Chapter 22

The Measurement of
National Income and
Product
 National Output and Value Added
• National Output: is the sum of all output
produced by all firms in the economy .

But, one firm’s output could be another firm’s

input, which means that some firms produce
output that are used as input by other firms .
 Therefore, if we add the output of
all firms, we will obtain a total
output that exceeds the value of the
economy’s actual output , so we will
overestimate the value of the
output produced by the economy .
 Example

• Wheat Flour Baker Total

Farmer Mill
Purchase from
other firms 0 $ 100 $ 130 $ 230

Factors of production 100 30 50 180

Total value of output 100 130 180 410
Here, we have a problem of Double Counting
To avoid this problem, we measure the value of output by using
The Value Added Concept
 The Value Added
• It is the the market value of the output
produced by the firm minus the purchases
from other firms : Therefore

• Value Added = Market Value – purchases

by a firm of output from other
produced firms
 Example
• Value added = market value of – purchase from
by a firm output other firms
• Value added by
Wheat Farmer = $ 100 - 0 = $ 100
• Value added by
Flour Mill = 130 - 100 = $ 30
• Value added by
The Baker = 180 - 130 = $ 50
Total value added = $ 410 - $ 230 = $ 180
by all firms in the economy
 Measurement of National Income
and Product ( GDP )
• If we add up the total flow of expenditure
on domestic output, this is called “the
Expenditure Approach“ .

• If we add up the total flow of income

generated by the flow of domestic
production, this is called “the Income
Approach“ .
 I. GDP from the Expenditure side
• The GDP for a given year is calculated by,
adding up the expenditure needed to purchase
the final output produced in the year .
Therefore, the value of output or GDP is the
sum of four categories :
Consumption + Investment + Government expenditure + Net Export

GDP = C + I + G + ( X – M )
• Consumption expenditure:
• Includes expenditure on all goods and services produces
and sold to their final users during the year such as:
haircut, dental care, food, durable goods, non-durables
goods, and clothes.
• Investment expenditure:
• includes expenditure on goods not for present
consumption. This includes: inventories (stocks of
inputs), capital goods such as factories, machines,
warehouses, and residential houses.
• Gross investment: is the total investment that occurs in
the economy which is divided into two parts:
replacement investment and net investment.
 Investment

• Replacement investment: is the amount of

investment that just maintain the level of
existing capital stock (it is called the capital
consumption allowance or depreciation).

• Net investment = gross investment-replacement

investment.
• Government purchases of goods and
services:
• This includes government purchases of currently
produced goods and services .
• Note that not all government expenditure is counted
as a part of GDP. All transfer payments are excluded
since they are not made in return for currently
produced goods and services. For example: social
security payments for retired people (pensions).
• Net exports:
• Which means that we group actual exports and
actual imports together as net exports. In other
words, total exports - total imports.
• When total exports is greater than total imports,
then net exports will be positive and vise versa.
 Example
• Given the following data, calculate the GDP
C = $ 3261 ; I = $ 773 ; G = $ 955
X = $ 70 ; M = $ 150
GDP = C + I + G + (X- M)

GDP =3261 + 773 + 955 + ( 70 – 150 )

= $ 4909
 GDP from the Income Side
• Adding up factors income or factors
payment and other claims on the value of
output.
• Factor payments:
• Wages and salaries: which includes all compensation
to employees (labor income).
• Rent: which includes payments for the services of land
and other factors that are rented. The amount of rent
in the GDP includes payments for rented housing plus”
imputed rent” for the use of owner-occupied housing.
• Interest: includes interest earned on bank
deposits and on loans to firms.
• Profit: includes both dividends (profits paid to
the owners of firms) and retained profits by
firms.
• Nonfactor payments:
• These payments includes indirect taxes and
depreciation.
• Note that taxes will be included when we calculate
GDP from the income side since they represent
income claimed by the government.
• Note also that we have to subtract governmental
subsidies on goods and services since these
payments allow incomes to exceed the market
value of output.
• So, indirect taxes net of subsidies will be added to
the four components of factor payments in order to
get the Net Domestic Product.
• Depreciation: is the value of capital that has
been used up in the process of producing final
output. It is the value that must be reinvested.
• It is part of gross profits but because it is
needed to compensate for capital used up in
the production process, it is not part of net
profit.
• Adding depreciation to net domestic product
gives Gross Domestic Product (GDP).
 GDP from the Income Side
• Example:
• Factor payments =
wages + rent + interest + profit
2933 + 20 + 396 + 652 = $ 4001
• Net Domestic Product = factor payments + ( indirect tax –
Govt. subsidies )
= 4001 + (424 - 10 ) = $4415
• GDP = net domestic product + Depreciation
= 4415 + 508 - (statistical discrepancy) 14
= $ 4909
 GDP VS GNP
• GDP : Measures the value of total
output produced domestically by
summing the value added by each
industry.

