Chapter 20 - Tracking the U.S. Economy

Many people believed that the stock of precious metals a nation accumulated in the public treasury was the finest indicator of economic prosperity throughout the 17th and 18th centuries when mercantilism was the prevailing economic strategy.

Mercantilism resulted in trade restrictions, which had the unintended consequence of decreasing the profits from comparative advantage. François Quesnay was the first to measure economic activity as a flow in the second part of the 18th century. He published his Tableau Économique in 1758, which depicted the cyclical movement of output and revenue through various sectors of the economy. His idea was most likely influenced by his understanding of blood's circular flow.

• The term double-counting refers to the mistakes of including both the value of intermediate products and the value of final products in calculating gross domestic product; counting the same product more than once

Although rough estimates of national income were created in England two centuries ago, precise calculations based on microeconomic data were perfected in the United States during the Great Depression. The resultant national income accounting system integrates massive amounts of data gathered from many sources across America.

The federal government summarized these facts, organized them into a cohesive framework, and reported on them. The development and execution of these accounts have been lauded as one of the twentieth century's greatest achievements. The United States national income accounts are the most extensively imitated and respected in the world, and their creator, Simon K.

Only final products and services, or items and services sold to the final, or end, user, are included in gross domestic product. Final products and services include a toothbrush, a set of contact lenses, and a bus journey. Who buys the product determines whether the sale is to the eventual user. When you buy chicken for supper, it affects GDP. However, because KFC is not the end customer, their purchases of chicken are not recorded in GDP. The transaction is only counted in GDP once the chicken has been cooked and sold by KFC.

Intermediate products and services, such as KFC's chicken, are those acquired for further processing and resale. This shift may be unnoticeable, such as when the grocer purchases canned items to replenish shelves. Or the intermediary products might be drastically transformed, like when a painter turns a $100 canvas and $30 in oils into a $5,000 work of art. The value of intermediary products and services is omitted from GDP to avoid the problem of double counting, which occurs when an item's value is counted more than once. Assume the grocer purchases a can of tuna for $1.00 and sells it for $1.50. If GDP included both the intermediate transaction of $1.00 and the final transaction of $1.50, the reported value would be $1.50.

As previously stated, one method of calculating GDP is to total up expenditure on all final products and services generated in the economy during the year. The spending method is best understood by breaking aggregate expenditure down into its constituents: consumption, investment, government purchases, and net exports.

Consumption, or more precisely, personal consumption expenditures, are purchases of final products and services made by households throughout the year. Consumption is the greatest expenditure sector, accounting for 70% of US GDP during the last decade. Consumption encompasses both nondurable and durable items, as well as services such as dry cleaning, haircuts, and air travel.

The term investment refers to the purchase of new plants, new equipment, new buildings, and new residences, plus net additions to inventories.

The expenditure method totals or aggregates production expenses. The income method totals or aggregates the income generated by such production. Again, double-entry bookkeeping guarantees that the aggregate output value equals the aggregate income paid for resources needed to generate that output: wages, interest, rent, and profit emerging from production. The cost of a Hershey Bar represents the earnings of resource providers along the route. Aggregate income is the sum of all the revenue earned by the economy's resource suppliers. As a result, we may state that

• Aggregate expenditure = GDP = Aggregate income

On its route to the consumer, a product often passes through numerous phases involving various businesses. A wooden desk, for example, begins as raw lumber, which is generally cut by one company, milled by another, assembled by a third, and retailed by a fourth. We prevent duplicate counting by including just the market worth of the desk when it is sold to the ultimate user or by adding the value contributed at each step of manufacturing. Each firm's value equals its selling price minus payments for inputs from other companies. The money gained by resource providers at each level is the value contributed at that stage. The value contributed at each stage adds up to the final good's market worth, and other firms.

The money gained by resource providers at each level is the value contributed at that stage. According to the income method, the value-added at all stages adds up to the market value of the final item, and the value contributed for all final goods adds up to GDP. Let's say you spend $200 on a wooden desk. This ultimate market value is immediately added to GDP. Consider the desk's history. Assume the tree that gave its life for your studies was chopped into a log and sold for $20 to a miller, who turned the log to lumber for $50 and sold it to a deck builder, who constructed the desk and sold it for $120 to a merchant, who sold it to you for $200.

Exhibit 1's column (1) shows the selling price at each step of manufacturing. If all of these trades were put together, the total would be $390, which would be more than the desk's market worth of $200.

To avoid duplicate counting, we only consider the value-added at each stage, which is stated in column (3) as the difference between the buy and selling prices at that level. Again, at each level, the value contributed equals the money gained by individuals who give their resources at that stage. For example, the retailer's $80 in value-added consists of money to resource providers at that step, ranging from the salesman to the janitor who cleans the showroom to the trucker who offers "free delivery" of your desk.