Measuring a Nations Income
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Overview
Why an economys total income equals
its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
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.
Microeconomics is the study of how
individual households and firms make
decisions and how they interact with one
another in markets.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Understanding the Economy
Identify the important areas:
Total output (and income)
The average of prices
Resource employment
Measure the important areas using:
Real Gross Domestic Product
Consumer Price Index
Monthly unemployment rate
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Circular-Flow Diagram
Product Market
$
Households
Businesses
$
Market for Factors
Principles of Macroeconomics: Ch 10
of Production
$
Second Canadian Edition
Figure 1 The Circular Flow
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
6
Copyright 2004 South-Western
Two Methods of Computing
An Economys Income
Expenditure Approach:
Sum the total expenditures by households
(from the top portion of the circular flow).
Resource Cost or Income Approach:
Sum the total wages and profit paid by firms
for resources (from the bottom portion of the
circular flow).
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Economys
Income and Expenditure
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.
The forces of supply and demand
determine the market equilibrium price and
quantity that is produced and exchanged.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Overview
Why an economys total income equals
its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Economys
Income and Expenditure
A measure of the income and
expenditures of an economy is Gross
Domestic Product (GDP).
Gross Domestic Product measures:
an economys total expenditure on newly
produced goods and services and the total
income earned from the production of these
goods and services.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Gross Domestic Product
The total market
value of all final
goods and services
produced during a
given period of
time within a
country, region, or
province.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Important Features of GDP
Output is valued at market-determined
prices.
Output is measured in dollar terms.
GDP records only the output of final
goods. We want to count production
only once.
Represents the amount of money one
would need to purchase a years worth of
the economys production of all final
goods.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
What Is and What Is Not
Counted in GDP?
GDP includes all items produced in
the economy and sold legally in
markets.
GDP does not include items
produced and consumed at home
that never enter the marketplace. It
does not include items produced and
sold illicitly, such as illegal drugs.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Gross National Product
The total market value
of all final goods and
services produced
during a given period
of time by the
nations residents,
regardless of the
place produced.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Quick Quiz!
Which contributes
more to GDP: the
production of a pound
of hamburger or the
production of a pound
of caviar? Why?
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Three Other Measures of
Income
Net National Product (NNP):
Total income of residents of a nation after
subtracting capital consumption allowances.
Personal Income:
The income that households and noncorporate businesses receive.
Disposable Personal Income:
The income that households and noncorporate businesses have left after taxes.
Principles of Macroeconomics: Ch 10
SecondEdition
Canadian Edition
First Canadian
Overview
Why an economys total income equals
its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Components of GDP
GDP (Y) is the sum of:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Four Components of
GDP
Consumption (C):
Is the spending by households on goods
and services
e.g. buying clothing, food, movie tickets
Investment (I):
Is the purchases of capital equipment
and structures
e.g. factory, houses, etc.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
The Four Components of
GDP (G):
Government Purchases
Includes spending on goods and services by
local, provincial and federal governments
(e.g. roads, police, etc.).
Does not include transfer payments,
because it is not made in exchange for
currently produced goods or services.
Net Exports (NX):
Exports minus imports.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Components of
Measurement
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Components of
Measurement
Consumption
57%
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Components of
Measurement
Investment
Consumption
17%
57%
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Components of
Measurement
Government
Purchases
21%
Investment
Consumption
17%
57%
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Components of
Measurement
Net Exports
Government
Purchases
5%
21%
Investment
Consumption
17%
57%
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Quick Quiz!
List the four
components of
expenditure.
Which is the
largest?
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Overview
Why an economys total income equals
its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
1) To compute the total value of different goods and services, the
national income accounts use market prices.
Thus, if
$0.50
$1.00
GDP = (Price of apples Quantity of apples)
+ (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3)
GDP = $5.00
2) Used goods are not included in the calculation of GDP.
3) The treatment of inventories depends on if the goods are stored or
if they spoil. If the goods are stored, their value is included in GDP.
If they spoil, GDP remains unchanged. When the goods are finally sold
out of inventory, they are considered used goods (and are not counted).
Principles of Macroeconomics: Ch 10
28
Second Canadian Edition
4) Intermediate goods are not counted in GDP only the value of
final goods. Reason: the value of intermediate goods is already
included in the market price. Value added of a firm equals the
value of the firms output less the value of the intermediate goods
the firm purchases.
5) Some goods are not sold in the marketplace and therefore dont
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.
Principles of Macroeconomics: Ch 10
29
Second Canadian Edition
Lets see how real GDP is computed in our apple and
orange economy.
For example, if we wanted to compare output in 2002 and output
in 2003, we would obtain base-year prices, such as 2002 prices.
Real GDP in 2002 would be:
(2002 Price of Apples 2002 Quantity of Apples) +
(2002 Price of Oranges 2002 Quantity of Oranges).
Real GDP in 2003 would be:
(2002 Price of Apples 2003 Quantity of Apples) +
(2002 Price of Oranges 2003 Quantity of Oranges).
Real GDP in 2004 would be:
(2002 Price of Apples 2004 Quantity of Apples) +
(2002 Price of Oranges 2004 Quantity of Oranges).
Principles of Macroeconomics: Ch 10
30
Second Canadian Edition
Principles of Macroeconomics: Ch 10
31
Second Canadian Edition
GDP Deflator = Nominal GDP
Real GDP
Nominal GDP measures the current dollar value of the output of
the economy.
Real GDP measures output valued at constant prices.
The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects whats happening to the overall level of prices in the economy.
Principles of Macroeconomics: Ch 10
32
Second Canadian Edition
Real versus Nominal GDP
GDP is the market value of the
economys current production, referred
to as Nominal GDP.
Real GDP measures any given years
total output in constant prices.
An accurate view of the economy
requires adjusting nominal to real GDP,
using the GDP Price Deflator.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP Price Deflator
The GDP Price Deflator is a price index
that uses a bundle of all final goods and
services.
It tells us the rise in nominal GDP that is
attributable to a rise in prices.
Converting Nominal GDP to Real GDP:
Real GDP20xx =
(Nominal GDP20xx ) (GDP deflator20xx)X100
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Quick Quiz!
Define Real and
Nominal GDP.
Which is a better
measure of
economic wellbeing? Why?
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP and Economic Well-Being
GDP Per Person tells us the income and
expenditure of the average person in the
economy.
It is a good measure of the material wellbeing of the economy as a whole.
More Real GDP means we have a higher
material standard of living by being able to
consume more goods and services.
It is NOT intended to be a measure of
happiness or quality of life.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
GDP and Economic Well-Being
Some factors and issues not in GDP that
lead to the well-being of the economy:
Factors that contribute to a good life such as
leisure.
Factors that lead to a quality environment.
The value of almost all activity that takes
place outside of the markets, e.g. volunteer
work and child-rearing.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Overview
Why an economys total income equals
its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Y
Y == CC ++ II ++ G
G ++ NX
NX
Totaldemand
demand
Total
fordomestic
domestic
for
output(GDP)
(GDP)
output
composed
isiscomposed
of
of
Investment
Investment
spendingby
by
spending
businessesand
and
businesses
households
households
Consumption
Consumption
spendingby
by
spending
households
households
Government
Government
purchasesof
ofgoods
goods
purchases
andservices
services
and
Netexports
exports
Net
ornet
netforeign
foreign
or
demand
demand
This is the called the national income accounts identity.
Principles of Macroeconomics: Ch 10
39
Second Canadian Edition
Principles of Macroeconomics: Ch 10
40
Second Canadian Edition
