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economics and Macro economics.
Measurement of Gross Domestic Product (GDP) and Gross National Income (GNI)
GDP and GNI
Gross Domestic Product (GDP) and Gross National Income (GNI) are commonly used for
assessing an economys level of achievements and economic progress. Except for some
technical adjustments, the two terms, viz., GDP and GNI are generally used some technical
adjustments, the two terms, viz., GDP and GNI are generally used synonymously to denote
a countrys national product or national income. Thus, in the ensuring analysis of national
income measurement, we shall be using GDP as a measure of nations annual production
and income.
GDP, as defined earlier, is the market value of all the final goods and services produced in
one year. Market value, in turn, as calculated by multiplying quantity of each good by its
price. Thus, if in an economy, Q denotes the total quantity of final goods produced and P is
the per unit price then value of product is P Q. and if the economy produces only this one
good Q, then GDP is equal to P Q, i.e., the market value of the good produced.
Now, if we look this from the point of view of a person who has purchased this good Q at
the market price P, his total expenditure on good is PQ. In other words, the expenditure of
the buyer on the good shows the value of the good. On the other side, if we look from the
point of view of the seller, he receives an amount equal to PQ by sale of the good. Thus PQ
is his income.

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Now, if we extend this logic to the entire economy, the GDP, which is equal to the market
value of all the final goods produced and market value is equal to PQ of each good, which in
turn, is the expenditure on each good, then GDP can be viewed as the total expenditure on
goods by all the spending units in the economy. And if we view it from producers point of
view, GDP is the value of the final goods (P Q) which they receive from selling those
goods. The receipts of the business enterprises are distributed as rewards among factors of
production for their services rendered in the production process and this constitutes factor
incomes (rent, wages, interest, profits), and the sum total of this factor incomes is called
national income.
Thus, corresponding to the two halves of the circular flow, we can measure national income
or GDP in two ways:
As value of production as denoted by the expenditure on goods produced as shown
by the right half of the Fig. 2.3 of circular flow of income. This is called Expenditure
Method or Spending Based GDP.
as income generated by the production process called Income Method or Income Based
GDP as shown by the left half of the Fig. 2.3 of the circular flow of income. Since, both
these methods have the same base, viz., the value of final goods and services as looked at
from buyers and sellers point of view and since the money value of good purchased by the
buyer must be the same as money value of the good sold by the seller (his receipts), the
value of GDP calculated by these two methods must be conceptually identical, though some
differences may crop in due to some errors of measurement.

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Expenditure Method or Spending Based GDP

Spending based calculation of GDP relies on the estimates of expenditure on the final goods
and services produced during the year by all the spending units, viz., domestic households,
business enterprises, government and the rest of the world. Accordingly, estimates are
prepared for the consumption expenditure, investment expenditure, government
expenditure and net foreign expenditure. These are discussed below:
Consumption Spending (C)
Consumption spending comprises of expenditure on the consumer goods produced during
the year, both by the individuals or the private households as well as by the government.
Private Consumption Spending
The private consumption spending includes such expenses as on food, clothing,
entertainment, household electronic goods, medicines, motor cars and all other non-durable
and durable goods that are needed to satisfy our individual and family requirements. Such
expenditure also includes individuals contribution to charities, religious donations, etc.
Government Consumption Spending (G)
Government consumption spending includes expenditure on such services like hospitals,
dispensaries, educational institutions, street lights, etc., that are used by the society
collectively. Besides, government expenditure on civil administration, internal security,
police, defence services, etc., is also a component of government consumption expenditure.
Thus,
Consumption Spending = Private Consumption Spending + Government
Consumption Spending
= Total Consumption Expenditure, which is denoted by the alphabet C.
Investment Spending (I)
Investment spending is defined as expenditure made on production or acquisition of goods
not meant for present consumption but for future use such as production of consumer goods
in future time period. The goods on which expenditure is made are called capital goods or
investment goods. Plant, machinery, equipment, etc., are the examples of capital goods
on which business enterprises spend money. Expenditure on production of such fixed assets
like machinery and equipment is called fixed investment or fixed capital.
Besides fixed investment, the business enterprises also spend money on maintaining
adequate stocks of raw materials and other inputs used in production to meet the smooth
flow of their output in the face of some unforeseen fluctuations and delays in getting
supplies of such inputs from their supply sources. Expenditure on maintaining such stock is
called inventory investment. Besides the stock of inputs sometimes the firms may not be
able to sell the entire amount of their finished product within the given year. So, at the end
of the year, some quantities of final goods remain unsold and add to the stock of
inventories. Thus, all these inventories are valued at their market price (i.e., what they are
worth today) and included in investment spending.

