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Measuring Macroeconomics:
(Performance of an Economy)
MACROECONOMICS • Gross Domestic Product (GDP): Total
Session – 2 output, income or expenditure of an economy
• Price Level (Price Index): Measures the level
of prices – CPI & WPI
• Unemployment Rate: Measures part of total
Measuring Macroeconomics Variables: labourforce who are unemployed
National Income Accounting • Net-Export (NX): Exports (X) - Imports (M)
(GDP) • Flows of Investment: inflows and outflows

1. GDP: (Gross Domestic Product) Basic Principles of Computing GDP

• GDP (Y) is the market value of all final goods and
services that are currently produced in a given time
period or current period/year
• Market value of all final goods and services
produced within an economy in a given period of
time: Included in GDP
• Used Goods: not a part of GDP
• Inventories: do not influence GDP of current
years
• Intermediate Goods and Value Added: value of
total output less value of intermediate goods is
included in GDP. So GDP = total value added of
all firms in the economy
• Imputed Value: included in GDP but difficult to
compute – problem of understimation

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GDP: Final goods & value added
• GDP = value of final goods produced
= sum of value added at all stages
of production.
• A firm’s value added is the value of its output
minus the value of the intermediate goods the
firm used to produce that output
• The value of the final goods already includes the
value of the intermediate goods,
so including intermediate and final goods in GDP
GDP = Total Expenditure = Total Value added
would be double-counting.
Methods for Measuring GDP:
1. Expenditure Method: total exp. or spending on
domestically produced final goods and services
in an economy (C + I + G + X - M) = GDP at
market prices = GDPmp (can be Nominal GDP
at current price or Real GDP at constant price)
– Output Method: value of all goods and services
produced in an economy in a year – GDP at
market price (GDPmp)
– Income Method: Sum total of factor incomes =
wages (land) + interest (capital) + profit
(organization) = GDP at factor cost (GDPfc)
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Measuring GDP
Expenditure Method (GDPmp): Total expenditure on
domestically produced on final goods & services.
Output Method (GDPmp): Total Value (not total value
of production but the value added) of goods & services
produced in an economy
Income Method (GDPfc): Payment for use of
factors of production (wage, rent, profit and
interest) or total income accrues to all factor of
production
(output) = total factor income (r + w + i + p)
Which Method is Better & Why?
• Estimates of GDP by using all three methods are
similar but not identical – due to different source
of data and statistical discrepancies
• Balancing Process is made to give identical GDP
estimates – so all method give same result
• Output method – to compare changing value added
in different sector – to measure sectoral growth
• Income method – to compare income distribution
• Exp. Method – to estimate aggregate demand
(C+I+G+X-M) – to estimate aggregate demand (AD)
Growth of GDP (real price) = Growth of actual demand
in the economy = Agg Demand
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Measuring GDP: Three Key Aspects

1. What is Domestic about GDP?
(GNP vs. GDP)
• Gross National Product (GNP):
Total income earned by the nation’s factors of
• What is Domestic about GDP? – (NFIA) GDP & production, regardless of where located.
GNP
• Gross Domestic Product (GDP):
• What is Gross about GDP? – (Depreciation) Total income earned by domestically-located
factors of production, regardless of nationality.
• Is GDP Nominal or Real? - (GDP deflator):
GNP – GDP = (factor payments from abroad) – (factor
(Nominal GDP/Real GDP x 100)
payments to abroad) or Net Factor from Abroad (NFIA)

GNP = GDP + NFIA (net factor income from Abroad)

GDP = GNP - NFIA

2. What is Gross about GDP? Other Macroeconomic Concepts:

(GNP vs. NDP) National Income
• NDP = GNP – Depreciation
• National Income = NNP – Indirect Business Taxes
(Depreciation = Gross investment (GI) – Net Investment (NI))
(NNP = GNP - Depreciation)
Size of depreciation determines the size of investment. If,
• Personal Income = (National Income – Corporate
GI > Depreciation, NI = +ve (rising economy)
profits – Social Insurance Contributions – Net
GI < Depreciation, NI = -ve, (declining economy)
Interest + Dividends + Govt. Transfer to Individuals
GI = Depreciation , NI = 0 (stagnant)
+ personal Interest Income)
Correct Estimates on depreciation often not availble
• Disposable Income = (Personal Income – Direct
• NDP not frequently used in economic & business
tax)
analysis
If depreciation is stable, ? GDP can be used as proxy for GNP

