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1. Measuring a Nation’s Income
Chapter 7

2. The Economy’s
Income and Expenditure
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.
To have this number make sense, it is also
best to look at income per person.

3. The Economy’s
Income and Expenditure
• For an economy as a whole, income must equal
expenditure because:
 Every transaction has a buyer and a seller.
 Every dollar of spending by some buyer is a dollar of
income for some seller.
 Say’s Law-Supply creates it’s own demand
 This process can be seen using a Circular Flow Diagram.

4. 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.
How much is the current GDP?
Gross Domestic Product

5. The Circular-Flow Diagram
Firms
Households
Market for
Factors
of Production
Market for
Goods
and Services
Spending
Revenue
Wages, rent,
and profit
Income
Goods &
Services sold
Goods &
Services
bought
Labor, land,
and capital
Inputs for
production
Household and firm
come to this market to
complete transaction
Household and firm
come to this market to
complete transaction

6. The Measurement of GDP
GDP is the market value of all final
goods and services produced within a
country in a given period of time.

7. What Is Counted and Not Counted in
GDP?
GDP includes all items produced in the economy and sold legally
in markets.
GDP excludes services that are produced and consumed at home
and that never enter the marketplace.
Caring labor, the work that is normally produced by women.
Because GDP does not count it, it diminishes its importance.
GDP also excludes black market items, such as illegal drugs.

8. Other Measures of Income
• Gross National Product (GNP)
• Net National Product (NNP)
• National Income
• Personal Income
• Disposable Personal Income

9. GNP
Gross national product (GNP) is the market value of all
products and services produced in one year by indigenous
labor and property supplied of a country.

10. GNP
GDP plus the income accruing to domestic residents as a
result of investments abroad, minus the income earned in
domestic markets accruing to foreigners abroad.
Mathematically:
GNP = GDP + Earning from Investment of Indigenous
Firms Abroad – Earning of Foreign Firms made
Investment in Domestic Business

11. GNP (Conti..)
GNP = GDP (Foreign Firm’s Production Domestically +
Indigenous Firm’s Production Domestically) + Indigenous Firm’s
Production Abroad –Foreign Firm’s Production Domestically
GNP = FFPD + IFPD + IFPA - FFPD
GNP = IFPD + IFPA
Indigenous
Firm’s
Production
Abroad
Indigenous
Firm’s
Production
Domestically

12. Net National Product (NNP)
Net national product (NNP) is the total
market value of all final goods and services
produced by residents in a country or other
polity during a given time period (gross
national product or GNP) minus
depreciation.
The net domestic product (NDP) is the
equivalent application of NNP within
macroeconomics, and NDP is equal to gross
domestic product (GDP) minus depreciation:
NDP = GDP - depreciation.

13. National Income (NI)
The total net value of all goods and services produced
within a nation over a specified period of time, representing
the sum of wages, profits, rents, interest, and pension
payments to residents of the nation.

14. Personal Income (PI)
In economics, personal income refers to an individual's
total earnings from wages, investment enterprises, and other
ventures. It is the sum of all the incomes actually received
by all the individuals or household during a given period

15. Personal Disposable
Income
Disposable income is total personal income
minus personal current taxes. In national
accounts definitions, personal income, minus
personal current taxes equals disposable
personal income. Subtracting personal
outlays (which includes the major category
of personal (or, private) consumption
expenditure) yields personal (or, private)
savings.

16. Measuring National Income
1. Income Method
2. Expenditure Method

17. Income Method
1. Rent From Land
2. Compensation for Labor
3. Interest on Capital
4. Profit by Organization
5. Mixed Income (self-employed individuals, farming
units, and sole proprietorships)

18. Income Method
Mathematically we can write it as
National Income = Rent + Compensation + Interest + Profit
+ Mixed income

19. Expenditure Method
National Income = C (household consumption) + G
(government expenditure) + I (investment expense) + NX
(net exports)

20. 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

21. Where
C = ƒ (Y) where Y is disposable income
C = mY where m in MPC
Putting in National Income equation (Expenditure Method)
Y = C + I +G +NX » Y= mY +I+G+ NX
Y –mY = I + G+ NX
Y(1-m) = I + G+ NX
Y = (I + G+ NX/ (1-m))
Where the term 1/1-m is the expenditure Multiplier

22. MPC

23. MPC
Marginal Propensity to Consume is equal to
∆𝐶
∆ 𝑌

24. Multiplier
A multiplier is a factor of proportionality that
measures how much an endogenous variable
changes in response to a change in
some exogenous variable.
For example, suppose variable x changes by 1
unit, which causes another variable y to
change by M units. Then the multiplier is M.

