F.

5 NSS Macro Econ

Supplementary Notes 1
1.1 Gross Domestic Product (GDP) (Book 5: Chapter 1)
A. Stock vs Flow (p.2-3)
⚫ Stock is any measurement at a particular moment of time, e.g. _________________________
⚫ Flow is any measurement that spreads over a certain period of time, e.g. _________________

Question: Classify the following into stock and flow.

(a) the number of Cokes in a refrigerator (e) rental income
(b) consumption of coffee per day (f) the inventory of a department store
(c) output of toys per day (g) the shopping expenditure of this month
(d) population of a country (h) the number of cars passing through the
tunnel from 8am to 9am
B. GDP (p.4)
Definition: GDP is the total market value of all final goods and services produced by all residents
producing units of a country or territory within a specific period of time.

Remarks:
1. The monetary (market) value of production
- In GDP accounting, the value of production is expressed in terms of ____________.

2. Only the value of final goods and services is included

- Intermediate goods are ___________ that are used up in producing final goods.
- Final goods are goods for final use or ___________ ________________.
- E.g. cloth vs. shirt, which one is final goods?
If shirt is bought by households, then shirt is ___________ goods. If cloth is bought by
textile producers, then it is _____________ goods.
- How about flour? Is it final goods or intermediate goods? (It depends whether the flour is
bought by households or bakery.)
- Only the value of (intermediate/ final) goods will be included in GDP.
- The value of intermediate goods is excluded. This is because its value has already been
included in the value of final goods.
- If intermediate goods were also counted, we would make the mistake of _____________
_______________, i.e. counting the value of intermediate goods more than once.

3. Meaning of resident producing units

- It includes both individuals and firms that maintain a centre of economic interest in that
economy. Their output is included in HK’s GDP.

4. GDP measures production that is spread over a period of time

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C. Circular flow model (p.9-10)

Households

Firms

⚫ Real flow: it reflects the flow of __________ services and the flow of final _________ and
___________. (→)
⚫ Money flow: it reflects the flow of ______________ on final goods and services and the flow
of factor payments (or ____________). (--->)

⚫ 3 ways to measure income/ output of an economy: (p.5)

(1) Expenditure on final goods and services –expenditure approach
(2) Total market value of the final goods and services produced by firms—output
approach/ value-added approach
(3) Factor income earned by households—income approach

D. The 1st approach of calculating GDP: Expenditure approach (p.11-19)

⚫ It measures the total spending of ____________, _________ and the _____________ on final
goods and services produced by the resident producing units within the economy.

⚫ GDP = C + I + G + (X – M)

⚫ Expenditure is classified into the following types:

C : _________________________________________
I : _________________________________________
G : _________________________________________
(X – M): _______________________________________

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 Private consumption expenditure (C) (P.11-12)
⚫ It includes consumption expenditure of households on final goods and services that are
currently produced, e.g. clothing, food, transport and entertainment.
⚫ Both households’ expenditures on renting premises and the market rental value of
owner-occupied premises are counted in private consumption expenditure.

Items excluded from the private consumption expenditure: (P.5-8)

(a) Second- hand goods
Their first sales had been counted already.

(b) Unreported market transaction and illegal transactions

They involve production and market value, and should be counted; but reliable data are difficult
to get, e.g. private tutoring, illegal hawkering, sales of pirated CDs.

Other items excluded from GDP:

(a) Intermediate goods
Intermediate goods are input which used to produce other goods and for resale. Intermediate
goods are excluded to avoid _____________ ______________ as their value is already counted
in the value of final goods.

(b)Non-marketed goods and services

E.g. Housewives’ work, voluntary work, self-made furniture, etc are regarded as non-marketed
goods and services. Since they have no market price, it is too costly to estimate and so left
outside GDP.

(c) Prizes or “income” won from gambling and lotteries

It is because they have no corresponding production

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 Gross investment expenditure (I) (P.12-15)
First approach to calculate gross investment expenditure (I)
(1) Classification according to types of capital goods invested
- Firms invest in two types of capital good: fixed capital and inventories.

Gross investment (I) = Gross domestic fixed capital formation + change in stocks

i) Gross domestic fixed capital formation (GDFCF)

It refers to the spending on fixed assets, e.g. expenditure on land, spending on building, plant and
machinery, equipment, etc.
➢ Firms buy many goods and services, e.g. raw materials, fuel, machinery and factories. The
first two are used up in production and they belong to intermediate products. Only the last
two can be used repeatedly in production. Capital that can be used repeatedly in
production is called fixed capital. Only fixed capital, e.g. ____________ and ___________
is finally consumed by firms. It is counted in GDP as a component of gross investment;
called gross domestic fixed capital formation.
➢ The value of the flat (no matter for residential or commercial use) should be included in
GDFCF. Buying residential flats is included in investment in GDP. It is classified as
investment expenditure instead of consumption expenditure because it involves a long
period of time.
➢ Commission or stamp duties are counted in investment in GDP since they are the return
to ___________ and _______________ for the services provided. .

