ECN 202: Principles of Macroeconomics Nusrat Jahan Lecture-2 Measuring a Nation’s Income

 When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.  For an economy as a whole, income must equal expenditure because:  Every transaction has a buyer and a seller.  Every dollar of spending by some buyer is a dollar of income for some seller.

 Economic interaction among agents in the Economy  The Circular Flow Model It shows how dynamic market creates continuous, repetitive flows of goods and services, resources and money.

Measuring Economic Success Economic success is measured by looking at 3 key variables- 1. Gross Domestic Product (GDP) 2. Unemployment and 3. Inflation 1.Gross Domestic Product (GDP) 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...” 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 (haircuts, housecleaning, doctor visits).  “... 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.  “... 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). 1.Gross Domestic Product (GDP) (Continued…)

 GDP does not include: Intermediate goods Goods produced in the past Non-market production Black market Underground economy Household production Methods of Calculating GDP  Value Addition Approach  Expenditure Approach  Income Approach 1.Gross Domestic Product (GDP) (Continued…)

 GDP using value-added approach Final value of output = sum of value-added by all firms in the economy Methods of Calculating GDP (continued…)

 GDP Using Expenditure Approach In this approach all the expenditures done in the economy are added to calculate GDP as Expenditure = Income. GDP = C + Ig + G + NX Where,  C = Consumption Expenditure: Spending by households on goods and services, with the exception of purchases of new housing  Ig = Gross Investment: Spending on capital equipment, inventories and structures, including household purchases of new housing  G = Government Expenditure: Spending on goods and services by local, state and federal governments  NX = Net Export: Spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports) Methods of Calculating GDP (continued…)

 GDP Using Income Approach GDP can also be measured by the income generated during production GDP = wages + rent+ interest + profits – net factor income from abroad + capital consumption allowance (depreciation) + indirect business taxes Methods of Calculating GDP (continued…)

 Distinction between GDP and GNP Gross National Product (GNP) = GDP + net factor income from abroad  Nominal GDP and Real GDP  Nominal GDP: The production of goods and services valued at current prices.  Real GDP: The production of goods and services valued at constant prices

The Economy Produces Two Goods: Food and Clothing YearPCPC QCQC PFPF QFQF Nominal GDPReal GDPGDP Deflator Nominal GDP is calculated by adding the amounts spent on each product. Real GDP is calculated by using the prices of food and clothing from 1997 to calculate the amounts spent in future years. GDP Deflator is Nominal GDP/Real GDP.  GDP Deflator: A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.