacity is said to be
static; the economy ends the year with the same amount of physical capital. When depreciation
exceeds gross investment, net investment is negative and production capacity declines; the
economy ends the year with less physical capital.
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Measuring Domestic Output and National Income
The first statement in wrong. Just because net investment was a minus $6 billion in 1933 does
not mean the economy produced no new capital goods in that year. It simply means depreciation
exceeded gross investment by $6 billion. So the economy ended the year with $6 billion less
capital.
The second statement is correct. If only one $20 spade is bought by a construction firm in the
entire economy in a year and no other physical capital is bought, then gross investment is $20—a
positive amount. This is true even if net investment is highly negative because depreciation is
well above $20. If not even this $20 spade has been bought, then gross investment would have
been zero. But gross investment can never be less than zero.
7-7
Define net exports. Explain how the United States’ exports and imports each affect domestic
production. Suppose foreigners spend $7 billion on American exports in a given year and
Americans spend $5 billion on imports from abroad in the same year. What is the amount of
America’s net exports? Explain how net exports might be a negative amount.
Net exports are a country’s exports of goods and services less its imports of goods and services.
The United States’ exports are as much a part of the nation’s production as are the expenditures
of its own consumers on goods and services made in the United States. Therefore, the United
States’ exports must be counted as part of GDP. On the other hand, imports, being produced in
foreign countries, are part of those countries’ GDPs. When Americans buy imports, these
expenditures must be subtracted from the United States’ GDP, for these expenditures are not
made on the United States’ production.
If American exports are $7 billion and imports are $5 billion, then American net exports are +$2
billion. If the figures are reversed, so that Americans export $5 billion and import $7 billion,
then net exports are -$2 billion—a negative amount. For this to come about, Americans must
either decrease their holdings of foreign currencies by $2 billion, or borrow $2 billion from
foreigners—or do a bit of both. (Another option is to sell back to foreigners some of the
previous American investments abroad.)
7-8
(Key Question) Below is a list of domestic output and national income figures for a given year.
All figures are in billions. The questions that follow ask you to determine the major national
income measures by both the expenditure and income methods. The results you obtain with the
different methods should be the same.
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Measuring Domestic Output and National Income
Personal consumption expenditures
Net foreign factor income earned
Transfer payments
Rents
Consumption of fixed capital (depreciation)
Social security contributions
Interest
Proprietors’ income
Net exports
Dividends
Compensation of employees
Indirect business taxes
Undistributed corporate profits
Personal taxes
Corporate income taxes
Corporate profits
Government purchases
Net private domestic investment
Personal saving
$245
4
12
14
27
20
13
33
11
16
223
18
21
26
19
56
72
33
20
a. Using the above data, determine GDP by both the expenditure and the income approaches.
Then determine NDP.
b. Now determine NI: first, by making the required additions and subtractions from GDP; and
second, by adding up the types of income that make up NI.
c. Adjust NI (from part b) as required to obtain PI.
d. Adjust PI (from part c) as required to obtain DI.
(a) GDP = $388, NDP = $361
(b) NI = $339
(c) PI = $291
(d) DI = $265
7-9
Using the following national income accounting data, compute (a) GDP, (b) NDP, (c) NI. All
figures are in billions.
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Measuring Domestic Output and National Income
Compensation of employees
U.S. exports of goods and services
Consumption of fixed capital (depreciation)
Government purchases
Indirect business taxes
Net private domestic investment
Transfer payments
U.S. imports of goods and services
Personal taxes
Net foreign factor income earned in U.S.
Personal consumption expenditures
7-10
$194.2
17.8
11.8
59.4
14.4
52.1
13.9
16.5
40.5
2.2
219.1
(a) Personal consumption expenditures (C)
Government purchases (G)
Gross private domestic investment (Ig)
(52.1 + 11.8)
Net exports (Xn) (17.8 - 16.5)
Gross domestic product (GDP)
$219.1
59.4
63.9
(b) Consumption of fixed capital
Net domestic product (NDP)
-11.8
$331.9
(c) Net foreign factor income earned in U.S.
Indirect business taxes
National income (NI)
-2.2
-14.4
$315.3
1.3
$343.7
Why do national income accountants compare the market value of the total outputs in various
years rather than actual physical volumes of production? What problem is posed by any
comparison over time of the market values of various total outputs? How is this problem
resolved?
If it is impossible to summarize oranges and apples as one statistic, as the saying goes, it is surely
even more impossible to add oranges and, say, computers. If the production of oranges increases
by 100 percent and that of computers by 10 percent, it does not make any sense to add the 100
percent to the 10 percent, then divide by 2 to get the average and say total production has
increased by 55 percent.
Since oranges and computers have different values, the quantities of each commodity are
multiplied by their values or prices. Adding together all the results of the price times quantity
figures leads to the aggregate figure showing the total value of all the final goods and services
produced in the economy. Thus, to return to oranges and computers, if the value of orange
production increases by 100 percent from $100 million to $200 million, while that of computers
increases 10 percent from $2 billion to $2.2 billion, we can see that total production has
increased from $2.1 billion (= $100 million + $2 billion) to $2.4 billion (= $200 million + $2.2
billion). This is an increase of 14.29 percent [= ($2.4 billion - $2.1 billion)/$2.1 billion)]—and
not the 55 percent incorrectly derived earlier.
