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Tony Stec 02/19/2012 ECO 1002 Chapter 7 Notes National Income Accounting- Measures the economys overall performance

e in the same way (theoretically) that a business handles accounting practices. This practice allows the Bureau of Economic Analysis to compile the National Income and Product Accounts (NIPA) for the U.S economy. This allows for: o Assess the health of the economy by comparing levels of production at regular intervals. o Track the long-run course of the economy to see whether it has grown, been constant, or declined. o Formulate policies that will safeguard and improve the economys health. The primary measure of an economys performance is aggregate output. Gross Domestic Product- Defines aggregate output as dollar value of all final goods and services produced within the borders of a country during a specific time period, usually a year. GDP is a monetary measure of aggregate output because it allows us to compare the outputs of one year to the outputs of another while taking into account changing prices. In order to ensure that all goods and services are only counted once for GDP, it is only the final, and not the intermediate sales of goods that are counted for GDP: o Intermediate Goods- Products that are purchased for resale or further processing or manufacturing. o Final Goods- Products that are purchased by their end users. Another way to ensure that multiple counting does not take place when computing GDP is to add up the value added at each intermediary step, which is the value of that steps output minus the inputs required for production (see Table 7.2 on page 131). There are two types of nonproduction transactions that, while including the final sales of goods and services, ought to not be counted in GDP. They include: o Financial Transactions; 1. Public Transfer Payments- social security, Medicare, Medicaid, welfare payments, etc. Because recipients contribute nothing to current production in return, counting this would overinflate GDP. 2. Private Transfer Payments- Gifts, money given from parents to children, etc. Again, these transactions produce no outputs. 3. Stock Market Transactions- The buying and selling of stocks is simple transfer of ownership. Payments provided to financial services, like stock brokering, are included, but the trading of stocks itself adds nothing to the final output of the country. o Secondhand Sales- reselling something at, for example, a garage sale, Goodwill, etc. These transactions add nothing new to the aggregate output for a country. There are two distinct ways of measuring GDP: The output, or expenditures approach, and the input, or income approach. o The Expenditures Approach- looks at the final value of all goods and services produced. 1. Personal Consumption Expenditures (C) - Covers all expenditures by households on goods and services. Durable Goods- products that have expected lives of three years or more (roughly 10% of PCEs)

Nondurable Goods- Products with less than three years of expected life (30% of PCEs). Services- The other 60% of PCEs, which is work done by other professionals. 2. Gross Private Domestic Investment (Ig)-All final purchases of machinery, equipment, and tools by business enterprises; all construction; and all changes in inventories. All construction represents capital because it can be rented out to produce further output. Capital is defined, loosely, as unconsumed outputs. 3. Noninvestment Transactions- These include the transfer of paper assets (bonds, stocks, etc.), the resale of tangible assets (homes, boats, etc.). Remember, investment in GDP is economic investment, meaning it must be creating new capital goods. 4. Gross Investment vs. Net Investment: Gross investment includes all investment in replacement and added capital. In contrast, Net Private Domestic Investment- includes only investment in the form of added capital. More specifically, this is seen as gross investment depreciation. Depending on the year, net private domestic investment can be either negative, zero, or positive, depending on how much depreciation occurs. Remember, while In (Net Investment) is helpful, it is Ig (Gross Investment) used in calculating GDP. 5. Government Purchases (G) - Government consumption expenditures and gross investment. This can be broken down into two further categories: Expenditures for goods and services that the government consumes in providing public services; and expenditures for publicly-owned capital, like schools and highways. 6. Net Exports (Xn) This section takes international trade into account. It is comprised by the exports minus the imports, taking into account that ownership of resources is not relevant because we are measuring what is produced within the U.S. The Income Approach: Looking at the nations wages, rent, profits, and interest in attempting to determine total output. There are many more variables that go into this calculation. 1. Compensation of employees- largest section of GDP through income method, defined as wages and salaries paid by businesses and government to their employees. 2. Rents- Income received by the households and businesses that provide property resources. This figure is calculated through the net rent approach, meaning it is net rent depreciation. 3. Interest- Money paid by private businesses to the suppliers of loans used to purchase capital. Also includes interest earned off savings deposits, CDs, and corporate bonds. 4. Proprietors Income- profit of a firm that flows to the owner. 5. Corporate Profits- These are broken down into three distinct categories: a) Corporate Income Taxes- Taxes levied on corporations profits, flowing to the government

b) Dividends- After-tax profits which some corporations choose to give out back to the investors. These flow to the households. c) Undistributed corporate profits- Any after-tax profits that arent distributed, but saved or retained for later. Also called retained earnings. 6. Taxes on production and imports- Include general sales, excise, business property, license fees, custom duties, and more forms of taxes. This is loosely considered as income to the government. 7. Comprising the previous 6 steps, it can be said that national income is the sum of private income and government income. After seeing that the income effect will produce a final GDP less than the expenditures approach. This means a couple adjustments must be made. 8. Net Foreign Factor Income- This differentiates between national income, (the income of all U.S. citizens supplying resources all across the globe) and domestic income (total income earned in the U.S. regardless of nationality of those who provided the resources). Therefore, we subtract all the income that Americans gain from supplying resources in other countries and add in the income earned in the U.S. by resources provided from different countries. This number is usually subtracted away from GDP because U.S. resources tend to earn more in other countries than foreign resources here. 9. Statistical Discrepancy- Taking into consideration the accounting error present in calculating GDP, this makes income method = expenditures method. 10. Consumption of Fixed Capital- The portion of GDP set aside to pay for the ultimate replacement of depreciated goods. Added into GDP There are various other ways of measuring a nations wealth with other statistics than GDP. Some include: o Net Domestic Product- Arises from the fact that GDP does not take into consideration how much of the fixed capital produced in previous years has depreciated. NDP is calculated by taking GDP minus consumption of fixed capital (depreciation) in order to show how much more new output has been produced from year to year. o National Income- The amount earned from U.S. citizens for their contributions of land, labor, capital, and entrepreneurial talent. We find this by taking NDP, subtracting the statistical discrepancy, and adding the Net foreign income factor. o Personal Income- All income received, whether earned or unearned. This is found by taking National Income, subtracting: Taxes on production and imports, social security contributions, corporate income taxes, undistributed corporate profits, and adding in transfer payments, like social security, Medicare, and Medicaid handouts. o Disposable Income- Personal Income less personal taxes. This is defined as the amount that consumers then have to split between consumption and savings. Remember that real GDP is adjusted for inflation and other price changes, where as nominal GDP is not. There are a few various terms to remember when computing real GDP: o Price Index- a way of accounting for inflation (or deflation) in macroeconomics. It is defined as the price in the base year over the price in the reference year, times 100. o Real GDP = Nominal GDP divided by price index (in hundredths).