2.1 Living Standards and Aggregation

© 1999-2020, Douglas A.Ruby (07-02-2020)

The evaluation of economic activity is really about measures of output or changes in output over a given period of time. The expectation is that any past additions to the wealth of a nation, whether it be physical capital or human capital, will lead to growth in current output. These aggregate output measures, when stated on a per-capita basis (output per person) can be interpreted as a measure of regional or national 'living standards' also known as the Standard of Living (SoL). If the growth rate in output exceeds the growth rate in population then living standards are assumed to be rising.

SoL = Output per Capita = Output / Population

such that if:

%Δ Output > %ΔPopulation,


SoL ↑.

This is not to say that the output of an economy is being equally divided among each individual. On average, living standards may be rising and yet, for some (many) the reality is that income and their claim on output remains unchanged year after year.

2.1.1 Aggregation

There are difficulties in measuring output in the aggregate. It is impossible to add different quantities of goods and services together as a single aggregate measure. The quantity of autos produced added to the quantity of apples and quantity of houses results in a meaningless measure:

Qautos + Qapples + ... + Qhouses + ..... + Qn
= Σ Qi = ???

To overcome this problem of aggregation, economists transform the above sum to a common unit of measure in currency terms. This is accomplished by pre-multiplying each item by its current market price 'Pi '. Thus, instead of adding individual quantities together, economists sum the expenditure for each ith good together:

Σ PiQi = PautosQautos + ... + PhousesQhouses + ..... + PnQn
= Aggregate Expenditure

As will be seen below, the use of market prices and expenditure measures to evaluate economic activity do cause other problems in attempts to accurately measure growth in a nation's output over time.

2.1.2 Measurement and National Income Accounting

The methods of National Income Accounting use two methods to determine this measure of aggregate expenditure:

  1. directly via the expenditure approach (through spending on final goods and services) or
  2. indirectly via the compensation approach (through payments made to the factors of production in producing goods and services).

The Expenditure Approach involves collecting data on the major components of spending in a given time period. This spending is in the form of consumption expenditure 'C', investment expenditure 'I', government expenditure 'G', and net-export expenditure 'NX'. When added together these four categories of spending make up what is known as the Gross Domestic Product or GDP for a given economy:

C + I + G + NX = Σ PiQi = GDP

Formally defined, GDP represents a measure of the market value of all final goods and services produced and purchased in a given year.

Expenditure Categories
Year Nominal Gross Domestic Product Personal Consumption Expenditures % NGDP Gross Private Domestic Investment % NGDP Government Expenditures % NGDP Net Export Expenditure % NGDP
1960543.3 331.661.0% 86.47615.9% 121.022.3% 4.20.8%
1965743.7 443.659.6% 129.617.4% 164.922.2% 5.60.8%
19701,075.9 647.760.2% 170.115.8% 254.223.6% 3.90.4%
19751,688.9 1032.861.2% 257.315.2% 382.922.7% 16.00.9%
19802,862.5 1754.661.3% 530.118.5% 590.820.6% -13.1-0.5%
19854,346.7 2722.762.6% 829.719.1% 908.420.9% -114.0-2.6%
19905,979.6 3,825.664.0% 993.516.6% 1,238.420.7% -77.9-1.3%
19957,664.1 4,984.265.0% 1,317.517.2% 1,452.218.9% -89.8-1.2%
200010,284.8 6,792.466.0% 2,033.819.8% 1,834.417.8% -375.8-3.7%
200513,093.7 8,794.167.2% 2,527.119.3% 2,493.719.0% -721.2-5.5%
201014,964.4 10,202.268.2% 2,100.814.0% 3,174.021.2% -512.7-3.4%
201518,224.8 12,284.368.1% 3,093.617.1% 3,237.317.8% -519.8-2.9%
201618,715.0 12,748.568.8% 3,178.716.4% 3,306.717.5% -518.8-2.8%
201719,519.4 13,312.168.2% 3,370.717.3% 3,412.017.5% -575.3 -2.9%
201820,580.2 13,998.768.0% 3.628.317.6% 3,591.517.4% -638.2 -3.1%
201921,427.7 14,562.768.0% 3,743.917.5% 3,753.017.5% -631.9 -2.9%
Source: St. Louis Federal Reserve (BEA: 07-01-2020)

The Compensation Approach involves measuring the amount of compensation paid to the various factors of production (land, labor, capital, entrepreneurship) used as inputs in the production process. For example in 2019:

Income Categories
Category Amount (%)
Compensation of Employees (labor) $11,441.0 (64.3%)
Proprietor's Income (entrepreneurship) 1,658.2 (9.3%)
Corporate Profits (capital) 1,543.7 (8.7%)
Net Interest (capital) 867.0 (4.9%)
Gross Rental Income
less depreciation expense .
Net Rental Income (land) 777.9 (4.4)
Taxes on Imports and Production (etc.) 1,494.8 (8.4%)
National Income $17,782.6 (100%)
Source: Bureau of Economic Analysis (07/2020)

Note that, historically, about 70% (compensation of employees and proprietor's income) of National Income represents the return to labor and the remaining one-quarter is known as the return to capital. This percentage of national income allocated between labor and the other factors of production has remained relatively constant over most of the past century with a significant decline being observed in the past decade.

The difference between gross domestic product and national income ($3,645.1) is due to depreciation expense, indirect business taxes (sales and excise taxes), and business transfers to individuals (through donations to the United Way and the like). For example, some of the payments (expenditure) to capital and land are made to cover the consumption of capital and equipment (to allow for wear and tear on the equipment). However, these payments are not received directly by the owners of capital and land in that they must allow for eventual replacement of these items. In the case of indirect business taxes, expenditure on some items like gasoline, liquor, and telephone calls, include the provision for a per-unit tax in the price of these items. These per-unit or excise taxes are transferred to some government agency and do not represent direct compensation to the owners of factor inputs.

Concepts for Review:

Top of page related: Macroeconomic Policy previous: Measures of Economic Activity next: Business Cycles Macroeconomic Theory
© 1999-2020, Douglas A.Ruby (05-20-2020)