TOPIC 2A

National
Income
Aggregates &
its Components

To know what can be done, and how to do it, is beyond doubt the most
valuable information. The next to it is to know what cannot be done
and why we cannot do it.
MALTHUS, 1820

Overview
1.

2.

3.

Why an economys total

income equals its total
expenditure or value
added.
How gross domestic
product (GDP) is defined
and calculated.
Breakdown GDP into its 4
major components.

National Income & Product

Accounting and Macroeconomics
Detailed calculations 1st worked out by
Simon Kuznets during the Great Depression
for the US
Large quantities of data collected &
organized from a variety of sources around
the country
The data summarized & assembled into a
coherent framework, and reported by the
A
good system for national income
government statistical department (e.g.
&CSO)
product accounting enhances our

understanding of how the

macroeconomy works
provides a foundation for any
macroeconomics models
also provides data to test
macroeconomic theories

The circular flow of income

Investment (I)

Factor
payments

Consumption of
domestically
produced goods
and services (Cd)

Export
expenditure (X)

Government
expenditure (G)
BANKS, etc

Net
saving (S)

GOV.

ABROAD

Import
Net
expenditure (M)
taxes (T)

The circular flow of income

INJECTIONS

Investment (I)

Factor
payments

Consumption of
domestically
produced goods
and services (Cd)

Export
expenditure (X)

Government
expenditure (G)
BANKS, etc

Net
saving (S)

GOV.

ABROAD

Import
Net
expenditure (M)
taxes (T)

WITHDRAWALS

The Circular Flow of Income

-

The relationship between injections

and withdrawals
-

the links between them

planned injections may not equal
planned withdrawals

Equilibrium in the circular flow

I+G+X = S+T+M

National income accounts

The 3 - methods of
national income accounting

Good macroeconomic policy depends on good measurement of what

is happening in the economy as a whole.

The circular flow of National income

(2) Production

(1) Incomes

(3) Expenditure

3 - Methods of Computing An
Economys Income
1.

Income Approach:
Sum the total wages, profit, rent, &
interest paid by firms to factors of
production (see the circular flow).

2.

Value Added (or Production)

Method
Sum the value added at each stage of
production process

3.

Expenditure Approach:
Sum the total expenditures (from the top
portion of the circular flow).

3 - Methods of Computing An Economys

Income

The Economys
Income and Expenditure
1.

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.

2.

For an economy as a whole, income must

equal expenditure or value added.

3.

The forces of supply and demand determine

the market equilibrium price and quantity
that is produced and exchanged.

The Economys
Income and Expenditure
1.

2.

A measure of the income of an

economy is Gross Domestic Product
(GDP).
G D P measures: an economys total
expenditure on newly produced goods
and services or the total income earned
from the production of these goods and
services or value added by all sectors
of the economy.

Gross Domestic Product

(GDP)

an

economys total expenditure on newly

produced goods and services OR the total
income earned from the production of
these goods and services during a given
period of time (usually a year) within a
country, state, or city.

Important Features of GDP

Output is valued at market-determined prices.
Output is measured in rupee 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.

What Is Not Counted in

GDP?
GDP includes all items produced in the
economy and sold legally in markets.
-Non-Market Activities: GDP does not
include items produced and consumed at
home that never enter the marketplace.
-Underground Activities: It does not include
items produced and sold illicitly, such as
illegal drugs, smuggling etc.

Gross National Product

(GNP)
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.

National Income & Related Aggregates

Four Important distinctions

Between a Gross Concept and a Net Concept

Remove Depreciation

Between a At Factor Costs Concept and a At

Market Prices Concept Remove Net
Indirect Taxes (Indirect Taxes Subsidies)

Between a Domestic Concept and a National

Concept - Add Net Factor Income from
Abroad (NFIA)

Between Real and Nominal concept Prices

National Income & Related Aggregates

Four Important distinctions

Between a Gross Concept and a Net

Concept GDP Vs NDP

Between a At Factor Cost Concept and a At

Market Price Concept GNPfc Vs GNPmp

Between a Domestic Concept and a

National Concept - GDP Vs GNP

Real and Nominal GDP

(Ta ) N
xe et
s In
di
re
ct

GDPmp

GDPfc
)
+
(

IA
f
N

)
+
(

IA
f
N

)
+
(

GNPfc

GNPmp

IA
f
N

NNPm
p

n
io
at
ci

) re
(+ ep
D

et
N
)
(+

xe
a
T
t
c
re
i
nd

NDPmp

*NfIA: Net Factor Income Earned from Abroad

Relationship Between Macro

Indicators

) re
( ep
D

on
i
at
i
c

Overview
1.
2.
3.
4.

