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Learning Module

Measuring National
Economy &
Economic Growth
Course Packet 01

Measuring National
Economy

Knowledge Area Code : PUBLIC AD

Course Code : PAEN 0223
Learning Module Code : LM-PAEN 0223
Course Packet Code : LM-PAEN 0223-02

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Course Packet 01

Measuring National Economy

Introduction

This is the first module that directly explores one of the most important topics in macroeconomics:
How do we measure economic production? What determines economic growth?

This lesson introduces Gros Domestic Product (GDP) and explain why for the economy, the value
of production equals income, which also equals expenditure. It also describes how economic statisticians
measure GDP and distinguish between nominal GDP and real GDP. The rate of growth of real GDP is the
first major indicator of economic performance, which provides information about a country’s ability to
increase its production of goods and services and in return increase income and standards of living over
time.

This lesson also presents the three approaches in computing GDP. A model called the circular flow
diagram illustrates how the expenditures approach and the income approach must equal each other, with
goods and services flowing in one direction and income flowing in the opposite direction, in a closed loop.
The lesson starts with a short discussion of the circular flow.

Learning Objectives
• Define gross domestic product (GDP) as the measure of total output of an economy and explain
its calculation.
• Explain the Expenditure Approach and Income Approach via the Circular Flow Diagrams.
• Explain the difference between real GDP and nominal GDP.
• Define and calculate the economic growth rate.

Learning Management System

The primary learning materials for this course are readings, lectures, video tutorials, and other resources
which can be accessed through our Google Classroom.

Duration
• Topic 04: Measuring National Economy = 6 hours (3 -hour synchronous discussion, 2 hour self-
directed learning with practical exercises and 1-hour assessment)

Delivery Mode
The delivery mode of this course is online synchronous and asynchronous.

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Assessment with Rubrics
Significant portion of your grade for this course will depend upon assessment of your knowledge and skills
as reflected in examinations in the following format: (a) Objective Type (True or False; Multiple Choice,
Matching Type), (b) Essay, and (c) Problem sets (are given to apply the reasoning skills you learned
throughout the module).

Additional Reading

The Circular Flow and GDP

https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/economic-iondicators-
and-the-business-cycle/21/a/the-circular-flow-and-gdp

GDP and Alternative Measures of Economic Performance

https://courses.lumenlearning.com/ivytech-econ201-master/part/macro-workings/

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Brief Lesson

The Circular Flow

Most economics texts start with a basic model of a market economy, the Circular flow of income diagram.
The circular flow diagram is a simple illustration to show how income flows through the economy
between producers and consumers.

The circular flow shows how national income or Gross Domestic Product is calculated.

The diagram makes it clear that consumers and producers are interdependent. Consumers rely on
producers to make goods and services available. When consumers buy products, money flows to
producers. At the same time, producers rely on consumers to provide labor for production. When labor is
provided, people get paid and that allows them to buy goods and services.

The circular flow diagram starts with two economic decision units: the household and the
Firm. These two entities capture the ideas of consumption (household) and production (firm). The diagram
goes on to illustrate the flow of money between the two sectors of the economy. Consumers buy goods and
services from firms, but firms pay people for their labor. This exchange of money takes place in two
different markets: the resource market and the output market (also referred to as the market for goods and
services).

Leakages (withdrawals) from the circular flow

Not all income will flow from households to businesses directly. The circular flow shows that some
part of household income will be:
1. Put aside for future spending, i.e., savings (S) in banks accounts and other types of deposit.
2. Paid to the government in taxation (T) e.g., income tax and national insurance.

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3. 3.Spent on foreign-made goods and services, i.e. imports (M) which flow into the economy.

Withdrawals are increases in savings, taxes or imports so reducing the circular flow of income and
leading to a multiplied contraction of production (output)

Injections into the circular flow are additions to investment, government spending or exports so
boosting the circular flow of income leading to a multiplied expansion of output.