25. Let’s say you find a dollar in the street. You
now have one dollar you did not have before.
You now have an “income” of one dollar.
What can you do with that dollar?? You can
spend all of it, save all of it, or spend some of
it and save some of it. You have options!
KEYNESIAN MULTIPLIER EFFECTS

26. • Let’s assume you decide to spend the WHOLE dollar.
Your spending of that dollar is an EXPENDITURE for
you and INCOME for the person (entrepreneur) you
traded with.
KEYNESIAN MULTIPLIER EFFECTS

27. How much did GDP increase with this
transaction?
$1.00
(you bought “stuff”)
KEYNESIAN MULTIPLIER EFFECTS

28. • Now what happens to that dollar in the
possession of the entrepreneur? They have
the same options you had:
Spend it or Save it.
KEYNESIAN MULTIPLIER EFFECTS

29. Let’s assume the entrepreneur spends the
WHOLE dollar at another business.
This expenditure for the entrepreneur is now
INCOME for another entrepreneur.
KEYNESIAN MULTIPLIER EFFECTS

30. How much did GDP increase with this
transaction?
$1.00
Does this sound familiar??
KEYNESIAN MULTIPLIER EFFECTS

31. This “found” dollar has now purchased $2.00
worth of goods and/or services.
The original dollar appears to be cloning itself!!
KEYNESIAN MULTIPLIER EFFECTS

32. If we repeat this pattern, it would go on
FOREVER and GDP would increase INFINITLEY.
Is this possible? Unlikely…Why?
KEYNESIAN MULTIPLIER EFFECTS

33. People have a TENDENCY TO SAVE some portion of
each dollar they receive.
Keynes called this: Marginal Propensity to Save
(MPS). In layman’s terms this means people have a
TENDENCY TO SAVE A PORTION OF EACH
ADDITIONAL DOLLAR they receive.
KEYNESIAN MULTIPLIER EFFECTS

34. The flip side of this is people have a TENDENCY TO
SPEND (or CONSUME) some portion of each dollar
they receive.
Keynes called this: Marginal Propensity to Consume
(MPC). In layman’s terms this means people have a
TENDENCY TO CONSUME A PORTION OF EACH
ADDITIONAL DOLLAR they receive.
KEYNESIAN MULTIPLIER EFFECTS

35. • Example: If I get an additional dollar I may
consume .90 and save .10.
• My Marginal Propensity to Consume (MPC)
that dollar is then: 90%.
• My Marginal Propensity to Save (MPS) that
dollar is then: 10%.
KEYNESIAN MULTIPLIER EFFECTS

36. • Example: If I get an additional dollar I may
consume .80 and save .20.
• My Marginal Propensity to Consume (MPC) is
then: 80%.
• My Marginal Propensity to Save (MPS) is then:
20%.
KEYNESIAN MULTIPLIER EFFECTS

37. Do you notice a pattern?
MPC + MPS = 1.00 (or 100%)
KEYNESIAN MULTIPLIER EFFECTS

38. • Let’s see how this works in practice.
• Assume the Government wants to increase their
spending by $10 billion dollars. Assume that the
MPC in the economy is 90% and the MPS is 10%
(remember these must equal 100%). What is going
to be the effect on the GDP when we consider the
Multiplier effect of EACH of those dollars?
KEYNESIAN MULTIPLIER EFFECTS

39. • The Government initially spends $10 billion in
the economy to purchase goods and services.
Does the Government SAVE any of this
money? NO. They spend the whole! What is
the immediate effect of this transaction on
GDP? It INCREASES by $10 billion.
KEYNESIAN MULTIPLIER EFFECTS

40. • What is now going to happen to that $10
billion now in the hands of people in the
economy? Keynes says that people in general
will spend 90% of it and save 10%.
• So when people spend 90% of $10 billion, how
much is GDP going to increase by? $9 billion.
KEYNESIAN MULTIPLIER EFFECTS

41. • With these initial two transactions, how much
has GDP increase by?
$10B + 9B = 19B
• Once again the original $10B has “magically”
turned into $19B in GDP .
KEYNESIAN MULTIPLIER EFFECTS

