Measurement of National

Income
Macroeconomics
Session 2 & 3
Learning Objectives
Understand circular flow of income and output
Define gross domestic product (GDP)
Various approaches to estimate GDP
Savings-Investment Identity
Distinguish between nominal GDP and real GDP
Understand the limitations of GDP
National Income Accounting
Gross Domestic Product (GDP)
The total market value of all final goods and
services produced by factors of production
located within a nations borders

Then what about income ??
The Simple Circular Flow
Two observations
In every economic exchange, the seller receives
exactly the same amount that the buyer
spends.
Goods and services flow in one direction and
money payments flow in the other.
The Simple Circular Flow
Profits explained
Question
Why is profit a cost of production?
Answer
Profits are the return entrepreneurs receive for the
risk they incur when organizing productive activities
6
Circular Flow - Simple
Assumptions:
Only two sectors
Consumers (Households) and Producers (Firms)
No government and no international trade (Closed
economy)


Consumers spend all their Income on goods an
services
Consumers are the owners of productive resource -
land, labour, capital and enterprise

Total Output = Total Income = Total Expenditure
O = Y = E

National Income Accounting
Gross Domestic Product (GDP)
The total market value of all final goods and
services produced by factors of production
located within a nations borders

What is the value of final output
Farmer produces 50kg wheat. Sells it @ Rs 10/kg
to baker (all 50 kg)
Baker produces 60 kg of bread and sells it @ Rs
20/kg (all 60 kg)

Total value of output
Contribution of different sectors in output

Avoid double counting..
Final and Intermediate Goods
What is a final good?
Wheat?
Steel?
Oil?
Bread?

Intermediate Goods
Goods used up entirely in the production of final
goods

What is the value of Final Output
Wheat produced by farmer: 50kg
Sold to baker: 30Kg @ Rs10/kg. 20 kg was
retained by farmer for consumption in family
Baker hired some additional workers and
Produced 40 Kg of bread.
Sold 40 kg of bread @ Rs 20 per kg.
Sold 30 kg of bread @ Rs 20 per kg.



Three Approaches of Measuring GDP
Expenditure Approach
Computing national income by adding up the value at
current market prices of all final goods and services
C + I + G+ X M

Income Approach
Measuring national income by adding up income received
by all factors of production

Production approach
Computing value added at each stage of production by
deducting value of intermediate products from the output
produced.

Deriving GDP by the expenditure approach
Consumption Expenditure (C)
Durables, Nondurables, Services

Food & Non-food items

Construction of residential buildings is a part of
investment rather than consumption. Imputed
rent is part of consumption.
Deriving GDP by the expenditure approach
Gross Domestic Investment (I)
The creation of capital goods, such as factories and
machines, that can yield production and hence
consumption in the future

In India, I includes investment by government as well.
In US, only private investment is taken as part of I.

A car bought by Reliance would be investment. Same
car bought by Mukesh Ambani would be private final
consumption expenditure.
Deriving GDP by the expenditure approach
Deriving GDP by the expenditure approach
Government Expenditures (G)
State, local, and federal
Valued at cost: for producing services such as
governance, education, health, etc.

In India, G includes only final consumption expenditure
by government. In US, G include both final
consumption expenditure and investments by
government.
Deriving GDP by the expenditure approach
Deriving GDP by the expenditure approach
Net Exports (Foreign Expenditures)
Net exports (X) = total exports - total imports
Mathematical representation of expenditure
approach
GDP = C + I + G + NX
Deriving GDP
by the Income Approach
Gross Domestic Income (GDI)
The sum of all incomewages, interest, rent, and
profitspaid to the four factors of production