An economy is in equilibrium when the rate of injections = the rate of withdrawals from the
circular flow.

The state of equilibrium

In terms of the five sector circular flow of income model the state of equilibrium occurs when the total
leakages are equal to the total injections that occur in the economy. This can be shown as:
Savings + Taxes + Imports = Investment + Government Spending + Exports

OR
S + T + M = I + G + X.

This can be further illustrated through a fictitious economy where:

S+T+M=I+G+X
$100 + $150 + $50 = $50 + $100 + $150
$300 = $300

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Financial Sector Added to the Circular Flow Model

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Five-sector model

The five-sector model adds the financial sector to the four-sector model.[19] Thus, the five-sector
model includes (1) households, (2) firms, (3) government, (4) the rest of the world, and (5) the financial
sector. The financial sector includes banks and non-bank intermediaries that engage in borrowing (savings
from households) and lending (investments in firms). [19] Money facilitates such an exchange smoothly.
Residuals from each market enter the capital market as savings, which in turn are invested in firms and the
government sector. Technically speaking, so long as lending is equal to borrowing (i.e., leakages are equal
to injections), the circular flow will continue indefinitely. However, this job is done by financial institutions
in the economy.

Significance of the study of circular flow of income

The circular flow of income is significant in four areas: [24]

1. Measurement of national income

2. Knowledge of Interdependence - Circular flow of income signifies the interdependence of
each of activity upon one another. If there is no consumption, there will be no demand
and expenditure which in fact restricts the amount of production and income.
3. Unending Nature of Economic Activities - It signifies that production, income and
expenditure are of unending nature, therefore, economic activities in an economy can
never come to a halt. National income is also bound to rise in future.
4. Injections and Leakages

Measuring the Size of the Economy: Gross Domestic Product

How large is the Philippine economy? The size of a nation’s overall economy is typically measured by
its Gross Domestic Product (GDP), which involves counting the production of millions of different goods
and services — houses, cars, smart phones, computers, steel, oranges, college educations, and all other new
goods and services produced in the current year — and summing them into a total peso/peso/dollar value.

GDP measures the market value of the goods, services, and structures produced by the nation’s economy
in a particular period. GDP is one of the most comprehensive and closely watched economic statistics; It is
used by the Executive and the Congress to prepare the national budget, by the Central Bank to formulate
monetary policy, and by the business community to prepare forecasts of economic performance that
provide the basis for production, investment, and employment planning. While GDP is used as an indicator
of economic activity, it is not a measure of well-being (for example, it does not account for rates of poverty,
crime, or literacy).

GDP is equal to the total expenditures for all final goods and services produced within the country in a
stipulated period of time. According to the Bureau of Economic Analysis (BEA), in 2015 the U.S. GDP

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totaled about $18 trillion in current peso/dollars, and about $16.4 trillion in chained 2009 peso/dollars,
which represents the largest level of GDP among all countries in the world. (8)

Each of the market transactions that enter into GDP must involve both a buyer and a seller. The GDP of an
economy can be measured either by the total peso/dollar value of what is purchased in the economy (the
Income Approach), or by the total peso/dollar value of what is produced (the Expenditure Approach). (6)

Definition of the GDP: Breaking Things Down

At its core, the gross domestic product (GDP) measures how much output a country’s economy has
produced in a stipulated period of time. Because adding up different goods and services, measured in
different measurement units, is not a practical way to measure production in the economy, economists rely
on the market value of goods and services produced. Thus, GDP represents the market value (expressed in
a country’s currency, such as the peso/dollar) of all final goods and services legally produced within a
country in a given time period, typically one year.

Watch It!

Watch this video by Marginal Revolution University (MRU) as it shows you how to make sense of
GDP as an important economic indicator. You’ll learn how GDP is computed, and you’ll get
answers to some pretty interesting questions along the way.

https://www.youtube.com/watch?v=mjJmo5mN5yA

In a nutshell, such measurement involves the calculation of market value, which for each unique good or
service produced consists of multiplying its quantity with the market price, followed by adding everything
up into an overall peso/dollar figure.

