Measuring national income

Key terms:

Gross Domestic Product (GDP) or national output - the total value of all final goods
and services produced in an economy in a given time period (usually one year).

Income method - measures the value of all income earned in a country from wages
(including benefits such as health insurance), self-employment, rent, shares and bank
interest, minus of course deductions to taxes.

Output method - calculates the total output produced in a country, counting only the
value added so that there is no double counting.

Expenditure method - calculates GDP by adding up the total money spent in the
economy. This includes private spending by households, investment spending by firms
and public sector spending by the government. The expenditure method also includes the
value of net exports, which is calculated by subtracted the value of imports (foreign goods
and services purchased by domestic citizens) from exports (goods and services purchased
by overseas residents).

Gross National Income (GNI) - made up of GDP plus net property income (current
transfers) from abroad. A GNP that is larger than GDP must have a positive figure
(balance) for net property income (current transfers).

Real GDP / GNI - GDP or GNI adjusted for the effects of inflation i.e. the rise in general
prices.

GDP / GNI per capita - GDP or GNI divided by the number of people in a nation. This
is a more accurate measure of living standards than the previous measurements because it
considers not only the size of a nation's income but the number of people that it is shared
between.

© Mark Johnson,
InThinking www.thinkib.net/Economics 1
Activities

1. Watch the video your teacher will show you and then complete the activities included on
the page.

(a) What is GDP?

(b) Why are tyres used in car production not included in GDP but used tyres sold in a a
garage would?

(c) Would a car manufactured by Ford in Mexico count in the USA's GDP or Mexico's?

(d) What is the difference between nominal GDP and real GDP?

Activity 2: Avoiding double counting

When calculating national income via the output method, a beer company records the
following data:

A farmer grows malt and barley worth $5 to the brewer. The brewer then turns the malt and
barley into beer worth $40 which it sells to a bar or cafe. A bar then sells the beer for $80 in
individual units. Calculate the size of the additional GDP belonging to each industrial sector
and what is the total value added to GDP.

© Mark Johnson,
InThinking www.thinkib.net/Economics 2
Activity 3

Start by watching the following short video which illustrates the difference between GDP and
GNI as a measure of national income. Then answer the following short questions.

(a) How is GDP calculated?

(b) What are finished goods and services?

(c) What are capital goods?

(d) How is the value of national assets such as mountains, forest and wildlife included in a
nation's GDP?

(e) Outline the impact on the GDP / GNI of your country of the following:

i. Multinational businesses which have established subsidiaries in your country?

ii. When citizens of your nation work or set up businesses overseas and then send remittances
back to their family?

Activity 4: Gross national income (GNI)

In 2019 the UK's GDP was recorded as £ 2,828.643 billion. However, that figure included
goods and services produced by overseas companies who immediately repatriate those profits
back to their home country. Similarly, this figure does not include profits enjoyed by UK
residents on businesses located overseas. The difference between the two figures (net
property income) was calculated at - £ 41 b. What was the UK's GNI?

© Mark Johnson,
InThinking www.thinkib.net/Economics 3
Activity 5

While the majority of countries have approximately the same value for GDP and GNP / GNI,
with the net transfers of money into and out of the country largely cancelling out, there are
notable exceptions. What might explain the disparity between GDP and GNI for the four
countries in the table below: All figures obtained from the IMF and relate to 2019.

Country GDP per capita GNI per capita GDP - GNI

Luxembourg $ 105,863 $ 70,260
Norway $ 75,389 $ 66,520
Singapore $ 57,713 $ 54,530
Ireland $ 68,710 $ 55,920

Activity 6

In January 12, 2010, on the West Indian

island of Hispaniola, comprising the
countries of Haiti and the Dominican
Republic, a large-scale earthquake occurred.
The most severely affected was Haiti,
occupying the western third of the island. An
exact death toll proved elusive in the
ensuing chaos. The Haitian government’s
official count was more than 300,000, but
other estimates were considerably smaller.
Hundreds of thousands of survivors were
displaced and many thousands of buildings
destroyed.

Outline the impact on Haiti's GDP and GNI of both the earthquake and rescue operation.

© Mark Johnson,
InThinking www.thinkib.net/Economics 4
Activity 7

Provide the correct terms to the definitions included.

