Measurement of National Economy

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Measurement of National Economy

  1. 1. Measurement of National Economy Lecture 3
  2. 2. Economy’s Income and Expenditure • When judging how a person is doing economically, we might first look at his/her income. • Similarly, when judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning. • This is the task of “GDP”.
  3. 3. Economy’s Income and Expenditure Cont… • GDP measures two things at once: – The total income of everyone in the economy – The total expenditure on the economy’s output of goods and services. • The reason that GDP can perform this trick of measuring both total income and total expenditure is that these two things are really the same. • “Therefore, for an economy as a whole , income must equal expenditure”.
  4. 4. Economy’s Income and Expenditure Cont… • Why is this true??? – An economy’s income is the same as its expenditure because every transaction has two parties: A ‘buyer’ and a ‘seller’. – E.g. A pays B Rs. 500 to clean her lawn. – In this case, B is the seller of a service and A is the buyer. – B earns Rs. 500 and A spends Rs. 500. – Thus, this transaction contributes equally to the economy’s income and to it’s expenditure. • Hence, GDP, whether measured as total income or total expenditure, rises by Rs. 500.
  5. 5. Economy’s Income and Expenditure Cont… • The equality of income and expenditure can be illustrated with the circular-flow diagram:
  6. 6. Figure 1 The Circular-Flow Diagram MARKETS Revenue FOR Spending GOODS AND SERVICES •Firms sell Goods and Goods •Households buy services and services sold bought FIRMS HOUSEHOLDS •Produce and sell •Buy and consume goods and services goods and services •Hire and use factors •Own and sell factors of production of production Factors of MARKETS Labor, land, production FOR and capital FACTORS OF PRODUCTION Wages, rent, •Households sell Income and profit •Firms buy = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western
  7. 7. Measurement of GDP • In simple terms, Gross Domestic Product (GDP) 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”.
  8. 8. Measurement of GDP Cont… • Break-up of Definition: – “GDP is the Market Value . . .” Output is valued at market prices. – “. . . Of All Final . . .” It records only the value of final goods, not intermediate goods. – “. . . Goods and Services . . .” It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).
  9. 9. Measurement of GDP Cont… – “. . . Produced . . .” It includes goods and services currently produced, not transactions involving goods produced in the past. • E.g. When Toyota produces and sells a new car, the value of the car is included in GDP. • But when a person sells a used car to another person, the value of the used car is NOT included in the GDP. – “ . . . Within a Country . . .” It measures the value of production within the
  10. 10. Measurement of GDP Cont… – “. . . In a Given Period of Time.” It measures the value of production that takes place within a specific interval of time, usually a year.
  11. 11. Components of GDP • GDP includes all items produced in the economy and sold legally in markets. • GDP excludes items that never enter the marketplace. • It excludes items produced and sold illicitly, such as illegal drugs.
  12. 12. Components of GDP Cont… • GDP is divided into four components: • Consumption (C) • Investment (I) • Government Purchases (G) • Net Exports (NX) • GDP (Y) is the sum of these and is calculated as per the following equation: Y = C + I + G + NX
  13. 13. Components of GDP Cont… • Consumption (C): – The spending by households on goods and services. • Investment (I): – The purchase of goods and services to be used in future. – The spending on capital equipment, inventories, and structures etc.
  14. 14. Components of GDP Cont… • Government Purchases (G): – The spending on goods and services by local, state, and federal governments. • Net Exports (NX): – Is the difference between the monetary value of exports and imports. – In simple terms, it refers to exports minus imports.
  15. 15. GDP and Economic Well-Being • GDP is the measure of the economic well- being of a society. • GDP tells us the income and expenditure of the people in the economy. • Higher GDP indicates a higher standard of living. • However, GDP is not a perfect measure of the happiness or quality of life.
  16. 16. GDP and Economic Well-Being Cont… • Following factors contribute to well-being but are not included in GDP. – The value of leisure. – The value of a clean environment. – The value of certain activities such as the value of the time parents spend with their children and the value of volunteer work etc.

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