ECN 202: Principles of MacroeconomicsNusrat Jahan

Lecture-2

Measuring a Nation’s Income

When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.

For an economy as a whole, income must equal expenditure because:

Every transaction has a buyer and a seller.

Every dollar of spending by some buyer is a dollar of income for some seller.

Economic interaction among agents in the Economy

The Circular Flow Model It shows how dynamic market creates continuous, repetitive flows of goods and services, resources and money.

Measuring Economic Success

Economic success is measured by looking at 3 key variables-

1. Gross Domestic Product (GDP)

2. Unemployment and

3. Inflation

1. Gross Domestic Product (GDP)

GDP is the market value of all final goods and services produced within a country in a given period of time.

“GDP is the Market Value . . .” Output is valued at market prices.

“. . . Of All Final . . .” It records only the value of final goods, not intermediate goods (the value is counted only once).

“. . . Goods and Services . . . “ It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

“. . . Produced . . .” It includes goods and services currently produced, not transactions involving goods produced in the past.

“ . . . Within a Country . . .” It measures the value of production within the geographic confines of a country.

“. . . In a Given Period of Time.” It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

1. Gross Domestic Product (GDP) (Continued…)

GDP does not include:Intermediate goodsGoods produced in the pastNon-market production

• Black market• Underground economy• Household production

Methods of Calculating GDP

Value Addition Approach

Expenditure Approach

Income Approach

1. Gross Domestic Product (GDP) (Continued…)

GDP using value-added approach

Final value of output = sum of value-added by all firms in the economy

Methods of Calculating GDP (continued…)

GDP Using Expenditure ApproachIn this approach all the expenditures done in the economy are added to calculate GDP as Expenditure = Income.

GDP = C + Ig + G + NXWhere,C = Consumption Expenditure: Spending by households on goods and services, with the exception of purchases of new housing

Ig = Gross Investment: Spending on capital equipment, inventories and structures, including household purchases of new housing

G = Government Expenditure: Spending on goods and services by local, state and federal governments

NX = Net Export: Spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)

Methods of Calculating GDP (continued…)

GDP Using Income Approach

GDP can also be measured by the income generated during production

GDP = wages + rent+ interest + profits – net factor income from abroad + capital consumption allowance (depreciation) + indirect business taxes

Methods of Calculating GDP (continued…)

Distinction between GDP and GNP

Gross National Product (GNP) = GDP + net factor income from abroad

Nominal GDP and Real GDP

Nominal GDP: The production of goods and services valued at current prices.

Real GDP: The production of goods and services valued at constant prices

The Economy Produces Two Goods: Food and ClothingYear PC QC PF QF Nominal GDP Real GDP GDP Deflator

1997 10 1000 2 20000 50000 50000 100

1998 11 1000 3 25000 86000 60000 143

1999 13 1200 4 30000 135600 82000 165

Nominal GDP is calculated by adding the amounts spent on each product. Real GDP is calculated by using the prices of food and clothing from 1997 to calculate the amounts spent in future years. GDP Deflator is Nominal GDP/Real GDP.

GDP Deflator: A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.