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Total investment expenditure thus estimated is called gross investment or gross capital
formation. If from this gross investment, we deduct depreciation and replacement
investment necessary to maintain the capital stock at the given level, we arrive at the figure
of net investment. However, the concept of investment that we use in the macroeconomic
analysis of national income determination is that of gross investment because replacement
investment also involves capital goods produced in the economy and form a part of its total
output.

Net Exports (X M)
Besides consumption spending (C), investment spending (I) and government spending (G),
another category of spending comprises of net exports, i.e., exports (X) minus imports (M)
or simply X M. Consumption spending by the private people as well as the government
does have an import content which comprises of expenditure on imported goods. Similarly,
a part of investment expenditure is on capital goods or machinery and equipment imported
from other countries. Thus, while this expenditure is made by our domestic entities
(consumers, investors, etc.), the goods or services on which this expenditure is made is not
a part of our domestic production. Therefore, to arrive at the total spending on our
countrys product, expenditure on imports must be deducted from the total expenditure.
Conversely, exports constitute expenditure by foreign consumers and investors on goods
and services produced in this country. Though the expenditure on exports (sale of goods to
the rest of the world) is a part of expenditure of foreign countries, the goods on which it is
incurred are a part of this countrys GDP. Thus value of exports must be added to the total
expenditure, deducing the value of imports from it. Thus, by domestic expenditure and
adding value of exports to the total domestic expenditure, we arrive at total expenditure on
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goods and services produced in this country or its GDP. A more convenient way is to find
the net exports or net expenditure abroad which equals to value of exports minus value of
imports (X M) and add it to the total expenditure on consumption an investment.
Thus, spending based GDP is equal to the sum total of expenditure of all above mentioned
categories of spending.
Therefore,
GDP = C + I + G + (X M).
Spending based GDP is the sum of private consumption, government consumption,
investment and net export spending on currently produced goods and services. It is the GDP
at market prifces.1
Income Based GDP or Income Method of GDP Calculation
Production generates income to those who contribute efforts and resources for the
production of goods and services. Total spending on the output (money value of production)
by the people accrues as revenue or sale proceeds to the business enterprises out of which
rent, wages, interest, etc., are paid and what remains is the profit or the reward of the
entrepreneurs. Thus wages + rent + interest + profits must be equal to the total sale
proceeds (value of the output) because the profit, being the residual item after all other
claims have been met, equates the value of output (as determined by spending) and the
factor incomes. Thus, value of production is equal to value of income and therefore GDP is
equal to GNI (gross national income). In a closed economy with no factor income from
abroad:
GDP = GNI = Wages + Rent + Interest + Profits.
There is, however, a difference between the GDP and GNI in an open economy. The
estimates of output produced measured by the GDP are not the same or equal to the total
income received by the factors of production in a country as measured by the GNI. This
difference is caused by what is called net factor income from abroad. Gross National
Income (GNI) is the measure of income received by the nationals of a country while GDP is
the value of output produced in a country. Income received may be more than the value of
domestic output when people receive income not only from domestic activities but also from
factor services provided by them outside their country. Thus, income on investments made
by the people in other countries, wages and salaries earned by this countrys nationals
working abroad are the examples that show total income received by a nation is more than
the value of output it produces. Conversely, some of countrys output may be produced with
the factor services provided by the people not belonging to this country and thus they have
a claim on it. The payments of profits, royalties, etc., on foreign investment and
emoluments paid to foreign employees thus make the GDP less than GNI. The difference
between the factor income going out of the country and that coming into the country from
rest of the world, is called Net Factor Income from Abroad. We can thus reconcile the
two concepts of income, viz., GDP and GNI as follows:
Gross National Income (GNI) = Gross Domestic Product (GDP) + Net Factor Income from
Abroad

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While Net factor = Compensation (wages, salaries, etc.) received by our Income from
Abroad nations from abroad minus what is paid out by this country to foreign nationals +
Net property income (rent, dividend, etc.) and entrepreneurial income
(profits, etc.) received from abroad.

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