GDP can be measured in three ways: 1) Expenditure approach measures total expenditures on final goods and services. 2) Income approach measures total income earned from production, including compensation, profits, and rents. 3) Production approach measures total value added at each stage of production. Real GDP is used to measure economic growth by adjusting for inflation using GDP deflators or price indexes. However, GDP has limitations as a welfare measure since it excludes nonmarket activities and environmental factors.

1. The Three
Approaches To
Measuring

2. OBJECTIVES
Ø Definition of GDP
Ø
Ø Explain the three ways of measuring GDP
Ø
Ø Real V Nominal GDP
Ø
Ø GDP deflator
Ø
Ø Explain how we use real GDP to measure economic growth
Ø
Ø Limitations of our measures of GDP

3. DEFINITIONS‘ FOR GDP
I. GDP is equal to the total expenditures for all final goods and services produced within the
country in a stipulated period of time (usually a 365-day year).
II.
III. GDP is equal to the sum of the value added at every stage of production (the intermediate
stages) by all the industries within a country, plus taxes less subsidies on products, in
the period.
IV.
V. GDP is equal to the sum of the income generated by production in the country in the period
—that is, compensation of employees, taxes on production and imports less subsidies,
and gross operating surplus (or profits)

4. CALCULATING (GDP):
EXPENDITURE APPROACH
GDP = C + I + G + (EX – IM) where:
C = Personal Consumption expenditures – household spending
on consumer goods
I = Gross Domestic Investment – spending by firms and
households on new capital, plant, equipment, inventory and
new residential structures
G = government consumption and investment
EX – IM = net exports – net spending by rest of the world or
exports minus imports
•

5. C = PERSONAL CONSUMER EXPENDITURES
CATEGORIES
1. Durable goods – goods that last a relatively long time such as cars
and household appliances
2.
3. Nondurable goods – goods that are used up fairly quickly such as
food and clothing
4.
5. Services – things we buy that do not involve the production of
physical things such as legal and medical services and
education

6. I = GROSS PRIVATE DOMESTIC
INVESTMENT
TYPES OF INVESTMENT
1. Gross Private Investment – total investment in capital, it is the purchase of
new housing, equipment and plants by private sector
2.
3. Nonresidential Investment – expenditures by firms for machines, tools, plants
and so on
4.
5. Residential Investment – expenditures by firms and on new houses and
buildings
6.
7.
8. Change in Business Inventories – amount by which firms inventories change
during a period, inventories are goods that firms produce now but intend
to sell later

7. GOVERNMENT CONSUMPTION AND INVESTMENT refers
to federal, state and local governments for final goods and
services.
NET EXPORTS (EX – IM) is the difference between exports and
imports, figure can be negative or positive
Example:
G + (EX – IM)

8. CALCULATING (GDP): INCOME APPROACH
GDP = National Income + Depreciation + (indirect taxes – Subsidies) + Net factor
payments to the rest of the world
1. NATIONAL INCOME - is the total income earned by the factors of production
owned by country’s citizen
a) Compensation of employees – includes wages, salaries and various
supplements
b) Proprietor’s income – income of unincorporated businesses
c) Corporate profits – income of corporate businesses
d) Net interest – interest paid by business
e) Rental income – income received by property owners in from of rent

9. 2. DEPRECIATION is the amount by which asset’s value falls in a given period
3.
4. INDIRECT TAXES are taxes like sales tax, customs duties and license fee
5.
6. SUBSIDIES are payments made by the government for which it receives no
goods or services in return
7.
8. NET FACTOR PAYMENTS TO THE REST OF THE WORLD payments of
factor income to the rest of the world minus receipt of factor income from the
rest of the world
Example:
CALCULATING (GDP): INCOME APPROACH

10. CALCULATING (GDP): THE PRODUCTION
APPROACH
Value Added: VA = total revenue – the value of intermediate goods
Total GDP is the sum of gross value added by institutional units that are resident in the economy (in
different economic activities) plus taxes on products and import (VAT, excise tax and customs duties)
less subsidies on products.
Calculation scheme is as follows:
Total output (goods and services) by types of activities in market prices - intermediary consumption
for generating goods and services = GDP at market prices + taxes on products and import - subsidies
on products = Total GDP at market prices
Example:

11. Real V Nominal GDP
Real GDP is the value of final goods and services produced in a given
year when valued at constant prices.
Calculating Real GDP
The first step in calculating real GDP is to calculate nominal GDP, which
is the value of goods and services produced during a given year valued at
the prices that prevailed in that same year.
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12. GDP DEFLATORS

13. USE REAL GDP TO MEASURE
ECONOMIC GROWTH
We use real GDP to calculate the economic growth rate.
The economic growth rate is the percentage change in the
quantity of goods and services produced from one year to the
next.
1. We measure economic growth so we can make:
Economic welfare comparisons
Economic welfare measures the nation’s overall state of
economic well-being.
Real GDP is not a perfect measure of economic welfare for
seven reasons:
a. Quality improvements tend to be neglected in
calculating real GDP so the inflation rate is
overstated and real GDP understated.
b. Real GDP does not include household production,
that is, productive activities done in and

14. USE REAL GDP TO MEASURE
ECONOMIC GROWTH
International welfare comparisons
Real GDP is used to compare economic welfare in one country with
that in another.
Two special problems arise in making these comparisons.
1. Real GDP of one country must be converted into the same
currency units as the real GDP of the other country, so an
exchange rate must be used.
2. The same prices should be used to value the goods and services
in the countries being compared, but often are not.
Business cycle forecasts
Real GDP is used to measure business cycle fluctuations.
These fluctuations are probably accurately timed but the changes in
real GDP probably overstate the changes in total production and
people’s welfare caused by business cycles.

15. Limits of GDP Measure
1. Leisure time
2.
3. Nonmarket economic activities
4.
5. Environmental quality and resource depletion
6.
7. Quality of life
8.
9. Poverty and economic inequality
10.
11. International GDP comparisons based on exchange rates,
which can introduce bias