Macroeconomic

Measurement
- Dr. Aashita Dawer
Measuring a Nation’s Income

´ Macroeconomics answers questions like the following:

´ Why is average income high in some countries and low in others?

´ Why do prices rise rapidly in some time periods while they are more
stable in others?

´ Why do production and employment expand in some years and

contract in others?
National Accounting
´ The idea of creating a system of national accounting to guide U.S.
economic policies first took place during the Great Depression in 1930s.
´ President Herbert Hoover and Franklin Roosevelt felt that national
production came down during Depression but they had no idea of the
fact that how much was the decrease.
´ Also they wanted to know that the policies they were following for the
country’s growth were actually helping the country in terms of income
rise or not.
´ The Department of Commerce commissioned Simon Kuznets to begin to
develop national income accounts.
´ The first set of accounts was presented in 1937.
´ Interest in the national income increased in 1940s because there was a
need for national income mobilization during World War II.
´ Now every country compiles national accounts using standardized
approach.
National Accounting
´ US Context:
Bureau of Economic Analysis: agency in-charge of
compiling and publishing national accounts
National Income and Product Accounts (NIPA)=A set of
statistics compiled by BEA concerning production ,
income , spending, prices and employment.

´ Indian Context:
Central Statistical Organization,
Ministry of Statistics and Programme Implementation.
National Accounting conventions
´ The entire economy is broken down into four national accounting
sectors-
§ Household and institutions sector: This includes both household
and nonprofit institutions that serve household such as nonprofit
hospitals, universities, trade unions, charities etc.(located
domestically)
§ Business sector: The BEA business sector concept is broader than
just for profit business. Certain business serving non-profit
organizations, such as trade associations and chambers of
commerce, the govt. agencies like postal service, railway etc.
are also included(located domestically)
§ Government sector: includes all federal, state and local govt.
entities except business like govt. enterprises.(located
domestically)
§ Foreign sector: All of the above located abroad. Eg. An
individual in another country buying goods imported from India,
will figure in Indian accounts as a part of foreign sector
Conventions about capital stock
´ Although natural, manufactured, human and social capital is crucial
resources for economic activity.
´ It is mainly the manufactured capital that is currently included in
accounting of the country’s income.
´ It is due to the fact that when the national accounts were originally
devised , manufacturing , machinery and factory buildings were main
roads to prosperity.
´ Manufactured capital:

´ Fixed assets: Equipment owned by businesses and governments-

structures, residences and software.
´ Inventories: stocks of raw materials or manufactured goods held
until they can be sold or used.
´ Consumer durable goods: Cars, Stoves, etc. used in Household
production : consumer good that are expected to last more than 3
years.
Conventions about Investment

´ Gross investment: All flows into the capital stock over a period of time
OR all addition to non financial-capital stock. It means new buildings
constructed, machinery purchased this year.

´ Net Investment: If out of Gross Investment an adjustment is made for

depreciation, then whatever is left is called as Net Investment.

´ Depreciation: Consumption of fixed capital, a decrease in quantity or

quality of stock capital

´ IMPORTANT: If over a period of time, the capital stock depreciates

faster than it is being replaced, net investment will be negative.
GDP: Gross Domestic Product

´ Gross domestic product (GDP) is a measure of the

income and expenditures of an economy.

´ It is the total market value of all final goods and services

produced within a country in a given period of time.
 GDP: Gross Domestic Product
´ “GDP is the Market Value . . .”
Output is valued at market prices. GDP measures all g & s using same the unit.
For example, how bread can be added to furniture items and gold as these goods are
different in nature and these have different standards of measurement. Similarly it is not
possible to add oranges with hamburgers.
´ “. . . Of All Final . . .”
It records only the value of final goods, not intermediate goods (the value is counted
only once). Final goods are intended for end consumers.
Example: Chair, Bread are final goods whereas wood, flour, wheat are considered as
the intermediary goods.
Here the value of chair or bread is to be considered and not wood and flour as these
have become a part of the final goods and to consider their value will result in double
counting and in certain cases it can be triple counting even.

´ “. . . Goods and Services . . . “

It includes both tangible goods (food, clothing, cars) and intangible services (haircuts,
movie tickets, dry cleaning, doctor visits).
 GDP: Gross Domestic Product
´ “. . . Produced . . .”
It includes goods and services currently produced, not transactions involving goods
produced in the past.
Market transactions of goods produced in the previous year’s such as old cars, houses,
factories built earlier are not included in GDP of the current year.
Similarly purchase and sale of assets such as stock and bonds do not involve current
production of goods and therefore are excluded from the GDP of the year.

