Explain why aggregate income equals aggregate output

Chapter 6 national income accounting
This chapter introduces national-income accounting. The data generated by national-income accounting is used to track the economy’s performance. This chapter provides a framework on which future chapters will build. The three questions that are to be kept in mind while reviewing the chapter are:

1. How much income is being produced? What is it being used for?
2. How much income is being generated in the marketplace?
3. What will happen to prices and wages?
LEARNING OBJECTIVES: After reading the chapter you should be able to:

1. Identify what GDP measures – and what it doesn’t
2. Explain why aggregate income equals aggregate output
3. Distinguish the major sub measures of output and income

GNP refers to output produced by American-owned factors regardless of location.
GDP refers to output produced within America’s borders.
GDP is geographically focused, including all output produced within a nation’s borders regardless of whose factors of production are used to produce it.

GDP measures production in dollar terms.
Nominal GDP – The value of final output produced in a given period, measured in the prices of that period (current prices).
Real GDP – The value of final output produced in a given period, adjusted for changing prices.

Gross private domestic Investment- depreciation=net private domestic investment
Corporate profits= retained earnings + corporate taxes + dividend
Investment = Expenditures on (production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories.

Wesley Clair Mitchell (1874-1948) furthered the development of index numbers as part of a broader effort to gather statistical data and improve economists’ ability to assess economic well-being. Mitchell believed that improving the available data was necessary if economic science was to advance in a meaningful way. As Mitchell expressed it, “Economics will develop more fruitfully in the future upon the quantitative side. The economists of today stand the best chances of improving upon the work of their predecessors if they rely more and more upon the most accurate statistical recording of observations.”(1)
Born in Russville, Illinois, the son of Civil War Army doctor turned farmer, Mitchell earned his Ph.D. at the University of Chicago in 1899. While Mitchell had a distinguished career as a teacher and researcher at the University of Chicago, University of California, Columbia University, and The New School of Social Research, Mitchell’s greatest contribution came when he founded the National Bureau of Economic Research (NBER) in 1920, where he served as the Director of Research from 1925 to 1945. The bureau still operates today, providing valuable data and studies for economists and policymakers.
Nominal GDP – The value of final output produced in a given period, measured in the prices of that period (current prices). (Current output at current prices.)
Real GDP – The value of final output produced in a given period, adjusted for changing prices. (Current output*base year prices.)
Watch YouTube video on calculating GDP ( http://www.youtube.com/watch?v=yUiU_xRPwMc)
Watch YouTube video (http://www.youtube.com/watch?v=QiNZdGAZzeAon) on the difference between GDP and GNP.
national income accounting:


Calculating real and nominal GDP: http://www.khanacademy.org/science/macroeconomics/gdp-topic/real-nominal-gdp-tutorial/v/real-gdp-and-nominal-gdp VERY IMPORTANT!!!!!
A. Three Ways to Compute GDP
Economists use three approaches to compute GDP—the expenditure approach, the income approach, and the value-added approach.
B. What GDP Omits
Some exchanges that take place in an economy are not included in GDP. These include some nonmarket goods and services, legal and illegal underground activities, sales of used goods, financial transactions, government transfer payments, and leisure.
C. GDP is Not Adjusted for Bads Generated in the Production of Goods
Some economists argue that GDP overstates our overall economic welfare, since it does not net out bads.
D. Per Capita GDP
Per capita GDP is found by dividing a country’s GDP by its population.
E. Is Either GDP or Per Capita GDP a Measure of Happiness or Well-Being?
GDP figures are useful for obtaining an estimate of the productive capabilities of an economy, but they do not necessarily measure happiness or well-being.
SOLVED PROBLEM. Nominal and Real GDP. In this exercise, you calculate nominal and real GDP for a simple economy. You then calculate real GDP using a base year