Comparing market values over time has the disadvantage that prices change. If the market value
in year 2 is 10 percent greater than in year 1, we cannot say the economy’s production has
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Measuring Domestic Output and National Income
increased 10 percent. It depends on what has been happening to prices; on whether the economy
has been experiencing inflation or deflation.
To resolve this problem, statisticians deflate (in the case of inflation) or inflate (in the case of
deflation) the value figures for the total output so that only “real” changes in production are
recorded. To do this, each item is assigned a “weight” corresponding to its relative importance in
the economy. Housing, for example, is given a high weight because of its importance in the
average budget. A book of matches would be given a very low weight. Thus, the price of
housing increasing by 5 percent has a much greater effect on the price index used to compare
prices from one year to the next, than would the price of a book of matches increasing by 100
percent.
7-11
(Key Question) Suppose that in 1984 the total output in a single-good economy was 7,000
buckets of chicken. Also suppose that in 1984 each bucket of chicken was priced at $10.
Finally, assume that in 1996 the price per bucket of chicken was $16 and that 22,000 buckets
were purchased. Determine the GDP price index for 1984, using 1996 as the base year. By what
percentage did the price level, as measured by this index, rise between 1984 and 1996? Use the
two methods listed in Table 7-6 to determine real GDP for 1984 and 1996.
X/100 = $10/$16 = .625 or 62.5 when put in percentage or index form (.625 x 100)
100  62.5
16  10 6
 .60 or 60% (Easily calculated

 .6  60% )
62.5
10
10
Method 1: 1996 = (22,000 x $16) ÷ 1.0 = $352,000
1984 = (7,000 x $10) ÷ .625 = $112,000
Method 2: 1996 = 22,000 x $16 = $352,000
1984 = 7,000 x $16 = $112,000
7-12
(Key Question) The following table shows nominal GDP and an appropriate price index for a
group of selected years. Compute real GDP. Indicate in each calculation whether you are
inflating or deflating the nominal GDP data.
Year
Nominal GDP,
Billions
Price index
(1996 = 100)
Real GDP,
Billions
1960
$527.4
22.19
$ ______
1968
911.5
26.29
$ ______
1978
2295.9
48.22
$ ______
1988
4742.5
80.22
$ ______
1998
8790.2
103.22
$ ______
Values for real GDP, top to bottom of the column: $2,376.7 (inflating); $3,467.1 (inflating);
$4,761.3 (inflating); $5,911.9 (inflating); $8,516 (deflating).
7-13
Which of the following are actually included in this year’s GDP? Explain your answer in each
case.
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Measuring Domestic Output and National Income
a. Interest on an AT&T bond.
b. Social security payments received by a retired factory worker.
c. The services of a family member in painting the family home.
d. The income of a dentist.
e. The money received by Smith when she sells her economics textbook to a book buyer.
f.
The monthly allowance a college student receives from home.
g. Rent received on a two-bedroom apartment.
h. The money received by Josh when he resells his current-year-model Honda automobile to
Kim.
i.
Interest received on corporate bonds.
j.
A 2-hour decrease in the length of the workweek.
k. The purchase of an AT&T corporate bond.
l.
A $2 billion increase in business inventories.
m. The purchase of 100 shares of GM common stock.
n. The purchase of an insurance policy.
(a) Included. Income received by the bondholder for the services derived by the corporation for
the loan of money.
(b) Excluded. A transfer payment from taxpayers for which no service is rendered (in this year).
(c) Excluded. Not a market transaction. If any payment is made, it will be within the family.
(d) Included. Payment for a final service. You cannot pass on a tooth extraction!
(e) Excluded. Secondhand sales are not counted; the textbook is counted only when sold for the
first time.
(f) Excluded. A private transfer payment; simply a transfer of income from one private
individual to another for which no transaction in the market occurs.
(g) Included. Payment for the final service of housing.
(h) Excluded. The production of the car had already been counted at the time of the initial sale.
(i) Included. The income received by the bondholders is paid by the corporations for the current
use of the “money capital” (the loan).
(j) Excluded. The effect of the decline will be counted, but the change in the workweek itself is
not the production of a final good or service or a payment for work done.
(k) Excluded. A noninvestment transaction; it is merely the transfer of ownership of financial
assets. (If AT&T uses the money from the sale of a new bond to carry out an investment in
real physical assets that will be counted.)
(l) Included. The increase in inventories could only occur as a result of increased production.
(m) Excluded. Merely the transfer of ownership of existing financial assets.
117
Measuring Domestic Output and National Income
(n) Included. Insurance is a final service. If bought by a household, it will be shown as
consumption; if bought by a business, as investment—as a cost added to its real investment
in physical capital.
7-14
(Last Word) What government agency compiles the U.S. NIPA tables? In what U.S. department
is it located? Of the several specific sources of information, name one source for each of the
four components of GDP: consumption, investment, government purchases, and net exports.
The Bureau of Economic Analysis (BEA) in the Department of Commerce compiles GDP
statistics.
The Census Bureau provides survey data for consumption, investment, and government
purchases. Consumption figures also come from industry trade sources as does some investment
data. The U.S. Office of Personnel Management also provides data on government spending on
services.
Net export figures come from the U.S. Customs Service and BEA surveys on service exports and
imports.
118