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National Income (NI)
(NI at Market Price & Factor Cost: Indirect Taxes)
• National Income (NI) = Factor incomes accrued
to the residents of a country (r + w + I + p).
• So NI to be calculated from GNP not GDP.
- Converting GDP into GNP = (GDP+NFIA).
- Correct measure of NI would be GNP at factor cost
(GNPfc) as indirect taxes do no accrue to the factor income.
- We have to also minus depreciation from GNPfc for correct
estimate of NI)
So NI or NNPfc should be GNPfc - Depreciation =
(r + w + i + p)
GDP at Market Price & Factor Cost
 GDP at current market price – indirect taxes + subsidies =
nominal GDP at factor cost
 GDP at constant market price – indirect taxes + subsidies =
real GDP at factor cost
Therefore, GDPmp differs from GDPfc by the amount of net
indirect taxes
GDPmp – (indirect tax – subsidies) = GDPfc
or
GDPmp - net indirect taxes = GDPfc
Or
GDPfc + net indirect taxes = GDPmp
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National Income at Factor Cost: (NNPfc)
• National Income (NI) = NNPfc - Factor incomes
accrued to the residents of a country (r + w + I + p).
– GNPmp – Net Indirect Taxes = GNPfc
– GNPfc – depreciation = NNPfc
– NNPfc = NI
How to estimate NI?
1. Convert GDPmp to GNPmp: (GNPmp = GDPmp + NFIA)
2. Convert GNPmp to GDPfc: (GNPfc = GNPmp – Net Indirect
Taxes)
3. Convert GNPfc to NNPfc: (NNPfc = GNPfc – Depreciation)
4. NI = NNPfc
Personal Income & Disposable
• Personal Income (PI) = All income earned in a
year by factor of production.
– But all earned income is not received (undistributed
profit, pension deducted from wage) in same year and
all received income is not earned (gift, pension,
welfare payment).
So, PI = (National Income – Corporate profits –
Social Insurance Contributions – Net Interest +
Dividends + Govt. Transfer to Individuals +
personal Interest Income) or,
PI = NI – (income earned but not received +
income received but not earned)
• Disposable Income (DI) = (Personal Income –
Direct tax)
• DI = Consumption + Saving
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Implication & Cross-Country

Omission from GDP
• By Definition (transfer payment, pension, social
security payment, financial transactions etc are
excluded)
• By measurement problems (non-market
transactions, unorganized sector activities, black
money) - underestimation of GDP
• Unable to capture through data collection: ( small
& petty producers, qualitative improvement)
• GDP Growth does not say anything about
distribution of income, not account for inefficiency
Comparison of GDP
• Average per capita GDP or GNP (unadjusted per
capita GDP): converted into a common currency say US
dollar ($). But there are problem of exchange rate volatility
& failure to capture inter-country relative price differences
• PPP Method: Adjust relative price differences of
comparable and representative goods & services of all
countries. For example average purchasing power of $ in
India is many times higher than in US
• GDP does not capture distribution of income,
pattern of spending and its welfare impacts
• HDI is better measure for this than GDP: (Ranks) –
High GDP per capita is not sufficient for high HDI

Measuring GDP (Real vs Nominal)

3. Measuring GDP (Real vs Nominal) Goods & Base Year Base Year Current Year Current year
Services (2004-05) (2004-05) (2012-13) (2012-13)
Price Quantity Price Quantity
• GDP is the value of all final goods and X1 2 40 3 60
services produced. X2 8 90 10 150

• nominal GDP measures these values X3 80 100 90 110

using current prices. X4 70 120 80 130

• real GDP measure these values using the
prices of a base year.
0 = Base Year, 1 = Current Year
Measuring GDP:
Base Year GDP = (P0 x Q0)2004-05 = 17200
Current Nominal GDP = (P1 x Q1)2012-13 = 21980
Current Real GDP = (P0 x Q1) = 19220

Measuring Current GDP Growth:

GDP (Nominal) = (21980 – 17200)/(17200) * 100 = 27.7%
GDP (Real) = (19200 – 17200)/(17200) *100 = 11.7%

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GDP Deflator
• GDP deflator is an index number
• It is one of the measures of the price level
& the GDP deflator, defined as
Nominal GDP
GDP deflator = 100 
Real GDP
General Price Level: Measurement
• Market clearing: An assumption that prices
are flexible, adjust to equate supply and
demand.
• In the short run, many prices are sticky –
adjust sluggishly in response to changes in
supply or demand. For example,
– many labor contracts fix the nominal wage
for a year or longer
– many magazine publishers change prices
only once every 3-4 years
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GDP Deflator, Nominal GDP & Real GDP
GDP deflator = NGDP/RGDP x 100
Or, N-GDP = Real GDP x GDP Deflator
Or, Real GDP = Nominal GDP/GDP Deflator
Example: If N-GDP rises 9% and R-GDP rises 4%,
then the inflation rate is approximately 5%.
Prices: flexible vs. sticky
• The economy’s behavior depends partly on
whether prices are sticky or flexible:
• If prices are sticky, then demand won’t always
equal supply. This helps explain
– unemployment (excess supply of labor)
– why firms cannot always sell all the goods
they produce
• Long run: prices flexible, markets clear,
economy behaves very differently
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Measuring General Price Level:

