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Measuring National Output and National Income
(Part A)
by
Charles Lamson
Macroeconomics relies on data, much of it collected by the government. To study the economy, we need data on total output, total income, total consumption, and the like. Much of the macroeconomic data are from the national income and product accounts, which describe the components of national income in the economy. These accounts are produced by the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce.
The national income and product accounts do more than convey data about the performance of the economy. They also provide a conceptual framework that macroeconomists use to think about how the pieces of the economy fit together. When economists think about the macroeconomy, the categories and vocabulary they use come from the national income and product accounts. The national income and product accounts can be compared with the mechanical or wiring diagrams for an automobile engine. The diagrams do not explain how an engine works, but they identify the key parts of an engine and show how they are connected. Trying to understand the macroeconomy without understanding national income accounting is like trying to fix an engine without a mechanical diagram and with no names for the engine parts. Gross Domestic Product The key concept in the national income and product accounts is gross domestic product (GDP). GDP is the total market value of a country's output. It is the market value of all final goods and services produced within a given period of time by factors of production located within a country.  GDP for 2020---the value of all output produced by factors of production in the United States in 2020---was $20.93 trillion (bea.gov). The centrality of GDP as a working concept cannot be overestimated. Just as an individual firm needs to evaluate the success or failure of its operations each year, so the economy as a whole needs to assess itself. GDP as a measure of the total production of an economy provides us with a country's economic report card. Because GDP is such an important concept, we need to take some time to explain exactly what its definition means. Final Goods and Services First note that the definition refers to final goods and services. Many goods produced in the economy are not classified as final goods, but instead as intermediate goods. Intermediate goods are produced by one firm for use in further processing by another firm. For example, tires sold to automobile manufacturers are intermediate goods. The value of intermediate goods is not counted in GDP. Why are intermediate goods not counted in GDP? Suppose that in producing a car General Motors (GM) pays $100 to Goodyear for tires. GM uses these tires (among other components) to assemble a car which sells for $12,000. The value of the car (including its tires) is $12,000, not $12,000 + $100. The final price of the car already reflects the value of its components. To count in GDP both the value of the tires sold to the automobile manufacturers and the value of the automobiles sold to the consumers would result in double counting.  Double-counting can also be avoided by counting only the value added to a product by each firm in its production process. The value added during some stage of production is the difference between the value of goods as they leave that stage of production and the cost of goods as they entered that stage. Value added is Illustrated in Table 1. The four stages of the production of a gallon of gasoline are (1) oil drilling, (2) refining, (3) shipping, and (4) retail sale. In the first stage, value added is the value of sales. In the second stage, the refiner purchases the oil of from the driller, refines it into gasoline, and sells it to the shipper. The refiner pays the driller $0.50 per gallon and charges the shipper $0.65. The value added by the refiner is thus $0.15 per gallon. The shipper then sells the gasoline to retailers for $0.80. The value added in the third stage of production is $0.15. Finally, the retailer sells the gasoline to consumers for $1. The value added at the fourth stage is $0.20, and the total value added in the production process is $1, the same as the value of sales at the retail level. Adding the total values of sales at each stage of production ($0.50 + $0.65 + $0.80 + $1 = $2.95) would significantly overestimate the value of the gallon of gasoline. TABLE 1  In calculating GDP we can either sum up the value added at each stage of production or we can take the value of final sales. We do not use the value of total sales in an economy to measure how much output has been produced. Exclusion of Used Goods and Paper Transactions GDP is concerned only with new, or current, production. Old output is not counted in current GDP because it was already counted back at the time it was produced. It would be a double counting to count sales of used goods in current GDP. If someone sells a used car to you the transaction is not counted in GDP, because no new production has taken place. Similarly, a house is counted in GDP only at the time it is built, not each time it is resold. in short:   Sales of stocks and bonds are not counted in GDP. These exchanges are transfers of ownership of assets, either electronically or through paper exchanges, and do not correspond to current production. However, what if I sell the stock or bond for more than I originally paid for it? Profits from the stock or bond market have nothing to do with current production, so they are not counted in GDP. However, if I pay a fee to a broker for selling a stock of mine to someone else, this fee is counted in GDP, because the broker is performing a service for me. This service is part of current production. Be careful to distinguish between exchanges of stocks and bonds for money (or for other stocks and bonds), which do not involve current production, and fees for performing such exchanges, which do. Exclusion of Output Produced abroad by Domestically Owned Factors of Production GDP is the value of output produced by factors of production located within a country. The three basic factors of production are land, labor, and capital. The labor of U.S. citizens counts as a domestically owned factor of production for the United States. The output produced by U.S. citizens abroad---for example, U.S. citizens working for a foreign company---is not counted in U.S. GDP because the output is not produced within the United States. Likewise, profits earned abroad by U.S. companies are not counted in U.S. GDP. However, the output produced by foreigners working in the United States is counted in U.S. GDP because the output is produced within the United States. Also, profits earned in the United States by foreign-owned companies are counted in U.S. GDP. It is sometimes useful to have a measure of the output produced by factors of production owned by a country's citizens regardless of where the output is produced. This measure is called gross national product (GNP). In 2020, GNP for the United States was $5,426.157 billion dollars.  The distinction between GDP and GNP can be tricky. Consider the Honda plant in Marysville, Ohio. The plant is owned by the Honda Accord operation, a Japanese firm, but most of the workers employed at the plant are U.S. workers. Although all the output of the plant is included in U.S. GDP, only part of it is included in U.S. GNP. The wages paid to U.S. workers are part of U.S. GNP, while the profits from the plant are not. The profits from the plant are counted in Japanese GNP because this is output produced by Japanese-owned factors of production (Japanese capital in this case). The profits, however, are not counted in Japanese GDP because they are not earned in Japan. *CASE & FAIR, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 391-393* end |
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