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Measuring Domestic Output and National Income

Measuring Domestic Output and National Income

The countries we find ourselves living in are so insanely massive; how can one place have hundreds of thousands of businesses and people all engaging in various economic activities? Who keeps track of all their output, and what does it mean for the country as a whole? In this explanation, we'll go into detail about measuring domestic output and national income. If you are ready to join us on this epic quest, keep on reading!

Types of National Income

National income refers to the total accounting that occurs in an economy, and knowing the many types of national income is a part of figuring it out.

National income is a measure of the overall performance of an economy.

The organization that gathers data for the national income accounts is the Bureau of Economic Analysis, an agency of the commerce department. They developed a report called the National Income and Products Accounts (NIPA). Information gathered in these reports is used to:

  • Analyze the health of the economy at various production levels

  • Track economic growth or decline

  • Plan policies to ensure the long-term economic health

The national income can be used to calculate the gross domestic product (GDP). This is called the income approach.

The income approach takes into account many sources of income, such as compensation of employees, rents, interest, proprietors' income, corporate profits, and taxes on production and imports. All of these income sources combined make up a country's national income, often referred to as the gross national income (GNI).

The gross national income for the United States in 2021 was $23,374,710,000,000 or 23.3 trillion dollars. The 2021 GNI was significant because it was a 9.94% increase from the previous year. Can you see your personal income reflected as a share of the national income? 1

For more information on national income and other related topics, check out our explanation of National Accounts!

Measures of National Income and Output

Let's discuss measures of national income and output!

National income is the summation of individual, business, and government cash inflows. It is a way of measuring output by determining how much money the output was purchased for, at which point it becomes the seller's income.

Using data from FRED (Federal Reserve economic data), the following breakdown of the real national income is provided.

Total Real National Income
$19,937.975 billion
Compensation of employees
$12,598.667 billion
Proprietor's income
$1,821.890 billion
Rental income
$726.427 billion
Corporate profits
$2,805.796 billion
Net interest and miscellaneous
$686.061 billion
Taxes on production and imports
$1,641.138 billion

Table 1 - Federal Reserve economic data real national income by category2

Using this data (and a few smaller categories left out), one can calculate GDP with the income approach.

The income approach formula uses the value of a nation's income, which includes wages, profits, interest, and rent.

The formula for the income approach is as follows:

\(\hbox{GDP} = \hbox{Total Wages + Total Profits +Total Interest + Total Rent + Proprietors income + Taxes}\)

Measurement of National Output and Income

Countries and those who are accountable for the ongoing economic success closely monitor the measurement of national output and income. They are strong indicators of the total productive capacity of a country and how it changes year to year. There are a few ways of calculating it, whether it's the final cost of the good, the value added at each step, or the total incomes of individuals and businesses.

No matter which approach is used to calculate GDP, they all provide a total valuation of the productive power of an economy. Having a strong GDP and GDP growth will entice other countries to invest and engage in business transactions.

For an in-depth explanation of measuring GDP, consider reading our explanation of Measured GDP

Domestic Output Formula

The domestic output formula refers to the GDP or gross domestic product of a nation. The three main ways of calculating GDP are the income approach, the expenditures approach, and the value-added approach.

The income approach calculates the total productive output by summing total income across an economy. The income approach totals the inflows of cash from providing goods or services. Similar to calculating the total cost of output, this approach comes from the opposite direction, calculating the money paid for output that becomes income. This approach has the added benefit of automatically including foreign purchases of domestic goods without imports needing to be calculated.

The income approach totals incomes across several categories; employees' wages, proprietors' income, corporate profits, rent, interest, and taxes on production and imports.

The formula for the income approach is as follows:

\(\hbox{GDP} = \hbox{Total Wages + Total Profits +Total Interest + Total Rent + Proprietors income + Taxes}\)

Next is the expenditures approach. The expenditure approach is calculated by the total of a country's expenditures across four major categories. These categories are consumer spending, business investment, government spending, and net exports, which are exports minus imports.The spending measured in the expenditure approach is exclusively for final goods, as intermediate goods are not counted. That means that many different production processes a product goes through do not matter, but only the final cost of the good does. This is done to prevent double counting the value of goods.

The formula for the expenditure approach is the following:

\(\hbox{GDP} = \hbox{C + I + G + NX}\)

\(\hbox{Where:}\)\(\hbox{C = Consumer Spending}\)\(\hbox{I = Business Investment}\)\(\hbox{G = Government Spending}\)\(\hbox{NX = Net Exports (Exports - Imports)}\)

These figures will leave you with what's called the nominal GDP, which is a snapshot of current prices and outputs.

However, real GDP is when inflation is accounted for in price changes. This is done as rising prices without corresponding increases in value will skew one into thinking the economy has grown. The real GDP is a comparison of the prices of a base year to the current year. This important distinction lets economists measure real growth in value rather than inflationary price increases. A GDP deflator is a variable that will adjust the nominal GDP for inflation.