´ “ . . . Within a Country . . .”
It measures the value of production within the geographic confines of a country, whether
done by own citizens or by foreigners located there.
If Indian citizen goes abroad to work, whatever he produces is not a part of India’s GDP.
On the other hand the work of Japanese citizen at Japanese owned factory in India is a
part of India’s GDP.

´ “. . . In a Given Period of Time.”

It measures the value of production that takes place within a specific interval of time,
usually a year or a quarter (three months).
GDP: Gross Domestic Product
´ GDP includes all items produced in the economy and
sold legally in markets.

´ What Is Not Counted in GDP?

´ GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
´ It excludes items produced and sold illicitly, such as
illegal drugs.
Measuring Gross Domestic Product

´ Imagine a simple economy with no government and foreign sector,

no depreciation and no banking sector-

Value of production= Value of spending= Value of income

´ Three Approaches for Measuring GDP:

§ Production Approach
§ Spending Approach
§ Income Approach
 Circular-Flow Diagram

MARKETS
Revenue FOR Spending
GOODS AND SERVICES
Goods • Firms sell Goods and
and services • Households buy services
sold bought

FIRMS HOUSEHOLDS
• Produce and sell • Buy and consume
goods and services goods and services
• Hire and use factors • Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, • Households sell Income
and profit • Firms buy
= Flow of inputs
and outputs
= Flow of dollars
Circular-Flow Diagram (With Government and Rest of
the World)
The Product Approach: The Value
Added Approach

´ In this method, the contribution of each enterprise to the generation of the

output is measured. Under this method economy is divided in to different
sectors such as industry, agriculture, trade, fishing mining, transport etc.
Then the net value added by each productive enterprise or sector is
estimated.
´ This method consists of three stages:
1-Estimating the gross value of domestic output;
2-Determining the intermediate consumption, i.e., the cost of
material, supplies, and services used to produce final goods or services;
3-Deducting intermediate consumption from gross value to obtain the net
value of domestic output.
The Product Approach: The Value
Added Approach
´ GDP = Business production + Household production + Government
Production
´ Gross value of output = Value of the total sales of goods and services +
Value of changes in the inventories.

´ Net value added = Gross value of output – Value of intermediate

consumption.

´ The sum of net value added in various economic activities is known as GDP
at factor cost.
´ This method is normally applied in the unorganized sectors like agriculture
where there are no proper accounts are maintained.
´ This method can be used with the other methods to arrive at national
income.
´ The advantage of this method is that it reveals the relative importance of
the different sectors of the economy.
The Spending Approach

´ GDP = C + I + G + X – M

´ C= Consumption of the private sector/household sector.

§ The spending by households on goods and services, with the
exception of purchases of new housing.
§ For renters, consumption includes rent payments; for owners,
consumption includes imputed rent value of the house but not
the purchase price or mortgage payments.
§ Includes spending on durables (cars, TV etc.), non-durables
(food, fuel etc.) and services (transportation, education etc.).
The Spending Approach
´ I= Investment of the business sector/private sector.
§ The spending on capital equipment, inventories, and structures,
including new housing that will be used for future production. It’s not
financial investment!
§ Includes spending on capital equipment (e.g. machines, tools),
structures (factories, office building), inventories (goods produced but
not yet sold).
´ G= Consumption and investment of the government sector.
§ The spending on goods and services by local, state, and federal
governments.
§ Does not include transfer payments because they are not made in
exchange for currently produced goods or services.
´ X= Expenditure of the foreign sector on the goods and services of the
domestic economy: Export
´ M=Expenditure of the household, business and government sector on the
goods and services of the foreign sector: Import
Examples:
´ In each of the following (hypothetical!) cases, determine how much GDP
and each of its components is affected (if at all).
´ Sonia spends ₹2000 to buy her husband dinner at the finest restaurant in
Sonipat. Consumption and GDP rise by ₹2000.
´ Atal spends ₹50000 on a new laptop to use in his marketing business. The
laptop was built in China. Investment rises by ₹50000, net exports fall by
₹50000, GDP is unchanged.
´ Narendra spends ₹49999 on a computer to use in his editing business. He
got last year’s model on sale for a great price from a local manufacturer.
Current GDP & investment unchanged, because the computer was built
last year.
´ Manmohan Motors builds ₹500 crore worth of cars, but consumers only buy
₹450 crore worth of them. Consumption rises by ₹450 crore, inventory
investment rises by ₹50 crore , and GDP rises by ₹500 crore.
The Income Approach
´ GDP = National Income – Net income payment of the foreign sector +
Depreciation