Suppose than an economy consists of only two types of products: computers and cars.
Sales and price data for these two products for two different years are as shown below:
year No. of
Computers Sold Price per
Computer No. of
cars Price per
2001 5000 $6,000 1000 $12,000
2012 10000 $2,000 5000 $20,000
Nominal GDP in any year is calculated by multiplying the quantity of each final product sold by its price and summing over all final goods and services. Assuming that all computers and automobiles are final goods, nominal GDP in 2001 is= 5000*$6,000+1,000*$12,000 = 30,000,000+12,000,000= 42,000,000
nominal GDP in 2012 is= 10000*$2,000+5,000*$20,000 = 20,000,000+ 100,000,000= 120,000,000
If 2012 is the base year
REAL GDP in 2001 is: 5000*$2,000+1,000*$20,000=10,000,000 +20,000,000 = 30,000,000
Real GDP in 2012 is= 10000*$2,000+5,000*$20,000 = 20,000,000+ 100,000,000= 120,000,000

In words: the value of cars and computers sold (nominal GDP/current GDP) at 2001 prices in 2000 was $42 million and in 2012 at 2012 prices was $120 million. The increase was caused by more of both items sold, while the price of cars increased, the price of computers decreased.
To make the data for the two years comparable, real GDP is calculated. The real GDP in 2001 was $30 million, that is, had the products been sold at 2012 prices this is the revenue that would have been earned. Thus we know that between 2001 and 2012 production increased from $30 million to $120 million showing the increased quantity of both goods sold.


1. A professional gambler moves from a state where gambling is illegal to a state where gambling is legal. Explain in an email what this does to the GDP.

3. a. Calculate and email the national income accounts based on the table below. Follow the example after section 6.2 from the textbook! You must calculate all six accounts: GDP, GNP NNP, NI, PI and DI.
b. Also calculate personal saving and net exports.
Show work!
Expenditures for consumer goods and services 600
Exports 120
Government purchases 500
Social security taxes 16
Gross Private Domestic Investment 300
Indirect business taxes 49
Corporate income taxes on profits 10
Personal income taxes 23
Corporate retained earnings 50
Receipts of factor income from the rest of the world 22
Payments of factor income to the rest of the world 20
Transfer payments 38
Imports 140
Depreciation 42
Statistical discrepancy 14

Hint: net factor income from abroad= receipts of factor income from abroad-factor payments to the rest of the word

4. Which of the following are included in GDP, and which are not?
a. The cost of hospital stays.
b. The rise in life expectancy over time.
c. Child care provided by a licensed day care center.
d. Child care provided by the child’s grandmother because she loves the child.
e. The sale of a used car.
f. The sale of a new car.
g. The greater variety of cheese available in supermarkets.
h. The iron that goes into the steel that goes into a refrigerator bought by a consumer.
i. The social security check received by a grandmother.
j. A check received by a student from her parents on her 19th birthday as a gift.

5. Complete Matching Ch 6-7. It is in the matching folder.
6. You are walking in Manhattan with your 8 year-old nephew, and carelessly you toss an ice cream wrapper in the street. Your nephew questions your action, as he has been told by his mother that this is not nice. As a future economist you will tell your nephew, that you are helping the economy by throwing trash on the street rather than in trash cans because the extra expenditures necessary to clean up the streets will increase GDP. Are you right or wrong? Explain.
7. The following article was published in the Wall Street Journal on March 27, 2015.
Economic Growth, Corporate Profits Slowed as 2014 Ended; Third estimate of fourth-quarter GDP shows an economy on a lower trajectory
Davidson, Kate
WASHINGTON–Profits at U.S. corporations in late 2014 posted their largest drop in four years, a reflection of an economy weighed down by a strong dollar and weak global demand.

The Commerce Department’s third estimate of fourth-quarter gross domestic product also showed that the economy slowed in the final months of 2014, putting the growth trajectory on a lower path ahead of an apparent slowdown early this year.

GDP, the broadest measure of goods and services produced across the economy, expanded at a seasonally adjusted annual rate of 2.2% in the fourth quarter, the Commerce Department said. That was unchanged from its previous estimate last month. Economists surveyed by The Wall Street Journal had expected an upward revision to 2.4% growth.

Corporate profits after tax–without accounting for the value of inventory and depreciation of buildings and equipment–fell at a 3% pace from the third quarter. That was the largest quarterly drop in profits since the first quarter of 2011.
On a year-over-year basis, the report pegged corporate profit growth at 2.9%, slowing from 5.1% annual growth in the third quarter. As a share of the total economy, corporate profits were just a hair below the record high of 10.5% set in 2013.