The following are several points to keep in mind when considering the output of the economy:

1. Production , not sales , within a given time period (typically one year) is what GDP captures. Not
all output produced in a year is sold that year. The unsold output becomes inventory. On the other
hand, if a car produced last year was only sold this year, it will be counted in last year’s GDP, when
it was first produced, and became inventory (last year).
2. In addition to market production , GDP includes some nonmarket production . GDP is composed
of goods and services, which are produced for sale in the market, and of nonmarket goods and
services, which are not sold in the market, such as: the defense services provided by the federal
government, the education services provided by local governments, the emergency housing or
health care services provided by nonprofit institutions serving households (such as the Red Cross),

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and the housing services provided by and for persons who own and live in their home (referred to
as “owner-occupants”). However, not all productive activity is included in GDP. In particular,
because data are not available to accurately measure their value, the following activities are NOT
included in GDP:
• Care of one’s own children

• Unpaid volunteer work for charities

• Illegal activities
3. Whenever possible, GDP is valued at market prices. This approach provides a common unit of
measurement (peso/dollars) that facilitates comparisons of the various goods and services that
make up economic activity. Using market values also facilitates the analysis of the impact of events
on the economy, such as the implementation of government programs or the occurrence of natural
disasters.
4. The reason why only final goods and services are included in the calculation of GDP is to avoid
double counting. A final or finished good or service is a good or service that is produced for its
final user, unlike an intermediate good or service, which is a good or service that is used as a
component of a final good or service.

5. Only legally produced goods and services are counted in the GDP.

6. The word” domestic” in Gross Domestic Product pertains to the fact that only the goods and
services produced within a country are counted in the GDP. So, a Toyota Philippines produced in
Laguna is counted in the Philippine GDP.
7. GDP measures production during a given period of time, typically one year. Production of a good
or service produced in a previous time period (even if perhaps sold in the present time period)
does not count in this period’s GDP.

Real GDP vs Nominal GDP

Comparing Real GDP to Nominal GDP

How much of the increase in GDP is the result of inflation and how much is an increase in real output? To
answer this question, we need to take a closer look at how economists calculate Real GDP (RGDP), and
how it differs from Nominal GDP (NGDP). The market value of production and hence GDP can increase
either because the production of goods and services are higher (quantities) or because the prices of goods
and services are higher. Because the focus in measuring GDP is to find out whether a country’s ability to
produce higher quantities of goods and services has changed, when calculating RGDP we try to remove
the effect of price changes by using prices of a reference year, called a base year. This way, we keep prices
fixed (unchanged) at the level they were in the base year whenever we calculate RGDP.

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Watch It!

Watch this video by Marginal Revolution University (MRU) as it explains the difference between
Nominal GDP and Real GDP and how real growth of the economy can be calculated.

https://www.youtube.com/watch?v=rGqhTQyY6g4

Calculating Real GDP

• Nominal GDP is the value of the final goods and services produced in a given year expressed in
terms of the prices in that same year.
• To calculate Nominal GDP , we use current year prices and multiply them by current year quantities
for all the goods and services produced in an economy. For the purposes of demonstrating the
method, we will work with hypothetical economies consisting of no more than two or three goods
and services. You can imagine that the same method applies if a lot more goods and services were
included.
• Real GDP allows the quantities of production to be compared across time. Real GDP is the value of
final goods and services produced in a given year expressed in terms of the prices in a base year.
o To calculate Real GDP, we use base year prices and multiply them by current year
quantities for all the goods and services produced in an economy. For the purposes of
demonstrating the method, we will work with hypothetical economies consisting of no
more than two or three goods and services. You can imagine that the same method applies
if a lot more goods and services were included.
o In the base year, RGDP is calculated using prices of the current year (base year = current
year), therefore RGDP always equals NGDP in the base year.

