Gross National Product: The Expenditure And Income Components of GNP

The Expenditure And Income Components Of Gnp As we pointed out in the first chapter of this book, a major task of any economy is creating a mechanism for determining what is produced. The National Income and Product Accounts were designed not only to provide information on the total value of final products produced over a year but also to keep track of the kinds of output we produce. GNP can be broken down into components that show how much of our productive resources are being allocated to satisfy consumers demands, to produce investment goods like new machinery, to be used by governments, and to produce goods for export. It can also provide us with information about how much of our income we use to purchase imported products. We can show how the receipts from the sale of final products are used to reward those who produce the output thereby dividing GNP into income components. You will see that the bulk of receipts that businesses receive for selling their products is allocated to paying their workers. The Expenditure Components of GNP GNP provides information on what we use our resources to produce by dividing expenditure on final products into components showing how much of our production we devote to consumption, investment, government activity, and exports. Let's examine the kinds of output that are included in GNP and show how these aggregates are measured in the National Income and Product Accounts. 1. Consumption. If you were to browse through the National Income and Product Accounts, you could find out how much consumers spend on haircuts, beer, cosmetics, or anything else. Personal consumption expenditures are purchases of final products (except new homes) by households. The NIPA treats the purchase of new homes as an investment (as opposed to consumption) purchase. Consumption consists of the purchase of both durable and nondurable goods and services by people like you. A durable good is one that lasts for a number of years, such as an automobile, a kitchen appliance, furniture, and similar items. Nondurable goods are items like food or fuel that consumers use up soon after purchase. Services are nonmaterial items including housing rents, transportation, household operating expenses for elec-tricity, gas, and water. Other services are those of physicians and hospitals, lawyers, mechanics, banks, insurance companies, hotels, educational institutions, and so on. In recent years, services have become the dominant component of consumption in the United States accounting for more than half the dollar value of consumption expenditures. Personal consumption expenditures were nearly $3.5 trillion in 1989, which amounted to 66 percent of GNP that year. You can now understand the importance of the consumer in the U.S. economy. Two thirds of the value of final products included in GNP are produced for the use and enjoyment of U.S. consumers. If we as consumers decided to spend less, the demand for goods and services would decline; and because of reduced sales, current aggregate production would also decline. 2. Investment. Investment is the purchase of final products by business firms for use in production or as additions to inventories and the purchase of new homes by households. Investment involves the production of new capital goods by businesses including changes in inventories of unsold goods, materials, and parts over the year. Gross private domestic investment includes new machinery, equipment, and structures, purchases of new homes by households, and changes in business inventories during the year. When inventories increase from one year to the next, they are added to investment. Reductions in business inventories during the year are treated as negative investment. Increases in business inventories represent goods that have been produced during the year but not sold to buyers in the market. These inventory accumulations must be included in GNP to accurately measure current production. In effect, the NIPA treats increases in business inventories as a final use of goods by businesses during the year. Similarly, when inventories decline during a year the decline represents goods that were produced in previous years but sold during the current year. To accurately measure current GNP, the decline in inventories must be subtracted from investment. Investment is domestic because it includes only that which takes place in the United States. For example, if IBM invests by building a new plant in Mexico, this investment is not part of U.S. GNP except to the extent that IBM purchases machinery in the United States for use in its Mexican plant. Investment is gross because it doesn't deduct that amount of purchases necessary to replace capital that wears out or becomes obsolete during the year. Depreciation (also called the capital consumption allowance) is an estimate of the value of capital goods that wears out or becomes obsolete during the year. Net private domestic investment is gross investment less depreciation. If gross investment were just equal to depreciation, net investment would be zero and there would be no net addition to the value of capital during the year. Gross private domestic investment totaled $771.2 billion in 1989, an amount equal to 14.8 percent of GNP. 3. Government purchases. A significant amount of resources are devoted to government use each year and government also purchases final products from business firms. Government purchases of goods and services