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The Circular-Flow Diagram
The equality of income and expenditure can be illustrated with the circular-flow diagram.
Revenue

Goods & Services sold

Market for Goods and Services

Spending Goods & Services bought

Firms

Households

Inputs for production
Wages, rent, and profit

Market for Factors of Production

Labor, land, and capital
Income

Define GDP

GDP, is defined as the total value of all goods and services produced within that territory during a given year. GDP is designed to measure the market value of production that flows through the economy.

Features of GDP  Includes only goods and services purchased by their final users. which are equal. so GDP measures final production.  Counts only the goods and services produced within the country's borders during the year.  Measures both output and income. whether by citizens or foreigners.  Excludes financial transactions and transfer payments since they do not represent current production. .

the "real GDP " would remain the same. For example. if both the "nominal GDP" and price level doubled between 1995 and 2005. "real GDP" is usually used as it gives a more accurate view of the economy. For year over year GDP growth. .Real GDP and Nominal GDP  Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation.

Over time. the general level of prices rise due to inflation. .Real GDP and Nominal GDP  Nominal GDP measures the value of output during a given year using the prices prevailing during that year. leading to an increase in nominal GDP even if the volume of goods and services produced is unchanged.

.Relation between Real GDP and Nominal GDP  Real GDP is calculated using constant prices whereas nominal GDP uses current prices. The difference between the nominal GDP and real GDP is due to the inflation rate in market.

because of the inflation the price for an apple goes up to \$3. In 2005. The nominal GDP in 2000 is (\$200 + \$150)= \$350 and the nominal GDP in 2005 is (\$300 + \$200) = \$500. . because real GDP only changes with the changing production level and therefore is a better size measure for economy. The price for an apple is \$2 in 2000.Example of Real GDP and Nominal GDP Our simplistic economy only produces apples and pears. whereas the price for a pear is \$4 at the same production levels. However real GDP did not change. Same year we produce 100 apples and 50 pears. whereas the price for a pear is \$3.

GDP does not include items produced and consumed at home that never enter the marketplace. It does not include items produced and sold illicitly. . such as illegal drugs.What Is Counted & Not Counted in GDP? GDP includes all items produced in the economy and sold legally in markets.

The Components of GDP GDP ◦ ◦ (Y) is the sum of: Consumption (C) Investment (I) ◦ ◦ Government Purchases (G) Net Exports (NX) Y = C + I + G + NX .

The Four Components of GDP  Consumption (C): ◦ Is the spending by households on goods and services e. food.g. etc. movie tickets Investment ◦ (I): Is the purchases of capital equipment and structures e.g. buying clothing. factory. houses. .

The Four Components of GDP Government ◦ Purchases (G): Includes spending on goods and services by local. ◦ Does not include transfer payments.). police. because it is not made in exchange for currently produced goods or services. provincial and federal governments (e. . roads. Net Exports (NX): Exports minus imports. etc.g.

GDP and Its Components (1998) Government Purchases Investment Net Exports 18% 16% -2 % Consumption 68 % .

Three Approaches to Measuring GDP  1.  Expenditures Approach: The total spending on all final goods and services (Consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) .Imports (M))  GDP = C + I + G + (X-M) .

Income approach Using the Income Approach GDP is calculated by adding up the factor incomes to the factors of production in the society.2. These include National Income (NY) + Indirect Business Taxes (IBT) + Capital Consumption Allowance and Depreciation (CCA) + Net Factor Payments to the rest of the world (NFP) .

GDP .CCA = NNP ( NET NATIONAL PRODUCT) NNP . NY = Employee compensation + Corporate profits + Proprietor's Income + Rental income + Net Interest CCA = Igross + Inet (I= Investment) NFP = Payments of factor income to the ROW minus the receipt of factor income from the rest of the world. Thus.NFP = GNP （GROSS NATIONAL PRODUCT) GNP .Income Approach         In this approach.IBT = NY (NATIONAL INCOME) .

purchase of intermediate goods to produce the goods sold. .3. Value added Approach:  The value of sales of goods .

