Lecture 1

MEASURING
A NATION’S INCOME

PRINCIPLES OF MACROECONOMICS

Lecturer: Minh Huynh, PhD.

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 Contents
1 From Micro to Macro analysis
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2 Two Models

3 Gross Domestic Product

4 The Components of GDP

5 Real versus Nominal GDP

6 Is GDP a Good Measure?

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 Objectives
● 1.1. Review Microeconomics and Macroeconomics.
● 1.2. Draw and explain the Circular-Flow Diagram (of
income).
● 1.3. Define GDP and list the components of GDP.
● 1.4. Compare & contrast Real GDP versus Nominal
GDP.
● 1.5. Identify some things that contribute to well-
being are left out of GDP.

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 ECONOMICS

●Microeconomics is ●Macroeconomics is
the study of how the study of the
individual economy as a whole.
Its goal is to
households and
explain the
firms make
economic
decisions and how changes that
they interact with affect many
one another in households,
markets. firms, and
markets at once.

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 Why do we learn macro?
● Macro is all around us
● It provides the environment in which business firms
operate
● It provides the environment in which the political
system operate.
● It is good for the formulation & evaluation of good
economic policy.
● It provides an understanding of how the world works.
● It provides basic knowledge for students of business.

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Model #1: The Business Cycle
 Model #2: The Circular Flow

MARKETS
Revenue FOR Spending
GOODS AND SERVICES
Goods •Firms sell Goods and
and services •Households buy services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars
 ACTIVE LEARNING

Decide if each statement is True or False. If answer is

false, change it to make it true

A. Households sell goods & services in the

product market.
B. Firms buy resources in the factor market.
C. Firms sell goods in the factor market.
D. Households sell resources in the factor market.

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 The Economy’s Income and Expenditure
● 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.

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 Gross Domestic Product (GDP)
● GDP measures total income of everyone in the
economy.
● GDP also measures total expenditure on the
economy’s output of g&s.

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 3 Ways of Measuring GDP
● Income Method:
 Labor income (wages/salary)
 Capital income (rent, interest, dividends)
 Government Income (taxes)
 Entrepreneurship (profits)
● Expenditure Method:
 Spending by consumers (C)
 Spending by businesses (I)
 Spending by government (G)
 Net spending by foreign sector (NX)
● Production Method:
 the value added summed across all firms in the economy.

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 Value Added
Value Added in the Production of a Gallon of Gasoline
(Hypothetical Numbers)
STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED
(1) Oil drilling $ .50 $ .50
(2) Refining .65 .15
(3) Shipping .80 .15
(4) Retail sale 1.00 .20
Total value added $ 1.00
 THE MEASUREMENT OF GDP

● GDP is the market value of all final goods and

services produced within a country in a given
period of time.

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 THE MEASUREMENT OF GDP
 “GDP is the Market Value . . .”
Output is valued at market prices.
 “. . . Of All Final . . .”
It includes all items produced in the economy and sold
legally in markets.
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).

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 THE MEASUREMENT OF GDP
 “. . . 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).
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 THE COMPONENTS OF GDP
● GDP includes all items produced in the economy
and sold legally in markets.

● What is not counted in GDP?

 GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
 It excludes items produced and sold illicitly, such
as illegal drugs.

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 THE COMPONENTS OF GDP
● GDP (Y) is the sum of the following:
 Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)
Y = C + I + G + NX

value of aggregate
total output expenditure

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 THE COMPONENTS OF GDP
Consumption (C):
oThe spending by households on goods and
services, with the exception of purchases of
new housing.
Investment (I):
oThe spending on capital equipment, inventories,
and structures, including new housing, but not
land.
Note: “Investment” does not mean the purchase
of financial assets like stocks and bonds.
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 THE COMPONENTS OF GDP
Government Purchases (G):
oThe spending on goods and services by local, state,
and federal governments.
oDoes not include transfer payments (such as Social
Security, unemployment insurance benefits,
welfare benefits) because they are not made in
exchange for currently produced goods or services.
Net Exports (NX):
oExports minus imports.

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THE COMPONENTS
THE COMPONENTSOF GDP
OF GDP
 ACTIVE LEARNING
GDP and its Components
In each of the following cases, determine how much the US’s
GDP and each of its components is affected.
A. Jerry spends $200 to buy her husband dinner
at the finest restaurant in Boston.
B. Sarah spends $1800 on a new laptop to use in her
publishing business. The laptop was built in China.
C. Jane spends $1200 on a computer to use in her editing
business. The computer is made by a local manufacturer.
D. General Motors builds $500 million worth of cars,
but consumers only buy $470 million worth of them.

