ECN 202

Principles of Macroeconomics
Instructor: Nabila Maruf
Independent University, Bangladesh
Lecture Note: 2
Chapter 10: Measuring A Nation’s Income

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Measuring A Nation’s Income
Microeconomics is the study of how households and
firms make decisions and how they interact in
markets.

Macroeconomics is the study of economy-wide

phenomena including inflation, unemployment and
economic growth.

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The Economy’s Income and Expenditure
Gross Domestic Product (GDP) measures two
things at once:
The total income of everyone in the economy
The total expenditure on the economy’s output of goods
and services.
For an economy as a whole, income must equal
expenditure.
Why is this true?
Every transaction has two parties: a buyer and seller.

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The Economy’s Income and Expenditure

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The Measurement of Gross Domestic Product
Definition of GDP: Gross Domestic Product (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…”

“You can’t compare apples and oranges”.
Yet GDP does exactly that.
Adds different kinds of products into single measure of
the value of economic activity.
To do this, it uses market prices.

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The Measurement of Gross
Domestic Product
 “…of All…”
GDP tries to be comprehensive.
Includes
 all items produced in the economy and sold legally in
markets.
 Excludes
 Most items produced and sold illicitly.
 Most items that are produced and consumed at home.

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The Measurement of Gross
Domestic Product
“…Final…”
GDP includes only the value of final goods.
The value of intermediate goods is already included in
the prices of the final goods.
Exception – when an intermediate good is produced and
added to firm’s inventory for use or sale at a later date.

“…Goods and Services…”

GDP includes both tangible goods (food, cars) and
intangible services (haircuts, doctor visits).
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The Measurement of Gross
Domestic Product
“…Produced…”
GDP includes goods and services currently produced.

“…Within a Country…”
GDP includes items produced domestically, regardless
of the nationality of the producer.

“…In a Given Period of Time.”

GDP measures the value of production within a specific
interval of time; that is a year or a quarter.
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The Components of GDP
Y = C + I + G + NX
Where,
Y = GDP
C = Consumption
I = Investment
G = Government purchases
NX = Net Exports

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The Components of GDP
Consumption: Spending by households on goods
and services with the exception of purchases of new
housing.
Example: automobiles, food, medical care, etc.

Investment: Spending on capital equipment,

inventories, and structures including household
purchases of new housing.

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The Components of GDP
Government purchases: spending on goods and
services by local, state and federal governments.
Transfer payments are not included in government
purchases.

Net Exports: spending on domestically produced

goods by foreigners (exports) minus spending on
foreign goods by domestic residents (imports).
NX = Export - Import

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The Components of GDP

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Three Approaches to Measure GDP
The three approaches to measure GDP are:

The Expenditure Approach

The Income Approach

The Production Approach (Value-Added Approach)

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Real Versus Nominal GDP
Total Spending rises from one year to the next because
1. The economy is producing a larger output of goods and
services.
2. Goods and services are being sold at higher prices.

Nominal GDP: The production of goods and services

valued at current prices.

Real GDP: The production of goods and services at

constant prices.
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Real Versus Nominal GDP
Real GDP:
A measure of the amount produced that is not affected
by price.
One year is designated as a base year.

For the base year nominal GDP and Real GDP are
equal.

Real GDP is a better gauge of economic well-being

than is nominal GDP.
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Real Versus Nominal GDP

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

The GDP deflator is calculated as follows:

GDP Deflator = Nominal GDP  100
Real GDP

The GDP deflator for the base year always equals 100.

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The GDP Deflator
The GDP deflator
measures the current level of prices relative to the level
of prices in the base year.
is used to monitor the average level of prices in the
economy and thus the inflation rate.
takes out inflation out of nominal GDP.

Inflation – a situation in which the economy’s overall

price level is rising.

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The GDP Deflator
Inflation Rate is the percentage change in some
measure of the price level from one period to the next.

The inflation rate between two consecutive years using

GDP deflator is computed as follows:

Inflation Rate = GDP deflator – GDP deflator Year 2

in year 2 in year 1 100
GDP deflator year 1

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Is GDP a Good Measure of Economic Well-
Being?
GDP – the best single measure of the economic well-
being of a society
Measures economy’s total income and total expenditure.
Nations with larger GDP
 Afford better healthcare
 Afford better educational systems

GDP does not directly measure those things that make

life worthwhile, but it does not measure our ability to
obtain many of the inputs into a worthwhile life.

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Is GDP a Good Measure of Economic Well-
Being?
GDP is not, however, a perfect measure of well-being
Some things that contribute to good life are left out of
GDP
 Leisure
 Activities that takes place outside markets
 Quality of environment
 Income distribution

Therefore, GDP is a good measure of economic well-

being for most – but not all – purposes.

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Other Measures of Income
Gross National Product (GNP):
GNP is the national income earned by a nation’s permanent
residents called nationals.
It includes the income that our citizens earn abroad.
It excludes the income that foreigners earn here.

Net National Product (NNP):

NNP is the total income of a nation’s residents (GNP) minus
losses from depreciation.
Depreciation is the wear and tear on the economy’s stock of
equipments and structures.
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Other Measures of Income
National Income:
Total income earned by a nations residents in the production
of goods and services.

Personal Income:
Income that households and noncorporate businesses receive.

Disposable Personal Income:

Personal Income minus personal taxes and certain nontax
payments.

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