´ National Income (NI)= Rent+ Wages+ Interest +Profit

´ Net Factor Income from abroad which is the difference between factor income
received from abroad by normal residents of the country for rendering
services in the foreign countries on one hand and the factor income paid to
the foreigners for their services in our domestic territory.
´ Depreciation: Consumption of Fixed Capital

´ Precautions:
1-Transfer payment is not to be included
2- Imputed rent of the self-occupied houses should be included.
3- Windfall gains like prizes and lotteries won should not be included
4-Receipts from the sale of second hand goods should not be considered.
5-Production used for self-consumption should be considered.
Which Approach is better?

´ When all the requisite data is available, three approaches are equally
good. But if there are data limitations, then we have to choose method
according to the availability of data.

´ If industries provide data on value added, then production approach is

preferred.

´ If expenditure data on consumption, Investment, govt. and export and

imports is available, then we apply expenditure method.

´ Income approach is considered less reliable as proper information on

wages and salaries and profits etc. is not available. Also deflation of Value
Added at constant prices is not possible .
Relationship between Savings and
Investment
´ GDP = GDP = C + I + G + X – M
´ GDP = Private Consumption + Private Investment + Government
Investment + Government Consumption + Net Exports
´ GDP – Private Consumption – Government Consumption = Private
investment + Government Investment + Net Exports
´ Savings = Investment + Net Exports
´ Also, for Net figures, always subtract Depreciation:
Net Domestic Product = GDP – Depreciation
Net Saving = Gross Saving - Depreciation
GDP growth rate
´ Percentage growth in GDP = [(Value of GDP in year 2 – Value of GDP in
year 1 )/ Value of GDP in year 1 ] * 100. Example:
Nominal vs Real GDP

´ Nominal GDP = Total production valued at current price

§ Money value of all the final goods and services produced in a year. This
money value is obtained using current year market price of final goods
and services produced.

§ Nominal GDP does not truly indicate the real performance or economic
growth of the economy if the prices are changing.

§ It is possible while nominal GDP is increasing over time; the real quantity of
the goods is the same. So for finding out the real change, we have to
eliminate the effect of price change.
Nominal vs Real GDP

´ Real GDP= Total production valued at a base year price

´ Values the production of goods and services at constant prices/ base year.
It is corrected for inflation.
´ An accurate view of the economy requires adjusting nominal to real GDP
by using the GDP deflator.
´ Change in nominal GDP reflects both prices and quantities; change in real
GDP is the amount that GDP would change if prices were constant (i.e., if
zero inflation).
Nominal GDP
Real GDP
GDP Deflator
´ An accurate view of the economy requires adjusting nominal to real GDP
by using the GDP deflator.
´ Change in nominal GDP reflects both prices and quantities; change in real
GDP is the amount that GDP would change if prices were constant (i.e., if
zero inflation).
´ The GDP deflator measures overall price level calculated as the ratio of
nominal GDP to real GDP x 100.
´ It tells us the rise in nominal GDP that is attributable to a rise in prices rather
than a rise in the quantities produced. • The GDP deflator is calculated as
follows:
´ GDP deflator= Nominal GDP*100
Real GDP
´ One way to measure the economy’s inflation rate is to compute the
percentage increase in the GDP deflator from one year to the next.
 Computing GDP Deflator
2004 (base year) 2005 2006
Price Quantity Price Quantity Price Quantity

Good A ₹30 900 ₹31 1000 ₹36 1050

Good B ₹100 192 ₹102 200 ₹100 205

Use the above data to solve these problems:

• Compute nominal GDP in 2004. ₹30 x 900 + ₹100 x 192 = ₹46,200

• Compute real GDP in 2005. ₹30 x 1000 + ₹100 x 200 = ₹50,000
• Compute the GDP deflator in 2006.
Nominal GDP = ₹36 x 1050 + ₹100 x 205 = $58,300
Real GDP = ₹30 x 1050 + ₹100 x 205 = $52,000
GDP deflator = 100 x (Nominal GDP) / (Real GDP)
= 100 x (₹58,300)/(₹52,000) = 112.1
Consumer Price Index
´ Index number is a figure that measures the change in magnitude of a
variable such as a quantity or price , compared to another period.
´ Consumer Price Index: An index measuring the change in prices of goods
and services bought by households.
CPI2 = (250/200)*100 = 125
INFLATION RATE

CPI1 is assumed 100

CPI2 = (250/200)*100 = 125

Inflation Rate= ((125-100)/100)* 100 = 25%

Difference between GDP Deflator and
CPI
´ The GDP deflator measures a changing basket of commodities while
CPI always indicates the price of a fixed representative basket.

