Unit code: 11102
Model answer to E1Q2/01
UNIVERSITY OF BRISTOL
Unit Title:
Department of Economics
Introduction to Macroeconomics A
Lecturer:
Nigel W. Duck
Model answer for Macroeconomic Exercise 1 Question 2
Section 1.
GDP, GNP and NNP
Gross domestic product (GDP) measures the value of the output of final goods and services
produced within a country’s borders during a particular period of time. “Gross” indicates that
no deduction is made for the depreciation of capital and buildings that takes place during the
period (see below); “Domestic” indicates that only the output of final goods and services
produced within the country’s borders is counted; “Product” means that only currently
produced final goods and services are counted. So, UK GDP in 2000 measures the total
output of final goods and services produced within the UK’s borders during 2000.
GNP measures the value of the output of final goods and services produced during a period
by the factors of production owned by the economy’s nationals. Thus, UK GNP would
include fees paid by the Saudi Arabian government to UK construction companies building
roads in Saudi Arabia. UK GDP would not. Japanese GNP would include the portion of the
value of Japanese cars built in the UK that is attributable to Japanese management; UK GNP
would not include this item but UK GDP would.
Net national product (NNP) equals GNP less an allowance for the depreciation of capital and
buildings that takes place during the period.
Section 2.
Three measures of GDP (or GNP or NNP)
The value of GDP (or GNP or NNP) can be measured in three different and independent
ways all of which, since they are all measures of the same thing, should give the same
answer. The three different measures are known as the expenditure-based, the output-based,
and the income-based measures of GDP.
The expenditure based measure of GDP adds up the value of all expenditures on final goods
and services produced domestically within the period; the output-based measure adds up the
value of the output of final goods and services produced domestically within the period; and
the income-based measure adds up all the incomes earned from the domestic production of
final goods and services within the period. Since all currently produced output is bought by
someone - even if the firm which produced it does not sell it to someone else then it can be
considered “bought” by the firm producing it - and since all receipts must accrue to someone,
either as wages or profits or some other form of income - the three different measures will
give the same answer if everyone reports their income, sales receipts and output accurately.
Section 3.
Market prices and factor cost
Valuation of GDP can be based either on the prices paid by the final users (consumers), in
which case it is known as GDP at market prices, or it can be based on the cost of the factors
used to produce it, in which case it is known as GDP at factor cost. The two differ if there
are expenditure taxes, e.g. VAT, which raise the market price or if there are subsidies which
drive the market price lower.
To illustrate: Imagine there are no expenditure taxes and no subsidies and the economy
produces 1000 gallons of milk selling £1 a gallon. The value of that output measured at
market prices is £1000 and this is the amount available to go to the factors - e.g. farm owners
and farm labourers - used to produce the milk. So, valued at factor cost, output will also be
£1000. Here there is no difference between GDP at market prices and GDP at factor cost.
modans_1.doc
Unit code: 11102
Model answer to E1Q2/01
Now imagine there is a 10% expenditure tax on milk so that the price of milk is £1.10, and
assume that the economy still produces and sells 1000 gallons. At market prices the value of
the output is £1100 - this is the amount consumers spend on milk. But sellers of milk have to
pay £100 to the government and so the amount available to be distributed to the factors of
production is only £1000. Here GDP at market prices is £1100 whilst GDP at factor cost is
£1000.
Now imagine there is a 10% subsidy on milk so that the price of milk is £0.90, and assume
that the economy produces and sells 1000 gallons. At market prices the value of output is
£900 - this is the amount consumers pay. But sellers of the milk receive £100 from the
government and so the amount available to be distributed to the factors of production is
£1000. Here GDP at market prices is £900 whilst GDP at factor cost is £1000.
In general the expenditure-based measure of GDP at market prices equals the expenditurebased measure of GDP at factor cost plus expenditure taxes minus subsidies.