include expenditure on final products by governments and all input costs, including labor costs, incurred by all levels of government in the United States. Each paper clip, computer, fighter plane, filing cabinet, and aircraft purchased by the government is included in the government purchases component of GNP. Also included is the entire payroll of all governments in the United States (state, local, and federal), representing purchases of labor services by governments. Governments themselves produce valuable goods and services, such as national defense, police and fire protection, roads, bridges, schooling, and environmental protection. However, government services like environmental protection, are not sold in the marketplace. Services like national defense, public education, and garbage pickup are indirectly valued in computing GNP because the cost (including labor) to make the services available are included in the government purchases component of GNP. Not all government expenditures represent purchase of final products. The government often incurs expenditures that disburse payments to individuals without requiring any service in return. Transfer payments are payments for which no good or service is currently received in return. Expenditures by government for social security pensions, welfare payments to the poor, and subsidies to agriculture and industry are examples of transfer payments. These transfer payments constitute a source of income for the recipients and, when spent, show up as consumption or possibly as investment in the GNP accounts. In effect, transfer payments are negative taxes representing payments by governments to individuals instead of payments by individuals to governments. Government expenditures (which include transfer payments) far exceed government purchases. The treatment of the government sector of the economy in the NIPA is often criticized for not providing sufficient information on the way governments affect both current and future economic performance. Governments also add worth to intermediate products by using labor and other inputs. In the NIPA all government purchase of intermediate products, investment goods, and labor are lumped together. This procedure makes it difficult to determine how much government activity is for investment (such as new roads) and how much is direct consumption of goods and services. There is no way to determine the worth added to intermediate products by government's use of labor and other inputs because government output is not typically sold in the marketplace. There is no measure of depreciation for government investment in the NIPA, so we cannot readily determine how much investment made by government is to replace worn out capital and how much represents a net addition to the nation's capital stock. The types of investments made by governments include roads, bridges, airports, structures, water resources development, sewers, mass transit, and other items referred to as the nation's infrastructure. Estimates indicate that government investment has not kept up with private investment spending in recent years.? Because infrastructure is an important input into the production process, the declining rate of government investment is likely to adversely affect private productivity. Government purchases amounted to $1025.6 billion or 19.8 percent of GNP in 1989. 4. Net exports. Exports represent expenditure on U.S. final products by foreigners and show us how much of our total production is sold abroad. Imports represent the value of goods and services produced abroad and purchased by Americans. Net exports represent the excess of expenditure on exports over imports. In measuring GNP, expenditure on imports by consumers, businesses, and governments must be subtracted from their total expenditures to avoid counting the value of production of other nations in the U.S. GNP. Exports must then be added to account for the portion of our domestic production that is sold to foreigners. When exports exceed imports, net exports are positive and foreign trade adds to GNP. When net exports are negative, imports exceed exports. In recent years imports have exceeded exports in the United States, and net exports have been a negative component of GNP. Throughout the 1980s we have been spending more than the value of what we have produced in the United States. As you will see, when a nation spends more than the value of its production, it must borrow from foreigners to make up the difference. In recent years, the United States has, in fact, been a net borrower from the rest of the world. In 1989, imports in the United States exceeded exports by $46.1 billion, and that amount was subtracted from the sum of consumption, investment, and government purchases to arrive at GNP. Aggregate Expenditure The sum of consumption expenditures (C), expenditure on investment goods (I), government purchases (G) and net exports (NE) for the year is aggregate expenditure. This represents the dollar value of the nation's final production and is therefore equivalent to GNP: GNP = C + I + G + NE = Aggregate expenditure Whenever some goods produced during the year are not sold and are added to inventory, the NIPA treats them as an investment expenditure by businesses. In this way the accounts must always balance because the value of aggregate production (GNP) will always, by definition equal aggregate expenditure. When the expenditure components of GNP are valued at base year market prices, aggregate expenditure measures real GNP.