42. • Now when people who receive the $9B, they are going to
spend 90%, or $8.1B and save 10%, or $900 Million.
• GDP is now growing again!
$10B + $9B + $8.1B = $27.1 Billion
It does not stop here. Each time the money is spent it keeps
reducing by the 90% and 10% ratio UNTIL it gets to ZERO and
GDP is some much larger number.
KEYNESIAN MULTIPLIER EFFECTS

43. • Do you want to do all that math to arrive at
how much GDP is going to increase in the end.
• Keynes came up with a simple formula to do
the math for you. Remember in the beginning
it was GOVERNMENT that started this buying
frenzy. This is very IMPORTANT to remember.
KEYNESIAN MULTIPLIER EFFECTS

44. • The Keynesian Government Spending Multiplier is 1/MPS.
• Let’s use the information we have already been given: The
MPC is 90% and the MPS is 10%.
• We can plug the appropriate number into the Government
Spending Multiplier and come up with a useful number.
• Govt. Spending Multiplier =
1/MPS = 1/10% = 1/.10 = 10
KEYNESIAN MULTIPLIER EFFECTS

45. • According to KEYNES when government spends a dollar in the economy it is going
to purchase a multiple of 10 times itself in GDP.
• If Government increases spending by 10 Billion, then the eventual impact on GDP
is going to be an increase of:
$10 Billion X 10 = $100 Billion
NOTE: This works in REVERSE as well. If Government DECREASES spending by $10
Billion, it will serve to DECREASE GDP by a multiple of 10!
KEYNESIAN MULTIPLIER EFFECTS

46. Measuring 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.
We measure economic growth so we can make:
• Economic welfare comparisons
• International welfare comparisons
• Business cycle forecasts

47. Measuring Economic
Growth
• 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.

48. Real versus Nominal GDP
• Nominal GDP values the production of
goods and services at current prices.
• Real GDP values the production of goods
and services at constant prices.

49. Real versus Nominal GDP (Conti…)
Example
Year Price of Meat
Pies
Quantity of
Meat Pies
Prices of
Kebabs
Quantity of
Kebabs
2001 $ 1 100 $ 2 50
2002 2 150 3 100
2003 3 200 4 150

50. Nominal GDP Calculation
Calculating Nominal GDP in 2001
(price in 2001 for meat ×Q. of meat sold in 2001) + (Price of Kebab in 2001 ×Q. of Kebab sold in
2001)
= (1 × 100 ) + ( 2 × 50) = $ 200
Nominal GDP in 2002
(price in 2002 for meat ×Q. of meat sold in 2002) + (Price of Kebab in 2002 ×Q. of Kebab sold in
2002)
= ( 2 × 150) + (3 × 100 ) = $ 600
Nominal GDP in 2003
(price in 2003 for meat ×Q. of meat sold in 2003) + (Price of Kebab in 2003 ×Q. of Kebab sold in
2003)
= ( 3 × 200 ) + ( 4 × 150) = $1200

51. Real GDP Calculation
Calculating Real GDP in 2001
(price in 2001 for meat ×Q. of meat sold in 2001) + (Price of Kebab in 2001 ×Q. of Kebab sold in
2001)
= (1 × 100 ) + ( 2 × 50) = $ 200
Real GDP in 2002
(price in 2001 for meat ×Q. of meat sold in 2002) + (Price of Kebab in 2001 ×Q. of Kebab sold in
2002)
= ( 1 × 150) + (2 × 100 ) = $ 350
Real GDP in 2003
(price in 2001 for meat ×Q. of meat sold in 2003) + (Price of Kebab in 2001 ×Q. of Kebab sold in
2003)
= ( 1 × 200 ) + ( 2 × 150) = $500
Note : Suppose Base year is 2001

52. GDP Deflator Calculation
Calculating GDP Deflator in 2001
(Nominal GDP in 2001 / Real GDP in 2001) × 100
= ($ 200 / $ 200) × 100
= 100
GDP Deflator in 2002
(Nominal GDP in 2002 / Real GDP in 2002) × 100
= ($ 600 / $ 350) × 100
= 171
GDP Deflator in 2003
(Nominal GDP in 2003 / Real GDP in 2003) × 100
= ($ 1200 / $ 500) × 100
= 240