EC 102: AUGUST 20

Gross Domestic Product (GDP)

- measure of income and expenditures in economy

• total market value of all final goods and services produced within a country in a
given period of time

◦ value

▪ monetary terms

▪ monetary terms because you can’t just add different products

together and get that sum

◦ final goods

▪ finished goods intended for consumption

• measures the output that is produced within the geographical borders of a

country

◦ given a period of time

Ways of Computing GDP

- expenditure approach

• GDP (Y) is the sum of

◦ consumption (C)

▪ spending by households on goods and services, with the exception

of purchases of new housing

▪ largest component of GDP

▪ primarily a function of income and taxes

◦ investment (I)

▪ spending on capital equipment, inventories, and structures,

including new housing

▪ function of interest rates, level of investor confidence

▪ some goods that are not consumed at home are sent to offices and
businessesF

◦ government purchases (G)

▪ spending on goods and services by local, and national

governments

◦ net exports (NX)

▪ exports minus imports

▪ exports are largely affected by foreign exchange rates

• Y = C + I + G + NX

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- income approach

◦ GDP is made up of:

▪ employee compensations (salaries, wages, and allowances) for

labor services rendered

▪ rental income for use of property and equipment

▪ corporate profits earned by shareholders of businesses

▪ interest payment in return lending financial resources

▪ depreciation

▪ indirect business taxes

• value-added approach

◦ GDP is the summation of the Gross Value-Added (GVA) from 3 major

production sectors in the economy

▪ agriculture

▪ industry

▪ services

GDP by Expenditure Shares Components

• household final consumption expenditure (consumption)

◦ purchase of goods and services by households (both durable and non-

durable)

• government final consumption expenditure (government purchases)

◦ wages of government employees, expenses on supplies, costs on

infrastructure projects, military spending, etc

◦ does not include transfer payments (charities and money for the needy, or
when the government transfers money to you for aid), subsidies, and
other government benefits or items that do not involve the purchase or
payment for a good

• capital formation (investment)

◦ purchase of goods for future use

◦ business fixed investment (i.s plant, equipment)

◦ residential fixed investment (i.e housing)

◦ inventory investment

• net exports (exports-imports)

◦ difference between value of exported goods and services, and value of

imported goods and services

◦ exports: goods produced at home and sold abroad

◦ imports: goods sold at home but produced abroad

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GDP vs GNI
• gross national income (GNI) = GDP + net primary income (NPI)

◦ NPI = earnings of local citizens working abroad (OFWs)

• GDP does not include NPI

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EC 102: AUGUST 22
3 Ways of Looking at GDP
• products (always together with services) -> Y= product or value added from
agriculture + product or value added from industry + product or value added
from services

• expenditure -> Y = C + I + G + NX

• income -> Y = employee compensation + rental income + corporate profits +

interest payment

GDP by Industrial Origin (GVA Approach) Components

• agriculture, hunting, fishery, and forestry

◦ agricultural aspect is country-specific

◦ agriculture includes production of

▪ palay

▪ corn

▪ coconut

▪ sugarcane

▪ banana

▪ other crops

▪ livestock

▪ poultry

▪ agricultural activities

▪ services

◦ fishery

◦ forestry

• industry

◦ mining and quarrying

◦ manufacturing

◦ construction

◦ electricity, gas, and water

• services

◦ transportation, communication, and storage

◦ trade (e.g. retail, not international trade)

◦ finance (e.g. banking)

◦ ownership of dwellings and real estate

◦ private services (e.g. tourism, BPOs, personal services)

◦ government services

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Limitations of GDP and GNI
• population size must be taken into account

◦ better to use real GDP per capita

◦ better to have a smaller population with higher GDP than higher

population with high GDP

• does not reflect income distribution

◦ better to use Gini coefficient

◦ two countries can have the same GDP and population, but depends on
the distribution

• does not accurately reflect the quality of life

◦ GDP is simply a measure of productivity

◦ better to use HDI or Gross National Happiness

▪ HDI = human development index

▪ HDI is the formula used by the UN

▪ HDI includes GDP, education, and the health of each person

• includes production made necessary by “bads” 

• does not include non-market activities that could be considered part of

economic activity

◦ i.e. household chores

• does not include illegal and informal sector

◦ i.e. unregistered businesses, illegal activities, underground economy

(unofficial)

• does not include externalities

◦ i.e. pollution, environmental damage (costs that should be factored into

GDP)

• when GDP is used to compare economic activity across countries, it ignores

country-specific attributes

◦ i.e. climate, geographical location

◦ better to use growth rates to compare economic activities across

countries

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EC 102: AUGUST 29

Economic Growth
• annual percentage increase in GDP per capita

◦ economic growth =  (present year value - past year value) x100  / past
year value

• GDP is the total market value of all commodities produced in the domestic
economy over a given time period, usually a year

• GDP per capita means that GDP has been normalised by population size and is
therefore a measure of average income of the population

• theoretically, GDP is represented by an “aggregate production functions” where

a composite output is produces by using homogeneous labor and homogeneous
capital

◦ GDP = F( Labor, Capital ) -> where GDP comes from

◦ GDP is produced using labor and capital

▪ labor = manpower, human effort

▪ capital = machines, equipment, tools, etc.

