Measuring Economic Activity

1. The national income and product accounts contain the major measures of income and product for a country. The gross domestic product (GDP) is the most comprehensive measure of a nation's production of goods and services. It comprises the dollar value of consumption (C), gross private domestic investment (I), government purchases (G), and net exports (X)produced within a nation during a given year. Recall the formula:
   
   GDP = C + I + G + X 
   
   This will sometimes be simplified by combining private domestic investment and net exports into total gross national investment (I^T = I + X):
   
   GDP = C + I^T + G


2. We can match the upper-loop, flow-of-product measurement of GDP with the lower-loop, flow-of-cost measurement, as shown in Figure 20-1. The flow-of-cost approach uses factor earnings and carefully computes value added to eliminate double counting of intermediate products. And after summing up all (before-tax) wage, interest, rent, depreciation, and profit income, it adds to this total all indirect tax costs of business. GDP does not include transfer items such as social security benefits.


3. By use of a price index, we can "deflate" nominal GDP (GDP in current dollars) to arrive at a more accurate measure of real GDP (GDP expressed in dollars of some base year's purchasing power). Use of such a price index corrects for the "rubber yardstick" implied by changing levels of prices.



4. Net investment is positive when the nation is producing more capital goods than are currently being used up in the form of depreciation. Since depreciation is hard to estimate accurately, statisticians have more confidence in their measures of gross investment than in those of net investment.


5. National income and disposable income are two additional official measurements. Disposable income (DI) is what people actually have left—after all tax payments, corporate saving of undistributed profits, and transfer adjustments have been made—to spend on consumption or to save.


6. Using the rules of the national accounts, measured saving must exactly equal measured investment. This is easily seen in a hypothetical economy with nothing but households. In a complete economy, private saving and government surplus equal domestic investment plus net foreign investment. The identity between saving and investment is just that: saving must equal investment no matter whether the economy is in boom or recession, war or peace. It is a consequence of the definitions of national income accounting.


7. Gross domestic product and even net domestic product are imperfect measures of genuine economic welfare. In recent years, statisticians have started correcting for nonmarket activities such as unpaid work at home and environmental externalities.


8. Inflation occurs when the general level of prices is rising (and deflation occurs when it is falling). We measure the overall price level and rate of inflation using price indexes—weighted averages of the prices of thousands of individual products. The most important price index is the consumer price index (CPI), which traditionally measured the cost of a fixed market basket of consumer goods and services relative to the cost of that bundle during a particular base year. Recent studies indicate that the CPI trend has a major upward bias because of index-number problems and omission of new and improved goods, and the government has undertaken steps to correct some of this bias.


9. Recall the useful formulas from this and the prior chapter:



1. For calculating single-period growth of GDP:



2. For calculating inflation with a single good:



3. Multiyear growth rate:



4. For calculating the CPI with multiple goods: