Potential National Income
Potential national income is defined in the same way as in Accounting for Growth, except that national income is valued in 1972 prices instead of 1958 prices. It is the value that national income (in 1972 prices) would have taken if (1) the percentage of the civilian labor force 16 years of age and over that is unemployed had been 4 percent; (2) the intensity of utilization of employed resources (aside from effects of labor disputes) had been that which on the average would be associated with a 4 percent unemployment rate; and (3) other conditions had been those that actually prevailed in that year.
Potential national income is derived by making the two adjustments to actual national income that are shown in columns 2 and 3 of table 2-4. The procedures are the same as those used in Accounting for Growth except for minor changes required by revisions of the data or indicated by the extension of the series to another seven years. That book should be consulted for additional explanation.
The first adjustment, shown in table 2-4, column 2, eliminates the effects on output per unit of input of fluctuations in intensity of utilization due to fluctuations in demand. The objective is to obtain the output that resources measured as actually in use would have produced under standardized demand conditions.
For the nonresidential business sector an output series with the proper movement could be obtained by dividing actual national income in this sector by the index shown in table 5-1, column 9. The index measures the effect on output per unit of input of changes in the intensity of utilization of employed resources resulting from fluctuations in the intensity of demand.
To set the level of potential output, the value of this index that corresponds to potential conditions must be estimated. It was put at 103.31 when (as in table 5-1) 1972 is 100. This index value corresponds to a 4 percent unemployment rate when a regression line relating the index to the unemployment rate is computed for the 1948-69 period.1 (At 3.5 percent unemployment the value is 103.73 and at 4.5 percent it is 102.90.)
One way to check this result was to examine years of relatively low unemployment. In one of the years from 1948 through 1976 the unemployment rate was 4.0 percent, in eight it was below 4.0 percent, and in twenty it was above 4.0 percent. To obtain a balanced sample scattered evenly around the 4.0 percent potential level, the twelve years of highest unemployment were discarded. This left seventeen years, in eight of which unemployment was below 4.0 percent and in eight above, with the range from 2.7 to 5.4 percent. In nine of these years the demand intensity index was above 103.31 and in eight it was below 103.31 so the figure selected divides this sample of years as evenly as possible, as it should. In these seventeen years the unemployment rate averaged 4.05 percent and the demand intensity index averaged 103.11. A small adjustment of these results (based on the regression elasticity) suggests that if unemployment had averaged 4.0 percent the demand intensity index would have averaged 103.16. This is reasonably close to the value of 103.31 obtained from the regression.2
To obtain column 2 of table 2-4, nonresidential business national income in 1972 prices, from table 2-6, column 5, was multiplied by the ratio of 103.31 to column 9 of table 5-1. (the index of the effect of____________________