Gross Domestic Product is the market value of all final goods and services produced domestically in a country in a year

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Gross Domestic ProductGross Domestic Product
MD Siyam HossainMD Siyam Hossain
Bangladesh Institute of Business & TechnologyBangladesh Institute of Business & Technology
Narayangonj,DhakaNarayangonj,Dhaka
Dhaka,BangladeshDhaka,Bangladesh
www.facebook.com/mdsiyamhossain

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1. CONCEPTS OF NATIONAL INCOME
Explaining national income following five concepts are needed:
 Gross National Product
 Gross Domestic Product
 Net National Product
 National Income
 Personal Income, and
 Disposable Income
1.1 Gross National Product (GNP)
Gross National Product measures the total output or aggregate supply
of goods and services. Gross National Product is the total market
value of all final goods and services produced in a year at home and
abroad.
GNP is the market value of final goods and services produced
in a year at home and abroad

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Regarding GNP following issues must be noted:
 GNP is a monetary measure
 For calculating gross national product accurately all goods and services
produced in any given year must be counted once, but not more than
once. Most of the goods go through a series of production before
reaching it market. As a result, parts components of many goods are
bought and sold many times.
 Hence, to avoiding double counting, GNP includes only the market value
of final goods and ignores intermediate goods
 The goods those are purchased for final use are final goods
 The goods those are purchased for further processing or for resale are
not final goods
 The value of final goods includes the value of all intermediate goods
used in their production
 GNP measures the market value of the annual output

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1.2 Gross Domestic Product (GDP)
 Gross Domestic Product is the market value of all final goods and
services produced domestically in a country in a year
 In GDP only domestically produced products and services are
accounted
Gross Domestic Product = Products + Services
1.3 Net National Product (NNP)
Net National Product = Gross National Production - Depreciation
 The value of capital depreciates due to use
 The charges for depreciation are deducted from GNP to get NNP
 NNP is called national income at market prices

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1.4 National Income (NI)
National Income = Net National Product - Indirect Taxes + Subsidies
 For calculation national income following issues are considered:
 National income at market prices and national income at factor cost
differ.
 National income at factor cost shows how much it costs society to
produce it.
 We use the term National Income for national income at factor cost.
 The difference between national income at market prices and net
national product at factor cost arises because of indirect taxes and
subsidies.
Example:
 Let a meter cloth sold for TK 50 includes TK 5 sales tax.
 In this case, the market price of the cloth is TK 50 per meter.
 However, the cost of factors engaged in its production and distribution
is only TK 45 (50 – 5 = 45).
 The value of cloth at factor cost in this case TK 45.
 So, value at factor cost is equal to its value at market price less the
indirect taxes on it.

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Example:
 Let a meter cloth sold for TK 50 includes TK 5 sales tax.
 In this case, the market price of the cloth is TK 50 per meter.
 However, the cost of factors engaged in its production and distribution is
only TK 45.
 The value of cloth at factor cost in this case TK 45.
So, value at factor cost is equal to its value at market price less the
indirect taxes on it.
Example:
 Let a ton of rice sold for TK 20 000 which includes TK 1000 subsidies.
 (The factors of production fertilizer, pesticides, and irrigation are
subsidized)
 If there were not subsidized, the sale value would become TK 21 000
So, value at factor cost is equal to its value at market price plus the
subsidies for it.
National income = Wages + Salaries of employees + rent of land +
Interest on capital + profits of entrepreneurs + undistributed profits
of joint stock companies + Income of self employed‑ ‑

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1.5 Personal Income (PI)
 PI is the income actually the individuals have in a year.
 National income differs from personal income
 Because a part of income is deduced (social security contributions)
 Conversely individuals receive some income that is not earned (social
security transfer)
PI = National Income – Corporate Income Taxes – Retained Earning
of the Corporate Social Security Contributions + Social Security‑
Transfer
1.6 Disposable Income (DI)
 DI is the income that could be either be consumed or saved.
 Apart of personal income is paid to government in the form of personal
taxes like income tax, personal property taxes, etc., what remains is
disposable income. So:
 DI is the income that could be either be consumed or saved.
 Disposable Income = Personal Income Personal Taxes‑ ‑
 Disposable Income = Consumption + Saving.

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2. MEASUREMENT OF NATIONAL INCOME
There are following three possible methods for calculating national income:
 Calculating Aggregate Outputs (Aggregate Output Method)
 Calculating Aggregate Income (Aggregate Income Method), and
 Calculating Aggregate Expenditures (Aggregate Expenditures
Method)
2.1 Aggregate Output Method
 This method calculates national income from the output side
 Economy is divided into different sectors such as agriculture, mining,
manufacturing, small enterprises, transport, communication, commerce, and
other services
 Gross domestic product is found out by adding up net values of all production
 The purchases of one industry from other industries are deducted from the
gross value of production of that industry
The aggregate values of all industries plus the net income from abroad give the
Gross National Product
 This method enables to trace the origin of the national income of the economy.
 So, this method is also called national income by industrial origin
 This method reveals the relative importance of the different industries showing
their contribution to the national income

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2.2 Aggregate Income Method
 This method measures national income by summing up of the
incomes of all Individuals in a country
 Individuals earn income by contributing their own services and the
services of their property such as land and capital to the national
production.
So, national income is defined as:
 National Income = Wages & salaries of employees + rent of land +
interest on capital + profits of entrepreneurs + retained earning of the
corporate + income of self employed‑
 This method shows the distribution of national income among
different income groups such as entrepreneurs, workers,
professionals, etc.
Example
Calculate from following GNP, GDP, NNP, NI, and Disposable income.
Wages and salaries 9,564. Net interest earnings 844; profits of the
companies 760; undistributed profits 240; corporate income tax 292;
Indirect taxes 1,872; Social security transfer 92; Social security
Contributions $100, Subsidies 92; Depreciation 1,620.

