Measuring a Nation’s
Income
10
Measuring a Nation’s Income
• Microeconomics
• Microeconomics is the study of how individual
households and firms make decisions and how they
interact with one another in markets.
• Macroeconomics
• Macroeconomics is the study of the economy as a
whole.
• Its goal is to explain the economic changes that
affect many households, firms, and markets at once.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
• GDP is the market value of all final goods and
services produced within a country in a given
period of time.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
• “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 (medical, legal, retail sales).
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
• “. . . 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.
THE MEASUREMENT OF GROSS
DOMESTIC PRODUCT
• “. . . 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).
GDP vs GNP
• Domestic Product – within a country
• National Product – owned by country’s citizens
• Example – Subaru plant – US GDP,
Japan’s GNP
• GNP - the market value of all final goods and
services produced by factors owned by a
country’s citizens in a given period of time.
Figure 1 The Circular-Flow Diagram
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Calculating GDP
• Expenditure Approach
• Income Approach
THE COMPONENTS OF GDP
• GDP (Y) is the sum of the following:
• Consumption (C)
• Durable goods
• Non-durable Goods
• Investment (I)
• Non-residential
• Residential (Housing)
• Inventories
• Government Purchases (G)
• Net Exports (NX) = Exports - Imports
Y = C + I + G + NX
Table 1 GDP and Its Components (Q2 2011)
Total (B$)
Percentage
GDP (Y)
15018.1
100%
Consumption (C)
10670.9
71%
Investment (I)
1882.7
13%
Government Purchases (G)
3027.0
20%
Net Exports (NX)
-562.5
-4%
GDP and Its Components
Government Purchases
20%
Net Exports
Investment
-4
%
13%
Consumption
71%
Income Approach
• National Income
•
•
•
•
Compensation of employees
Proprietor’s income
Corporate profits
Interest and rental income
57%
7%
9%
7%
• Depreciation
13%
• Indirect Taxes and Subsidies
7%
• Net Factor Payments to rest of the world
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.
Table 2 Real and Nominal GDP
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 measures the changes in the price level.
The GDP Deflator
• The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =
 100
Real GDP
The GDP Deflator
• Converting Nominal GDP to Real GDP
• Nominal GDP is converted to real GDP as follows:
Real GDP20XX
Nominal GDP20XX

 100
GDP deflator20XX
Nominal and Real GDP in the U.S.,
1965–2011
$16,000
$14,000
billions
$12,000
Real GDP
$10,000
(base year
2005)
$8,000
$6,000
Nominal
GDP
$4,000
$2,000
$0
1960
1970
1980
1990
2000
2010
GDP AND ECONOMIC WELLBEING
• 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.
Limitations of GDP
• Measures only income – ignores quality of
education, medical care, environment
• Excludes non-market production
• Excludes underground economy
Table 3 GDP, Life Expectancy, and Literacy
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.
Summary
• GDP is the market value of all final goods and
services produced within a country in a given
period of time.
• GDP is calculated through four components of
expenditure: consumption, investment,
government purchases, and net exports.
Summary
• 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.
• The GDP deflator—calculated from the ratio of
nominal to real GDP—measures the level of
prices in the economy.