Measures of Economic Activity Unit 2.1 What are GNI, GDP, and GNP? How does circular flow tell us about these forms of economic activity? Why should one be cautious about national income statistics?

Quick review: National income (value of output, or GDP)=a.k.a. aggregate output=total output –not always true CFI model shows that value of aggregate output produced=total income generated in producing that output=expenditures made to purchase that output GDP-the market value of all final goods and services produced in a country over time (usually annual) –Most common measure of value of aggregate output

Calculating GDP (Factor) Income method -adding up all income earned by factors of production within a country in a year –Wages earned by labor (employment income) –Rent earned by land (rental income) –Interest earned by capital (household net interest) –Profits earned by entrepreneurship (self- employment income) Compiled figures give us GDP at factor cost, adjusted for statistical discrepancies –Furthest extent based on real use of FOP, used to compare with expenditure method

Only those incomes that are come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude: Transfer payments e.g. the state pension; income support for families on low incomes; unemployment pay and welfare assistance Private transfers of money from one individual to another Income not registered with the IRS –Every year, billions of dollars of activity are not declared to the tax authorities –This is known as the shadow economy or black economy Published figures for GDP by factor incomes will be inaccurate because much activity is not officially recorded – including subsistence farming, barter transactions and the share economy mentioned above.

Calculating GDP Expenditure method- measures the total amount of spending to buy final goods and services in a country in a year –“final”=g/s ready for final use, not intermediate Basically looks at total spending over time and divides spenders into groups in order to follow flows/see who is spending and on what; equation: C+I+G+(X-M) –Consumption: divided into durables (cars, refrigerators), non- durables (clothing, Coca-Cola), and services (hotel stays, repairs) –Investment here refers only to firms’ expenditures on capital goods (fixed capital formation) –Why do we subtract imports? They involve domestic spending on g/s produced in other countries, so must be taken out of total GDP expenditures

Calculating GDP Output method-measures the value of each g/s produced in the economy in a year (total output value) and then subtract cost of factor use Must avoid “double counting” of transfer payments; count only final goods, and NOT the value added on to the good between output at each stage –Example next slide!

Value-Added and Contributions to a Nation’s GDP Output method of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value-added. –Value added is the increase in the value of goods or services as a result of the production process Value-added = value of production - value of intermediate goods EXAMPLE 1: You buy a ham and mushroom pizza from Dominos at a price of $ This is the final retail price and will count as consumption. The pizza has many ingredients at different stages of the supply chain – for example tomato growers, dough, mushroom farmers and also the value created by Dominos themselves as they put the pizza together and get it to the consumer. EXAMPLE 2: Some products have a low value-added, for example those really cheap t-shirts that you might find in a supermarket for little more than $5. These are low cost, high volume, low priced products. EXAMPLE 3: Other goods and services are such that lots of value can be added as we move from sourcing the raw materials through to the final product. Examples include designer jewelry, perfumes, meals in expensive restaurants and sports cars

GDP vs. GNI/GNP What happens when the output of an economy is produced with factors of production belonging to foreigners? Clue is in whether production is: –Domestic: produced within the country’s boundaries (where produced, but not who owns) –National: produced using a given country’s factors (who owns, not where produced) –i.e., U.S. multinational firm in India sends its profits back to the U.S.—output is produced in India, but profit income is received by U.S. residents Does profit count as Indian or U.S. income and output? The profit income is included in Indian GDP because it is created by production taking place in India; However, is also part of U.S. GNI (see next slide) because it is income received by U.S. residents

GDP—account of money value of g/s produced within an economy in a year, regardless of domestic or foreign ownership of FOP Gross National Income (GNI), formerly known as Gross National Product (GNP)—measures total income of the country’s residents, regardless of where income originates –Takes into account foreign ownership in the economy and domestic ownership of firms abroad –GDP + property income from abroad – property income paid abroad = GNI –GDP + net property income from abroad = GNI Explanatory video

Real vs. Nominal GDP/GNI Video clip Video clip Nominal value—money value; value measured in terms of current price (nom=name; face value) Problem=value of money continuously changes (inflation) –Economists try to avoid nominal GDP figures Since we measure GDP using money terms, the value of output has been inflated by the increase in prices –Output calculated by Q X P Real value—measurement of value taking into account changes in prices over time, in order to make meaningful comparisons of GDP over time –Creates “constant price” Allows us to compare nominal value with base value, or base year –base year--used for comparison for the level of a particular economic index –The arbitrary level of 100 is selected so that percentage changes (rising or falling) easily shown –Ex: find rate of inflation between 2005 and 2010; one would make calculations using 2005 as the base year, or the first year in the time set HL material: GDP deflator: GDP real = GDP nom base year___x 100 Price index of base year Since GDP is composed of millions of different goods, it’s impossible to measure it in actual quantities, so we measure it in value terms—Q X P.

Total and per capita GDP/GNI “Gross” is total amount made as a result of some activity. “Net” is the amount left over after all deductions are made. Net value is not allowed to be made lower. Per capita (“per person” or “per head”)—takes the total value (output, income, expenditure) and divides it by the total population of a country –GDP/GNI divided by the total population Ex: Ireland’s GDP 2001: €114,744; divided by the population, we get per capita GDP €29,889

Word of advice: Beware of averages when considering per capita GDP/GNI, either nominal or real! Income distribution can be such that a small proportion of the population accounts for most of the income; this does not show in the per capita GDP/GNI figures.