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 FYI: GNP
● GNP (Gross National Product) is the market value of
all the products and services produced in one year by
labor and property supplied by a nation’s permanent
residents (called nationals)
● While GNP measures the output generated by a
country's enterprises (whether physically located
domestically or abroad) GDP measures the total
output produced within a country's borders -
whether produced by that country's own local firms
or by foreign firms.

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 FYI: GNP & GDP
● A is outputs (incomes) made
by Vietnamese in Vietnam.
C
● B is outputs (incomes) made
A by foreigners in Vietnam.
● C outputs (incomes) made
B by Vietnamese abroad.

● GDP = A + B (1)
In VN In other GNP = A + C (2)
countries
(1) => A= GDP - B
 GNP = GDP + C – B
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 FYI: GNP & GDP
GNP = GDP + NIA
● NIA (Net Income From Abroad)

- Developed countries:
NIA > 0  GNP > GDP
- Developing countries:
NIA < 0  GNP < GDP
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 REAL VERSUS NOMINAL GDP
● Nominal GDP values the production of goods and
services at current prices.

● Real GDP values the production of goods and

services at constant prices.

● An accurate view of the economy requires

adjusting nominal to real GDP by using the GDP
deflator.

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 The GDP Deflator
● The GDP deflator is a measure of the price level
calculated as the ratio of nominal GDP to real GDP
times 100.
● It tells us the rise in nominal GDP that is
attributable to a rise in prices rather than a rise in
the quantities produced.
● The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =  100
Real GDP
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 A Numerical Example

 Compute Nominal GDP in each year.

 Compute Real GDP in each year using 2010 as the base
year.
 Compute the GDP Deflator in each year
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A Numerical Example

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 The GDP Deflator
● Converting Nominal GDP to Real GDP
Nominal GDP is converted to real GDP as
follows:
Nominal GDP20XX
Real GDP20XX   100
GDP deflator20XX

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 Real GDP Controls for Inflation
● Changes in nominal GDP can be due to:
Changes in prices.
Changes in quantities of output produced.

● Changes in real GDP can only be due to changes in

quantities,
because real GDP is constructed using constant
base-year prices.

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 REAL VERSUS NOMINAL GDP
● Is Nominal GDP or Real GDP a better
measure of economic well-being? Why?

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 GDP AND ECONOMIC WELL-BEING
● GDP is the best single measure of the
economic well-being of a society.
● GDP per person tells us the income and
expenditure of the average person in the
economy.
● Higher GDP per person indicates a higher
standard of living.
● GDP is not a perfect measure of the happiness
or quality of life, however.

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 GDP AND ECONOMIC WELL-BEING
● Some things that contribute to well-being are
not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place
outside of markets, such as the value of the
time parents spend with their children and the
value of volunteer work.

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 SUMMARY
● Because every transaction has a buyer and a
seller, the total expenditure in the economy must
equal the total income in the economy.
● Gross Domestic Product (GDP) measures an
economy’s total expenditure on newly produced
goods and services and the total income earned
from the production of these goods and services.

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 SUMMARY
● GDP is the market value of all final goods and
services produced within a country in a given period
of time.
● GDP is divided among four components of
expenditure: consumption, investment, government
purchases, and net exports.
● Nominal GDP uses current prices to value the
economy’s production. Real GDP uses constant base-
year prices to value the economy’s production of
goods and services.

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 SUMMARY
● The GDP deflator—calculated from the ratio of
nominal to real GDP—measures the level of prices
in the economy.
● GDP is a good measure of economic well-being
because people prefer higher to lower incomes.
● It is not a perfect measure of well-being because
some things, such as leisure time and a clean
environment, aren’t measured by GDP.

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 HOMEWORK
Question 1:
For each of the transactions listed below, state:
i) how it would affect Vietnam’s GDP (rise/ fall/
unchanged), and
ii) which of the following national income
accounting categories it would enter:
Consumption (C), Investment (I), Government
purchases (G), Net Exports (NX).

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 HOMEWORK
a) A Vietnamese buys a new made-in-Vietnam car.
b) Dr. Kang buys a new house in Binh Duong New City.
c) You buy a pizza.
d) Binh Duong province builds Highway XYZ.
e) Tribeco Company builds a new bottling plant in Da
Nang.

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 HOMEWORK
Question 2: What two things does gross domestic
product measure? How can it measure two things at
once?
Question 3: Which contributes more to GDP—the
production of a pound of hamburger or the production
of a pound of caviar? Why?
Question 4: List the four components of expenditure.
Question 5: Define real GDP and nominal GDP. Which is
a better measure of economic well-being? Why?
Question 6: Why should policymakers care about GDP?

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