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.

The Components of GDP - Expenditures

GDP (Y) is the sum of:

1.

Private Consumption (C)

Investment (I)
Government Purchases (G)
Net Exports (NX) i.e. Exports minus
Imports

Y = C + I + G + NX

The Four Components of GDP

Private Consumption (C):

1.

Is the spending by households on

goods and services

e.g. buying clothing, food, movie tickets

Investment (I):

2.

Is the purchases of capital equipment

and structures

e.g. factories, houses, machinery, trucks

etc.

The Four Components of GDP

Government Purchases (G):

1.

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):

2.

Exports minus imports (also called trade

balance).

INDIA - GDP Components

Net Exports
Government
Purchases

-5% = (21 26)

17%

Investment
32%

Private Consumption
56%

Overview

1.
2.
3.
4.

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.

Real versus Nominal GDP

1.

2.

3.

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.

GDP Price Deflator

The GDP Price Deflator is a price
index that uses a bundle of all final
goods and services.

1.

2.

It tells us the rise in nominal GDP that

is attributable to a rise in prices.

Converting Nominal GDP to Real

GDP:
Real GDP200x =
(Nominal GDP200x ) (GDP deflator200x)X100

Real & Nominal GDP

For 2012-13
Nominal GDP was

94610.13

Real GDP (constant 2004-5 prices)

55054.37

GDP Price Deflator

171.8
Homework: Find these for 1990, 2000, and 2010

Ref: RBI and CSO

GDP and Economic Well-Being

GDP Per Person tells us the income
and expenditure of the average
person in the economy.

1.

It is a good measure of the material

well-being 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.

GDP per capita - looking at if

Differently
GDP per capita =

GDP
Population

GDP
Hours
Number Employed Labor Force

Hours Number Employed

Labor Force
Population

Labor
LaborProductivity
Productivity
Average
AverageHours
HoursWorked
Worked

Employment
EmploymentRate
Rate
Labor
LaborForce
Force
Participation
ParticipationRate
Rate

GDP and Economic Well-Being

Some factors and issues not in
GDP that lead to the wellbeing of the economy:

1.

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.

International Comparison of Aggregates

Requires expressing the aggregate in terms of a
common currency.
2. Use of exchange rate is not a satisfactory
solution
Reasons:
- does not reflect the relative purchasing powers of
different currencies because it is based on the
traded commodities - small part of the GDP
- need not reflect the overall price levels of the
countries.
- foreign transactions are subject to controls.
1.

Purchasing Power Parity (PPP)

Aggregates
Domestic aggregates are expressed in US
dollar by using the purchasing power
concept.

Purchasing Power Parity (PPP)

It is the number of domestic currency units
required to purchase a representative
basket of goods and services in the
domestic country that one US dollar will
buy in USA.

Measuring what matters

Sep 17th 2009 The Economist
* Report by the Commission on the Measurement of Economic
Performance and Social Progress. Available at
www.stiglitz-sen-fitoussi.fr.

Human Development Index (HDI)

The basic idea of human developmentenrichment of lives & achievement of
maximum freedom through enhanced
capability.

HDI seeks to provide a quantitative indicator

of this.
It is a composite index based on 3 indicators:
longevity measured by life expectancy at
birth;
educational attainment, as measured by a
combination of adult literacy (two-third
weight) and the combined gross primary,
secondary and tertiary enrolment ratio
(one-third weight); and

District Human Development Reports for Districts in India

Gross National
Happiness Index
(GNHI)
Computed by Bhutan
Ref.
The Economist, 2004, Dec