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1 SUMMARY Chapter Summary Podcast Summary PowerPoint National income accounting measures annual output and income flows. The national income accounts provide a basis for assessing our economic performance, designing public policy, and understanding how all the parts of the economy interact. LO5-1 The most comprehensive measure of output is gross domestic product (GDP), the total market value of all final goods and services produced within a nation's borders during a given period. LO5-1 In calculating GDP, we include only the value added at each stage of production. This procedure eliminates the double counting that results when business firms buy intermediate goods from other firms and include those costs in their selling price. LO5-1 To distinguish physical changes in output from monetary changes in its value, we compute both nominal and real GDP. Nominal GDP is the value of output expressed in current prices. Real GDP is the value of output expressed in constant prices (the prices of some base year). Each year some of our capital equipment is worn out in the process of production. Hence GDP is larger than the amount of goods and services we could consume without reducing our production possibilities. The amount of capital used up each year is referred to as depreciation. LO5-4 By subtracting depreciation from GDP we derive net domestic product (NDP). The difference between NDP and GDP is also equal to the difference between gross investment the sum of all our current plant and equipment expenditures and net investment the amount of investment over and above that required to replace worn-out capital. LO5-4 All the income generated in market sales (GDP) is received by someone. Therefore, the value of aggregate output must equal the value of aggregate income. LO5-3 Page 110 The sequence of flows involved in this process is GDP less depreciation equals NDP plus net foreign factor income equals national income (NI) less indirect business taxes, corporate profits, interest payments, and Social Security taxes plus transfer payments and capital income

2 LO5-3 Key Terms equals personal income (PI) less personal income taxes equals disposable income (DI) The incomes received by households, business firms, and governments provide the purchasing power required to buy the nation's output. As that purchasing power is spent, further GDP is created and the circular flow continues. LO5-3 national income accounting gross domestic product (GDP) GDP per capita intermediate goods value added nominal GDP real GDP base year inflation production possibilities depreciation net domestic product (NDP) investment gross investment net investment exports imports net exports national income (NI) personal income (PI) disposable income (DI) saving Questions for Discussion 1. The manuscript for this book was typed for free by a friend. Had I hired a secretary to do the same job, GDP would have been higher, even though the amount of output would have been identical. Why is this? Does this make sense? LO GDP in 1981 was $2.96 trillion. It grew to $3.07 trillion in 1982, yet the quantity of output actually decreased. How is this possible? 3. If gross investment is not large enough to replace the capital that depreciates in a particular year, is net investment greater or less than zero? What happens to our production possibilities? LO Can we increase consumption in a given year without cutting back on either investment or government services? Under what conditions? LO Why is it important to know how much output is being produced? Who uses such information? LO What jobs are likely part of the underground economy? LO Clear-cutting a forest adds to GDP the value of the timber, but it also destroys the forest. How should we value that loss? LO Is the Index of Social Health, discussed in the News on page 109, a better barometer of well-being than GDP? What are its relative advantages or disadvantages? LO Over 4 million websites sell a combined $100 billion of pornography a year. Should these sales be included in (a) GDP and (b) an index of social welfare? LO Are you better off today than a year ago? How do you measure the change? LO The value of total expenditure must equal the value of total income. Why? LO5-3

3 web activities to accompany this chapter can be found on the Online Learning Center: Page 111 mobile app Visit your mobile app store and download the Schiller: Study Econ app today! PROBLEMS FOR CHAPTER 5 LO Suppose that furniture production encompasses the following stages: Stage 1: Trees are sold to lumber company. $ 8,000 Stage 2: Lumber is sold to furniture company. $17,000 Stage 3: Furniture company sells furniture to retail store.$28,000 Stage 4: Furniture store sells furniture to consumer. $56, What is the value added at each stage? Stage 1: Stage 2: Stage 3: Stage 4: 2. How much does this output contribute to GDP? 3. How would answer (b) change if the lumber were imported from Canada? 2. If real GDP increases by 2 percent next year and the price level goes up by 4 percent, what will happen to nominal GDP? 3. What was real per capita GDP in 1933 measured in 2008 prices? (Use the data in Table 5.4 to compute your answer.) LO Based on the following figures, Consumption $200 billion Depreciation 20

4 Retained earnings 12 Gross investment 30 Imports 40 Exports 50 Net foreign factor income 10 Government purchases How much is GDP? 2. How much is net investment? 3. How much is national income? 4. If all prices were to double overnight, what would be the LO Change in real GDP? 2. Change in nominal GDP? 5. What share of U.S. total income in 2010 consisted of 1. Wages and salaries? 2. Corporate profits? (Note: See Table 5.5 for data.) Compute real GDP for 2010 using average prices of 2000 as the base year. (On the inside covers of this book you'll find data for GDP and the GDP price deflator used to measure inflation.) 2. By how much did real GDP increase between 2000 and 2010? 3. By how much did nominal GDP increase between 2000 and 2010? 7. Suppose all the dollar values in Problem 4 were in 2000 dollars. Use the Consumer Price Index shown on the end cover of this book to convert Problem 4's GDP to 2010 dollars. What is the value of that GDP in 2010 dollars? (You'll be converting the figures from their nominal to their real values, with 2010 as the base year; use the following formula: CPI 2 /CPI 1 = GDP 2 /GDP 1.) 8. According to the data in Table 5.3, what is 1. Real GDP in 2008, at prices of 2007? 2. Real GDP in 2007, at prices of 2008?

5 Page On the accompanying graph, illustrate (A) nominal per capita GDP and (B) real per capita GDP for each year. (The necessary data appear on the endpapers of this book.) 1. By what percentage did nominal per capita GDP increase in the 1990s? 2. By what percentage did real per capita GDP increase in the 1990s? 3. In how many years did nominal per capita GDP decline? 4. In how many years did real per capita GDP decline? LO According to the News on page 109, do per capita GDP data (A) overstate or (B) understate the rise in U.S. well-being since 1990? (Enter A or B.) LO Using the following data, what is the value of 1. total output (GDP)? 2. total income? Consumer goods and services $10,000 Wages and salaries 9,000 Corporate profits 1,000 Investment in plants, equipment, and inventory2,500

6 Proprietor's income 1,500 Taxes on output and imports 1,000 Depreciation 1,500 Exports 1,500 Government goods and services 3,000 Imports 2,500 Rents 500

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