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UNIT 1
NATIONAL INCOME AND NATIONAL OUTPUT
The Scoreboard for economic performance is the National Income accounting system. Simon
Kuznets developed the basic concepts and outlined the measurement procedures during the
1920s.
DEFINITION of Gross Domestic Product (GDP): It is the market value of all final goods and
services produced within a country during a specific period, usually one year.
2. Counts only CURRENT PRODUCTION i.e., only the goods and services produced during
the specified period. Examples : Annual GDP (Jan 1st Dec 31st ) or quarterly GDP (Jan 1st
March 31st ).
- Purchase of a used car (made in 2005) would not be counted in 2007 GDP.
- However if a used car dealer purchase a used car (made in 2005 for $200,000 refurbishes it and
sell it for $ 300,000 in 2007, the VALUE ADDED = $ 100,000 is included in 2007 GDP.
Real GDP is calculated using the constant prices or base year prices. Real GDP is GDP adjusted
for changes in the price level.
Nominal GDP is calculated using current year prices. It is often referred as the money GDP.
GDP DEFLATOR: A price index that reveals the cost during the current period of purchasing
the items included in GDP relative to the cost during a base year. Because a base year is
assigned a value of 100, as the GDP deflator takes on values greater than 100, it indicates the
prices have risen.
PRICE INDEX:
Inflation is generally measured by the change in the sum of index of the general price level
(average of all the prices in the economy). An index number expresses the cost of a market
basket of goods relative to its cost in same base period.
Consumer Price Index (CPI) :
CPI is the common measure of the price level. A CPI is a price index computed each month by
the STATIN using a bundle that is meant to represent the market basket purchased monthly by
the typical urban consumer.
CPI in a given year = Value of market basket of goods in given year X 100
Cost of market basket in base year
Inflation rate in a given year = CPI in a given year CPI in previous year X 100
CPI in previous year
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DOLLARS THE COMMON DENOMINATOR FOR GDP
Economies produce different type of goods which need to be measured in different measurement
units, for example, solid goods (wheat, cloth, bread etc.) are measured in pounds or kilos, yards
or meters etc, liquids (milk, oil etc.) are measured in gallons or liters. Since all these goods
cannot be added together, all the goods are converted into market values and then added.
1. ALL FINANCIAL TRANSACTIONS : Since they do not involve current production. eg.
Purchases and sales of stocks and bonds DO NOT count because only ownership rights are
transferred.
- However, if a stockbroker made the purchase of stocks on your behalf and charges a
COMMISION FEE, this fee (the cost of a service rendered) is COUNTED IN CURRENT GDP.
2. ALL PRIVATE AND PUBLIC SECTOR INCOME TRANSFERS. A gift of $ 50,000
towards payment of school fee.
a. Aunts gift of $ 50,000 towards payment of school fee.
b. Social Security or welfare payments.
c. Student grants / bursaries.
3. NON-MARKET PRODUCTION : These are DO-IT YOURSELF activities that does not
involve a market production. Examples. a. mowing the lawn, b. painting the house.
4. UNDERGROUND ECONOMY: Market transactions that take place outside RECORDED
MARKET CHANNELS.
a. Some are UNREPORTED LEGAL market transactions just to evade taxes.
(eg. What is called Robot/ illegal taxis in Jamaica.)
b. Some are ILLEGAL ACTIVITIES such as drug trafficking and prostitution.
1. GDP fails to count LEISURE and HUMAN COST associated with the production of goods
and services.
Example: One country attains a US $ 20,000 per capita GDP. (GDP divided by population) with
an average work week of 30 hour. Another country attains the same US $ 20,000 per capita GDP
with an average work week of 50 hours. Internationally Both countries are recorded as having
the same GDP. HOWEVER, the first country is BETTER OFF because it produces MORE,
LEISURE or SACRIFICES LESS HUMAN COST.
DOUBLE COUNTING
An accounting problem that occurs when measuring output. The problem is that final output is
made up of many stages. Hence, you must take care either to (A) include the extra value added at
each stage of production or (B) only record the value of FINAL output. Sales at intermediate
stages of production are not counted by GDP because the value uses good. (IMPORTANT TO
NOTE when using the OUTPUT METHOD to calculate the GDP).
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GDP AND THE STAGES OF PRODUCTION
1. Farmers Wheat
2. Millers Flour
A measurement system used to estimate national income and its components. This is one
approach in measuring an economys aggregate performance.
1. Consumption [C] : There are three main categories; Durable goods, non-durable goods and
services.
2. Gross Private Domestic Investment [I] : refers to the purchase of new capital housing,
plants, equipment and inventory. It includes expenditures for: replacements of machinery,
equipment and building worn out during the year, and net additions to the stock of capital goods.
3. Government Consumption and Investment [G]: includes expenditure by state and local Govt.
for final goods (eg. schools) and services (eg. military salaries).
4. Net Exports [X-M]: is the difference between Exports and Imports. This figure can be
positive (developed countries) or negative (developing countries).
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II. INCOME EXPENDITRE APPROACH:
Looks at GDP in terms of who receives it as Income not who purchases it. The four (4)
components are National Income, Depreciation, Indirect Taxes minus subsidies, and Net factor
payments to the rest of the world.
National Income includes income from employment, self-employment, profits and rent.
A. NOMINAL GDP : is GDP expressed at current prices. It is often called MONEY GDP.
It reflects a). changes in the real size of the economic variable.
b) Inflation a change in the general level of prices.
B. REAL GDP : is GDP adjusted for changes in the price level. It uses the constant prices.
Real Values eliminate the impact of change in the price level. leaving only the
real changes in the size of an economic variable.
We can use the GDP deflator together with nominal GDP to measure Real GDP.
THE GDP DEFLATOR : is a price INDEX that reveals the cost of purchasing the items included
in GDP during the period relative to the cost of purchasing these same items during the base
year.
Since the BASE YEAR is assigned a value of 100, as the GDP deflator takes on values greater
than 100 ( or the base year) it indicates that prices have risen.
Year Nominal GDP (US $ Billion) GDP Deflator Real GDP (US $ Billion)
2002 $ 6,244 100 $ 6,244
2005 $ 7,246 107.5 ?
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GDP - A GOOD MEASURE DESPITE ITS LIMITATIONS
GDP was designed to measure THE VALUE of the goods and services PRODUCED in the
MARKET SECTOR. In spite of its shortcomings and limitations REAL GDP is a
REASONABLY PRECISE measure of the rate of output in the market and how that output rate
is changing.
Adjusted for changes in prices, ANNUAL and QUARTERLY (Real ) GDP data provide the
information required to track the performance level of the economy.
]
GNP A closely related measure to GDP is the total market value of all final goods and
services produced by the citizens of a country.
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