Module 2 GDP

Module # 2
Gross Domestic Product (GDP)
Spring 2023, Principles of Macroeconomics (Undergraduate), Dr. Hidayat U. Khan

ECONOMIC MEASURES
 In order to ensure that our economic goals of full

employment, stable prices and economic growth are
met, our government constantly takes
measurements of the economy (National Income &
Product Accounts)
 Three important measurements are
– Gross Domestic Product (GDP)
– Unemployment rate
– Inflation rate
Spring 2023, Principles of Macroeconomics Economics

(Undergraduate), Dr. Hidayat U. Khan
Module Objective
 Understanding and/or Application of the following key

concepts and methods regarding;
– Gross Domestic Product (GDP)
– Sectorial Classification used for computing GDP
– Understanding and appllication of the three different approaches
of computing GDP
– Ability to compute growth rates of GDP, nominal and real GDP
– Understanding and ability to compute commonly used price
indicators and the inflation rate
Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

Khan
Modoule Outline
1. An Overview of National Accounting
2. Defining Gross Domestic Product
3. Measuring Gross Domestic Product
4. Growth, Price Changes and Real GDP
5. Savings, Investment and Trade

Khan
Significance of Gross Domestic Product
 GDP is the measure most often used to gauge the

economic performance of a country
– GDP Growth is used for international comparisons
– Rate of change in GDP is what we usually refer to as

“economic growth“
– Recessions are usually defined as a fall in GDP

Khan
An Overview of National
Accounting
Historical Origins of National Accounts
 In the 19th century: First attempts to measure national income

in England and France
 By 1900, only 9 countries computed national income
 Great Depression and World War II increased interests in
national income measurement
 By 1940, 33 countries computed national income
 Today, all countries measure national income
– In Pakistan, Ministry of Finance
– In the European Union, national statistical offices and the European
statistical Eurostat compile national accounts
– The broad standards, in casee of the United States of America
Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

Hidayat U. Khan
National Accounting Sectors
 Household sector: Households and non-profit organization, including

household firms
 Non-financial corporations sector: All private and public corporate
enterprises that produce goods or provide non-financial services to
the market
 Government sector: All central, state, regional and local
governments and social security funds
 Financial corporations sector: All private and public entities
engaged in financial intermediation
 Rest of the world: All entities located outside a country’s borders

Hidayat U. Khan
Conventions about Capital Stocks
 Components of manufactured capital:
– Fixed assets: equipment owned by businesses and governments

(e.g. structures, dwellings, software, intellectual property
products)
– Inventories: stocks of raw materials or manufactured goods held

until they can be used or sold
– Consumer durable goods: equipment owned by households that

is used in household production of goods and services

Hidayat U. Khan
Conventions about Investment
 Investment:
– Addition to stocks of nonfinancial assets
 Gross investment:
– All flows into the capital stock over a period of time
 Net investment:
– Gross investment minus depreciation
 Depreciation:
– Decrease in the quantity or quality of a stock of capital
Spring 2023, Principles of Macroeconomics Economics (Undergraduate),

Dr. Hidayat U. Khan
Defining
Gross Domestic Product
Module # 2 GDP Principles of Marcoeconomics Spring 2022 Dr. Hidayat Ullah Khan
What’s a Gross
Domestic Product? Broccoli? I was gonna say
“Preparation H.”
GDP
This is the most important measure of economic
activity.

Dr. Hidayat U. Khan
GDP is a measure of the income and expenditures of an
economy. Every Rupee spent is an amount of income earned by
someone else.
Expenditures Market for Expenditures

Goods & Services
Goods
Goods & Services
and Services
Firms Households
Inputs for Labor, land,

production Market for and capital
Factors
Income of Production
Spring 2023,
Income
Principles of Macroeconomics Economics (Undergraduate),
Dr. Hidayat U. Khan
Expanded Circular Flow

The Definition of
GDP is the market value of all final

goods and services produced
within a country in a given time
period.

