Chapter 02 Measuring A Nation's Income

Lesson Outline
Chapter 02
o What is Gross Domestic Product (GDP)?
o How is GDP related to a nation’s total income and spending?
Measuring a Nation’s o What are the components of GDP?
Income o How is GDP corrected for inflation?
o Does GDP measure society’s well-being?
Md. Kaysher Hamid
Md. Kaysher Hamid © MKH BUP 2024
0 1
Micro vs. Macro Income and Expenditure

2 3
 Microeconomics  Gross Domestic Product (GDP)

The study of how individual households and firms make decisions, • Measures total income of everyone in the economy.
interact with one another in markets.
• GDP also measures total expenditure on the economy’s output of g&s.
 Macroeconomics
The study of the economy as a whole.
For the economy as a whole,
income equals expenditure
because every dollar a buyer spends
is a dollar of income for the seller.
Md. Kaysher Hamid © MKH BUP 2024 Md. Kaysher Hamid © MKH BUP 2024
2 3
The Circular-Flow Diagram The Circular-Flow Diagram
4 5
 A simple depiction of the macroeconomy Households:

 Illustrates GDP as spending, revenue, factor payments, and income
 own the factors of production,
sell/rent them to firms for income
 Preliminaries: Firms  buy and consume goods & services
o Factors of production are inputs like labor, land, capital, and
natural resources. Firms: Households
o Factor payments are payments to the factors of production (e.g.,  buy/hire factors of production,
wages, rent). use them to produce goods and services
 sell goods & services
4 5
What This Diagram Omits

Revenue (=GDP) Spending (=GDP)
Markets for 7
G&S Goods &

G&S
sold Services bought  The government
o collects taxes, buys g&s
 The financial system

Firms Households o matches savers’ supply of funds with borrowers’ demand for loans
 The foreign sector

o trades g&s, financial assets, and currencies with the country’s
Factors of Labor, land, residents
production Markets for capital
Factors of
Wages, rent, Production Income (=GDP)
profit (=GDP)
The Circular-Flow Diagram 6
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Gross Domestic Product (GDP) Is… Gross Domestic Product (GDP) Is…
8 9
…the market value of all final goods & services …the market value of all final goods & services
produced within a country in a given period of produced within a country
time. in a given period of time.
Final goods: intended for the end user
Goods are valued at their market prices, so: Intermediate goods: used as components
 All goods measured in the same units or ingredients in the production of other goods
(e.g., dollars in the U.S.)
GDP only includes final goods—they already embody
 Things that don’t have a market value are excluded, the value of the intermediate goods used in their
e.g., housework you do for yourself. production.
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produced within a country in a given period of produced within a country in a given period of
time. time.
GDP includes tangible goods (like DVDs, mountain GDP includes currently produced goods,
bikes, beer) not goods produced in the past.
and intangible services (dry cleaning, concerts, cell
phone service).
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produced within a country in a given period of produced within a country in a given period of
time. time.
GDP measures the value of production that occurs within Usually a year or a quarter (3 months)
a country’s borders, whether done by its own citizens or
by foreigners located there.
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Real vs. Nominal GDP Real versus Nominal GDP

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o If output doubles and prices stay the same, GDP doubles  Inflation can distort economic variables like GDP, so we have two
o If output stays the same and prices double, GDP doubles versions of GDP:
o Do we prefer one way of doubling GDP to the other?  Nominal GDP
o values output using current prices
o not corrected for inflation
 Real GDP
o values output using the prices of a base year
o is corrected for inflation
14 15
Real vs. Nominal GDP
EXAMPLE:
Pizza Latte
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year P Q P Q
2011 $10 400 $2.00 1000
2012 $11 500 $2.50 1100
2013 $12 600 $3.00 1200
Compute nominal GDP in each year:

Increase:
2011: $10 x 400 + $2 x 1000 = $6,000
37.5%
2012: $11 x 500 + $2.50 x 1100 = $8,250
2013: $12 x 600 + $3 x 1200 = $10,800 30.9%
Md. Kaysher Hamid 1717

16 17
EXAMPLE: EXAMPLE:
Pizza Latte Nominal Real
year GDP GDP
year P Q P Q
2011 $6000 $6000
2011 $10 400 $2.00
$2.00 1000
2012 $8250 $7200
2012 $11 500 $2.50 1100
2013 $10,800 $8400
2013 $12 600 $3.00 1200
Compute real GDP in each year, In each year,
using 2011 as the base year:
Increase: • nominal GDP is measured using the (then) current
2011: $10 x 400 + $2 x 1000 = $6,000 prices.
20.0% • real GDP is measured using constant prices from the
2012: $10 x 500 + $2 x 1100 = $7,200 base year (2011 in this example).
16.7%
2013: $10 x 600 + $2 x 1200 = $8,400
Md. Kaysher Hamid 1818 Md. Kaysher Hamid 1919
18 19
EXAMPLE: The GDP Deflator
Nominal Real
year GDP GDP 21
2011 $6000 $6000  The GDP deflator is a measure of the overall level of prices.
37.5% 20.0%
2012 $8250 $7200
 Definition:
2013 $10,800 30.9% $8400 16.7%
nominal GDP
• The change in nominal GDP reflects both prices and GDP deflator = 100 x
quantities. real GDP
 The change in real GDP is the amount that  One way to measure the economy’s inflation rate is to compute the
GDP would change if prices were constant percentage increase in the GDP deflator from one year to the next.
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
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EXAMPLE: The GDP Deflator