Term Definition
The total output of a nation or the total income of a country
Gross domestic product, plus net property income from abroad
GDP or GNI adjusted for the effects of inflation
GDP or GNI divided by the number of people in a nation

Activity 8: HL activities

(a) Calculate the GDP of the following nation using the expenditure method

Billion £
Private consumption 1,220.311
Business investment 503.209
Government spending 174.072
Exports 300.000
Imports 428.000
Total GDP (expenditure method)

(b) Calculate GDP via the income method:

Billion £
Income from wages / government benefits 1,300.000
Income from rent 510.450
Interest earned 489.000
Dividends and profits earned 1,100.000
Net taxes paid 1,500.545
Total GDP (income method)

© Mark Johnson,
InThinking www.thinkib.net/Economics 5
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

IB Economics: www.ibdeconomics.com

2.1 ECONOMIC ACTIVITY: STUDENT LEARNING ACTIVITY

Answer the questions that follow.

1. DEFINITIONS

Define the following terms:

 Income  Exports
 Factors of production  Export receipts
 Land entrepreneurship).  Imports
 Resources  Import payments
 Land  Withdrawals (leakages)
 Labour  Injections
 Capital  Current account deficit
 Entrepreneurship  Current account surplus
 Public good  Circular flow model
 Merit good  Real flows
 Tax revenue  Money flows
 Interest  Financial institutions
 Interest rate  Transfer payments
 Domestic firm  Subsidies
 Government expenditure  Investment
 Budget deficit  Savings
 Budget surplus
[10 marks]

2. SHORT- ANSWER QUESTIONS

1. Outline the types of payment associated with each of the factors of production. [4 marks]

2. Distinguish between the closed and open economy models of the circular flow of income.
[4 marks]

3. Use examples to explain the relationship between real and money flows. [4 marks]
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

4. Explain the role of the substitution effect and the income effect of a change in price in explaining
the law of demand. [4 marks]

5. Sketch the closed economy circular flow of income, labeling all money and real flows.
[4 marks]

6. Use the diagram in in question 5 to explain how the income from the factors of production are
equal to goods and services expenditure, which are both, in turn, equal to the total value of all
goods and services produced in an economy. [6 marks]

7. Outline the withdrawals and injections into the circular flow model of income. [4 marks]

8. Distinguish between ‘withdrawals’ (leakages) and ‘injections’ in the circular flow model of income.
[4 marks]

9. Outline what happens to the size of the income flows when:

i. Injections are greater than withdrawals
ii. Withdrawals are greater than injections [4 marks]

10. Outline how each of the following events affects the size of income flows in the circular flow model:

i. The government increases sales taxes

ii. Interest rates in an economy increase
iii. The currency depreciates making imports more expensive and increasing the revenues
earned from exports
iv. Business confidence increases and investment spending increases
v. Income support payments such as the pension and unemployment benefits are
increased
vi. There is a major economic recession in a country’s major export market
vii. The government reduces spending on health an education
viii. Consumer confidence decreases
ix. Foreign imports become more price competitive within domestic markets
x. Retirement saving is made mandatory at five per cent of income [10 marks]
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

3. MULTICHOICE QUESTI ONS

Choose the best answer to each question. [40 marks]

1. Capital is associated with which of the following incomes from the factors of production
a. Wages
b. Rent
c. Profit
d. Interest

2. Which of the following is an injection into the circular flow model of income?
a. Savings
b. Import payments
c. Export receipts
d. Taxation

3. Rent is the income associated with which factor of production?

a. Land
b. Labour
c. Capital
d. Enterprise
4. Labour is associated with which of the following incomes from the factors of production
a. Wages
b. Rent
c. Profit
d. Interest

5. Which of the following is an injection into the circular flow model of income?
a. Savings
b. Import payments
c. Investment
d. Taxation

6. Which of the following is an injection into the circular flow model of income?
a. Savings
b. Import payments
c. Government expenditure
d. Taxation

7. Which of the following is an injection into the circular flow model of income?
a. Savings
b. Import payments
c. Consumer expenditure on goods and services
d. Taxation
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

8. Which of the following is a withdrawal (leakage) from the circular flow model of income?
a. Investment
b. Savings
c. Export receipts
d. Consumer expenditure on goods and services

