Principles

Of

Topic 6 : Concepts of National Income – GDP and GNP

 Learning Objectives

6.1) Gross Domestic Product (GDP)

6.2) Gross National Product (GNP)

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 ECONOMICS

MICRO MACRO

individual firms, how a region or a whole

households, markets, (aggregate) economy
and industries operates

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 Introduction to Macroeconomics

• Macroeconomics is the study of

economy - wide phenomena, including
inflation, unemployment, and economic
growth.

• We begin our study of macroeconomics

with the country’s total income and
expenditure.
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 Learning Objectives
6.1) Gross Domestic Product (GDP)
a) GDP defined
b) Measuring GDP
c) Uses of National Income
d) Limitations of GDP
e) GDP and the standard of living

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 Concepts of National Income

• Which statistics would you seek to tell

how well the economy is doing?
• The answer requires understanding some
of the nuts and bolts of national income
accounting.
• Despite certain limitations, the national
income accounting system provides a
valuable indicator of an economy’s
performance.
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 A. Gross Domestic Product
LO-6.1a

• Def : The total market value of all final

goods & services produced within a
country in a given period of time.
• To understand this definition, let’s take
it apart and examine each of its parts
separately.
• The first key phrase in the definition is
“market value”.
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 …market value…
LO-6.1a

• GDP adds together many different

kinds of products into a single measure
of the value of economic activity.
• GDP is usually expressed in the
currency of a particular country, e.g.,
Malaysia (RM).
• Things that don’t have a market value
are excluded, e.g., housework you do
for yourself. 8
 …market value…
LO-6.1a

• Example 1: Assume that economy of

Malaysia only produced 4 erasers
(RM0.25 each), 6 bananas (RM0.50
each) and 3 pairs shoes (RM20/pair).
• Then the market value of this
economy’s production, or its GDP, is
equal to…
(4 x 0.25) + (6 x 0.5) + (3 x 20) = RM64
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 …market value…
LO-6.1a

• Example 2 : I get a haircut. If a barber

cut it and reported the income to the
government, my payment for it would
be counted in GDP.

• If my friend cut it and didn't report the

income, my payment would not be
counted in GDP.
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 …of all…
LO-6.1a

• GDP tries to be comprehensive. It

includes all items produced in an
economy and sold legally in markets.

• Underground economy: The part of the

economy in which transactions take
place and in which income is generated
that is unreported and therefore not
counted in GDP.
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 …of all…
LO-6.1a

• This includes activity that is unrecorded

because the actual work is illegal. Eg: drug
trafficking.
• It is also includes unrecorded activity that
is legal, but people are doing it illegally.
Eg: If foreign workers do not have the
appropriate work permits to do work such
as cleaning, building or working in
restaurants, their work will go unrecorded.
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 …final…
• GDP does not measure total transactions in
the economy. It counts the value of final
output but not intermediate goods.
• Final goods or services: goods or services
consumed by the ultimate user; because
they are the end product of the production
process.
• Intermediate goods or services: goods or
services used up in the production of final
goods and services.
LO-6.1a
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 …final…
LO-6.1a

• Example : Production of a new car counts

toward GDP. Production of the tires,
dashboard, CD player, etc. that come with
the car are not part of GDP, because they
are intermediate goods used in production
of another good.
• Counting the sale of final goods and
intermediate products would result in
double and triple counting.
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 …final…
• There are two ways of eliminating double or
triple counting.
• The first is to calculate only final sales.
• A second way is to follow the value added
approach.
• Value added: The difference between the
value of goods as they leave a stage of
production and the cost of the goods as
they entered that stage.
LO-6.1a 15
 …final…
Example: Suppose that bread is the only final
product of an economy: It goes through
several (4) stages of production.

LO-6.1a 16
 …final…
• Stage 1: A farmer who produces wheat. Wheat
is an intermediate good here, and the farmer
sells the wheat to a miller for RM400, meaning
that the farmer added RM400 of value.

