Chapter 2 2

Chapter 2.2: MEASURING OUTPUT USING GDP 1 Measuring output using GDP approach; income and adjusting for depreciation, taxes and subsidies.. 5 The expenditures approach • G: Government ex

Chapter 2.2: MEASURING OUTPUT

USING GDP

1

Measuring output using GDP

approach;

income and adjusting for depreciation, taxes and subsidies.

• GDP can be determined in two ways, both of which,

in principle, give the same result.

2

The expenditures approach

GDP = C + I + G + X – M

• C: Consumption S: Saving

S = Yd – C Yd:Disposable Income The amount of money that an individual or household has to spend or save after income taxes have been deducted

• I: Investment

• De: Depreciation

• Net Investment = Gross Investment – Depreciation

I = In + De ó In = I – De

• Economic Investment includes:

• 1) all final purchases of machinery, equipment, and tools by businesses

2) all construction (including homes)

3) changes in inventories (To include items produced one year but sold the

next If businesses are able to sell more than they currently produce, this

entry will be a negative number )

5

The expenditures approach

• G: Government expenditure: Government spending on

goods and servives (G) and Transfer Payments (Tr) Government spending (G) is the sum of government expenditures on final goods and services It includes salaries

of public servants, purchase of weapons for the military, and any investment expenditure by a government (Cg, Ig)

It does not include any transfer payments, such as social

security or unemployment benefits.

• NX: net export: NX = X - M

6

• In an economy: households receive wages

• Then they use to purchase final goods and services.

• Since wages eventually are used in consumption (C), the expenditure approach to calculating GDP focuses on the end consumption expenditure to avoid double counting.

• The income approach, alternatively, would focus on the income made by households as one of its components to derive GDP.

The income approach

•GDP = De + W + R + i + Pr + Ti

•W: Wages (Labor Income )

•R: Rent

•i: Interest

•Pr: Profit

•Tax including: Ti (Indirect Taxes: VAT, sales tax, custom duties, excise tax) and Td (Direct Taxes: Income tax, corporation tax, property tax,

inheritance tax, gift tax)

Tx = Ti + Td

• Personal Income Taxes?

• Indirect Business Taxes?

9

•2 Retained earnings

•3 Dividents

10

•Income tax

•Corporation tax

•Property tax

•Inheritance tax

•Gift tax

•Sales

•Value-added tax

•EXCISE TAX

The output approach (net product/value

added approach)

• GDP = AVA + IVA + SVA

• Value added from each of the main economic sectors:

Agriculture, Industry, Services

GDPfc = GDPmp - Ti

• NDP (Net Domestic Product) = GDP - De

• NNP (Net National Product) = GNP – De

• NI (National Income) = NNPmp – Ti.

• PI (Personal Income) = NI - Pr*+Tr

13

• PI (Personal Income) = NI - Pr*+Tr

(Pr*: the profit retained (Retained earnings) and paid to the government

Retained earnings are used to set up funds such as production development fund, welfare and reward fund, reserve fund,

Profits paid to the government include corporate income tax and other required deductions

Corporate profits (which equals the sum of corporate taxes, dividends, and retained earnings)

DI (Disposable Income):

DI = PI - personal income tax 14

•Personal Income = National Income

− Indirect Business Taxes

− Corporate Profits

− Social Insurance Contributions

− Net Interest

+ Dividends

+ Government Transfers to Individuals + Personal Interest Income

•Next, if we subtract personal tax payments and certain nontax

payments to the government (such as parking tickets), we obtain

disposable personal income:

•Disposable Personal Income

= Personal Income − Personal Tax and Nontax Payments

GNP = GDP + NIA

• NIA: Net income from Abroad

GDP and Economic Well-Being

•GDP per capita is often used to measure a country's well being or

standard of living

•The higher the GDP per capita for a country the better off the country

is

•But there are some problems with using GDP per capita to measure a

country's standard of living

17

Problems with using GDP to Measure the Standard of Living:

1 non-market transactions are not included in GDP: GDP does not measure total output or total utility

GDP doesn’t measure some very useful output because it is unpaid (homemakers’ services, parental child care, volunteer efforts, home

improvement projects) Called non-market transactions

2 leisure increases the standard of living but it isn't counted

GDP doesn’t measure improved living conditions as a result of more leisure.

3 the underground economy produces goods and services but they are not included in GDP

•GDP does not include output from the Underground Economy Illegal activities

are not counted in GDP (estimated to be around 8% of U.S GDP)

•Legal economic activity may also be part of the “underground,” usually in an effort to avoid taxation

18

Conclusion

•Even though GDP does not measure all output, it still allows

economists to assess the state of the economy, providing a

solid foundation to predict its future course and to measure

the results of public policies