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.

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).

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.

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.

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.

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

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.

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

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

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.

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

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

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.

Fig. 1 - US real GDP growth. Source: Bureau of Economic Analysis⁴