GDP:two measures of national

product
flow of product approach. Earning
and cost approach
Maimoona sjid butt
 Today in lecture
• GDP: Two Measures of National Product.
• Flow of Product Approach, Earning or Cost
Approach.
• Value Added Approach. Real GDP vs. Nominal
GDP
• The single most important concept in
macroeconomics is the gross domestic product
(GDP),which measures the total value of goods and
services produced in a country during a year.
• GDP is part of thenational income and product
accounts
(ornational accounts), which are a body of statistics
that enables policymakers to determine whether
the economy is contracting or expanding and
whether a severe recession or inflation threatens.
When economists want to determine the level of
economic development of a country, they look at
its GDP per capita
• In this chapter, we explain how economists
measure GDP and other major
macroeconomic indicators.
GROSS DOMESTIC PRODUCT:THE YARDSTICK OF AN
ECONOMY’S PERFORMANCE
• The gross domestic product (GDP) is the most
comprehensive measure of a nation’s total output of
goods and services. It is the sum of the dollar values of
consumption (C ), gross investment (I ), government
purchases of goods and services (G ), and net exports (X )
produced within a nation during a
given year
• We now discuss the elements of the national
income and product accounts. We start by showing
different ways of measuring GDP and distinguishing
real from nominal GDP. We then analyze the major
components of GDP. We conclude with a discussion
of the measurement of the general price level and
the rate of inflation.
Two Measures of National Product:
Goods Flow and Earnings Flow
• There are 2 ways to calculate GDP:
1. Income Approach: a method of calculating
GDP by adding together all incomes in the
economy
2. Expenditure Approach: a method of
calculation GDP by adding together all
spending in the economy
The GDP Identity
• GDP calculated as total income is identical to GDP
calculated as total spending

GDP expressed as total income ≡ GDP expressed as

total spending

• This applies to the entire Canadian economy, not just

the simplified economy shown in Figure 10.2
Breakdown of Figure 10.2
• In short, because all spending on final
consumer products ends up as some form of
household income, annual income equals
annual spending
• This explains the GDP Identity
Breakdown of the Income Approach
• Made up of 7 categories
1. Wages and Salaries
2. Corporate Profits
3. Interest Income
4. Proprietors’ Incomes and Rents
 These form the basis of GDP calculated using the
income approach
Breakdown of the Income Approach
Cont.
1. Indirect Taxes
2. Depreciation
 These are added on by Statistics in order to
balance GDP calculated by the income approach
with GDP calculated by the expenditure approach
 Using the income approach, GDP is the sum of all
6 categories
Wages and Salaries
• Largest income category
• Represents close to 60% of GDP
• Includes direct payments to workers in both
businesses and government as well as
employee benefits such as contributions to
employee pension funds
Corporate Profits
• Includes all of the profits declared to the government
by corporate businesses such as the profits paid as
corporate income tax, the profits paid out to
corporate shareholders as retained earnings
• Retained Earnings: profits kept by businesses for new
investment
Interest Income
• Includes interest paid on business loans and bonds
and income such as royalty payments (the latter
occurring less frequently)
• Includes adjustments to the value of businesses’
unsold products
Proprietors’ Incomes and Rents
• This includes the earnings made by sole
proprietorships, partnerships, self-employed
professionals, farmers as well as the income to
landlords from renting property
• Recall that incomes are received by owners of
proprietorships for supplying various types of
resources to their business
Indirect Taxes
• Taxes that are charged on products rather then be
applied to households or businesses (i.e.: P.S.T)
• Not included in the GDP with the income approach,
but rather with the expenditure approach
• To balance the results from the 2 approaches, taxes --
subsidies that businesses receive are added to
income-based GDP
Depreciation
• Like indirect taxes, must also be added to the income
approach
• Includes durable assets such as buildings, equipment
and tools that eventually wear out and need to be
replaced
• Considered a cost of business and shows up in the
expenditure approach
The Expenditure Approach
• GDP found using this approach is the sum of
purchases in the product markets
Categories of Products
• Final Products: products that will not be processed
further and will not be resold
• Intermediate Products: products that will be
processed further or will be resold
 Ex: Flour that is bought by a household for home baking is a
final product. Flour that is bought by a bakery to make bread
to be sold is an intermediate product
Double Counting
• This occurs when the values of all products,
both final and intermediate are included in the
GDP calculations
• Would cause estimates to be too high & not
reflect the real activity in the economy
Value Added
• In order to prevent double counting, the concept of
value added is applied to the GDP
• Value Added: the extra worth of product at each
stage in its production; a concept used to avoid
double counting in calculating GDP
Categories of Purchases
• Recall that expenditure -based GDP is
calculated on the basis of almost all purchases
in the economy
• Few products are excluded
• Those that are included, fall under 4 distinct
categories
Excluded Purchases
• There are two types of excluded purchases:
financial exchanges and second-hand
purchases
• These are excluded because they are not
related to current production
Financial Exchanges
• This includes a gift of money between family
members and is not included in the GDP
• This is a transfer of of purchasing power from
one party to another
• Also excluded are bank deposits and
purchases of stock
Second-Hand Purchases

• Excluded from GDP because they have been

accounted for previously in their very first
transaction to their original owner (first consumer)
• In brief, if they were included, GDP would double
count and thus overestimate
Included Purchases
• Included in the GDP calculations
1. Personal consumption (C)
2. Gross investment (I)
3. Government purchases (G)
4. Net exports (X-M)
• Each contribute to the the economy
Expenditure Equation