• Stage 2: The miller now uses the wheat to

make flour, which is a second intermediate
good, and sells the flour to a baker for RM600.
This means that the miller created RM200 in
value (RM600 sale - RM400 purchase).
LO-6.1a 17
 …final…
LO-6.1a

• Stage 3: The baker uses the flour and makes

bread; sells to shopkeepers for RM800, and
adds RM200 of value (RM800-RM600).
• Stage 4: They sell the bread to the consumers
and is a final good for RM900. The value added
by them is RM900-RM800=RM100.
• Note the RM900 final bread price is equal to the
total value added for each step in the process
(RM400+RM200+RM200+RM100=RM900).
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 …goods and services…
LO-6.1a

• GDP includes tangible goods – can been

seen, tasted, felt, heard or smelled before
purchase. (lasi lemak, clothing, cars, beer,
etc)

• Intangible services – cannot been seen,

tasted, felt, heard or smelled before
purchase. (haircuts, house cleaning, doctor
visits, etc).
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 …produced…
LO-6.1a

• GDP includes currently produced goods,

not goods produced in the past within a
given country.

• Example: unsold inventories, even apples

rotting on supermarket shelves, are part of
GDP. If they're sold next year, they're still
only part of this year's, but not next year's.
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 …within a country…
• GDP measures the value of production that
occurs within a country’s borders, whether
done by its own citizens or by foreigners
located there.
• Example 1: My teaching services in this
classroom: counted in Malaysia GDP,
because I'm an Malaysia citizen.
• Example 2: the teaching services of a
visiting faculty member from Holland: he's
not a Malaysia citizen, but it is in GDP.
LO-6.1a 21
 …in a given period of time…
LO-6.1a

• GDP measures value or production that

takes place within a specific interval of time.
• usually one year (12 months).

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 B. Measuring GDP
LO-6.1b
• GDP measures two things at once..
a) Total income of everyone in the
economy
b) Total expenditures of the outputs of
goods and services.
• GDP measures both because the are really
the same things.
Total Income = Total expenditures
• You can calculate GDP in two ways…
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 Measuring GDP
LO-6.1b

• Expenditure approach: A method of

computing GDP that measures the total
amount spent on all final goods and
services during a given period.
• Income approach: A method of computing
GDP that measures the income - wages,
rents, interest, and profits - received by all
factors of production in producing final
goods and services.
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 Measuring GDP
•
LO-6.1b
Expenditure Approach:
GDP = C + I + G + NX

• Income Approach:
GDP = Wages + Salaries + Rental +
Interest + Dividends + Profits

• GDP is the same no matter how it is

computed because every expenditure by a
buyer is at the same time income for the
seller.
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 The Expenditure Approach

There are four main categories of expenditure:

LO-6.1b

GDP = C + I + G + NX
where:
C = Consumption expenditure
I = Investment expenditure
G = Government expenditure
NX = Net exports expenditure
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 Consumption Expenditures
• Consumption expenditures are purchases of newly
produced goods and services by households.
Consumption is broken down into:
• Durable goods that last for a long time.
(automobiles, furniture…) LO-6.1b

• Nondurable goods that last for a short time.

(clothing, food, gasoline…)
• Services that reflect work done in which people play a
prominent role in the delivery.
(legal advise, medical treatment, education…)
……………………………………………………………………………………………………………………………………………………………………………

C = Goods + Services
C = (Durable goods + Nondurable goods) + Services
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 Investment Expenditure
• Expenditures on (production of) new plant,
equipment, and structures (capital) in a given time
period, plus changes in business inventories.
• Fixed investment - LO-6.1b

- capital equipment (e.g., machines, tools)

- structures (factories, office buildings,
houses)
• Inventories investment - goods produced but not
yet sold.
……………………………………………………………...........................................................................…

I = Fixed investment + Inventories investment

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 Government Expenditures
• Government payments (at the federal, state, and local
levels) for goods and services or investment in
equipment and structures are referred to as
government expenditures.
• When individuals pay taxes, those taxes are either
spent by government on goods and services or are
returned to individuals in the form of transfer payments.
……………………………………………………….............................................................................................