ii) Change in stocks

➢ If there are unsold goods (implying total expenditure < total output), then we suppose these
unsold goods were bought by the _____________ and kept in their warehouses. This
means there is an “increase in stocks” or called “increase in the ______________”.
➢ It should be included in the gross investment expenditure and GDP because they represent
final goods that are currently produced.
E.g. Carpenter produced $1000 tables. It only sold $700 tables.
Then, C = ________________
I = __________________

➢ If the sales value is greater than the production value in that current year, then the change in
inventory is negative.
➢ It should be deducted from gross investment expenditure and GDP because they represent
sales of goods that are not currently produced.
E.g. Current output is $1000 and sales value is $1200
Then, C = ________________
I = _________________
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Second approach to calculate gross investment expenditure (I)
(2) Classification according to purposes of investment
⚫ During production process, most capital goods will experience a reduction in its value owing
to tear and wear, obsolescence or outdated. Such reduction in value (of capital goods) is
_______________________or capital consumption allowances.
⚫ Because of the effect of depreciation, we need to distinguish gross domestic fixed capital
formation and net domestic fixed capital formation
⚫ Gross domestic fixed capital formation = Net domestic fixed capital formation + depreciation.
E.g. if the gross domestic fixed capital formation is $500 and the depreciation is $200, then
the net domestic fixed capital formation is __________.

Gross investment expenditure(I)= Net domestic fixed capital formation + _______________ + change in stocks

OR
Gross investment expenditure (I) = Gross domestic fixed capital formation + change in stocks

⚫ Net investment expenditure is the expenditure that domestic firms spend to expand their
stock of fixed capital (net value) and inventories. Net investment expenditure = Net domestic
fixed capital formation + change in stocks
OR
Gross investment expenditure = Net investment expenditure + ________________________

Remarks:
Items EXCLUDED from the investment: (p.7-8)
(a) Transactions of shares and bonds
Expenditures on the purchase of shares are excluded from GDP. It is because these
transactions are a ______________ of _______________ only. No current production of
goods. However, commission or stamp duties are counted since they are the return to
___________ and _______________ for the services provided.
(b) Capital gain from sale of shares or properties is excluded because there is no production.
E.g. In 2001, Shirley spent $10,000 to buy the share of HSBC. 2 years later, she found that
the share price was increased and she sold it out for $12,000. In this case, the capital gain is
________________.

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 Government consumption expenditure (G) (P.15-16)
⚫ The government is involved in the production of many goods and services, e.g.
_______________________________________________________________
⚫ These value of goods and services is estimated in the following types of expenditures:
- government spending on final goods and services for providing these services.
- government spending on its employees, including ____________ and housing allowances.
⚫ Transfer payments from government to citizen are (included/ excluded) because the
recipients do not provide any goods and services in return, e.g. unemployment assistance,
social security assistance, other welfare payments, etc.
⚫ Government spending on infrastructure (e.g. tunnel, bridges, etc.) belongs to fixed capital
spending, so they should be included in gross ________________ expenditure in national
income accounting.

Net exports (X – M) (P.17-18)

Net exports = Total export of goods and services – Total imports of goods and services

⚫ Total exports of goods and services = Domestic export of goods + Re-exports + Exports
of services
⚫ Why should we deduct the total import from the total export?
i. Imported goods and services are not domestically produced.
ii. The value of imported goods and services are implicitly included in the consumption
expenditure, gross investment and government expenditure. Since imports are not
____________ produced, imports must be deducted.
⚫ Exports are included in GDP because they are _________ production (even though exports
are not consumed by the domestic citizens).

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Summary:
Items excluded Reasons
1. Production for self- It does not involve market transaction.
consumption
e.g. a farmer growing crops for
his own consumption
2. Second-hand/ used goods It is to avoid double counting.
e.g. sales of second-hand cars or
property
3. Illegal transaction It should be included but it is not reported to the
e.g. drug trafficking or government.
smuggling of stolen cars
4. Unreported transaction It should be included but it is not reported to the
e.g. private tutors providing government.
tutoring services
5. Intermediate goods It is to avoid double counting.
e.g. raw materials
6. Transaction of shares or bonds It is the expenditure without any corresponding production
of goods and services.
7. Social welfare received It is the expenditure without any corresponding production
of goods and services.
8. Gifts, gambling, lucky draw It is the expenditure without any corresponding production
received of goods and services.
9. Imported goods and services It is not produced by the resident producing units.