GDP = C + I + G + ( X - M )
Personal Consumption
• Household spending on goods and services.
• Make up 60% of the GDP
• Goods include: nondurable and durable
• Nondurable: goods that are consumed just once. Ex:
food
• Durable: goods that are consumed repeatedly over
time. Ex: bikes and CD’s
Gross Investment
• Purchases of assets that are intended to produce
revenue.
• Makes up 15-25% of the GDP year-year
• Most important spending in this category is on
capital goods (machines etc) used by businesses
• Also included are expenditures by government
agencies into capital goods
Gross Investment Cont.
• Related to the economy’s capital stock
• The total value of productive assets that provide a flow of
revenue
• Recall that capital such as machinery depreciate in value
• Net investment is the gross investment minus depreciation
• Represents the yearly change in the economy’s stock of
capital
• Capital stock is the total value of productive assets that
provide a flow of revenue
Gross Investment Cont.
 Also includes:
• inventories of different companies stocks of unsold
goods and materials
• Building construction with owner-occupied housing
• Included here instead of personal consumption
because the owner could rent it out for a profit
Government Purchases
• Include current spending by all levels of government
on goods and services
• Make up 20% of GDP
• Ex: The federal government buying a battleship for
the Navy, or a municipality hiring a paving company
to repair roads
Net Exports
• Final category of purchase and includes the purchases of
goods and services by foreigners, or exports
 This is calculated via the exports -- imports
• This is done because while exports include an American
furniture store buying Canadian softwood, imports include a
Canadian paintball player buying an American paintball gun
• Represented as net exports, they make up a small % of GDP,
yet viewed independently of each other, they each make up
about 25% of the GDP
GDP and Living Standards
• GDP can be used to determine our standard of living
via per capita GDP
• This is the GDP per person and is calculated as
GDP/population
 In short, per capita GDP is the total $ value of output
per person
 Ex: in 1993 our GDP was $710 723 million and our
population was 28.753 million.  our per capita GDP
was $24, 718 per person
Limitations of GDP
• Recall: GDP is a measure of the total $ value of all
final goods and services produced in an economy
over a given period
• Indicates economic activity and living standards (to
some extent)
• Has quantitative and qualitative limitations
• Does not tell us about what is purchased or produced
Excluded Activities
• GDP does not include some types of productive
activities meaning that the GDP can actually
understate economic activity and living standards
• Non-market activities: productive activities that take
place outside the market place such as housework,
unpaid child care and the work of “do-it-yourselfers”
• Have vital impact on our living standards
Excluded Activities Cont.
• Underground economy: all the productive
transactions that go unreported
• Include things such as smuggling or “under-the-
table” transactions
• These are transactions paid for in cash so as to avoid
applicable taxes
Product Quality
• With the introduction of new technology and
an increase of living standards, the quality of
our goods has increased dramatically over the
years
• GDP can only add up selling prices, cannot
fully capture these quality improvements
Composition of Output
• Refers to the different uses of GDP between
countries
• A country that dedicates its GDP towards to
health care and education would have a much
higher standard of living than a country that
dedicated its GDP towards military uses
Leisure
• Many people consider this important to living
standards
• Despite the fact that we are able to work
every hour of the day, people do not
• The hours worked per week has decreased
dramatically over the past century
Leisure Cont.
• GDP has no way of representing this change in
working hours per week
• This would indicate in increase in the standard
of living
• Furthermore, leisure is not a commodity and
thus cannot be bought or sold on the market
The Environment
• GDP does not differ between economic activities that
harm the environment, and those that don’t
• May not accurately represent spillover costs and
benefits
• Ex: the cleaning up of an oil spill would be added to
GDP, the creation of a new nature preserve would
likely not be added
Gross National Product (GNP)
• The total income acquired by Pakistani both
within Pakistan and elsewhere
• Recall that GDP focuses on the incomes made
in Pakistan while GNP focuses on earnings of
Pakistanis
• In order to calculate GNP, 2 adjustments must
be made to GDP
Calculating GNP
1. Income earned from Pakistani investments by
foreigners is deducted from GDP
i.e.: interest payments on a Pakistanis government
bond held in Japan
2. Income earned from foreign investments by
Pakistanis is added to GDP
i.e.: a stock dividend from an American company paid
to a Pakistani sharholder
Calculating GNP Cont.
• The 2 adjustments can be made in an
investment income account
• Foreign investment in Pakistani is higher than
Pakistanis investment in foreign countries
•  GDP -- the account shows net investment
income to foreigners = GNP
Net Domestic Income (NDI)
• NDI represents what is earned by households
supplying resources in pakistan
• NDI = GDP -- amounts that are not earning
from current production
i.e.: indirect taxes, depreciation allowances,
statistical discrepancy
Personal Income
• The income actually received by households
• Calculated via adjustments made to net
domestic income
(Refer to 10.10)
Transfer Payments
• Government payments to net domestic income
• Unrelated to earned income
• Received by households
• Excluded from net domestic income, but are part of
households’ personal income
Disposable and Discretionary Income

• Disposable Income: household income minus

personal taxes and other personal transfers to
government
• Used to buy necessities such as food, housing
and clothing
• Discretionary Income: disposable income --
purchases of necessities