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33Measuring a Nations Income
Tapas PaulDepartment of Economics
Definition of Economics
All economic questions arise because we want morethan we can get.
Our inability to satisfy all our wants is called
scarcity.
Because we face scarcity, we must makechoices.
The choices we make depend on the incentives we
face.Anincentiveis a reward that encourages an actionor a penalty that discourages an action.
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Economics is the social science that studies the choices
that individuals, businesses, governments, and entire
societies makeas theycopewith scarcityandthe incentives
that influenceandreconcilethosechoices.
Economicsdividesin tomainparts:
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Measuring a Nations Income
Macroeconomics answers questions like thefollowing:
Why is average income high in some countries andlow in others?
Why do prices rise rapidly in some time periods whilethey are more stable in others?
Why do production and employment expand in someyears and contract in others?
THE ECONOMYS INCOME ANDEXPENDITURE
When judging whether the economy is doing wellor poorly, it is natural to look at the total incomethat everyone in the economy is earning.
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THE ECONOMYS INCOME ANDEXPENDITURE
For an economy as a whole, income must equalexpenditurebecause:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar ofincome for some seller.
THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
Gross dom estic product (G D P) is a measure of
the income and expenditures of an economy.
It is the total market value of all final goods and
services produced within a country in a given
period of time.
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THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
The equality of income and expenditure can beillustrated with the circular-flow diagram.
Figure 1 The Circular-Flow Diagram
Spending
Goods and
services
bought
Revenue
Goods
and services
sold
Labor, land,
and capital
Income
=Flow of inputs
and outputs
=Flow of dollars
Factors of
production
Wages, rent,
and profit
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS
Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
Firms sell
Households buy
MARKETS
FOR
GOODS AND SERVICES
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THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
GDP is the market value of all final goods andservices produced within a country in a givenperiod of time.
THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
GDP is the Market Value . . .
Output is valued at market prices.
. . . Of All Final . . .
It records only the value of final goods, notintermediate goods (the value is counted only once).
. . . Goods and Services . . .
It includes both tangible goods (food, clothing, cars)and intangible services (haircuts, housecleaning,doctor visits).
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THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
. . . Produced . . .
It includes goods and services currently produced, nottransactions involving goods produced in the past.
. . . Within a Country . . .
It measures the value of production within thegeographic confines of a country.
THE MEASUREMENT OF GROSSDOMESTIC PRODUCT
. . . In a Given Period of Time.
It measures the value of production that takes placewithin a specific interval of time, usually a year or aquarter (three months).
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THE COMPONENTS OF GDP
GDP includes all items produced in the economyand sold legallyin markets.
THE COMPONENTS OF GDP
What Is Not Counted in GDP?
GDP excludes most items that are produced andconsumed at home and that never enter themarketplace.
It excludes items produced and sold illicitly, such asillegal drugs.
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THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption(C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
THE COMPONENTS OF GDP
Consumption(C):
The spending by households on goods and services,with the exception of purchases of new housing.
Investment(I):
The spending on capital equipment, inventories, andstructures, including new housing.
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THE COMPONENTS OF GDP
Government Purchases(G):
The spending on goods and services by local, state,and federal governments.
Doesnotinclude transfer payments because they arenot made in exchange for currently produced goodsor services.
Net Exports(NX):
Exports minus imports.
Table 1 GDP and Its Components, USA
Copyright2004 South-Western
Tk in billion
FY2006
GDP at current price 4590
Consumption (C) 3316
Investment (I) 1025
Government Expenditure (G) 611
Net Export (NX) -362
Table 1GDP and Its Components, Bangladesh, FY2006
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GDP and Its Components, USA (2001)
Consumption
69%
Government Purchases
18%Net Exports
-3 %Investment
16%
GDP and Its Components, Bangladesh(FY2006)
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MEASURING GDP (different approaches)
(i) Wheat Industry:
Expenditure Receipts
Wages 40
50Dividends 0
Interest 10
Expenditure Receipts
Wages 30
110Purchaseof Wheat 50
Dividends 15
Interest 15
Expenditure Receipts
Wages 60
200Purchaseof Flour 110
Dividends 30
Interest 0
Calculate GDP using different approaches:1. Final Good Approach: Tk 2002. Value added approach:Value added in Wheat: 50
Value added in Flour: 110-50 = 60
Value added in Bread: 200-110 = 90
Total value added/GDP = 200
3. Income Approach:Total wage income in economy: 40+30+60 = 130
Total Dividends income: 0+15+30 = 45
Total interest income: 10+15+0 = 25
Total income/GDP = 130+45+25 = 200
(ii) Flour Industry: (iii) Bread Industry
Two Approaches to GDP
Income ApproachWagesRental IncomesInterest IncomesProfits
Expenditure Approach
Final-Product or Value-AddedThe Sum of the Money Spent to Buy
the Output
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Two Approaches to GDP
ExpenditureApproach
IncomeApproach
GDP
= =
+
Consumption byHouseholds
Investment byBusinesses
Government
Purchases
ExpendituresBy Foreigners
+
+
+
+
+
Wages
Rents
Interest
Profits
StatisticalAdjustments
+
GDP Approaches Compared
Compensation
Rents
Interest
Proprietors Income
Corporate Profits
Taxes on Production and
Imports
National Income
Net Foreign Factor Income
Statistical Discrepancy
Consumption of Fixed Capital
Gross Domestic Product
$ 7125
73
498
939
1352
917
$10,904
-34
43
1574
$ 12,487
Personal Consumption (C)
Gross Private Domestic
Investment (Ig)
Government Purchases (G)
Net Exports (Xn)
Gross Domestic Product
Accounting Statement for the U.S. Economy, 2005, in Billions
ReceiptsExpenditures Approach
AllocationsIncome Approach
$ 8746
2105
2363
-727
$ 12,487
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Figure: Sectoral Contribution in Bangladesh (FY1973 FY2012)
Sectoral Contribution
What do you think from this trend?
