MEASURING NATIONAL

OUTPUT AND NATIONAL

INCOME
Abdul Bayes
(abdulbayes@yahoo.com)
01730781937
* Source: Compiled from various presentations by different lecturers.
 COURSE CONTENT
• Macro economic concepts – GDP,GNP, Inflation, Growth rate etc.

• Consumption, Investment functions

• Inflation

• Aggregate demand and supply

• Inflation and unemployment

• Monetary and fiscal policy

• International trade, BOP, foreign exchange market and exchange rate

• Financial market

• Money and money market

• Labor Market
 Gross Domestic Product
• Gross Domestic Product (GDP) is the most widely
reported measure to indicate a country’s economic
performance

• GDP is the market value of all final goods and

services produced in a nation during a specific
period of time, usually a quarter or a year
Why Worry about GDP?
Is it part of GDP?
• A parent that stays home to care for a baby
• Dinner at a restaurant
• Dinner at home
• A social security check
• A haircut
• The construction of an office building
• The sale of a ten-year-old house
• An oil change
• Interest on a CD at your bank
• A new car
• Tires purchased by Ford to put on a new car
 National income accounting
• National income accounting is about measuring
economic activity
• One of the most comprehensive measures of a
country’s economic activity is the value of total
production of its goods and services, called
national product
• The rate of economic growth is an important
indicator of a country’s economic performance
(although a high growth rate does not necessarily
lead to less poverty)
 Gross National Product
• Gross National Product (GNP) is the market value
of all goods and services produced by nationals
(e.g. UK citizens) wherever they are located.

• GDP/GNP are expressed in monetary terms, thus

rely on the markets to establish the relative
values of goods and services
 GDP vs. GNP
• Gross Domestic Product (GDP) is the total value of final
goods and services produced during a given period within
the geographic boundaries of a country regardless of by
whom. The goods and services are produced domestically.

• Gross National Product (GNP) is the total value of final

goods and services produced during a given period by the
citizens of a country no matter where they live. The goods
and services are produced by the “nationals” of the
country.
CIRCULAR FLOW MODEL
$ COSTS $ INCOMES
RESOURCE
MARKET

RESOURCES INPUTS

BUSINESSES HOUSEHOLDS

GOODS & GOODS &

SERVICES SERVICES

PRODUCT
MARKET
$ REVENUE $ CONSUMPTION
 GDP and
Circular Flow
 Points to remember when measuring GDP...
(a) Secondhand transactions are not included (since merely
exchanges of previously produced goods)
(b) Private or public transfer payments are not counted (e.g.
unemployment insurance benefits – not made in exchange of
a service => no new production)
(c) Only final goods, intermediate goods not included (e.g.
bread yes, flour no)
=> If any of these items were included in the calculations,
the measurement of economic activity would be subject to
‘double-counting’
(d) Excludes financial transactions and income transfers
since these do not reflect production.
 Three different ways of measuring GDP

• Output approach, income approach, expenditure approach

• GDP may be measured as the total output of final goods and
services. This uses the concept of value added
– Value added: difference between the value of a good as it
leaves a stage of production and the costs of that good as it
entered that stage
– Summing the ‘value-added’ of the different stages of
production gives the total value of economic activity
 GDP as
Valued-Added
 Measuring value added
Stage of production Value of Sales Value Added
1 – Oil Drilling $0.50 $0.50
2 – Refining $0.65 $0.15
3 – Shipping $0.80 $0.15
4 – Retail Sale $1.00 $0.20
Total Value Added $1.00
• GDP may be measured as the total income earned
by the factors of production (i.e. land, labour and
capital) derived from producing the output =>
sum of factor incomes

• GDP may be measured by using the expenditure

on total output. It is measured initially at market
prices, including indirect taxes such as VAT but
excluding subsidies. This approach provides a
very useful identity Y = C + I + G + X – M
(see why in a couple of slides!)
• The income and expenditure measures are expressed in
monetary terms at the market prices that prevail (i.e. at
current prices or in nominal terms)
• Nominal GDP (p x q) can grow because of three reasons:
– Output (q) rises and prices remain unchanged
– Prices (p) rise and output remains unchanged
– Both output and prices rise

• In order to control for price changes GDP can be

calculated using a base set of prices. The real measures
can then be obtained by deflating GDP by a relevant price
index
GDP, GNP, NNP, National Income, Personal Income
and Disposable Income
GDP
Plus: receipts of factor income from the rest of the world
Less: payments of factor income to the rest of the world
Equals: GNP
Less: depreciation
Equals: NNP
Less: indirect taxes minus subsidies plus other
Equals: National Income
Less: corporate profits minus dividends
Less: social insurance payments
Plus: personal interest income received from government
and consumers
Plus: transfer payments to persons
Equals: personal income
Less: personal taxes
Equals: disposable personal income
The Expenditure approach is important for
highlighting linkages between macroeconomic
indicators ….
Component parts of expenditure based GDP
• UK GDP (Y), 2003 estimated (billion) = £1,099.4
a) Consumption expenditure (C) = £951.4
(on durables, non-durables, services)

b) Investment (I) = £175.8

(stock-building, capital formation, housing)

c) Government expenditure (G) = £231.7

(roads, health, education, but not transfer payments)

d) Exports of goods and services (X) = £276.0

e) Imports of goods and services (M) = £308.4
(C, I,G have import component, thus M need to be subtracted from
economic activity)
 National Accounts Identity