Dr. Hidayat U. Khan
A measure of the total market value
of final goods and services newly
produced within a country‘s borders
over a period of time (usually one
year)

Hidayat U. Khan
Defining Gross Domestic Product
 Market value
– For most components of GDP, we can simply
refer to the market prices of goods and
services to determine their contribution to
GDP

Hidayat U. Khan
 Final goods and services
– a good that is ready for use, needing no further
processing
– In contrast, an intermediate good is a good that will
undergo further processing
– Excluding intermediate goods and services avoids
double counting

Hidayat U. Khan
Final goods and services
 a good that is ready for use, needing no further

processing
 Excluding intermediate goods and services avoids GDP = €4
Rs. XXX
double counting
Rs. 40
Rs. 3o
Rs.20
Rs. 10
wheat flour bread sandwich

Khan
Final goods and services
 a good that is ready for use, needing no further

processing
 Excluding intermediate goods and services avoids GDP = €4
Rs. 40
double counting
Rs. 40
Rs. 3o
Rs.20
Rs. 10
Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan

 What period?
 Which goods?
 Where?
– The goods and services are produced within the physical
borders of the country
 What period?
– GDP measures production during a specific time period,
normally a year or a quarter of a year
 Which goods?
– Only new goods and services are counted
 Where?
– The goods and services are produced within the physical
borders of the country
Measuring
Measuring Gross Domestic Product
Value of Production = Value of Spending = Value of Income
 Production approach
– sums up the value of all final goods and services produced in
each national accounting sector
 Spending approach
– who buys the final goods and services that have been produced
 Income approach
– totals compensation received by everyone involved in
production
Hidayat U. Khan
Three Approaches of Measuring
Production Expenditure Income
Market value Consumption Labor Income

of final
goods and = =
services
Investment
Government
spending Capital Income
Net exports
Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan 25

The Product Approach
 Measures the value of all final goods and services by

their market value in respective currency
 Value-added approach: adds up all value-added

contributions at each step in the production process
 Imputations are used to estimate values of

components of GDP

Khan
EXPENDITURES APPROACH: Spending Break up
(by the four sectors are added together)
Consumer Spending 71% (Consumption)
+Business Spending 13 % (Investment)
+Government Spending 20%

+Foreign Spending -4 % (Net EXports)
Net Exports = Exports – Imports

[Imports represent production
Spring 2023, Principles outside
of Macroeconomics Economics a country]
EXPENDITURES APPROACH: Spending Break up
(by the four sectors are added together)
Consumer Spending 51% (Consumption)
+Business Spending 13 % (Investment)
+Government Spending 40%

+Foreign Spending -4 % (Net EXports)

[Imports represent production
Spring 2023, Principles outside
of Macroeconomics Economics a country]
THE INCOME (Factor Payment) APPROACH
This approach adds together all the income earned in

the production of goods & services
Wages (income from labor/services)+
Rents (income from natural resources/properties)+
Interest (income from capital investments)+
Owner’s Income (profit earned by sole proprietorship and
partnerships)+
Corporate Profits (dividend on shares/stocks)
= TOTAL INCOME EARNED
Khan
VALUE ADDED APPROACH
 GDP is calculated by adding up the value of
their production of final goods and services.
 The cost of intermediate goods (inputs in the
production process) must be subtracted out to
avoid double counting.
 We count only each producer’s value added
(value of production minus input costs) in the
calculation of GDP

Calculating GDP of Single Sector Economy
A

Calculating GDP of Single Sector Economy

EXPENDITURES APPROACH
Consumption (Personal Spending)
Spending by Households
•Durable Goods[12%]
•Nondurable Goods[29%][soup & soap]
•Services[59%]

Investment - Spending by Businesses on capital
4 Subcategories
A. Tools, equipment , machinery
B. Buildings (offices, factories)
C. Residential buildings (your house)
D. Inventory adjustments

Government Expenditures (state/local & federal)
Government expenditures of goods/services

produced (not transfer payments)
3 Subcategories
A. Federal government
B. State governments
C. Local governments

Net Exports

[Imports represent production outside a country]
Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat

U. Khan
GDP measures FINAL GOODS AND SERVICES
(products in the form sold to consumers)
not intermediate goods
Intermediate Goods – components of the final good.
A. Toyota buys batteries (from AGS) or tires (from Yokohama)

for its cars.
B. KFC buys chickens and other ingredients to eventually sell fried

Chickens to customers.

Khan
It includes goods and services CURRENTLY PRODUCED,
not transactions involving goods produced in the past/used goods.
Second Hand Sales = no current production.
A. If a 1957 Chevy (Chevrolet) is bought in 2009
Chevy
[It has not been produced again so would not count.]
B. Boots produced in 2000 are bought in a Resale Store in 2009.
They also have not been produced again.
A salesman’s commission on a used good
would count. You are buying his services.
Hidayat U. Khan
– what is not counted
Purely Financial Transactions – stocks, bonds, CDs.

There is no current production.
A. If 100 shares of Dell stock is bought
I’m going to buy 100

shares of Dell Stock.
Exchanging one financial asset for another

It measures the value of production that takes
place WITHIN A SPECIFIC TIME PERIOD, usually a
year or a quarter (three months). Inventory
adjustments must be made to know what was
produced within each period.