Nominal Real GDP
23
year GDP GDP Deflator
2011 $6000 $6000 100.0
14.6%
2012 $8250 $7200 114.6
2013 $10,800 $8400 128.6
12.2%
Compute the GDP deflator in each year:
2011: 100 x (6000/6000) = 100.0

2012: 100 x (8250/7200) = 114.6
2013: 100 x (10,800/8400) = 128.6

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ACTIVE LEARNING
Class Practice
Computing GDP
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2011 (base yr) 2012 2013 2021 (base yr) 2022 2023
P Q P Q P Q P Q P Q P Q
Good A $30 900 $31 1000 $36 1050 Rice $20 800 $25 900 $29 1100
Good B $100 192 $102 200 $100 205 Apple $50 180 $65 200 $90 230
Use the above data to solve these problems: Pen
Use $10to solve
the above data 1500these$15 1800
problems: $17 2000
A. Compute nominal GDP for 2011, 2012, and 2013 A. Compute nominal GDP for 2021, 2022, and 2023
B. Compute real GDP by considering 2011 as base year. B. Compute real GDP by considering 2021 as base year.
C. Compute the GDP deflator & inflation rate for 2012 and C. Compute the GDP deflator & inflation rate for 2022 and
2013 2023. Comment on the changes of purchasing power in these
years.
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The Components of GDP Consumption (C)

26 27
 Recall: GDP is total spending.  is total spending by households on
 Four components: o Goods- Durable & Nondurable goods

o Services- Intangible items
o Consumption (C)
o Investment (I)  Note on housing costs:

o For renters,
o Government Purchases (G)
consumption includes rent payments.
o Net Exports (NX)
o For homeowners,
 These components add up to GDP (denoted Y): consumption includes the imputed rental value of the house, but not
the purchase price or mortgage payments.
Y = C + I + G + NX
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Investment (I) Investment (I)
28 29
 is total spending on goods that will be used in the future to produce more  Business capital includes
goods. o Business structures (such as a factory or office building),
 Investment is the sum of purchases of o Equipment (such as a worker’s computer), and
o Business capital, o Intellectual property products (such as the software that runs the
o Residential capital, and computer).
o Inventories.  Residential capital includes the landlord’s apartment building and a

homeowner’s personal residence.
Note: “Investment” does not mean the purchase of

financial assets like stocks and bonds.
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Government Purchases (G) Net Exports (NX)

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 Government purchases include spending on goods and services by local,  Net exports equal the foreign purchases of domestically produced goods
state, and federal governments.
(exports) minus the domestic purchases of foreign goods (imports).
 It includes
NX = exports – imports
o the salaries of government workers as well as
 Exports represent foreign spending on the economy’s g&s.
o expenditures on public works.
 Imports are the portions of C, I, and G that are spent on g&s produced
 is all spending on the g&s purchased by govt at the federal, state, and local
abroad.
levels.
 G excludes transfer payments, such as Social Security or unemployment  Adding up all the components of GDP gives:
insurance benefits. They are not purchases of g&s.
Y = C + I + G + NX
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The Components of GDP The Components of GDP
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 Bangladesh prepares GDP based on production and expenditure approach.
 Production based estimate of GDP encompasses 3 broad sectors which are

agriculture, industry and service. Moreover, overall GDP was consisting of 15
sectors in 2005-06 base year. In 2015-16 base year BBS restructured some of
the existing sectors and includes new sectors for estimating the value addition of
the new base year (2015-16) GDP. Currently, the total number of sector in GDP
is 19.
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36 37
36 37

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 While BBS uses expenditure method primarily to estimate the expenditure • The required data on exports and imports are taken from the Balance of
components of GDP such as investment (I), public expenditure (G), Export (Ex) Payments (BOP) of the country, which is reported by the Bangladesh
and Import (Im).
Bank.
 Household Income and Expenditure Survey (HIES) of BBS helps to get an idea
• Public expenditure comes from Annual budget.
of the private consumption expenditure (C).
 Investment has two parts – Gross Fixed Capital Formation (GFCF) and changes
in inventories.
o The public part of GFCF is estimated from Annual Development