(1) Y=C+I+G+X-M
Expenditures → GDP = C + I + G + Xn
 Gross domestic product
or ‘grossly deceptive product’?
• Non-market transactions
– The ‘care’ economy (underestimation of housewives/husbands work)
– Subsistence agriculture

• Distribution, nature and quality of goods produced

• Leisure time
• The hidden economy
– Illegal activities
– Informal sector

• Economic ‘bads’
– No distinction between green and polluting industries
• This list of omissions suggests that GDP figures
are a dubious guide to the quality of life in
different countries
• Nevertheless GDP per capita is used a broad
indicator of living standards

• Examples of alternative measures:

– HDI (weighted average of life expectancy,
education and income)
 Other national accounts
• GDP + Net Factor Income (NFI) = GNP
• Net National Product (NNP) = GNP - Depreciation
(depreciation: estimate of the capital worn out by producing GDP)
• National Income: total income earned by the owners of
resources, including wages, rents, interest and profits
NI = NNP - indirect taxes [taxes on goods sold, e.g. VAT]
• Personal Income: total income received by households that is
available for consumption, saving and the payment of personal
taxes
• Personal disposable Income (PDI): Personal Income minus
personal income taxes plus transfer payments received by
individuals
– PDI = PI – income taxes + transfers
 NOMINAL VERSUS REAL GROSS
DOMESTIC PRODUCT

1.NOMINAL GDP
GDP measured in current price or pesos – all
components of GDP valued at their current prices.

Example: Burger
Year 1 – (Price = 20pesos, Quantity =
100pcs)
Year2 – (Price = 30pesos, Quantity = 100pcs)
2. REAL GDP
Nominal GDP adjusted for price changes is called
Real GDP.

All the main issues in computing real GDP can be

discussed using the simple three-good
economy for 2 years provided by the table below.
 A THREE GOOD ECONOMY
Production Price/ Unit GDP in Yr1 GDP in Yr2 GDP in Yr 1 GDP in Yr 2
in Yr1 in Yr1 in Yr 2 in Yr 2
Prices Prices Prices Prices

Yr 1 Yr 2 Yr 1 Yr 2 P1 x Q1 P1 x Q2 P2 x Q1 P2 x
Q1 Q2 P1 P2 Q2
Good X 6 11 .50 .40 3.00 5.50 2.40 4.40

Good Y 7 4 .30 1.00 2.10 1.20 7.00 4.00

Good Z 10 12 .70 .90 7.00 8.40 9.00 10.80

12.10 15.10 18.40 19.20

nominal Real GDP Real GDP nominal
GDP in Yr2 in Yr1 GDP
in Yr 1 in Yr 2
 REAL GDP: Percentage Change

(19.20-12.10)/12.10 x 100 = .587 x 100 =

58.7 percent
To understand this, let’s look at the sources of economic growth….where
does production come from?

“is a function of”

Y F A, K , L 
Real GDP

Productivity Capital Labor

Stock

Real GDP = Constant Dollar (Inflation adjusted) value of all goods and
services produced in the United States

Capital Stock = Constant dollar value of private, non-residential fixed assets

Labor = Private Sector Employment

Productivity = Production unaccounted for by capital or labor

Suppose we have the following Cobb-Douglas production function:

A 1% rise in capital A 1% rise in

raises GDP by 1/3% employment raises
GDP by 2/3%

1 2
Y  AK L 3 3

We can rewrite the production function in terms of growth rates to decompose

GDP growth into growth of factors:

1 2
%Y %A %K  %L 
3 3
Real GDP Growth
Productivity Growth Capital Growth
(observable) Employment
(unobservable) (observable)
Growth
(observable)
Our model of economic growth begins with a production function

1 2
Y  AK L 3 3
Real GDP

Productivity Capital Labor

Stock

Given our production function, economic growth can result

from
• Growth in labor
• Growth in the capital stock
• Growth in productivity
 Our simple model of economic growth 1 2
begins with a production function with
one key property – diminishing marginal
Y  AK L
3 3

product of capital

Change in Production Y
F ( A, K , L )
Y
Y
MPK  K
K

Change in Capital Stock

Y

As the capital stock K

increases (given a fixed
level of employment), the
productivity of capital
declines!!
K

An economy can’t grow through capital accumulation alone forever!

 Lets use an example. The current level of capital per capita will determine
the current standard of living (output per capita = income per capita)

y 1
y  Ak 3

1 g A 0
y 68 12
3
g L 2%
A 6
K 8,000
L 1,000

k
k 8
Economic Growth
Determinants
Rule of 72
72 ÷ annual % growth ≈ Years to double value
• Shows the number of years required for a
variable to double at a given annual rate of
growth
2010 Growth Rates and Doubling Time
(World Bank)
Country Annual Growth Rate Years to Double
United States 3.0% 24
Mexico 5.5% 13.09
Greece -3.5%
South Africa 2.8% 25.7
Australia 2.2% 32.7
Brazil 7.5% 9.6
Russian Federation 4.0% 18
India 8.8% 8.1
China 10.4% 7.0
Production Possibility Curve
• Shows trade-offs, Capital
Goods
opportunity costs and
efficiency A C

• Model also shows

economic growth as an
outward shift as society B
can increase production D

Consumer
Goods
 Business Cycle
Real Long-Run
GDP Growth Trend

Peak

Expansion

Recession

Trough

Time