GNP – Ownership
All goods/services produced China Europe
legally for pay by citizens of a country.
[Citizenship mattered, not geography]
Nike in
Plano, TX
Indonesia
Provo,UT in Chicago
GDP - Location
All goods/services produced BMW in Waco
legally for pay in a country’s borders. Honda in Ohio
[Geography matters, not citizenship]
The difference between GDP & GNP

The Product Approach: Value Added
 Adds up all value-added contributions at each step in the production process
GDP = Rs.40
+ 10
+ 10
+ 10 30
20
10 10

The Product Approach
Business production
+ Households and institutions production
+ Government production
− Taxes less subsidies on products
= GDP

Convention about household production (Imputations)
 Counted as household production:

– Imputed rent of owner-occupied dwellings
 Not counted as household production:
– Domestic and personal services produced and consumed
within the same household (e.g. cleaning, preparation of
meals or the care of sick and elderly)
– Volunteer services that do not lead to the production of

goods, e.g. care-taking or cleaning without payment

Table 2.1 Gross Domestic Product, Euro Area,
Product Approach, 2021
Sector and subsector Production by sector

(trillions of euros)
Households and nonprofit institutions production 0.33
Business production 7.17
Government production 1.82
Total: Gross value added 9.33
Taxes less subsidies on products 1.07
Total: Gross domestic product 10.40
Source: Eurostat, National Accounts Database. May 17, 2021

Note: Totals may not add up exactly due to rounding.

The Spending Approach
Adds up the value of newly produced goods and services

bought by
1. the household and
2. institution,
3. business,
4. foreign, and
5. government sectors.

Personal Consumption
+ Private Investment
+ Government consumption
+ Net exports
= GDP

Spending Approach, 2021
Type of spending Spending by Spending by sub-
category category
(trillions of euros) (trillions of euros)
Household and NPISH final consumption expenditure 5.74
Final consumption expenditure of general government 2.17
Gross capital formation 2.03
Gross fixed capital formation 2.05
Changes in inventories and acquisitions less disposals -0.02

of valuables
External balance of goods and services 0.46
Exports of goods and services 4.75
Less: Imports of goods and services 4.29
Gross domestic product 10.40
Source Eurostat, National Accounts Database. May 18, 2021.

Illegal Activities and GDP
In October 2021, euro area GDP increased by more than

€300 billion – overnight!
Background: Eurostat changed rules:
 Research & Development was classified as investment (counted in

GDP), not intermediate consumption (not counted in GDP)
 Illegal market activities were counted (smuggling, trafficking, durgs)
 Italian GDP was revised up by 1 percent, British GDP by 0.6 percent

and Danish GDP by 0.2 percent

The Income Approach
Production related incomes (wages, rents, and profits) earned by

all people and organizations inside the euro area are summed up
in national income
– Income from foreign production received by domestic residents is
subtracted
– Income from domestic production received by foreign residents is
added
– Add depreciation
– Statistical discrepancy: results from income approach not exactly
reconciles results from product and spending approaches
The Income Approach
National Income
− Net income payments from the foreign sector
+ Depreciation
= GDP

Income Approach, 2021
Types of income and adjustments Income and adjustments

National income 8.62
Less: Net income receipts from the rest of the world 0.07
Plus: Depreciation (consumption of fixed capital) 1.84
Total: Gross domestic product 10.40
Source: Eurostat, National Accounts Database. May 18, 2021.


Growth, Price Changes and
Real GDP
Calculation of GDP Growth Rates
Value2 -Value1
percentage change = * 100
Value1
GDP2021 -GDP2020
growth rate of GDP = * 100
GDP2020

Table 2.4 Example: Calculate GDP Growth Rate (USA)
Euro Area
2020 2021
GDP USD10.1 trillion USD10.4 trillion
10.4 - 10.1
growth rate of GDP = * 100 = 3.0 %
10.1

Nominal vs. Real GDP
 Nominal (current USD) GDP: gross domestic product

expressed in terms of current prices
 Real GDP: a measure of gross domestic product that

seeks to reflect the actual value of goods and services
produced, by removing the effect of changes in prices
(inflationary effects).

