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National Income Accounting


Gross Domestic Product (GDP)

GDP is the international standard for measuring the economic output and growth of countries. It is the market value of all final goods and services produced within a country, usually measured in the span of a year, stated in terms of that year’s prices.

  1. Related to GDP is gross national product (GNP), which is a measure of the final output of the citizens and businesses of a country, regardless of where in the world the output is produced.

  2. GDP = GNP + net foreign factor income, where net foreign factor income is the income from foreign sources located domestically minus the income of domestic sources located internationally.

  3. GDP only measures final output, and each final good is multiplied by its price; when one firm sells products to another firm for use in production of yet another good, the first firm’s products are called intermediate products and do not count toward GDP; this prevents double-counting. Intermediate goods can be eliminated from the calculations either by only counting final goods or by counting the value added by each firm toward a final product.

  4. GDP measures market activity, not welfare or happiness. Also, it does not capture household work, illegal commerce, or improvements in the environment or quality of life.

  5. There are three ways to calculate GDP: via the expenditure approach, income approach, and production approach


Expenditure Approach: GDP = C + I + G + (X – M))

GDP can be calculated as the sum of four categories: consumption (C), investment (I), government expenditures (G), and net exports (exports – imports, or X – M).

  1. Households can spend their income on domestic goods, or they can save it, pay taxes, or buy foreign goods.

    1. Consumption: Households buy the goods produced by the businesses; this is the biggest category of GDP. It is about 70% of GDP in the US.

    2. Investment: Households can save a portion of their income, which goes into financial markets; businesses can borrow this money and invest it in equipment, factories, or inventories; this is gross investment.

    3. Government expenditures: This category consists of government payments for goods and services.

    4. Net exports: Goods exported to other nations (exports) are a part of the country’s output, but the spending on foreign goods imported to the country (imports) does not add to domestic production. Net exports are equal to exports minus imports.

  2. Net Domestic Product (NDP) = GDP – depreciation; where depreciation accounts for the gradual wearing out of factories and equipment


Income Approach

GDP can also be calculated through three different income approaches: aggregate, national, and personal.

  1. Aggregate income: The most common income approach and is the total income measured by adding all labor income (wages, salaries, and benefits), capital income (interest, profits, and rent), depreciation, indirect business taxes, and net income of foreigners.

  2. National income: The total income earned by citizens and businesses within a country during one year. It is the sum of labor income and capital income and excludes indirect business taxes, depreciation, and the net income of foreigners.

  3. Personal income: The total income paid directly to individuals. It includes capital income, labor income, and transfer payments.


Production Approach

The production approach is the total production of all firms or industries in the economy. In order to avoid double-counting (mentioned above), only the value added by each manufacturer is counted. The total value added will be equal to the final price.


Real GDP and Nominal GDP

  1. Nominal GDP: GDP calculated at existing prices.

  2. Real GDP: Nominal GDP adjusted for inflation, and it measures what is really produced; real GDP = nominal GDP / GDP deflator.