Question:
Country A’s Gross Domestic Product (GDP) Components $ billion
Private consumption expenditure 160
Government consumption expenditure 60
Gross domestic fixed capital formation 20
Increase in inventory 5
Imports of goods 1620
Exports of goods 1456
Imports of services 177
Exports of services 290
Net income form abroad -10

What is the country A’s GDP?

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E. The 2nd approach of calculating GDP: Output/ Value-added approach (P.21-24)
⚫ Output approach is to measure the market value of all final goods and services currently
produced
⚫ This method includes final goods only, because intermediate goods (goods used up in the
production process) is not for the final consumption of households.
⚫ Illustration 1:
A produced $300 rice. B produced $500 tables. C produced $400 chairs.
The GDP is __________________.

⚫ Illustration 2:
Mr. A is the owner of an iron mine. He sold $1 million iron to Mrs. B.
Mrs. B refined the iron into steel and sold it to Company C at $1.5 million.
Company C used the steel to make furniture and sold the furniture in the market at $2.8
million.

The gross sales revenue of ALL market transaction is _____________ million.

The final consumption goods enjoyed by the citizens is ____________ million only.
Total sales revenue of ALL goods is not the same as the output enjoyed by the economy. This
is the problem of double counting (value of intermediate goods has been counted more than
one time).
Intermediate goods in the above example are: _____________________________________
Final goods are: _______________________

In order to avoid the problem of double counting, we calculate the GDP by one of the following 2
ways:

(a) Calculate the final goods only:

Only the furniture is final consumption goods. We only include ______ million in the calculation
of GDP. Values of intermediate goods are already included in the final goods.

Problem:
E.g. Calculate the contributions to GDP in the following production chain:
Value of wheat sold to millers $250
Value of flour sold to bakers $600
Value of flour sold to consumers $300
Value of bread sold to consumers $800

However, in real life, we do not use this method because we cannot distinguish between ________
goods and _____________ goods, it is difficult to know who are final consumers.
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(b) Calculate the value-added of each production stage:
Value-added = Value of output – value of intermediate products purchased from other producing
units and used up during production
Value-added = Value of output (e.g. value of clothes produced by a factory) – Value of intermediate
consumption (e.g. cloth, button, thread).

The value-added of Mr. A is _____________________________ = ___________________

The value-added of Mrs. B is ____________________________ = ___________________
The value-added of Co. C is _____________________________ = ___________________

GDP = Summation of all value-added

= __________________________________________
= _____________________

The advantage of this method is (i) no need to distinguish ___________ goods and
__________________ goods. (ii) It can also avoid the problem of ___________ ____________.
The contribution to GDP is usually calculated by value-added in output approach.

Question 1:
$600 $800
$300 Table seller
Lumbering firm Timber manufacturer Households
Bookcases seller
$500 $900
Calculate the GDP of the above production chain by the value-added approach.
GDP = __________________________________

Question 2:
$2M
Imported pigs $20M $90M
$1M Supermarket A’s restaurant Consumers
Local pigs

Calculate the contribution of the above production chain to HK’s GDP using the value-added
approach.
GDP = ____________________________________

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F. The sales value of current production of goods or services is not equal to the contribution
to GDP
Question 1:
The sales revenue of a TV sets manufacturer in 2010 was $300,000. Give TWO reasons to explain
why the contribution of this manufacturer to GDP in 2010 was less than $300,000.

There are three possible reasons:

1. Some of the components of TV sets were __________________ from other countries. The
______________ value was not included in the GDP because they were not local production.
2. Some TV sets sold in 2010 were _______________ of previous years. They were not
_______________ production.
3. Some components of TV sets were not produced by this firm. Other firms’ contribution in the
production process should have been deducted.

Question 2:
The sales revenue of a local travel agency was reduced by $200 million. Give TWO reasons to
explain why the reduction in that part of Hong Kong’s GDP contributed by the travel agency is less
than $200 million.

There are three possible reasons:

1. Part of the decrease in sales revenue is not locally produced, they were _____________ from
other countries, e.g. like the value of imported raw materials. The value of imports bought by
this firm for its production but they are not _________ production.

2. Part of the decrease in sales revenue was ______________ of last year. Part of the decrease in
sales revenue is not included in GDP as they are not ____________ production.

3. The value of outputs of other firms in HK that are bought by this firm for its production. Other
firms’ contribution in the production process should have been deducted.

Question 3:
Suppose a country’s export value of goods and services decreases by $3 billion. In reality, the
resulting decrease in GDP may be more than $3 billion. Explain a factor that would lead to a
more-than $3 billion decrease in GDP.

