Principles of Economics
Final term
Topic 1: Measuring National
Income - GDP
Objectives and Instruments of
Macroeconomics
Objectives:
Output: High level and rapid growth of output
Employment: High level of employment with
involuntary unemployment
Price-level stability
2
Instruments of Macroeconomics
Instruments
Monetary policy:
Controlling the money supply to determine
the interest rates
Fiscal Policy:
Government expenditure
Taxation
3
Measuring National Income
Three main statistics of macroeconomics:
1. GDP—Gross domestic product, which tells us
the nation’s total income and the total
expenditure on its output of goods and services
2. CPI—the Consumer Price Index, which
measures the level of prices (inflation)
3. Unemployment rate —this tells the fraction of
workers who are unemployed.
4
Economic Models
Economists use models to simplify reality in
order to improve our understanding of the
world.
The most basic macroeconomic model
include:
The Circular Flow Diagram
Figure 1 The Circular-Flow Diagram
MARKETS
Revenue FOR Spending
GOODS AND SERVICES
•Firms sell
Goods Goods and
•Households buy
and services services
sold bought
FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production
Factors of MARKETS Labor, land,
production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of money
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The Circular-Flow Diagram
The circular-flow diagram is a visual model of the
economy that shows how money flow through
markets among households and firms.
THE MEASUREMENT OF
GROSS DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure
of the income and expenditures of an
economy.
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).
Hallmark Card: Paper is an intermediate good.
“. . . Goods and Services . . . “
It includes both tangible goods (food, clothing,
cars) and intangible services (haircuts,
housecleaning, doctor visits).
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.
GDP includes all items produced in the
economy and sold legally in markets.
REAL VERSUS NOMINAL GDP
Nominal GDP values the production of goods
and services at current prices.
REAL VERSUS NOMINAL GDP
Real GDP values the production of goods and
services at constant prices.
Not Counted in GDP
What Is Not Counted in GDP?
GDP excludes most items that are produced
and consumed at home and that never enter
the marketplace.
It excludes items produced and sold illicitly,
such as illegal drugs.
THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
THE COMPONENTS OF GDP
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of
new housing.
Investment (I):
The spending on capital equipment,
inventories, and structures, including new
housing.
THE COMPONENTS OF GDP
Government Purchases (G):
The spending on goods and services by local,
state, and federal governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
Net Exports (NX):
Exports minus imports.
GDP & Components of Expenditure
GDP Government
Consumption Purchases
Nondurable goods Defense
Durable goods Non-defense
Services Net Export
Investment Export
Nonresidential fixed Import
investment
Residential fixed
investment
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GDP deflator
GDP deflator comes from nominal and real
GDP
GDP deflator : Nominal GDP/Real GDP
*100
With GDP deflator we can also measure the
difference in price levels of good and services
in a country at a given timeframe
GDP AND ECONOMIC WELL-
BEING
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.
Higher GDP per person indicates a higher
standard of living.
GDP AND ECONOMIC
WELL-BEING
GDP is not a perfect measure.
Some things that contribute to well-being are
not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place
outside of markets, such as the value of the
time parents spend with their children and the
value of volunteer work.
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 divided among 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.
Summary
GDP is a good measure of economic well-
being because people prefer higher to lower
incomes.
It is not a perfect measure of well-being
because some things, such as leisure time
and a clean environment, aren’t measured by
GDP.