G = Total Expenditure (federal + state + local

LO-6.1b
government)

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 Government Expenditures
LO-6.1b

• Transfer payments – are transactions wherein

one party is not obliged to deliver a good or
service in return for the payment.
• Examples: retirement benefits, unemployment
benefits, scholarships, and donations.
• Transfer payments are not included in the
calculation of GDP because that spending
does not associate with the production of
goods and services.
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 Net Exports Expenditure
LO-6.1b

• Exports: goods produced in the country that are

purchased by foreigners.
• Imports: goods produced abroad that are
purchased by residents in the country.
• Imports are subtracted from GDP, as they
represent goods produced abroad, and were
included in consumption, investment, and
government purchases.
……………………………………………………………………………………………………………

NX = Total Exports (x) - Total Imports (M)

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 Incomes Approach
LO-6.1b
• Income Approach:
GDP = Wages + Salaries + Rental +
Interest + Dividends + Profits

• National income is the total income earned by

citizens and businesses of a country.

• Firms make payments to households for supplying

their services as factors of production.

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 Incomes Approach
• Wages and Salaries - Income received by labor from
firms for services rendered to them.
• Rental income - Payment for rented inputs. LO-6.1b
• Net interest - The difference between total interest
payments received and total interest payments made
by households.
• Profits - Corporate profits earned by business
corporations or payment of dividends to shareholders.

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 Nominal vs Real GDP
LO-6.1b

• If total GDP rises from one year to the next,

one of 2 things must be true.
a) Economy is producing larger output
of goods.
b) Goods and services are being sold at
higher prices.
• GDP may rise even if there hasn’t actually
been an increase in economic activity.
• If prices of goods and services rise (inflation),
then this will overstate the value of GDP. 34
 Nominal vs Real GDP
• Nominal GDP: GDP that is not adjusted for
inflation. The value of goods and services in
current prices.
• Real GDP: The dollar price of GDP in a base
year’s price, used to compare changes in
GDP from one year to the next. Real GDP is
corrected for inflation. An increase in real
GDP is an increase in economic growth.
Real GDP = Nominal GDP adjusted for inflation
LO-6.1b

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 Nominal GDP
LO-6.1b

• GDP at current prices.

• We multiply quantities purchased by the
price at which they sold on that year.
• Example: For 2015 GDP, we use prices
paid in 2015 .
• Because we use prices of 2015 to compute
GDP for 2015, we say that we used
“current” prices.
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 Real GDP
• GDP at constant prices. LO-6.1b

• For Real GDP, we multiply quantities purchased

by the price at which they sold on the base year.
• A base year is chosen during which the economy
experiences no economic crisis
• Example: For 2015 GDP, we use prices prevailing
in base year .
• Because we use prices of base year to compute
GDP for 2015 , we say that we used “constant”
prices.

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 Example: A
Pizza Milk
year P Q P Q
2015 RM10 400 RM2.00 1000
2016 RM11 500 RM2.50 1100
2017 RM12 600 RM3.00 1200

Compute nominal GDP in each year: Increase:

2015: RM10 x 400 + RM2 x 1000 = RM6,000

37.5%
2016: RM11 x 500 + RM2.50 x 1100 = RM8,250
30.9%
2017: RM12 x 600 + RM3 x 1200 = RM10,800
LO-6.1b 38
 Example: B
Pizza Latte
year P Q P Q
2015 RM10
RM10 400 RM2.00
RM2.00 1000
2016 RM11 500 RM2.50 1100
2017 RM12 600 RM3.00 1200
Compute real GDP in each year, using LO-6.1b

2015 as the base year:

Increase:

2015: RM10 x 400 + RM2 x 1000 = RM6,000

20.0%
2016: RM10 x 500 + RM2 x 1100 = RM7,200
2017: RM10 x 600 + RM2 x 1200 = RM8,400
16.7%
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 Example
LO-6.1b
Nominal Real
year GDP GDP
2015 RM6000 RM6000
2016 RM8250 37.5% RM7200 20.0%
2017 RM10,800 30.9% RM8400 16.7
%
• Nominal GDP grows reflects both prices and quantities.
• The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
• Hence, real GDP is corrected for inflation.