◦ aggregate = country

◦ composite = combined

◦ homogeneous = alike, uniform, standard

• for economic growth to happen, GDP must increase, which means more need for
labor and capital

Distribution
• what is the effect of economic growth on the distribution of income? does
economic growth lead to greater or lesser inequality?

• what do we mean by distribution of income?

◦ two approaches to distribution of income

▪ functional/factor distribution

▪ class-based measure of inequality (used by the classical

economists where the working class only supplied labor, that
capitalists only capital, and the landlords)

▪ look at share of labourers versus share of capitalists (ex.

capitalists get 75% and laborers het 25%)

▪ size/interpersonal distribution

▪ arose because of increasing diversity in types of labor and

types of capital

▪ suppose we divide society into income classes from poorest

to richest (ex. 

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 • inequality is often expressed in terms of the size or interpersonal approach to
distribution

◦ inequality of outcomes

▪ refers to differences in levels of a chosen metric of outcomes (such

as consumption, income, or wealth)

▪ can come from difference in effort and difference in

circumstances

◦ inequality of opportunity

▪ refers to that part of inequality that is due only to different

circumstances, not different efforts

◦ another worthy distinction is the following

▪ relative inequality 

▪ refers to proportionate difference between rich and poor

▪ can be measured as Y^R/ Y^P -> income of the rich

divided by the income of the poor

▪ absolute inequality

▪ refers to absolute difference in income

▪ can be measure as Y^R - Y^P -> income of the rich minus

income of the poor

Poverty
• two kinds of poverty

◦ absolute poverty (fixed poverty line)

◦ relative poverty (poverty line rises with average income)

• the more relative the poverty measure used, the less impact economic growth
will have

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EC 102: SEPTEMBER 3
Economic Growth and Distributional Change
• the pessimistic view: economic growth increases inequality

◦ the classical economists believe that economic growth in a capitalist

economy is not expected to improve the distribution of income. this
comes from the idea of a “stationary state” where eventually the economy
settles into a state of zero growth

▪ science and technology saves us from stationary state but keeping

the population low

◦ the reasons behind the pessimistic ver of classical economists

▪ fixed natural resources

▪ diminishing returns

◦ classical economists believe that the answer lies in technological

progress, but for technological progress to increase output per capita,
people must be capable of “moral restraint” to keep the population low

◦ Marxists support the idea that economic growth in a capitalist economy

worsens income distribution

▪ their reason is: real wages will be suppressed due to capitalists’

drive for profits combined with the existence of a reserve army of
the unemployed

▪ Marxist Economics -> society is divided into two conflicting social

classes (capitalists and laborers), creating a conflict in distribution

▪ if stationary state happens, capitalists will have no choice but to

treat the labourers more unfairly, and threaten that they can just
pick from the reserve army of the unemployed, therefor the gap
between social classes stays

◦ problem with pessimistic view is that the stationary state never happened

▪ economy was never stagnant because technology kept evolving

• the optimistic view: economic growth reduces inequality

◦ Frank Ramsey in his “Mathematical Theory of Saving” (1928) provided an

argument why economic growth can lessen inequality and poverty, the
theory states that

▪ there is a given distribution of discount rates across the population.

those with high discount rates relative to the equilibrium interest
rate end up poor while those with low discount rates relative to the
equilibrium interest rate end up rich

▪ discount rate = one’s attitude towards the future

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 ▪ high discount rate = one puts less weight on the future (ex.
you don’t save)

▪ low discount rate = one values the future (ex. greater

savings)

▪ the poverty rate is a decreasing function of the interest

▪ economic growth increases the rate of interest since it increases

the marginal product of capital anti must be that r = MPK in
equilibrium

▪ hence, economic growth lessens the poverty rate and inequality

• pessimistic, then optimistic view: The Kuznets Hypothesis

◦ an inverted U: inequality increases with growth in a poor economy but

starts to decrease after some critical level of income

◦ the hypothesis features

▪ dual economy: composed of a low mean, low inequality rural sector

and a high mean, high inequality sector

▪ growth-induced rural-to-urban migration: the first migrants obtain

larger gains resulting in increased inequality; later, as more
migration occurs, increased competition lowers the premium