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# INTRODUCTION TO MACROECONOMICS

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.

## It measures the productivity output of a countrys economy. It is an indication of the wealth or

the stage of development of the nation.

## WHAT COUNTS TOWARD GDP ?

1. Counts only FINAL goods (goods and services purchased by their ultimate or final users). AS
OPPOSED TO INTERMEDIATE goods (goods purchased for resale or for use in producing
another good or service).

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 AND NOMINAL 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.

## Calculation of GDP Deflator = (Nominal GDP/Real GDP) x 100

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.

## Calculation of Consumer Price Index :

CPI in a given year = Value of market basket of goods in given year X 100
Cost of market basket in base year

## Calculation of Inflation rate in a given 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.

## EXCLUDED FROM GDP.

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.

## GDP FAILS TO COUNT (LIMITATIONS)

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.

## 2. GDP CANNOT ACCOUNT FOR PRODUCTIVE LOSS

When a National Disaster such as a hurricane, earthquake, occurs, goods that are
destroyed are not subtracted from GDP and there is no way to account for the loss in productive
capacity to the economy.
The REBUILDING that occurs after a natural disaster, however, is counted in GDP. For this
REASON, disasters like floods and earthquakes can actually end up INCREASING GDP
ANOTHER EXAMPLE: Your text book get stolen (DOESNT AFFECT GDP). Replace text
book (count towards GDP).

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

## Stages of Production Sales receipt at each Amount added to the

Production stage of production value of output

1. Farmers Wheat

2. Millers Flour

## DOLLAR The Common Denominator of GDP :

The vastly different goods and services produced in our modern world have only one thing in
common. Someone pay a price for them. Therefore when measuring output, units of each goods
are weighted according to their Purchase Price.

## NATIONAL INCOME ACCOUNTING

A measurement system used to estimate national income and its components. This is one
approach in measuring an economys aggregate performance.

## I. THE EXPENDITURE APPROACH:

There are four (4) components : Personal Consumption Expenditure [C], 2. Gross Private
Domestic Investment [I], 3. Government Consumption and Gross Investment [G], and 4. Net
Exports [X Im].
GDP = C + I + G + X - M

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.

## GDP : National Income

+
Depreciation
+
(Indirect Taxes Subsidies)

National Income includes income from employment, self-employment, profits and rent.

## III. OUTPUT METHOD:

The output contributed by the various sectors (industries) of the economy is added to give
National Output. When calculating GDP by this method it is necessary to avoid DOUBLE
COUNTING. The economy is broken up into various sectors. The money spent on making the
goods (inputs) is taken away from the money received from the sale of the goods (outputs) to
give each sectors Value added. TAKING FINAL OUTPUT OR ADDING UP EACH
SECTORS VALUE ADDED gives National Income. Industries includes agriculture,
manufacturing etc.

## IMPORTANCE OF MAKING THE DISTINCTION

BETWEEN NOMINAL AND REAL GDP

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.

## HOW DO ONE MAKE THE ADJUSTMENT FROM NOMINAL TO REAL GDP

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.

Real GDP

## 2. Growth Rate = Real GDP - Real GDP

(Real GDP) (current year) (base year)
__________________________ X 100
Real GDP (base year)

Year Nominal GDP (US \$ Billion) GDP Deflator Real GDP (US \$ Billion)
2002 \$ 6,244 100 \$ 6,244
2005 \$ 7,246 107.5 ?

## Shows that between 2002 and 2005 Nominal GDP increased by 16 %.

But when the 2005 GDP is deflated to account for price increases, we see that real
GDP increased by only 7.9 %.

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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.

## GNP = GDP + income received by citizens - income paid to foreigners

for factors of production for the contributions to

## Factors influencing the size of the National Income:

Natural resources.
Nature of labour force.
Amount of capital investment.
Efficient utilization of resources.
Political stability.
Ability of the country to produce innovative ideas.
Availability of foreign direct investment flows.

## Uses of National Income Statistics:

To measure the total income of a country.
To measure the improvement in national wealth and the standard of living over-time.
To compare the economic activity of different countries.
To identify trends in consumer expenditure.
To identify trends in industrial production.
To assist government in its economic planning.

## Factors influencing the size of the Gross Domestic Product (GDP)

GDP and social welfare.
GDP and environment.
GDP and the underground economy.

## RELATED INCOME MEASURES:

There are five (5) ALTERNATIVE measures of domestic output of income.
1. NET DOMESTIC PRODUCT = GDP Depreciation
2. NET NATIONAL PRODUCT = GNP Depreciation
3. NATIONAL INCOME = The total income payments to owners of human
(labour) and physical capital during a period. It
includes both DOMESTIC and FOREIGN
income earned by the nationals.
4. PERSONAL INCOME (GROSS INCOME) = The total income received by
individuals that is available for consumption,
saving and payment of personal taxes.
5. DISPOSABLE INCOME = Gross Income minus Taxes. It is income
available after personal taxes which can either
be spent on consumption or saved..

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