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 C. Uses of National Income
LO-6.1c

a) Standard of living comparison

b) Economic performance over time
c) National planning
d) Sectoral contribution
e) Economy policy

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 Uses of National Income (GDP)
a) Standard of living comparison: Compare the
standard of living in different countries to the
people living in the same country at difference
times. LO-6.1c

b) Economic performance over time : Measure the

performance of an economy over time by
comparing the national income of one time to that
of another. Whether the economic performance of
a nation is growing, stagnant or declining.

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 Uses of National Income
c) National planning : Government to formulate its short
term and long term economic planning and forecast
future developments base on current economic
performance. LO-6.1c

d) Sectoral contributions - Enable us to identify the

important sectors that contribute towards economic
growth.
e) Economic policy - With national income stimates,
future economic policies for development of a nation
can be formulated. 43
 D. Limitations of GDP
a) Does not measure income distribution. LO-6.1d

b) Does not measure non-monetary output or

transactions (e.g., barter, household activities,
voluntary work).
c) Secondhand sales.
d) GDP does not account of changes in quality of goods
and services.
e) Does not include “illegal” activities like drug
trafficking, prostitution, moonlighting and loan
sharking.
f) Does not include unreported sales and productions. 44
 Limitations of GDP
LO-6.1d
g) Does not include transfer payments.
h) Selling stock or bond does not add to GDP.
i) Does not include the value for intermediate
goods.
j) GDP not include goods produced in the past.
k) Value of the imported goods are not included in
GDP.

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 E. GDP And The Standard Of Living
a) Standard of living can be thought of as a measure of the
quality of life or level of material prosperity enjoyed by
individuals, a specific demographic group, or a geographic
region such as a country.
LO-1e
b) Factors determine a country's standard of living:
- Household income
- General health
- Level of crime
- Access to education
- Access to social services
- Political freedom
- Social freedom
- etc
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 GDP And The Standard Of Living
c) People may have higher incomes, but not necessarily
higher standards of living. LO-1e

d) GDP may grow because people are working longer

hours or taking fewer holidays.
e) It is possible that large part of a country’s output is in
goods that do not benefit consumers such as defence.
f) If this is the case, then it would be hard to argue that a
higher GDP will raise living standards.
g) GDP correlates to standard of living but is NOT a
measure of standard of living.
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 Learning Objectives

(6.2)
Gross National Product

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 GDP vs GNP

• GDP : The total market value of all final

goods & services produced within a country
in a given period of time.

• Gross National Product (GNP) : The total

market value of all final goods and services
produced within a given period by factors of
production owned by a country’s citizens,
regardless of where the output is produced.
LO-6.2
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 GNP
• To clarify, let us use an example:
LO-6.2

• If a US business had a manufacturing plant located in

China, any profit made by the plant would not be
calculated in the US GDP, but would be accounted for
in the US GNP.
• If a Canadian business has a manufacturing plant
located in the US, any profit made by the plant would
be included in US GDP, however it would be
subtracted from the value of the US GNP.
• Consequently, those both GDP and GNP are
measures of economic activities, the two values can
be extremely different.
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exercises
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Which of the following items are included in GDP?
(Indicate whether included or not included)
a) Ross buys a new pair of jeans at a local
department store. __________________
b) Joey has his mustache trimmed at his hair
salon. __________________
c) Rachel buys an antique chest at a resale shop.
__________________
d) Monica makes her own pasta sauce in her
apartment. __________________
e) Michael travels to Austria and buys wine and
cheese. __________________

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