Example:

Table 3 contains summarized information for a hypothetical economy’s total production and
corresponding prices (you can think of them as average prices) of all the final goods and services it
produced in 2015 and 2016. The base year is 2015.

Table 3

Year 2015

Item Quantity Price

Goods 120 $50

Services 100 $65

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Year 2016

Item Quantity Price

Goods 130 $55

Services 110 $70

In 2015, nominal GDP = 120 x $50 + 100 x $65 = $6,000 + $6,500 = $12,500

In 2016, nominal GDP = 130 x $55 + 110 x $70 = $7,150 + $7,700 = $14,850

Nominal GDP has increased significantly, but what how much has real GDP changed between these years?
To calculate RGDP, we first need to decide which one will be the base year. Use 2015 as the base year. Then,
real GDP in 2015 equals nominal GDP in 2015 (always the case for the base year) = $12,500.

To calculate real GDP in 2016, we need to use the 2016 quantities and the 2015 prices, since 2015 is the base
year.

RGDP in 2016 = 130 x $50 + 110 x $65 = $6,500 + $7,150 = $13,650.

Notice that RGDP has increased less than NGDP from 2015 to 2016. This will always be the case if both
prices and quantities increase from year to year.

Watch It!

This video defines nominal and real GDP and use a numerical example to illustrate why measuring
nominal GDP produces a false impression of the actual level of output a nation is producing from
one year to the next. It also explains a simple formula to determine the GDP deflator, the price index
that allows us to adjust nominal GDP to arrive at real GDP.

https://www.youtube.com/watch?v=iNfNZ1mIGRE

Approaches in Measuring GDP

GDP can be measured in three different ways: the value-added approach, the income
approach (how much is earned as income on resources used to make stuff), and the expenditures
approach (how much is spent on stuff). However, you will likely run into the expenditures approach the
most as you progress through this course.

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The circular flow diagram illustrates how the expenditures approach and the income approach
must equal each other, with goods and services flowing in one direction and income flowing in the opposite
direction, in a closed loop.

Key Mathematical Model: Two approaches to

measuring GDP

The Expenditures Approach

GDP can be calculated using the expenditures

approach using the following equation:
Y=C+I+G+X-M

Each component is described in the table below:

Category definition

C consumption: spending by households

I investment: spending by businesses on capital and inventory

government spending: spending by all government entities on goods and services (but not
G transfer payments)

exports: goods and services produced within a country that are purchased in other
X countries

imports: goods and services that are produced in other countries but are purchased in your
M country.

The Income Approach

GDP can be calculated using the income

approach using the following equation:

Y=w+i+r +p

Where each category refers to the income

received from supplying one of the four
economic resources:

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Category definition
w wages earned from labor

i interest earned on capital

r rent earned on land

p profits earned on entrepreneurial talent

GDP and Related Measures of Production and Income

In addition to GDP, another macroeconomic measure of production is GNP.

• Gross National Product, ( GNP ) is the market value of all final goods and services produced
anywhere in the world in a given time period by the factors of production supplied by the residents
of the country. So, coconut oil products produced in Korea by a Philippine company is part of
Philippine GNP but not part of Philippine GDP.
• Philippine GNP equals Philippine GDP plus net factor income from abroad.

Unlike GDP, which takes the value of goods and services based on the geographical location of
production, Gross National Product estimates the value of goods and services based on the location of
ownership. It is equal to the value of a country’s GDP plus any income earned by the residents in foreign
investments, minus the income earned inside the country by foreign residents. GNP excludes the value of
any intermediary goods to eliminate the chances of double counting since these entries are included in the
value of the final products and services.

How to Calculate the Gross National Product?

