CHAPTER 27

Measuring Domestic Output and National Income

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 Chapter Contents
Assessing the Economy’s Performance
The Expenditures Approach
The Income Approach
Other National Accounts
Nominal GDP versus Real GDP
Shortcomings of GDP

27-2

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 Assessing the Economy’s Performance
National income accounting measures economy’s
overall performance.
Bureau of Economic Analysis compiles National
Income and Product Accounts:
• Assess health of economy
• Track long-run course
• Formulate policy
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LO27.1
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 Gross Domestic Product
Measure of aggregate output.
Avoid multiple counting
• Market value final goods
• Ignore intermediate goods
• Count value added
Domestic output only

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LO27.1
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 Comparing Heterogeneous Output by Using
Money Prices 

Year Annual Output Market Value

1 3 sofas and 2 computers 3 at $500 + 2 at $2,000 = $5,500
2 2 sofas and 3 computers 2 at $500 + 3 at $2,000 = $7,000

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LO27.1
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 Value Added in a Five-Stage Production Process
(2)
Sales Value
(1) of Materials (3)
Stage of Production or Product Value Added
$ 0
$120 (= $120 − $ 0)
Firm A, sheep ranch 120
60 (= 180 − 120)
Firm B, wool processor 180
40 (= 220 − 180)
Firm C, coat manufacturer 220
50 (= 270 − 220)
Firm D, clothing wholesaler 270
Firm E, retail clothier 350 80 (= 350 − 270)

Total sales values $1,140

Value added (total income) $350

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LO27.1
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 Gross Domestic Product: Transactions
Exclude financial transactions:
• Public transfer payments
• Private transfer payments
• Stock market transactions
Exclude secondhand sales: Example: sell used car to a
friend.
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LO27.1
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 Two Approaches to GDP
Income approach
• Count income derived from production
• Wages, rental income, interest income, profit
Expenditure approach
• Count sum of money spent buying the final goods
• Who buys the goods?

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LO27.1
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 The Expenditures and Income Approaches to GDP
Compared 

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 Accounting Statement for the U.S. Economy Using the
Expenditures (Receipts) Approach, 2018

Billions
Sum of:
Personal consumption expenditures (C) $14,051
Gross private domestic investment (ig) 3,711
Government purchases (G) 3,550
Net exports (Xn) –654
Equals:
Gross domestic product $20,658

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LO27.1
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 Accounting Statement for the U.S. Economy, Using
the Income (Allocations) Approach, 2018
Billions
Sum of:
Compensation of employees $10,908
Rents 767
Interest 563
Proprietors’ income 1,580
Corporate profits 2,321
Taxes on production and imports 1,535
Equals:
National income $17,674
Less: Net foreign factor income 255
Plus: Consumption of fixed capital 3,298
Plus: Statistical discrepancy –59
Equals:
Gross domestic product $20,658
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LO27.1
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 Personal Consumption Expenditures
Personal consumption expenditures (C)
• Durable goods
• Nondurable goods
• Consumer expenditures for services
• Domestic plus foreign goods produced

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LO27.2
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 Expenditures Approach
Gross private domestic investment (Ig)
• Plant, machinery, and equipment.
• Residential construction.
• Research and development.
• Creation of new works of art, music, etc.
• Changes in inventories.
Creation of new capital assets.
Noninvestment transactions excluded. 27-13
LO27.2
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 Expenditures Approach: Investment
Gross investment, depreciation, net investment, and the stock of capital 

27-14
LO27.2
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 Expenditures Approach Concluded
Government purchases (G)
• Expenditures for goods and services
• Expenditures for publicly owned capital
• Excludes transfer payments
Net exports (Xn)
• Add exported goods
• Subtract imported goods
• Xn= exports (X) - imports (M)
GDP = C + Ig + G + Xn
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LO27.2
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 Global Perspective 27.1
COMPARATIVE GDPs IN TRILLIONS OF U.S. DOLLARS, SELECTED NATIONS, 2017 

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LO27.2
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 The Income Approach (1 of 2)
Compensation of employees
Rents
Interest
Proprietor’s income
Corporate profits
• Corporate income taxes
• Dividends
• Undistributed corporate profits
Taxes on production and imports 27-17
LO27.3
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 The Income Approach (2 of 2)
From national income to GDP:
• Subtract net foreign factor income
• Statistical discrepancy
• Consumption of fixed capital

