- The value of the firm’s output minus the value of inputs
- Alternatively this method adds up the output of final goods and services.
- If $100 worth of goods and services has been produced (output method) this must have generated $100 worth of income (income method) for the various factors of production and will lead to $100 worth of spending (expenditure method).
- If people do not buy some, firms end up with stocks of unsold goods which are included in investment and assumes the firms ‘bought’ the goods for themselves.
- For this reason GDP = National Income = National Output.
- If spending by households is added up this will show the spending at market prices. But this does not truly reflect income earned by factors because of indirect (sales) taxes paid by firms to govt. and subsidies received by firms from govt. Therefore:
Market price - indirect taxes + subsidies = factor cost.
Adjustments to National Income Accounts
- Gross Domestic Product (GDP): the value of final goods and services produced by factors within the domestic economy. It must be adjusted to exclude:
- Goods made in previous years and sold this year
- Capital gains which are just a redistribution of benefits.
- Intermediate goods or semi-finished goods:
- Final goods already include the value of the intermediate good, and it would be double counting to include intermediate as well as final goods
- Circulating capital or inventories or stocks of raw materials, intermediate goods and final goods.
- Capital equipment, machinery and buildings, and residential housing
- Gross investment consists of:
- Net investment (new physical capital and stocks or inventories)
- Depreciation or capital consumption: repair and maintenance to existing stocks of capital or replacement of worn out capital.
- Net Domestic Product (NDP) = GDP - depreciation. Because depreciation is an estimate, most economists prefer to work with GDP.
- Gross National Product (GNP) includes the value of final goods and services produced by factors owned by domestic households all over the world:
GNP = GDP + Foreign investment income – investment income paid to foreigners
- For developing countries, GDP tends to exceed GNP: factor payments made to foreigners exceed factor payments received from foreigners
- For industrialized countries, GDP is smaller than GNP: factor payments received from foreign countries are larger than what is paid to foreigners.
- Personal Disposable Income is obtained by:
GNP = GDP at market prices + net property income from foreign economies
GNP at factor cost = GNP at market prices - indirect taxes + subsidies
Net National Product (NNP) = GNP at factor cost - depreciation
where: NNP is sometimes referred to as Net National Income (NNI)
Personal Income = NNP - retained earnings - business taxes + transfers
where: retained earnings = undistributed profits
Personal Disposable Income = Personal Income – personal income taxes.
Standard of Living
Comparisons over Time
- If national income rises is this an indication of a rise in the standard of living?
- Inflation: can cause GDP to rise even if there is no extra production.
- To eliminate this problem GDP is adjusted for inflation:
- Real GDP = Nominal or current GDP/Price deflator
- Does the price deflator take into account the increase in quality of goods and services and the fall in the prices of goods such as videos and computers?
- Population increases: cause GDP to rise but not necessarily per person:
- To adjust for this problem we divide by the population:
- Real Per Capita GDP = Real GDP/Population
- Per capita income still ignores the distribution of income: there could be a few rich people and large numbers of poor.
- Non-market sector: goods and services traded in a barter or parallel economy which are not reported as output or income. Should we include them?
- Future growth through capital goods: national income accounting does not distinguish between the production of consumption and capital goods:
- Producing consumption goods leads to more today but less tomorrow.
- Production of capital goods involves less consumption today but higher future growth and greater consumption in the future.
- Externalities: pollution and the cleanup of pollution or increased traffic congestion and the resulting increase in gas consumption can actually lead to a rise in GDP even though the quality of life may have been reduced.
- Quality of life: pollution regulations or more vacation time can lead to a fall in GDP but lead to an increase in the quality of life; how should we adjust?
- Govt. services: how do we value national defense or govt. medical services? We count them at cost which may be too high or too low an estimate.
Comparing Across Countries
- Purchasing power parity: rather than use a single currency to compare we convert to PPPs which measure the actual purchasing power of domestic income in terms of what it can buy within the country.
- Accounting systems are different amongst countries. Many LDCs cannot afford comprehensive systems and use a lot of guesswork or estimation to fill the gaps.
- Climate differences: some countries spend more on energy to heat or cool houses and offices.
- There may be considerable differences in the distribution of income, the size of the non-market sector, the balance between consumption and capital goods production and between production of consumer goods and weapons for war.