Lecture 1

Measuring A Nations Income

(Ch:10; P.O.M.E)
ECO 104
Faculty: Asif Chowdhury

 An economy can go through good phases and

also downturns. During the good phases
economic activities like production rises,
employment
rises
&
income
level
consequently rises too. The opposite happens
during economic downturns. Hence an
economys performance is an important
consideration for all concerned, & for this
purpose various statistics are collected &
reported. They include total income level,
unemployment rate & inflation rate.

 All these statistics are Macroeconomic in nature.

These variables affect all the households & all the
firms in an economy. Hence considering these
variables are important. Although Microeconomic
analysis like demand & supply are relevant at
Macroeconomic level too ( the whole economy
consist of many households & many firms)
considering aspects at aggregate or macro level
is also necessary. Hence statistics reflecting
overall economic performances are important for
policymakers & economist. One such statistics is
GDP.

Gross Domestic Products

(GDP):
The income level of an individual can
indicate the standard of living of that
individual. Similarly the total income
level of everyone in the economy can
indicate whether the economy is
doing well. GDP provides a measure
of the total income level. GDP is
considered to be the single best
measure of economic well being.

 GDP measures both income & expenditure

simultaneously. This is possible because
income must equal expenditure in an
economy and income & expenditures are
really the same. This reasoning can be
illustrated by the fact that in a
transaction/exchange, there are always
two parties involved, the buyer & the
seller. What is expenditure for the buyer is
income for the seller.

The Circular Flow Diagram:

Another alternative way to view this incomeexpenditure equality is the circular flow diagram.
It contains one household & one firm. Two
simplifying assumptions are made. Household
makes all the expenditures & household spend all
of their income. The Firm sells goods & services in
the goods/services market. The expenditure by
households on these goods & services goes to the
firm as income. From this income firm pays for
the labor wages, rent ( capital & property) & profit
( for the firm.) This payment is done through the
factor market.

 Households provide the labor & the

rented assets. The profit of the firm
comes under household income since
firms are also members of the household.
GDP here can be calculated as either
considering the total expenditure by the
household, or the total income of the firm
( wages+ rent+ profit). Both will provide
the same measure.

A Closer look into GDP:

GDP is formally defines as:
The market value of all final goods & services
produced within a country in a given period of
time.
This definition have several implications as is
illustrated below by breaking down the phrases
of the definition:
GDP is the market value: includes different goods
& services by computing their value (PXQ). Here
P is price & Q is quantity. Higher is the price
higher is the contribution to GDP ( higher value.)

 Of All: GDP includes all goods & services that are sold
legally. Market value of housing services are also
included. Rent paid by tenant is expenditure whereas
rent received by the household is income. However
anything sold illegally are excluded from GDP ( illegal
drugs) & anything produced & consumed at home/ non
commercially is also excluded from GDP.
Final: GDP includes all value of all final goods &
services. Values of intermediate goods are not
considered since their value is included in the final
goods. An exception is firms inventory kept back for
later use. That is valued as a final good & is included in
current GDP.

 Goods & Services: GDP includes value of both goods

as well as services.
Produced: GDP doesnt include transaction value of
used goods. It only includes values of currently
produced goods & services.
Within a Country: GDP only includes value of goods
& services produced within national boundary.
In a Given Period of Time: GDP is usually reported on
a quarterly ( 3 months) or annual basis. The GDP
statistics reported is adjusted for seasonal spikes,
this adjustment is done through a statistical
procedure & is known as seasonal adjustment.

Components of GDP:
GDP can be computed using the expenditure
approach. This is done by the following
relationship:
Y = C + I + G + NX
Y= GDP, C= Consumption, I= Investment, G=
Government expenditure, NX= Net Export.
The above equation is an identity, since it
holds true all the time. The total expenditure
(GDP) will always be distributed among the
four above mentioned components.

 C= households expenditure on goods & services

I = firms expenditure on investment goods &
services
G= Government Expenditure
NX= Export-Import
When households buy housing its actually
considered as an investment expenditure.
Government
expenditure
only
includes
expenditure on goods & services. Transfer
payment is excluded.

 Inventory investment by firms is

adjusted from GDP once the final
goods is sold. Its considered as
negative inventory investment by
firms then.
The NX variable adjust the impact of
expenditure on imported goods by C,I
& G since imported goods & services
are excluded from GDP calculation.

Real GDP Vs. Nominal GDP:

Nominal GDP measures the GDP at current
price level.
Real GDP measures the GDP at constant
price level.
GDP Deflator: measures the change in price
level. Its the ratio of Nominal GDP over
Real GDP. GDP Deflator provides a measure
of change in current price level relative to
some base year price. GDP Deflator can be
used to measure inflation rate.

GDP is not always the best

measure of well being:
High GDP doesnt reflect different
aspects contributing to a good life. Such
aspects can include:
Leisure
Exclusion of outside the market activities
Impact on environment not considered in
GDP
Doesnt portray actual picture regarding
distribution of income.