Nominal vs. Real GDP
Remove price
Nominal GDP (inflationary) Real GDP
effect
Total Actual value of
Production goods and
valued at services
current prices produced

Table 2.5 Calculation of Nominal GDP in an
“Bananas-and-Oranges” Economy
(1) (2) (3) (4)

Description Price per dozen Quantity Contribution to
(Rs) (dozens) nominal GDP
[(2) × (3)] (Rs.)
Year 1
Bananas 100 100 10000
Oranges 200 50 10000
20000
Year 2
Bananas 150 100 15000
Oranges 200 75 15000
30000

Calculating Real GDP
 Constant-prices method (until the 1990s)

– Use prices from one particular year, the base year, to evaluate
value of production in all years
– Constant-Price Real GDP = Total production valued at base year
prices
 Chain-linked prices (since the 1990s)

– Real and nominal GDP are equal in the reference year
– Yields a unique growth rate
– Computationally complex

Table 2.6 Calculation of Constant-Rs Real GDP
(1) (2) (3) (4)

Description Price per dozen Quantity (dozen) Contribution to real
in base year (Rs.) GDP [(2) × (3)] (Rs.)
Year 1 (Base)
Bananas 100 100 10000
Oranges 200 50 10000
Rs. 20000
Year 2
Bananas 100 100 10000
Oranges 200 75 15000
25000
*Bold type indicates base year prices

Real versus Nominal GDP,
Chained 2010 euros, 1995-2015
 Nominal GDP grows faster than real GDP when prices are rising
12
Real GDP (chained 2010 euros)
10
Real and Nominal GDP
Nominal GDP
8
0
1995 2000 2005 2010 2015
.
Source: Eurostat
Consumer Price Index
Consumer price index (CPI) measures changes in the

prices of goods and services bought by households
 calculated using a weighted average of the prices of

various goods and services it tracks
Constant Weight Price Index =
sum of current prices weighted by base quantities

* 100
sum of base prices weighted by base quantities

Table 2.7 Calculation of a Constant-Weight Price Index
(1) (2) (3) (4)

Description Price per dozens Quantity in base Sum of (prices ×
(Rs.) year base quantities)
(2) × (3)] (Rs.)
Year 1 (Base)
Bananas 100 100 10000
Oranges 200 50 10000
20000
Year 2
Bananas 150 100 15000
Oranges 200 50 10000
25000
*Bold type indicates base year quantities

Table 2.8 Calculation of a Constant-Weight Price Index
(1) (2) (3) (4)

Description Price per kilogram Quantity in base year Sum of (prices × base
(Rs.) quantities) (2) × (3)]
(Rs.)
Year 1 (Base)
Apples 100 100 10000
Oranges 200 50 10000
25000 20000
CPI2 = *100 = 125
2000
Year 2
Apples 150 100 15000
Oranges 200 50 10000
20000 25000
CPI1 = *100 = 100
20000
*Bold type indicates
Springbase
2023, year quantities
Principles of Macroeconomics Economics
Harmonized Consumer Price Index (HCPI)
Item Weights 2017
Micellaneous goods
and services Food and
10% beverages
Restaurants and 17%
hotels
11% beverages, tobacco
(recreational goods)
Education 5%
1%
Clothing and
Recreation and
foodwear
culture
7%
11%
Communications
4% Housing, water,
Transport electricity, gas
Household
5% Health 17%
equipment
5% 7%
Source: Eurostat 2021
Inflation Rate: Definition and Calculation
 Inflation is the percentage change in the Consumer

Price Index
CPI2 - CPI1
inflation rate = * 100
CPI1
 Our example:
125 - 100
inflation rate = * 100=25 %
100

Savings, Investment, and
Trade
Net Domestic Product and Saving
 Net domestic product (NDP): a measure of national

production in excess of that needed to be replaced due to
worn-out manufactured capital i.e. Depreciation (we get
NDP, by subtracting depreciation from GDP)
– Net domestic product = GDP – Depreciation
 Net saving is a better measure that gross saving of

whether we are “putting aside for the future”
– Net saving = (Gross) Saving - Depreciation
Appendix
Chain-Linked Real GDP

How to Calculate Chain-Linked Real GDP
1. Calculate Fisher quantity index
Year 2 GDP in Year 1 prices Year 2 GDP in Year 2 prices

X
Year 1 GDP in Year 1 prices Year 1 GDP in Year 2 prices
2. Set chain-type quantity index equal to 100 in

reference year
3. Multiply with Fisher index from current year
4. Multiply chain-type quantity index times level of
nominal GDP in reference year
5. Divide by 100
Example: “Bananas and Oranges” Economy
Plug in values from Table 2.5 and 2.6:
1. Fisher quantity index