´ GDP deflator frequently changes weights while CPI is revised very

infrequently.

´ CPI will consider imported goods because they are still considered as
consumer goods while GDP deflator will only contain prices of domestic
goods.
GDP and Well being

´ It is a general tendency to consider national income as a proxy for national

success.
´ But the economists dating back to Simon Kuznets have warned that GDP is
a specialized tool of measuring economic activity and should not be
confused with national wellbeing.
´ In the recent years doubts have been expressed about the validity of
national income as a measure of economic welfare.
´ It has been asserted by several modern economists that national income is
not a satisfactory measure of economic welfare.
´ Even if increase in GDP may increase welfare if all other things are
constant, there are many other factors which are equally or more
important.
Critiques of GDP

´ Household production
´ Leisure
´ Human and social capital formation
´ Interaction of economy and environment
´ Defensive expenditure
´ Product or production method that reduce than increase well-being
´ Financial Debt and GDP
´ Inequality and GDP
‘Means’ to an ‘End’…Means or End?

´ What should we measure? GDP captures only economic production.

´ Are there something that GDP does not include but is valuable for human-
wellbeing? Excludes Health outcomes or Environmental Quality. v
´ Does it include certain things that should be excluded as it harms human-
well being?
´ Undoubtedly, GDP is a an indicator that tells one (important) thing about
the economy but there are many other aspects of the economy which the
indicator does not talk about.
Measuring “economic production” to
measuring “well being”!
´ Multidimensionality: Satellite Account
´ Additional or parallel accounting systems that provide measure for social
and environmental factors in physical terms without necessarily including
monetary valuation.
´ Monetary valuation: Neither feasible nor desirable
´ Example: Changes in Health/ loss of Productivity, Changes in violence
´ Crude Oil
´ Dashboard approach
´ Material living standards, health, education, political voice, social
connections and the environment.
Subjective Well Being approach

´ Subjective Well-Being (SWB): A measure of welfare based on survey

questions asking questions on their own degree of life satisfaction.

´ Quantification of subjectivities…on the scale of 1(not satisfied at all) to

10 (extremely satisfied), rate how happy are you with your life these
days?

´ World Happiness Report from Columbia University, the Gallup World Poll
and the European Social Survey.

´ Despite limitations SWB gives useful information about quality of life.

Relationship between SWB and GDP
´ Are average SWB levels higher in countries with higher GDP per capita?
´ As GDP per capita increases in a particular country over-time, do SWB
levels rises?
Alternative Approaches

´ The Genuine Progress Indicator (GPI)

GPI and GDP

United States of America New Zealand

The Better Life Index (BLI)
Human Development Index (HDI)

´ Life expectancy at birth

´ Years of formal education
´ Real per capita GDP
Measuring Household Production

´ How to measure unpaid productive activities?

´ Replacement –cost method: valuing hours at the
amount it would be necessary to pay someone to do
the work.
´ Opportunity-cost method: valuing hours at the amount
that the unpaid worker could have earned at a paid
job.
Accounting for Environment

´ Environmentally adjusted net domestic product: GDP less depreciation of both

manufactured and natural capital.

´EDP = GDP – D(m) – D(n)

´ Valuing environmental factors /services-
´ Damage Cost Approach: Assigning a monetray value to an
environmental service that is equal to the actual damage done
when the service is withdrwan.
´ Maintenance Cost Approach: assigning a monetary value to an
environmental service that is equal to what it would cost to
maintain the same standard of services using an alternative
method.
Conclusion

´ No single approach has emerged as the best substitute,

adjust or compliment GDP.
´ Any macroeconomic indicators involve several
assumptions.
´ With new indicators, it is interesting to note how results
change under different assumptions.
Exercise I
Exercise II
Best Wishes!