\(\hbox{Real GDP} = \frac{\hbox{Nominal GDP}} {\hbox{GDP Deflator}}\)

For more information on the distinction between nominal and real GDP, read our explanation of it!

Another way to calculate GDP is the value-added approach. This approach, rather than taking the final good, calculates the additional value each step of production adds to a product.

\(\hbox{Value-Added} = \hbox{Sale Price} - \hbox{Cost of Intermediate Goods and Services}\)

\(\hbox{GDP} = \hbox{Sum of Value-Added for All Products and Services in the Economy}\)

Imagine your favorite candy. You buy it in a package for two dollars, but what is the value-added breakdown of that package?

Raw materials such as sugar cane, starch, and palm oil are harvested and processed.The materials are sold to a candy factory for $0.30 (per package).

The candy factory processes it into the shape and flavor you know and love.

The candy factory sells the candy packages to a distributor for $1.50 (per package).

The distributor provides boxes of candy to be featured in convenience stores.The packages of candy here are sold for $2.00

Following the example, the farmers who grew and harvested the raw materials created $0.30 of value.

The candy factory that processed the materials sold them for $1.50.

However, we must subtract the $0.30 value they paid for.

Therefore, the candy factory added a $1.20 value.

Finally, the distributor handled the shipping and logistics to provide the candy at the consumer's convenience for $2.00, minus the $1.50 they paid, so the distributor added $0.50 of value.

\(\hbox{Value-Added} = \ $0.30+$1.20+$0.50=$2\)

In the example above, the value-added approach isolates each step of the production process and the value they provide. However, as you can see, it is the same as the final good price.

National Output Examples

To have an example of national output, we will use the expenditure approach to calculate the actual GDP for the United States in 2021, Quarter 1.

We will look at all the productive categories of an economy and use them to calculate the value of all final goods produced.

\(\hbox{GDP} = \hbox{C + I + G + NX}\)

\(\hbox{Where:}\)\(\hbox{C = Consumer Spending}\)\(\hbox{I = Business Investment}\)\(\hbox{G = Government Spending}\)\(\hbox{NX = Net Exports (Exports - Imports)}\)

Using data from the Bureau of Economic Analysis, quarter 1 of 2021.3 (numbers are in billions of US dollars)

\(\hbox{C = 14,439.1}\)\(\hbox{I = 3,752.4}\)\(\hbox{G = 3,831.6}\)\(\hbox{NX = -541.7}\)

\(\hbox{GDP} = \hbox{14,439.1 + 3,752.4 + 3,831.6 + (- 541.7)}\)

\(\hbox{GDP} = \hbox{21,481.4 billion US dollars}\)

The example above can be seen in the graph below in Figure 1. The sharp rise in GDP after 2020 is from the calculations that were done in the example above. Notably, the major dips in GDP occur during massive financial crises, such as the 2008 financial crisis and the 2020 Covid-19 pandemic.

Measuring Domestic Output and National Income US Real GDP Growth StudySmarterFig. 1 - US real GDP growth. Source: Bureau of Economic Analysis4

Measuring Domestic Output and National Income - Key takeaways

  • Domestic output refers to the gross domestic product, which is the total productive output of a country.
  • National income is the total money earned across all economic actors, from households to businesses and the government.
  • There are three ways of calculating GDP: the expenditure approach, the income approach, and the value-added approach.
  • Nominal GDP is the current output measured with current prices, whilst real GDP measures the actual growth in productive value by removing inflation from the price changes.

References

  1. GNI United States 2021, https://www.macrotrends.net/countries/USA/united-states/gni-gross-national-income
  2. Table 1 Federal reserve economic data, https://fred.stlouisfed.org/release/tables?rid=53&eid=42133
  3. Expenditure approach GDP Data, https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey
  4. Fig. 1 US Real GDP growth, Bureau of Economic Analysis Table 1.1.1 https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey

Frequently Asked Questions about Measuring Domestic Output and National Income

Gross domestic product, gross net product, national income are all measures of domestic output. They calculate the total productive value of an economy in a given time frame.

Net domestic product and national income can be calculated in multiple ways. The income approach calculates all incomes of individuals and business. The expenditure approach calculates the final value of goods and services sold. The value-added approached calculates the productive value of each step in a production process.

The three methods are as follows. The income approach calculates all incomes of individuals and business. The expenditure approach calculates the final value of goods and services sold. The value-added approach calculates the productive value of each step in a production process.

The five main categories that national income is characterized by are: compensation of employees, proprietors income, rental income, corporate profits, and net interest.

National income and output are relatively the same, they are both productive measures of an economy. National income focuses on how much the country is paid for its goods and services. The national output is the value of final goods and services produced.

Final Measuring Domestic Output and National Income Quiz

Question

What is real GDP?

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Answer

Real GDP is GDP that accounts for inflation and has been adjusted to reflect changes in prices.

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Question

What is nominal GDP?

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Answer

Nominal GDP is GDP that has not accounted for inflation and includes its current prices.