Deriving Real GDP in Chained (Year 1) Rs.
Type of measure Year 1 Year 2

Nominal GDP Rs. 20000 Rs. 30000
Fisher quantity index 1.225
(current to previous year)
100 × 1.225
Chain-type quantity index 100 =122.5
(122.5 × Rs.20000)/100
Real GDP (chained Year 1
Rs.) = Rs. 20000 = Rs.24500

Resources:
Macroeconomic
Measurement – The
Current Approach
Chapter 5
© Dünhaupt, Dullien, Goodwin, Harris, Nelson, Roach, Torras

Household and institution spending

+ Business spending
+ Net foreign sector spending
+ Government spending
= GDP

The Relationship of Savings, Investment and Trade
Spending Approach to GDP:

GDP = Personal consumption + Private investment + Net
exports + Government consumption + Government
investment
Rearranging:
GDP – Personal consumption – Government consumption =
Private investment + Government investment + Net exports
Saving = Investment + Net exports

The Relationship of Savings, Investment and Trade
GDP = Personal consumption + Private investment + Government consumption +

Government investment + Net exports
GDP = C + I + GC++ GI + X-M
GDP − Personal consumption − Government consumption = Private Investment +

Government investment + Net exports
GDP
− C - GC = I + GI + X-M
Saving = Investment + Net exports
S = I + X-M
Net Domestic Product and Saving
 Net domestic product: national production in excess of that needed to replace

worn-out manufactured capital
Net domestic product = GDP − Depreciation
 Net saving: how much is put aside for the future
Net saving = (Gross) Saving − Depreciation

What to take home
 GDP is the predominant measure for national income

 In Economics, national accounting, five sectors are
distinguished
– Household sector,
– non-financial corporations sector,
– government sector,
– financial corporations sector,
– rest of the world
 GDP can be measured by using the production, spending,
or income approach
 Inflation is the change of prices over time
 GDP can be computed in real terms (correcting for
inflation) or in nominal terms

The Estimated Size of Euro Area
Manufactured Capital Stock, 2021
Type of capital Value in trillions of euros

at the end of the year
Machinery and equipment (total economy) 4.28
Other buildings and structures (total 11.66
economy)
Cultivated assets and Intangible fixed
assets (total economy)
0.41
Dwellings (households, non-profit
institutions serving households)
14.29
Dwellings (government and corporations) 2.43
Total value of manufactured capital 33.07
Sources: ECB, Statistical Data Warehouse. May 18, 2021, and authors’ calculations.
Hidayat U. Khan

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Module # 2

Gross Domestic Product (GDP)

Spring 2023, Principles of Macroeconomics (Undergraduate), Dr. Hidayat U. Khan

 In order to ensure that our economic goals of full

Spring 2023, Principles of Macroeconomics Economics

 Understanding and/or Application of the following key

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

1. An Overview of National Accounting

2. Defining Gross Domestic Product

3. Measuring Gross Domestic Product

4. Growth, Price Changes and Real GDP

5. Savings, Investment and Trade

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

 GDP is the measure most often used to gauge the

– Rate of change in GDP is what we usually refer to as

– Recessions are usually defined as a fall in GDP

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

 In the 19th century: First attempts to measure national income

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

 Household sector: Households and non-profit organization, including

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

 Components of manufactured capital:

– Fixed assets: equipment owned by businesses and governments

– Inventories: stocks of raw materials or manufactured goods held

– Consumer durable goods: equipment owned by households that

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

Spring 2023, Principles of Macroeconomics Economics (Undergraduate),

Spring 2023, Principles of Macroeconomics Economics (Undergraduate),

Expenditures Market for Expenditures

Inputs for Labor, land,

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

GDP is the market value of all final

Spring 2023, Principles of Macroeconomics Economics (Undergraduate),

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr.

 a good that is ready for use, needing no further

wheat flour bread sandwich

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

 a good that is ready for use, needing no further

wheat flour bread sandwich

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan

Value of Production = Value of Spending = Value of Income

Production Expenditure Income

Market value Consumption Labor Income

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan 25

 Measures the value of all final goods and services by

 Value-added approach: adds up all value-added

 Imputations are used to estimate values of

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U.

Consumer Spending 71% (Consumption)

+Business Spending 13 % (Investment)

+Government Spending 20%

Net Exports = Exports – Imports

Consumer Spending 51% (Consumption)

+Business Spending 13 % (Investment)

+Government Spending 40%

Net Exports = Exports – Imports

This approach adds together all the income earned in

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan

Spring 2023, Principles of Macroeconomics Economics (Undergraduate), Dr. Hidayat U. Khan

Spring 2023, Principles of Macroeconomics Economics

Investment - Spending by Businesses on capital