REAL VERSUS NOMINAL GDP
Nominal GDPvalues the production of goods andservices at current prices.
Real GDPvalues the production of goods andservices at constant prices.
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REAL VERSUS NOMINAL GDP
An accurate view of the economy requiresadjusting nominal to real GDP by using the GDPdeflator.
Table 2 Real and Nominal GDP
Copyright2004 South-Western
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The GDP Deflator
TheGDP deflatoris a measure of the price levelcalculated as the ratio of nominal GDP to realGDP times 100.
It tells us the rise in nominal GDP that isattributable to a rise in prices rather than a rise inthe quantities produced.
The GDP Deflator
The GDP deflator is calculated as follows:
GDP deflator =Nominal GDP
Real GDP 100
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The GDP Deflator
Converting Nominal GDP to Real GDP
Nominal GDP is converted to real GDP as follows:
Real GDPNominal GDP
GDP deflator20XX
20XX
20XX
= 100
Table 2 Real and Nominal GDP
Copyright2004 South-Western
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Figure 2 Real GDP in the United States
Billions of
1996 Dollars
$10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,0001970 1975 1980 1985 1990 20001995
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Figure 3: Real GDP in the Bangladesh
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Figure 4:Real GDP inBangladesh
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GDP CalculationinBangladesh, atconstantprice, croretkFY07 FY08 FY09
Agricultural Sector 62580 64585.2 67605.1
1. Agriculture& Forestry 48730 50156.7 52568.4
A) Crops 35133 36071.7 37883.8B) Livestock 8447 8653.2 8952.5C) Forestry 5150 5431.8 5732.1
2. Fisheries 13850 14428.5 15036.7I ndustry 86219 92065.1 97520.5
3. Mining& Quarrying 3443 3750.9 4102.4Gas& non-refined oil 2106 2279.7 2500.5Other mining 1337 1471.2 1601.9
4. Manufacturing 51372 55077.2 58339.3
A) Large& MediumScale 36507 39157.2 41370.2B) Small Scale 14865 15920 16969.1
5. Electric, Gas& Water Supply 4608 4919.3 5141.6
electricity 3813 4068 4216.1Gas 545 587.1 637.7Water 249 264.2 287.7
6. Construction 26796 28317.7 29937.2
Service Sector 143995 153342.3 162931.3
7. Wholesale& retail trade 41700 44543.4 47371.3
8. Hotel & restaurants 2023 2175.6 2340.5
9. Transport & Communication 29809 32356.6 34817.6
10. Financial intermediaries 5139 5596 6043.5
Bank 3846 4168.1 4468.9Insuarance 1089 1198.8 1317.2Others 204 229.1 257.4
11. Real estate& Housing 22381 23220.5 24106.2
12. Public administration& defense 8044 8543.2 9143.2
13. Education 7433 8012.9 8657.1
14. Health& Social Works 6693 7162.7 7703.5
15. Community, Social & Personal Services 20773 21731.4 22748.4
Import duty 10179 11733.4 12595.5T otal 302973 321726 340652.4Real Growth Rate 6.43 6.19 5.88
GDP AND ECONOMIC WELL-BEING
GDP is the best single measure of the economicwell-being of a society.
GDP per persontells us the income andexpenditure of the average person in theeconomy.
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GDP AND ECONOMIC WELL-BEING
Higher GDP per person indicates a higherstandard of living.
GDP is not a perfect measure of the happiness orquality of life, however.
GDP AND ECONOMICWELL-BEING
Some things that contribute to well-being are notincluded in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes placeoutside of markets, such as the value of the time
parents spend with their children and the value ofvolunteer work.
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Table 3 GDP, Life Expectancy, and Literacy
Copyright2004 South-Western
Summary
Because every transaction has a buyer and aseller, the total expenditure in the economy mustequal the total income in the economy.
Gross Domestic Product (GDP) measures aneconomys total expenditure on newly producedgoods and services and the total income earned
from the production of these goods and services.
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Summary
GDP is the market value of all final goods andservices produced within a country in a givenperiod of time.
GDP is divided among four components ofexpenditure: consumption, investment,government purchases, and net exports.
Summary
Nominal GDP uses current prices to value theeconomys production. Real GDP uses constantbase-year prices to value the economysproduction of goods and services.
The GDP deflatorcalculated from the ratio ofnominal to real GDPmeasures the level of
prices in the economy.
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Summary
GDP is a good measure of economic well-beingbecause people prefer higher to lower incomes.
It is not a perfect measure of well-being becausesome things, such as leisure time and a cleanenvironment, arent measured by GDP.