9. Which of the following is not a money flow in the circular flow of income model?
a. Income
b. Investment
c. Factors of production
d. Transfer payments

10. Investment in Economics is:

a. Households buying shares
b. Households and firms buying shares
c. Firms buying capital goods
d. Savings in the form of shares or term deposits

11. Which would not be considered part of the income payments flow in the circular flow model?
a. Royalties
b. Professional fees
c. Sickness benefits
d. Wages

12. Which of the following is a real flow in the circular flow of income model?
a. Income
b. Investment
c. Goods and services
d. Taxation

13. A money flow between the government sector to the household sectors is:
a. Import payments
b. Taxation payments
c. Transfer payments
d. Subsidies

14. Which of the following is not a money flow in the circular flow of income model?
a. Income
b. Investment
c. Goods and services
d. Taxation

15. Wages is the income associated with which factor of production?

 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

a. Land
b. Labour
c. Capital
d. Enterprise

16. Collectively, the returns for each of the four factors of production is termed:
a. Income
b. Earnings
c. Wages
d. Gross domestic product

17. Which of the following is a withdrawal (leakage) from the circular flow model of income?
a. Indirect taxation
b. Investment
c. Export receipts
d. Consumer expenditure on goods and services

18. Which of the following is a real flow in the circular flow of income model?
a. Income
b. Investment
c. Goods and services
d. Taxation

19. Which of the following is not necessarily true in the two sector circular flow of income model?
a. Income = goods and services expenditure
b. Transfers and taxation = Income
c. Goods and service expenditure = total value of output
d. Total value of output = income

20. Which of the following is a real flow in the circular flow of income model?
a. Expenditure on goods and services
b. Investment
c. Capital goods
d. Taxation

21. Which of the following increases the level of economic activity?

a. Investment and savings
b. Expenditure on imports
c. Factors of production
d. Government spending and exports

22. Which of the following increases the level of economic activity?

a. Transfer payments and export receipts
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

b. Expenditure on imports
c. Goods and services
d. Transfer payments and savings

23. Profit is the income associated with which factor of production?

a. Land
b. Labour
c. Capital
d. Enterprise

24. Which of the following is a withdrawal (leakage) from the circular flow model of income?
a. Investment
b. Export receipts
c. Import payments
d. Consumer expenditure on goods and services

25. Land is associated with which of the following incomes from the factors of production
a. Wages
b. Rent
c. Profit
d. Interest

26. Which of the following increases the level of economic activity?

a. Expenditure on imports
b. Exports and savings
c. Factors of production
d. Consumer expenditure and export receipts

27. Which of the following decreases the level of economic activity?

a. Transfer payments
b. Higher interest rates
c. Factors of production
d. Government spending and exports

28. Which is a money flow between the financial and firms sectors of the economy?
a. Savings
b. Investment
c. Interest
d. Capital

29. Which of the following is not necessarily true in the two sector circular flow of income model?
a. Income = goods and services expenditure
b. Goods and service expenditure = total value of output
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

c. Total value of output = income

d. Export receipts = import payments

30. Which is a money flow between the financial and household sectors of the economy?
a. Savings
b. Investment
c. Interest
d. Capital

31. Enterprise is associated with which of the following incomes from the factors of production
a. Wages
b. Rent
c. Profit
d. Interest

32. Interest is the income associated with which factor of production?

a. Land
b. Labour
c. Capital
d. Enterprise

33. Which of the following is not necessarily true in the two sector circular flow of income model?
a. Income = goods and services expenditure
b. Goods and service expenditure = total value of output
c. Investment = Income
d. Total value of output = income

34. Which is a money flow between the firms and overseas sectors of the economy?
a. Import receipts
b. Foreign exchange
c. Export payments
d. Export receipts

35. Which of the following is a withdrawal (leakage) from the circular flow model of income?
a. Investment
b. Import payments
c. Government expenditure on goods and services
d. Transfer payments

36. Which of the following is the money flow that corresponds to the real flow of resources?
a. Consumption
b. Incomes
c. Factors of production
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

d. Goods and services

37. Which of the following is a real flow in the circular flow of income model?
a. Income
b. Investment
c. Goods and services
d. Taxation

38. Which of the following is not a money flow in the circular flow of income model?
a. Expenditure on goods and services
b. Investment
c. Capital goods
d. Taxation

39. The real flow that corresponds to the money flow of consumption is:
a. Spending on goods and services
b. Resources
c. Incomes
d. Goods and services

40. Savings in Economics is:

a. Placing money in a financial institution
b. Money tied up in the bank or shares
c. Interest bearing bank deposits
d. Consumption foregone

5. TRUE OR FLASE Q UESTIONS

Indicate whether the following statements are true or false.