Programme (ADP) and
o The private part of it comes from import data and survey of firms.
38 39
ACTIVE LEARNING
The Components of GDP GDP and its components
40 41
A. Debbie spends $200 to buy her husband dinner

at the finest restaurant in Boston.
Consumption and GDP rise by $200.
B. Sarah spends $1800 on a new laptop to use in her

publishing business. The laptop was built in China.
Investment rises by $1800, net exports fall

by $1800, GDP is unchanged.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
Md. Kaysher Hamid © MKH BUP 2024 permitted in a licenseHamid
Md. Kaysher distributed with a certain product or service or otherwise on a password-protected website for classroom use.
40 41
ACTIVE LEARNING
GDP and its components GDP and Economic Well-Being
42 43
C. Jane spends $1200 on a computer to use in her editing business.
She got last year’s model on sale for a great price from a local  Real GDP per capita is the main indicator of the average person’s
manufacturer. standard of living.
Current GDP and investment do not change, because the  But GDP is not a perfect measure of well-being.
computer was built last year.
 Robert Kennedy issued a very eloquent yet harsh criticism of GDP:
D. General Motors builds $500 million worth of cars, but

consumers only buy $470 million of them.
Consumption rises by $470 million,
https://www.youtube.com/watch?v=77IdKFqXbUY
inventory investment rises by $30 million,
and GDP rises by $500 million.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a licenseHamid
Md. Kaysher distributed with a certain product or service or otherwise on a password-protected website for classroom use. Md. Kaysher Hamid © MKH BUP 2024
42 43
GDP and Economic Well-Being Shortcomings of GDP
44 45
 Measurement Issues
o Nonmarket Goods and Services
o Underground Economy
o Imputed Values for Nonmarket Goods and Services
o Changes in quality and the inclusion of new goods
o Leisure Costs
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Shortcomings of GDP Then Why Do We Care About GDP?

46 47
 Shortcomings in Well-Being Measurement • GDP does not directly measure those things that make life worthwhile,
o GDP and the Environment but it does measure our ability to obtain many of the inputs for a
o Composition and Distribution of Output worthwhile life.
o Non-material Sources of Well-being • Having a large GDP enables a country to afford better schools, a cleaner
environment, health care, etc.
• Many indicators of the quality of life are positively correlated with GDP.
For example…
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Then Why Do We Care About GDP? Other National Accounts
48 49
 Gross National Product (GNP)
o The market value of all the goods and services produced in one year by
the factors of production owned by the citizens of the country
o GNP includes GDP, plus any income earned by residents from overseas
investments and employments (remittance), minus income earned within
the domestic economy by overseas residents.
Gross National Product (GNP) = Gross Domestic Product (GDP) + Net

Income from Non-residents
48 49
Other National Accounts Other National Accounts

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 Private Disposable Income
o The amount of money that households have available for spending

and saving after income taxes have been accounted for.
Private Disposable Income =
Personal Income – Income Taxes
https://thefinancialexpress.com.bd/economy/new-economic-matrix-coming
50 51
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Chapter 02 Measuring A Nation's Income

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Lesson Outline

Md. Kaysher Hamid © MKH BUP 2024

Micro vs. Macro Income and Expenditure

 Microeconomics  Gross Domestic Product (GDP)

 A simple depiction of the macroeconomy Households:

What This Diagram Omits

G&S Goods &

 The financial system

 The foreign sector

Real vs. Nominal GDP Real versus Nominal GDP

o Do we prefer one way of doubling GDP to the other?  Nominal GDP

o values output using current prices

o not corrected for inflation

o values output using the prices of a base year

o is corrected for inflation

Compute nominal GDP in each year:

Md. Kaysher Hamid 1717

EXAMPLE: The GDP Deflator

Compute the GDP deflator in each year:

2011: 100 x (6000/6000) = 100.0

2013: 100 x (10,800/8400) = 128.6

Md. Kaysher Hamid 2222

The Components of GDP Consumption (C)

 Recall: GDP is total spending.  is total spending by households on

 Four components: o Goods- Durable & Nondurable goods

o Investment (I)  Note on housing costs:

 Investment is the sum of purchases of o Equipment (such as a worker’s computer), and

o Residential capital, and computer).

o Inventories.  Residential capital includes the landlord’s apartment building and a

Note: “Investment” does not mean the purchase of

Government Purchases (G) Net Exports (NX)

 Bangladesh prepares GDP based on production and expenditure approach.

 Production based estimate of GDP encompasses 3 broad sectors which are

The Components of GDP The Components of GDP

The Components of GDP The Components of GDP

o The public part of GFCF is estimated from Annual Development

A. Debbie spends $200 to buy her husband dinner

Consumption and GDP rise by $200.

B. Sarah spends $1800 on a new laptop to use in her

Investment rises by $1800, net exports fall

D. General Motors builds $500 million worth of cars, but

o Nonmarket Goods and Services

o Imputed Values for Nonmarket Goods and Services

o Changes in quality and the inclusion of new goods

Shortcomings of GDP Then Why Do We Care About GDP?

o Composition and Distribution of Output worthwhile life.

 Gross National Product (GNP)

Gross National Product (GNP) = Gross Domestic Product (GDP) + Net

Other National Accounts Other National Accounts

 Private Disposable Income

o The amount of money that households have available for spending

Private Disposable Income =

Personal Income – Income Taxes

Md. Kaysher Hamid © MKH BUP 2024

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