Expenditure figures are measured at market prices and hence are inclusive of taxes and
subsidies. If you add them up you get expenditure-based GDP at market prices. Subtracting
expenditure taxes and adding subsidies gives expenditure-based GDP at factor cost.
Since the income figures, by definition, show the payments going to factors, they incorporate
subsidies and exclude expenditure taxes. Adding each income item therefore gives the
income-based measure of GDP at factor cost.
Section 4. Calculations to answer question 2.
The calculations required to answer question 2 are summarised in the Table below. Taking
each item in turn:
#1 Consumption expenditure is an item measured from expenditure data; it is measured at
market prices and appears in the calculation of expenditure-based GDP.
#2 Profits are a form of income to owners of firms etc. and so enters in the income-based
estimate of GDP.
#3 Central government expenditure is an item of expenditure and so appears in the
expenditure-based column. It will be measured at market prices. Strictly this item should be
termed central government expenditure on goods and services - it should not include
government transfer payments such as payments to the unemployed.
#4 Depreciation is the allowance mentioned above to obtain NNP from GNP.
#5 Net property income from abroad is a measure of income earned abroad by home
economy nationals minus income earned by foreigners from their operations in the domestic
economy. As explained above GNP minus this item is a measure of GDP.
#6 Rent is a form of income and appears therefore in the income-measure of total output.
#7 Local government expenditure is an item of expenditure like central government
expenditure and so appears as an item in the expenditure-based measure of output.
#8 Subsidies as explained above are to be added to (and expenditure taxes subtracted from)
GDP at market prices to GDP at factor cost.
#9 & #13 Income from self-employment and employment are obviously forms of income and
therefore appear in the income-based measure of GDP.
#10 & #14 Imports of goods and services are negative items in the expenditure-based
measure of output: because we are measuring output produced domestically then expenditure
on goods and services produced abroad must be subtracted from total expenditure.
#11 Profits from companies are a form of income to shareholders etc. and so appear as an
item in the income-based measure of output.
#12 & #16 Exports of goods and services are positive items in the expenditure-based measure
of output: because we are measuring output produced domestically then expenditure by
modans_1.doc
Unit code: 11102
Model answer to E1Q2/01
foreigners on goods and services produced domestically abroad must be added to find
expenditure-based output.
#15 Taxes on expenditure as explained above are to be subtracted from GDP at market prices
to give GDP at factor cost.
#17 Investment expenditure is a form of expenditure and therefore appears in the
expenditure- based measure of output.
#18-#25 are all clearly items in the output-based measure of output.
(i) So expenditure-based GDP at factor cost equals expenditure-based GDP at market prices
plus subsidies minus taxes on expenditure, that is 570+16-71 = 515. This equals GDP at
factor cost given by the sum of the other two columns.
(ii) GNP at market prices equals GDP at market prices plus Net Property Income from
Abroad = 570 +3.3 = 573.3. Net National Product equals Gross National Product minus an
allowance for the depreciation that has occurred in buildings/machinery over the period.
Hence NNP at market prices equals GNP at market prices minus Depreciation = 573.3-60 =
513.3.
Table Different Measures of Output
Expenditure
Output
Income
Item #1.
375
Item #18.
19
Item #13.
355
Item #3.
80
Item #19.
12
Item #9.
55
Item #7.
33
Item #20.
110
Item #11.
61
Item #17.
106
Item #21.
10
Item #2.
3
Item #12
115
Item #22.
35
Item #6.
41
Item #23.
89
Item #24.
40
Item #25.
200
Item #16.
31.5
Less
Item #10.
-130.5
Item #14.
-40
_____
GDP at market prices 570
Less Item #15.
-71
Plus Item #8.
16
_____
GDP at factor cost
Plus Item #5.
515
3.3
GNP at factor cost
518.3
Plus Item #15.
71
Less Item #8.
-16
_____
GNP at market prices 573.3
Less #4.
60
NNP at market prices 513.3
modans_1.doc
_____
GDP at factor cost 515
___
GDP at f.c. 515