1. Investment is equal to savings in the closed economy circular flow model

True
False

2. The return from each of the four different factors of production is income
True
False

3. An injection into the circular flow decreases the level of economic activity
True
False
 IB Economics – The Level of Overall Economic Activity
2.1: Economic Activity

4. Investment is the purchase of shares and financial instruments by households.

True
False

5. Savings and investment are both injections into the circular flow model.
True
False

6. Import payments are a withdrawal from the circular flow model.

True
False

7. A current account surplus is when tax receipts are greater than government expenditure.
True
False

8. A money flow always has a corresponding real flow in the circular flow model.
True
False

9. Savings is forgone consumption.

True
False

10. In the two sector mode: goods and service expenditure = income = total value of output
True
False

Source: www.IBDeconomics.com
 IB Economics – The Level of Overall Economic Activity
Exam Practice Questions: 2.2: Measures of Economic Activity

IB Economics: www.IBDeconomics.com

2.2 MEASURES OF ECONOMIC ACTIVITY: EXAM PRACTICE QUESTIONS

Answer the questions that follow.

1. IB ECONOMICS PAPER 1 EX AMINATION QUESTIONS

1. Distinguish between GDP and GNI/GNP as measures of economic activity. [10 marks]

2. Analyse the use of GNP per capita to compare the standard of living between different countries.
[10 marks]

3. Discuss the usefulness of GDP as a measure of economic well-being. [15 marks]

4. Evaluate the use of national income statistics for making comparisons of the standard of living over
time. [15 marks]

5. Contrast the concept of ‘green GDP’ with other ways a country can measure economic activity.
[10 marks]

Source: www.IBDeconomics.com
 IB Economics – The Level of Overall Economic Activity
2.2: Measures of Economic Activity

IB Economics: www.ibdeconomics.com

2.2 MEASURES OF ECONOMIC ACTIVITY: STUDENT LEARNING ACTIVITY

Answer the questions that follow.

1. DEFINITIONS

Define the following terms:

 Asset  Investment
 Capital goods  Market price
 External cost  Monetary value
 Factors of production  Negative externalities
 Final goods  Nominal GDP
 Foreign direct investment  Nominal value
 GDP  Output
 GDP per capita  Production
 Green GDP  Productive capacity
 Gross domestic product  Productivity
 Gross national income  Real GDP
 Hidden economy  Real value
 Income distribution  Revenue
 Inflation  Standard of living
 Inputs  Third parties
[10 marks]

2. SHORT- ANSWER QUESTIONS

1. Explain why the two terms ‘aggregate output’ and ‘national income’ can be used
interchangeably. [4 marks]

2. Explain the usefulness of knowing the value of national income. [4 marks]

3. Outline why it is only the value of final goods and services which are measured when valuing a
nation’s output. [4 marks]
 IB Economics – The Level of Overall Economic Activity
2.2: Measures of Economic Activity

4. Outline each of the four components of the expenditure approach to measuring GDP. Provide
examples of spending within each category. [4 marks]

5. In regards to measuring economic activity: [6 marks]

i. Distinguish between the three different approaches that can be used to calculate GDP.
ii. Explain why each of the three approaches to measuring GDP should, theoretically, give
rise to the same result.

6. Distinguish between GDP, GNI and GNP. [4 marks]

7. Explain:

i. Why price changes over time can be problematic when comparing GDP statistics.
ii. Explain how economists overcome this problem. [6 marks]

8. Explain why economists often make a distinction between GDP per capita and GDP.
[4 marks]

9. Outline why national income statistics do not necessarily measure the ‘true’ value of output or
income. [4 marks]

10. Explain why GDP per capita or GNI per capita may not be appropriate as a basis for comparison
of the standards of living between different societies or over time. [6 marks]