The official formula for calculating GNP is as follows:

Y=C+I+G+X+Z

Where:
C – Consumption Expenditure
I – Investment
G – Government Expenditure
X – Net Exports (Value of imports minus value of exports)
Z – Net Income (Net income inflow from abroad minus net income outflow to foreign countries)

Alternatively, the Gross National Product can also be calculated as follows:

GNP = GDP + Net Income Inflow from Overseas – Net Income Outflow to Foreign Countries

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Importance of GNP

Policymakers rely on Gross National Product as one of the important economic indicators. GNP
produces crucial information on manufacturing, savings, investments, employment, production outputs of
major companies, and other economic variables. Policymakers use this information in preparing policy
papers that legislators use to make laws. Economists rely on the GNP data to solve national problems such
as inflation and poverty.

When calculating the amount of income earned by a country’s residents regardless of their location,
GNP becomes a more reliable indicator than GDP. In the globalized economy, individuals enjoy many
opportunities to earn an income, both from domestic and foreign sources. When measuring such broad
data, GNP provides information that other productivity measures do not include. If residents of a country
were limited to domestic sources of income, GNP would be equal to GDP, and it would be less valuable to
the government and policymakers.

The information provided by GNP also helps in analyzing the balance of payments. The balance of
payments is determined by the difference between a country’s exports to foreign countries and the value
of the products and services imported. A balance of payments deficit means that the country imports more
goods and services than the value of exports. A balance of payments surplus means that the value of the
country’s exports is higher than the imports.

GDP Per Capita

What Is Per Capita GDP?

Per capita gross domestic product is a metric that breaks down a country's economic output per
person and is calculated by dividing the GDP of a country by its population.

Applications of Per Capita GDP

Governments can use per capita GDP to understand how the economy is growing with its
population. GDP per capita analysis on a national level can provide insights on a country’s domestic
population influence. Overall, it is important to look at each variable’s contribution to understand how an
economy is growing or contracting in terms of its people. There can be several numerical relationships that
affect per capita GDP.

If a country’s per capita GDP is growing with a stable population level it can potentially be the
result of technological progressions that are producing more with the same population level. Some
countries may have high per capita GDP but a small population which usually means they have built up a
self-sufficient economy based on an abundance of special resources.

A nation may have consistent economic growth but if its population is growing faster than its
GDP, per capita GDP growth will be negative. This is not a problem for most established economies, as
even a tepid pace of economic growth can still outpace their population growth rates. However, countries

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with low levels of per capita GDP to begin with—including many nations in Africa—can have rapidly
increasing populations with little GDP growth, resulting in a steady erosion of living standards.

Global analysis of per capita GDP helps provide comparable insight on economic prosperity and
economic developments across the globe. Both GDP and population are factors in the per capita equation.
This means countries with the highest GDP may or may not have the highest per capita GDP. Countries
may also see a significant increase in per capita GDP as they become more advanced through technological
progressions. Technology can be a revolutionary factor that helps countries increase their per capita
ranking with a stable population level.

Watch It!

Watch this video as MRU helps us understand how GDP per capita can be used to measure a
country’s standard of living.

https://www.youtube.com/watch?v=Z0qHA93oOSc

Sources:

Circular Flow of Income. https://en.wikipedia.org/wiki/Circular_flow_of_income

Understanding the Circular Flow of Income and Spending https://www.tutor2u.net/economics/

reference/circular-flow-of-income-and-spending

The Circular Flow and GDP. https://www.khanacademy.org/economics-finance-domain/ap-

macroeconomics/economic-iondicators-and-the-business-cycle/21/a/the-circular-flow-and-
gdp#:~:text=GDP%20can%20be%20measured%20in,much%20is%20spent%20on%20stuff).

Principles of Macroeconomics. https://courses.lumenlearning.com/atd-fscj-macroeconomics/ chapter/

measures-of-income/

Boundless Economics. https://courses.lumenlearning.com/boundless-economics/chapter/measuring-output-

using-gdp/

Gross National Product. https://corporatefinanceinstitute.com/resources/knowledge/economics/gross-

national-product-gnp/

What Is Per Capita GDP? https://www.investopedia.com/terms/p/per-capita-gdp.asp

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