• GNP : Measures the income received by

residents of the country no matter where
that income was generated.
 Sources of differences between GDP and
GNP
• 1. Some local production creates factor income
for foreigners which will be sent (at least
partially) abroad and thus, it is not a part of the
country’s GNP (and it will be counted as a part of
the country’s GDP).

• 2. Some of the local residents earn income as a

result of foreign investments which will be
counted as a part of the country’s GNP (but not in
the country’s GDP).
 GDP VS. GNP
• GDP
_ value of domestic based assets
owned by foreigners …….

+ value of foreign based assets

owned by local residents . …….
_________
= GNP …….
 Example
• Given that the value of GDP = $ 4909 and the
value of domestic based assets owned by
foreigners equals to $ 2000 , and the value of
foreign based assets owned by the local residents
equals to $ 3000 . Find the value of the GNP ?
• GNP = 4909 – 2000 + 3000 = $ 5909
• If GNP > GDP the country is a net creditor
• If GNP < GDP the country is a net debtor
 Which Measure Is Better?
• GDP is superior to GNP as a measure of
domestic economic a ctivity.
• GNP is superior to GDP as a measure of the
economic well-being of domestic residents.
 Disposable Personal Income
• It is the part of national income that is available
to households to spend or to save.
• To calculate the disposable income we have to
subtract from GDP the parts that are not
available to households such as: depreciation,
taxes, retained profits, interest paid to
institutions, and add transfer payments.
 Total Value, Productivity and Per Capita
• GDP = per capita GDP or how much
total population there is on average for each person

• GDP =average output per employed worker

# of people employed

• GDP =output per hour of labor input

Total # of working hours
 Calculation of Nominal and Real
National Income
• Given the following data below, calculate both
the nominal and the real national income for 2
years .Assuming that year 2 is the base year.
Quantity produced Prices
Wheat Steel Wheat Steel
year 1 100 20 $ 10 $ 50
year 2 110 16 12 55
 Calculation of Nominal Income
• Nominal income = current X current
quantities prices
Therefore :
• Nominal income for year 1 equals to :
( 100 X 10 ) + ( 20 X 50 ) = $ 2000
• Nominal income for year 2 equals to :
( 110 X 12 ) + ( 16 X 55 ) = $ 2200
 Calculation of Real income
• Real income = current X prices of the
quantities base year
Therefore :
Real income for year 1 equals to :
( 100 X 12 ) + ( 20 X 55 ) = $ 2300
Real income for year 2 equals to :
( 110 X 12 ) + ( 16 X 55 ) = $ 2200
 Implicit GDP Deflator
• Is an implicit price index that compares the
nominal and the real GDP over a given period of
time.
• This index measures the change in prices over
that period . Therefore,

• Implicit GDP = GDP at current prices_ X100

deflator GDP at base year prices
 Example
• Given that :
GDP at current prices for year 1 = $ 2000
( Nominal GDP of year 1), and
GDP at base year prices for year 1 = $ 2300
( Real GDP for year 1) , therefore
• Implicit GDP Deflator = 2000 X 100
for year 1 2300
= 86.9
• This means that the price level of year 1 is 86.9% of the
price level of year 2 (the base year).
• Note that we can use year 1 as our base year.
What National Income Does Not Measure ?

• There are some economic activities that are

not included in the GDP or GNP such as :

• Illegal Activities.
• Unreported Activities.
• Nonmarket Activities.
• Economic Bads.
 Illegal Activities
• Example :
• Drugs trade
• Gambling
• Liquor
• All such activities are not included in
the value of the GDP .
 Unreported Activities
• These are legal activities, but are not
reported for tax purposes .
 Nonmarket Activities

• Any do it yourself activity and any

voluntary work .
 Economic Bads
• Pollution, congestion, and other disamenities
associated with economic growth are called
“economic bads” and are not reflected
(measured) in the calculation of GDP or GNP.
• For example, the value of the damage done by
the acid rain is not deducted from the GDP or
GNP.
 Do the Omission Matter ?
• If we wish to measure the flow of goods
and services through the market sector of
the economy, then most of these omissions
will not matter .

• But, If we wish to measure the overall flow

of goods and services available to satisfy
the people’s wants regardless of the
sources of goods and services , then the
omissions are undesirable.