MBA (IB) 2022-24

Trimester I
▪ The production side of the economy transforms inputs (labor,
capital) into output (GDP)
▪ Inputs = factors of production
▪ Payments to these factors = factor payments
“Output is a function of labor and capital,” where the functional form
can be defined in various ways

2-2
▪ GDP is the market value of all final goods and services produced within a country in a
given period of time.
▪ = Total income earned by domestically located factors of production, regardless of
nationality.

▪ GNP focuses on production of goods and services by the country's residents only,
irrespective of the geographical area in a given period of time.
▪ = Total income earned by the nation’s factors of production, regardless of where
located.
▪ Resident of an economy could be an individual or organization.
▪ Factor incomes: Incomes earned by various factors of production.
1. Rent -> Land
2. Wages -> Labour
3. Interest -> Capital
4. Profit -> Organisation
▪ Example: The factor incomes earned by Tata Consultancy Services (TCS) in USA is
a part of USA’s GDP but a part of India’s GNP.

▪ Net Factor Income from Abroad (NFIA)

▪ = Factor incomes earned by our residents (Citizens) from the rest of the world –
Factor incomes earned by non-residents from our country.
▪ GNP = GDP+NFIA

▪ Note: UN systems of National Accounts prefers GDP as the measure of economic

activity. Thus, most of the countries follows GDP.
GDP Measurement
▪ 3 ways to measure GDP: (1) Expenditure method, (2) Output or production method and
(3) Income method.

Expenditure method

▪ Measures the expenditure or total spending on domestically produced goods and services.
▪ That means, Expenditure incurred on the purchase of a final good/service is also the market
value of it which is what GDP is about.

▪ Expenditure on final goods/services has 4 components:

Expenditure on
1. Consumption goods/services (C) by private sector
2. Investment goods/services (I) by private sector
3. Govt. expenditures (G)
4. Expenditures by foreigners on our export Or our Export earnings (X)
▪ Here,
▪ GDP = Consumption Exp+ Investment Exp+ Govt Exp+ (Export Earnings-Import Exp)

▪ Note: We also import and spend money on foreign goods which must be subtracted.
Thus Export Earnings-Import Exp (X-M) is the net export earning.
▪ GDP measured by expenditure method is expressed as GDP at market prices.
Output Method
This method adds up the value, expressed in market prices, of all goods and
services produced in the economy.
▪ This method arrives at the true value of goods and services produced in the economy not by
adding up the total value of production, but the value added at each stage of production (and
avoids problem of double counting).
▪ GDP through value added is also reported as GDP at market price.

▪ Note: Value added is

the value of output minus the value of the intermediate goods
used to produce that output.
▪ The value added is calculated as the difference between the market sales value of
the materials and the value of the good at the previous production stage value. Using
this method will avoid multiple counting.
▪ Nonproduction transactions are excluded from GDP calculation and are of two types: purely financial
transactions and secondhand sales.
▪ Public transfer payments These are the social security payments, welfare payments, and veterans’
payments that the government makes directly to households. Since the recipients contribute nothing to
current production in return, to include such payments in GDP would be to overstate the year’s output.
Income method
This method adds up the total income that accrues the various factors of
production.

Note: In Output method we get GDP by the difference:

=Total value (or revenue) – total cost of intermediate.
Who gets the money/income(GDP)?
It is paid as income to those who helped in producing the output
i.e. Factor incomes -> Rent , Wage, Interest, Profit
GDP arrived through his method is called GDP at factor cost.
Reality
▪ The GDP at market price may not be equal to the GDP at factor cost.
▪ Because
▪ (1) factors like indirect tax we pay while purchasing and this tax is not getting
included into the factor incomes (rent, wage etc).
▪ Or due to subsidy (by govt) which is distributed to the factors of production but
does not show up in the posted market price.
Thus, we can write,
GDP at market price – (indirect taxes – subsidies) = GDP at factor cost.
(2) Due to statistical discrepancies
Note: Output method is used while comparing sectoral growth rates.
Expenditure method is used to arrive at estimates of AD or to find trends in different
components of demand.
Income method is useful to understand how the income is distributed.

Net Domestic Product (NDP)

NDP = GDP – Depreciation value (of capital goods)
 National Income
Factor incomes accrued to the residents of a country.
How to arrive?
Steps:

1. Incomes of the residents of the country so GDP has to be converted to GNP

2. GNP at factor cost ->GNP at market prices include indirect taxes which do not accrue to factors of
productions.
3. Depreciation has to be taken care of.
4. GNP at factor cost – Depreciation = NNP at factor cost which is the NI.
Some important concepts
▪ Personal income (PI) includes all income received, regardless of whether it is earned or
unearned.
▪ Disposable income is PI less personal taxes.

▪ A stock is a quantity measured at a point in time.

▪ Example:
“The U.S. capital stock was $10 trillion on January 1, 2016.”
▪ A flow is a quantity measured per unit of time.
▪ Example: “U.S. investment was $2 trillion during 2016.”

▪ Investment is spending on new capital.

▪ Example (assuming no depreciation):
• 1/1/2018:
Economy has $10 trillion worth of capital
• During 2018:
investment = $2 trillion
• 2018:
Economy will have $12 trillion worth of capital
 GNP VS. GDP IN SELECT COUNTRIES, 2012

Country GNP GDP GNP – GDP

(% of GDP)
Bangladesh 127,672 116,355 9.7
Japan 6,150,132 5,961,066 3.2
China 8,184,963 8,227,103 −0.5
United States 16,514,500 16,244,600 1.7
India 1,837,279 1,8585,740 −1.2
Canada 1,821,424 1,779,635 2.3
Greece 250,167 248,939 0.5
Iraq 216,453 215,838 0.3
Ireland 171,996 210,636 −18.3

▪ GNP and GDP in millions of current U.S. dollars.