Measuring General Price Level:
Consumer Price Index (CPI)
• Measure of General Price Level: weighted • A measure of changes in level of
average of several prices presented in consumer prices
form of Index number • Uses:
• Consumer Price Index (CPI): changes in – tracks changes in the typical household’s
prices of consumer cost of living
• Wholesale price Index (WPI): changes in – adjusts many contracts for inflation
prices of producer
– allows comparisons of dollar amounts over
• GDP Deflator: changes in national prices
time
None is a perfect measure of price changes

The composition of the CPI’s

How CPI is constructed
“basket”
Food and bev. 6.2%
1. Survey consumers to determine composition 17.4% 5.6%
of the typical consumer’s “basket” of goods. Housing
3.0%
Apparel 3.1%
2. Every month, collect data on prices of all items 3.8%
(both goods & services) in the basket; Transportation 3.5%
compute cost of basket Medical care

3. CPI in any month equals Recreation

Cost of basket in that month
100  Education 15.1%
Cost of basket in base period
Communication

Other goods 42.4%

and services

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Reasons CPI may overstate inflation

PRICE INDICES
 Price indices measure the changes in the overall price level
which affect the purchasing power of goods and services in
general. There are three types of Price indices:
• Substitution bias: The CPI uses fixed weights,
so it cannot reflect consumers’ ability to substitute
toward goods whose relative prices have fallen.

• Introduction of new goods: The introduction

 Consumer Price Index (CPI) of new goods makes consumers better off and, in
 Wholesale Price Index (WPI) effect, increases the real value of the dollar. But it
 GDP Deflator does not reduce the CPI, because the CPI uses
fixed weights.
Let us begin with Consumer Price index (CPI)
• Unmeasured changes in quality:
Quality improvements increase the value of the
29 dollar, but are often not fully measured.

CPI vs. GDP Deflator Wholesale Price Index (WPI)

prices of capital goods • Methodology used same as CPI but data
– included in GDP deflator (if produced changes
domestically)
• Includes only goods not services
– excluded from CPI
• Wholesale price not retail price
prices of imported consumer goods • Quantity weights are constant similar to
– included in CPI CPI
– excluded from GDP deflator • Reported with two weeks time lag unlike
two months time lag in case of CPI
the basket of goods
– CPI: fixed
• Used to measure inflation
– GDP deflator: changes every year

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Price Indices: A Comparison
CPI Vs WPI CPI WPI GDP Deflator
CPI (IW) WPI Basis: Basis: Basis:
∑PtxQo ∑PtxQo ∑PtxQt
∑PoxQo ∑PoxQo ∑PoxQt
Commodity Groups Weights Commodity Groups Weights

Prices: Prices: Prices:

Retail Wholesale Market
Food Group 46.2 Primary Food 15.40

Pan Supari, tobacco etc 2.3 Manufactured Food 11.54 Basket: Basket: Basket:

Consumption goods & services Only goods; no services Domestically produced final 
Fuel & Light 6.4 Other Primary Goods 6.63 goods & services

Housing 15.3 Other Manufactured  52.20

Goods Weights: Weights: Weights:
Clothing 6.6 Fuel & Power 14.23 Fixed Fixed Not Fixed

Miscellaneous Group 23.3 All 100.00

Lag: Lag: Lag:
1 month 2 weeks 1 year
Total 100.00

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6. Saving & Investment Introduction of Saving and Investment

to the Circular Flow Diagram
• Saving (S) – part of income for future consumption
• Investment (I) – produced for future consumption
• Relation between S & I is important for macroeconomic
management
• Lets GDP=GNP=NI as ‘Y’ & NI – Taxes = DI
Y = C + I + G + X-M or, - (NI through Exp method)
Y- C = I + G+ X-M, or – (income after consumption)
S + T = I +G+X-M, or – (Income expenditure identity)
S+ (T-G) + (X - M) = I - (T-G – fiscal balance, X-M – net
investment from abroad)
I = Sp + Sg + Srow – (Relationship between S & I)
If ‘I’ & ‘Sp’ to be stable – relationship between fiscal and
current account deficits will interact – higher fiscal deficit
will spill over to current A/C deficit - twin deficit

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Measuring Unemployment
• The unemployed are those without who either are on
temporary layoff or have taken specific action to look for
work
• The total labor force is total of the civilian employed, the
armed forces and the unemployed
• The actual unemployment rate (U) is defined below:

• Each month 1,500 census workers interview a random

sample of 60,000 households to estimate unemployment

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