There is one reason:

1. Following the decrease in export, the production of some services which helps export will also
cut. These include ____________, insurance services. The amount of GDP from these
productions of the exports related services will also decrease, which will result more than $3
billion decrease in GDP.
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Question:
The following table shows the percentage contribution of GDP of the major economic activities in
2009. State the type of production of each economic activity.
Economic activity Percentage Type of production
contribution to GDP
1. Agriculture and fishing 0.05%
2. Mining and quarrying 0.01%
3. Manufacturing 2.29%
4. Electricity, gas and water 2.55%
5. Construction 3.17%
6. Wholesale, retail and import and export trades, 26.57%
restaurants and hotels
7. Transport, storage and communications 7.46%
8. Financing, insurance, real estate and 27.62%
business services
9. Community, social and personal services 18.46%
10. Ownership of premises 11.83%

G. The 3rd approach: Income approach (Out of the syllabus)

⚫ In the income approach, GDP measures the total income generated from production.
⚫ GDP measures the total income earned by factors of production owned by a country’s
residents, as rewards to their production of goods and provision of services. It can be
subdivided into the following categories:
- Wages: it refers to salaries, bonus and commissions
- Interest: it refers to the net interest paid by business
- Rent: it refers to the income earned by individuals for the use of their real assets, such as
farms, houses, and stores. (The implicit rental value of owner-occupied houses is
estimated).
- Profit: _____________________________________________________
⚫ By income approach, GDP include ___________, ____________, ____________,
____________ (including ________________).
⚫ But the income approach had discontinued since 1981.
⚫ In theory, GDP estimates by the 3 approaches should be the same. But in practice, 3 different
approaches would obtain different values of GDP (owing to statistical discrepancy).

Question: Which of the following should be included in GDP?

- Capital gain
- Value of shares
- Dividend
- Stamp duty
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H. Gross National Income (GNI) (p.26-28)
⚫ Definition:
GNI is the total income earned by residents from engaging in production in a specific
period of time.
⚫ What is “resident”?
Residents of a territory comprise of individuals and organizations.
For individuals, it refers to those people who normally stay in the territory, irrespective of
_______________. Those who normally intend to stay and work in HK at least _______ year
are regarded as residents of HK.
⚫ For example, ____________ ___________ and imported workers who have worked in HK on
long-term contract are also regarded as residents of HK.
⚫ Both the income of residents from _________ or _________ production are included in GNI.
⚫ Income earned by non-residents (who are working in resident production units) is
______________ in GDP but it is _______________ from GNI.

⚫ GNI = GDP + factor income earned by – factor income earned by

___________________ ___________________
from _______________ from ______________
the territory the territory

GNI = GDP + factor income earned abroad – factor income paid abroad

GNI = GDP + ______________________________________________ OR

GDP = GNI – ______________________________________________
⚫ Factor income: earnings receivable or payable for the provision of factors of production.
Factors of production Return
Land Rental
Capital Interest or dividend
Entrepreneur Profit (as dividend or retained profit)
Labour Wages
⚫ Factor income include wages, salaries, company’s profits, rental income, dividends from
shares, bond interests, interests earned from bank deposits, etc.
⚫ Example: suppose Mr. Chan is a HK resident. He owns a flat in Canada and last year received
$10,000 as rental income. Would this be included as HK’s GNI? GDP?
HK’s GNI (Yes / No) HK’s GDP (Yes / No)
This $10,000 rental income is an example of HK’s factor income earned abroad.
⚫ Another example: Mr. Wong, a US resident, owns some HSBC’s share and received $50,000
dividends last year. Would this be included in HK’s GNI? GDP?
HK’s GNI (Yes / No) HK’s GDP (Yes / No)
The dividend income is an example of HK’s factor income paid abroad.
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Remark:
⚫ GNI = GDP + Net external primary income flows
= GDP + Primary income earned by residents from outside the economic territory
- Primary income earned by non-residents from within the economic territory

Question:
Explain whether the following earnings are included in (a) Hong Kong’s GDP and (b) Hong
Kong’s GNI. Are they belong to factor income from abroad or factor income paid abroad?

Included in Included in Factor income from

GDP? GNI? abroad/ factor
income paid abroad?
a. Salary of an USA accountant working in
a local accounting firm for 3 months
b. Salary of a Filipino maid working in
Hong Kong for 2 years
c. Income of a local singer performing in a
concert organized in Singapore
d. Dividends of a local teacher owning
shares of Microsoft
e. Payment to a US consultant hired by the
MTR Corporation Limited on a
three-month contract
Question: Under what situation will GNI be smaller than GDP?
Summary:
Whether the money or income is included in GDP:
Included:
There is current production of goods and services by a resident producing unit.

Not included:
➢ No related production of goods or services from the money or income and belongs to a
transfer of ownership E.g. ________________________________________
➢ No related current production of goods or services from the money or income
E.g. ___________________________________________________________
➢ No production of goods or services by that resident producing unit
E.g. ___________________________________________________________
Question:
Suppose Mary receives $5000 as public assistance but spends only $3500 on food, transportation.
She keeps the rest in the bank as saving deposits. Explain whether these items would affect the
GDP in HK.
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