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what is GDP?

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Answer

GDP is the value of all final goods and services produced in a specific time period.

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Question

What is the difference between nominal and real GDP?

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Answer

nominal GDP does not account for inflation; real GDP does account for inflation.

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Question

How do you calculate nominal GDP?

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Answer

Units of Output X Price of Item Per Unit

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How do you calculate real GDP?

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Answer

Nominal GDP / Price Index (in hundreds)

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Question

Assume a country only sells laptops. The laptops cost $200 and the country sold 10,000 units. What is nominal GDP?

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Answer

2,000,000

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Question

Assume a country only sells laptops. The laptops cost $10 and the country sold 1,000 units. What is nominal GDP?

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Answer

10,000

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Question

The nominal GDP is 500, and the price index is 150. What is real GDP?

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Answer

333.33

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True or False: real GDP does NOT account for inflation?

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False

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True or False: nominal GDP can also be known as, "current prices"

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Answer

True

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True or False: Another way to calculate real GDP is by multiplying the specific year's output by the base year's prices.

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Answer

True

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True or False: The formula for nominal GDP is: Nominal GDP = real GDP / price index

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Answer

False

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Question

True or False: The formula for real GDP is: Real GDP = Nominal GDP / Price Index (in hundreds)

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True

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Question

In year 1, there were 30 units of TVs produced at a price of $500. In year 2, there were 50 units of TVs produced at a price of $550. What is real GDP in year 2?

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Answer

25,000.

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Question

Define GDP.

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Answer

GDP is the value, in monetary terms, of an economy's annual total output of goods and services.

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Economists use changes in GDP to measure economic performance.

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True

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There are 5 types of GDP.

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False

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The types of GDP are nominal GDP and _____.

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Real GDP

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Nominal GDP uses constant prices.

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False

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Non-production transactions are not included in the GDP.

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True

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What are non-production transactions?

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Non-production transactions are transactions that are not tied to the production of final goods.

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Real GDP uses current prices.

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False

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Define nominal GDP.

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Answer

Nominal GDP is the monetary value of the total annual goods and services produced in an economy using current prices.

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Define real GDP.

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Real GDP is the monetary value of the total annual goods and services produced in an economy using constant prices.

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Under the value added approach, GDP is measured by summing up the value added by the government, businesses, and households.

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True

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The expenditures approach of measured GDP puts together all the income on final goods and services in the economy during the year in question.

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False

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Government spending on goods and services is included in the expenditure approach.

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True

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The income approach includes employee compensation.

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True

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Economists use nominal GDP to measure economic growth.

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False

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What is the expenditure approach?

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Answer

The expenditure approach is a method used to measure the GDP of a country by taking into account the final value of goods and services.

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The expenditure approach considers ____________.

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Answer

Public expenditure

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Expenditure approach calculates _________.

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Nominal GDP

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What is the relationship between the expenditure approach and aggregate demand?

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The expenditure approach, as the name suggests, is focused on the total spending in the economy. The total spending in the economy is also represented by Aggregate Demand. Therefore, the expenditure approach's components are the same as those of aggregate demand.

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What are the four types of spending considered in the expenditure approach?

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Answer

  1. Consumption
  2. Investment 
  3. Net exports of goods and services 
  4. Government purchases

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______________ refers to the spending by individuals on final goods and services, including those produced in other countries.

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Personal consumption expenditure

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What are the type of goods included in personal consumption?

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All

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______ goods include short-lived consumer items, such as food, gas, or clothing.

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Non-durable

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Buying the new iPhone 14 is an example of ___________.

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Personal consumption expenditure

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What does investment involve under the expenditure approach?

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Investment involves the purchase of new capital goods (also known as a fixed investment) and the expansion of a company's inventory (also known as inventory investment).

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Which one of the following is not a category of private investment?

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Non-durable goods

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Pfizer spending billions of money on R&D to develop the COVID-19 vaccine is an example of ______________.

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Answer

Gross domestic private investment 

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What are the categories included in Government purchases?

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  1. Spending on goods and services that the government needs to provide public services.
  2. Spending on long-lasting public assets like schools and highways.
  3. Expenditure on research and development and other activities that add to the economy's stock of knowledge.

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Question

What is an example of government purchases that the expenditure approach would include?

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Answer

An example of government purchases that would be included in the GDP calculation by the expenditure approach is the government buying new software technologies for national defense.

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_____ are defined as the goods and services created within a nation that are sold to buyers outside of that country.

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Answer

Exports

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_____ are defined as goods and services produced outside of a country that are sold to buyers of that country. 

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Answer

Imports

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Question

What is the expenditure approach formula?

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Answer

The expenditure approach formula is:


\(GDP=C+I_g+G+X_n\)

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Question

What is the national account?

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The national account refers to accounting for the value of all transactions that take place within an economy.

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What are national accounts?

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National accounts (or other national accounts) in economics refers to the subaccounts that combine to form the GDP.

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What does NDP stand for?

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Answer

Net Domestic Product

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