27-18
LO27.3
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 Other National Accounts
• Net domestic product (NDP)
• National income (NI)
• Personal income (PI)
• Disposable income (DI)

27-19
LO27.4
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 U.S. Income Relationships, 2018
Billions
Gross domestic product (GDP) $20,658
Less: Consumption of fixed capital 3,298
Equals: Net domestic product $17,360

Net domestic product (NDP) $17,360

Less: Statistical discrepancy −59
Plus: Net foreign factor income 255
Equals: National income (NI) $17,674

National income (NI) $17,674

Less: Taxes on production and imports 1,375
Less: Corporate income taxes 244
Less: Social Security contributions 1,367
Less: Undistributed corporate profits 825
Plus: Transfer payments 3,720
Equals: Personal income (PI) $17,581*

Personal income (PI) $17,581

Less: Personal taxes 2,050
Equals: Disposable income (DI) $15,531

*Some of the items combine categories that appear in the more detailed accounts. 27-20
LO27.4
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 U.S. Domestic Output and the Flows of Expenditure
and Income

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LO27.4
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 Nominal GDP vs. Real GDP
GDP is a dollar measure of production.
Using dollar values creates problems.
Nominal GDP: Based on prices that prevailed when
output was produced.
Real GDP:
• Reflects changes in the price level.
• Uses base year price.
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LO27.5
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 GDP Price Index
Use price index to determine real GDP.

Price Price of market basket

in specific year
index
in given
= Price of same basket × 100
year in base year

Real Nominal GDP

GDP =
Price index (in hundredths)

27-23
LO27.5
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 Calculating Real GDP (Base Year = Year 1)
(4)
(2) Unadjusted, (5)
(1) Price of (3) or Nominal, Adjusted,
Units of Pizza Price Index GDP or Real,
Year Output per Unit (Year 1 = 100) (1) × (2) GDP
1 5 $10 100 $ 50 $50
2 7 20 200 140 70
3 8 25 250 200 80
4 10 30 --- --- ---
5 11 28 --- --- ---

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LO27.5
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 Steps for Deriving Real GDP from Nominal GDP
Method 1
1. Find nominal GDP for each year.
2. Compute a GDP price index.
3. Divide each year’s nominal GDP by that year’s price index (in hundredths) to
determine real GDP.
Method 2
1. Break down nominal GDP into physical quantities of output and prices for each year.
2. Find real GDP for each year by determining the dollar amount that each year’s
physical output would have sold for if base-year prices had prevailed. (The GDP price
index can then be found by dividing nominal GDP by real GDP.)

LO27.5 27-25

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 Real World Considerations
Nominal GDP, Real GDP, and GDP Price Index for the United States, Selected Years

(1) Year (2) Nominal GDP, (3) Real GDP, (4) GDP Price Index
Billions Billions (2009 = 100)
1995 $ 7,664.0 $10,167.3 –––––
2000 10,289.7 ––––– 81.9
2005 13,095.4 14,235.6 92.0
2009 14,417.9 ––––– 100.0
2010 14,958.3 14,779.4 101.2
2015 17,947.0 16,348.9 109.8

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LO27.5 Source: U.S. Bureau of Economic Analysis.

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 Shortcomings of GDP
Nonmarket activities
Leisure and psychic income
Improved product quality
The underground economy
GDP and the environment
Composition and distribution of output
Noneconomic sources of well-being 27-27
LO27.6
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 Global Perspective 27.2
THE UNDERGROUND ECONOMY AS A PERCENTAGE OF GDP,
SELECTED NATIONS, 2015 

27-28

Source: Medina, Leandro, and Friedrich Schneider. Shadow

LO27.6 Economies Around the World: What Did We Learn Over the Last
©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. 20 Years? International Monetary Fund (IMF). 2018.
 Gross Output
Sum of:
• Resource extraction
• Production
• Distribution
• Final output (GDP)
Larger than GDP.
Better reflection of productive side of economy. 27-29
LO27.6
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 Last Word: Measuring Quality to Price the
Priceless
GDP more difficult to measure in digital age.
How do you:
• Account for quality improvements?
• Internet products that are free of charge?
Hedonic adjustment.
Dollar value on time. 27-30

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