Despite the fourth-quarter dip, “U.S. corporations continued to drive a healthy bottom-line,” Andrew Wilkinson, an analyst for Interactive Brokers, said in a note to clients. “The dip does, however, suggest some impact on net income from a stronger dollar.”
The overall picture last quarter was reflective of a divergence between consumers and businesses. Consumers spent at the fastest pace since 2006, but business investment has been decelerating for the past several months and government outlays have fallen.
Many economists expect the current quarter to remain sluggish. Several forecasters trimmed their first-quarter GDP estimates earlier this week following a disappointing report on business spending and investment.
Forecasting firm Macroeconomic Advisers lowered its forecast a tenth of a percentage point on Friday, pointing to signs of weaker momentum for consumer spending following the fourth-quarter GDP revisions.

The Commerce Department will release its first estimate of GDP in the first quarter, which ends next week, on April 29.
Despite the uneven growth, the U.S. economy has been advancing at a fast enough pace to add jobs at a strong clip and bring some sidelined workers back into the job market.

But a strengthening U.S. dollar and weak global demand are weighing down the nation’s exports and inflation, while crimping profits for U.S. companies that do business abroad.
Foreign trade was a net drag on growth last quarter, despite an increase in exports. Exports grew at a 4.5% rate in the fourth quarter, up from an earlier estimate of 3.2% growth and matching the third-quarter’s pace, primarily due to more spending on travel and other services as the dollar strength has made overseas visits favorable. Imports rose sharply.
Total exports as a share of GDP have grown steadily over the past several decades, and export stagnation could undermine growth.

Federal Reserve officials are paying increased attention to the strong-dollar effects as they weigh when to begin raising interest rates. Fed Chairwoman Janet Yellen said this month that the strong dollar is probably one reason for weak export growth , but it also reflects the strength of the U.S. economy.
“We do see considerable underlying strength in the U.S. economy and in spite of what looks like a weaker first quarter, we are projecting good performance for the economy,” Ms. Yellen said at a news conference following the Fed’s latest policy meeting.
In the fourth quarter, Friday’s report showed, consumer spending climbed at a seasonally adjusted annual rate of 4.4%, up from an earlier estimate of 4.2%.

But a downward revision to private inventories largely offset the upward revisions to exports and consumer spending.
Business investment–which reflects spending on software, research and development, equipment and structures–grew at a 4.7% rate, slightly lower than last month’s estimate of 4.8% and down from the third quarter’s 8.9% pace.

Government spending contracted at a 1.9% pace, reflecting a sharp drop in federal defense outlays.
The housing market expanded at a modest pace. Residential investment grew at a 3.8% pace in the fourth quarter, up from 3.2% in the third quarter.
Measurements of underlying demand in the economy also showed signs of weakness last quarter. Real final sales of domestic product, a measure that excludes changes to inventories, grew at a 2.3% pace, down from the third quarter’s 5.0% rate.
Despite slower growth in the fourth quarter, growth in the second half of 2014 was still “very solid” and should pick up again in the second half of 2015, PNC economists Stuart Hoffman and Gus Faucher said in a note to clients.
“Solid consumer fundamentals, an improving housing market, expanding business investment, the boost from lower energy prices, and reduced emphasis on government deficit reduction will all support growth this year,” Messrs. Hoffman and Faucher said.
In an email explain which components of GDP dragged down economic growth in the fourth quarter? Which components of GDP grew at a robust pace? Include numbers to support your answers.

8. In 1980, Austria had a GDP of $70 billion (measured in U.S. dollars) and a population of 8.1 million. In 2000, Austria had a GDP of $160 billion (measured in U.S. dollars) and a population of 8.4 million. By what percentage did Austria’s GDP per capita rise between 1980 and 2000? Email. (Hint look at formulas listed before previous chapter.)

9. Post your comment as to what will happen to nominal and real GDP in the following case: “Suppose a new computer is invented that costs one-quarter of existing computers and performs as well. Now when GDP is calculated production of the same number of computers creates only one-quarter as much dollar output.”

10. Do you, or anyone you know, participate in the “underground economy?” Who benefits, and who bears the costs of these underground activities? Post.

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