Good Rice Price per unit 20 Q sold 1000 GDP Expenditure 20.Expenditure Approach  Uses the upper loop of the circular flow diagram.  Example: Suppose the economy has only one product. rice.000 . namely.000 20.

Suppose that in the production of rice the sales and expenses are as follows: Sales Expenses: P 20.000 6.000 20.000 P 20.000 .000 Wages Rent Interest Total Profit GDP=Sum of Payments to factors 8000 4000 2000 14.Income Approach   Uses the lower loop of the circular flow diagram: sum of payments to the various factors of production.

000 Stage of Prod’n Farmer .000 15. Value of intermediate good 12.Value Added Approach  Suppose that rice is the only final product of an economy: It goes through several (3) stages of production.000 3.000 Value-added 12.Rice GDP= Total Value Added Value of Sales 12.Palay Rice Miller -Milled Rice Retailers .000 .000 20.000 15.000 20.000 5.

The results would help the country to forecast the economic progress. determine the demand and supply. . The Indian GDP is calculated by the expenditure method. understand the buying power of the people. the position of the economy in the global arena. the per capita income.Importance of GDP  Calculating GDP is extremely important has the performance of the economy is fixed by means of this method.

a housing bubble) Transactions on the Blackmarket .g.The major limitations of GDP The GDP fails to measure or express changes in a nation's:        Quality of life Unpaid labour Intangible valuables (e. feeling secure) Real Savings Standard of Living Uneven inflationary price changes (e.g.

Indian Economy-Facts on India GDP  The Indian economy is the 12th largest in the world  It ranks 5th pertaining to purchasing power parity (PPP) according to the latest calculation of the World Bank     The GDP of India in the year 2007 was US \$1.182 at PPP .09 trillion India is the one of the most rapidly growing economies in the world The growth rate of the India GDP was 9.4% per year Due to the huge population the per capita income in India is \$964 at nominal and \$4.

It is the yardstick of measuring the functioning of the economy. .Indian Economy-Facts on India GDP  By Calculating GDP the performance of the Indian economy can be determined. India's economy has huge potential of expansion. Role of major industries in India GDP is important as based on this only the total GDP is calculated. Despite witnessing a slowdown. so agriculture makes the major contribution to the GDP. . due to the global recession. In terms of US Dollar exchange rate India's economy is the twelfth largest.  India is largely an agrarian economy.

Trend of Growth Rate of India's GDP  1960-1980: 3.4% .4% 1990-2000: 4.4% 2000-2009: 6.5% 1980-1990: 5.

Points to remember while calculating GDP in India  Calculating India GDP has to be done cautiously pertaining to the diversity of the Indian Economy. petroleum. manufacturing. such as primary or agriculture sector. information technology. and tertiary or service sector. telecommunication. textile.  There are different sectors contributing to the GDP in India such as agriculture. etc. .  The different sectors contributing to the India GDP are classified into three segments. secondary sector or manufacturing sector.

biotechnology. aviation. and tourism would experience very high rate of growth . India at present is one of the biggest exporter of highly skilled labor to different countries The new sectors such as pharmaceuticals. nanotechnology. telecommunication. India has become one of the most favored destinations for outsourcing activities.Points to remember while calculating GDP in India With the introduction of the digital era. manufacturing. shipbuilding. Indian economy has huge scopes in the future to become one of the leading economies in the world.

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I stands for business investment as capital which includes construction of a new mine. medical expenses. purchase of machinery and equipment for a factory. GDP = consumption + investment + (government spending) + (exports-imports) and the formula is GDP = C + I + G + (X-M) Where.C stands for consumption which includes personal expenditures pertaining to food. purchase of software.The method of Calculating India GDP  The method of Calculating India GDP is the expenditure method. buying goods and services but investments on financial products is not included as it falls under savings  . which is. households. expenditure on new houses. rent.

The method of Calculating India GDP  G stands for the total government expenditures on final goods and services which includes investment expenditure by the government. purchase of weapons for the military. and salaries of public servants  X stands for gross exports which includes all goods and services produced for overseas consumption  M stands for gross imports which includes any goods or services imported for consumption and it should be deducted to prevent from calculating foreign supply as domestic supply .