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Solution
National Income: Wages and salaries 9,564 + Net interest
earnings 844+ Profits of the companies 760 + Undistributed
profits 240 =
Personal Income = National Income - Corporate income tax
292 + Social security transfer 92 - Undistributed profits 240 -
Social security Contributions $100 =
Disposable Income = Personal Income – Personal Tax =
NNP = National Income - Indirect taxes 1,872 + Subsidies 92
=
GNP = NNP - Depreciation 1,620 =
GDP = GNP – Income Abroad =
(Let income from abroad is 10% of GNP)

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2.3 Aggregate Expenditure Method
 Aggregate Expenditure Method calculates national income by adding up all
the expenditure made on goods and services during a year.
 Income can be spent either on consumer goods, investment goods,
government expenditure, or net export.
 Net export equals the difference between export and import
 Hence, the gross national product is found by adding up:
o Consumption Expenditure: This is what private individuals spend on
consumer goods and services?
o Investment Expenditure: This is what private businesses spend on
replacement, renewals, and new investment?
o Net Export Expenditure: This is what foreign countries spend on
goods and services of the national economy less what national
economy spends on the output of the foreign countries?
o Government Expenditure: This is what the government spends on the
purchase of goods and services?
Gross National Product = Consumption Expenditure (C) + Gross Domestic
Private Investment (I) + Government Purchases (G) + Net Export (NX)
[GNP = C + I + G + NX]

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 The best way to calculate national income is to use all these three
methods and cross checks the result.‑
Example:
By the Expenditure Method, we can get the same result. Total GNP
18,564 consists of Personal Consumption Expenditure 13,488, Gross
Private Domestic Investment 1,804, Government Purchases of Goods
and Services 3,096, Net Foreign Investment 176.
3. Difficulties of Measurement
There are some conceptual problems for measuring national income.
They are:
 Non magnetized economic activities such as the services of‑ housewives.
 If any body employs a home servant for household work, the payment
appear in national income.
 Treatment of the payment made by the government sector.
 Treatment of income arising out of activities of the foreign firms in a
country.

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7. INFLATION, PRICE INDEXES AND GDP
 Let a country produces and consumes only wheat
 In this case, it is easy to measure GDP
 Let it produces 100-ton wheat
 Let the price of 1-ton wheat is $1
 The quantity of GDP would be 100-ton wheat
 The value of GDP would be $100
 Let now suppose that next year the prices double, i.e. price of
1-ton wheat is $2
 So, next year the value of GDP would be $2000
 But clearly nothing real has changed.
 While nominal GDP has doubled
 Real GDP is unchanged which is what we care about

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Calculation of Real and Nominal GDP
Calculation of Real GDP
 Real GDP measured at the prices of base year say 2000
 That means, in calculating real GDP, today's physical output is
multiplied by the prices base year 2000
 It means:
 Real GDP is what today's output would have been worth
had it been sold at the prices of base year, say 2000

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Calculation of Nominal GDP
 Nominal GDP measures the value of output in a given
period in the prices of that period
 Or, Nominal GDP is the value of output in current
dollars
 Thus 1990 nominal GDP measures the value of goods
produced in 1990 at prices prevailing in 1990
 And 2005 nominal GDP measures the value of goods
produced in 2005 at the market prices that prevailed
in 2005

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 Nominal GDP changes from year to year for two
reasons:
First, the physical output of goods changes
Second, market prices changes
 Changes in nominal GDP that results from price
changes do not tell anything about the performance of
the economy
 That is why we use real rather than nominal GDP for
comparing GDP in different years
 If all prices change in fixed proportion, then GDP
changes in proportion of price change
 However, normally some prices rise more than others
 Such differences are generally inconsequential for
understanding macro theory

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8. INFLATION, PRICES AND GDP
 Inflation is the rate of changes in price
 Let Pt-1
is the price level of the last year
 Pt
is today's price level
Then the inflation rate over the past year can be written as:
Where π stands for the inflation rate
Hence, today's price level equals:
Pt
= Pt-1
+ π × Pt-1
Alternative way to calculate inflation:
Where:
ΣP1
= Sum of the prices from calculating year
ΣP0
= Sum of the prices from base year
1
1
−
−−
= t
tt
P
PP
π
0
1
P
P
∑
∑
=π

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Problem
Price essential goods in three groups A, B and C from 2005 and
2006 are given below. Calculate nominal and real GDP. Discuss the
result.
Goods Q-05 Q-06 P-05 P-06
A 6 11 $.50 $.40
B 7 4 $.30 $1.00
C 10 12 $.70 $.90

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Calculation of Nominal GDP
Q-05× P-05 Q-06× P-05 Q-05× P-06 Q-06× P-06
$3.00 $5.50 $2.40 $.4.40
$2.10 $1.20 $7.00 $4.00
$70 $8.40 $9.00 $10.80
Σ= $12.10 Σ= $15.10 Σ= $18.40 Σ= $19.20
 Nominal GDP in year 2005: $12.10
 Nominal GDP in year 2006: $19.20

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Calculation of Real GDP in 2006 considering price weight:
 Considering 05 as base year Real GDP in 06 = Σ[Q-06× P-05] =
$15.10
Growth of Real GDP from 05-06 considering price weight:
 Growth from 05-06 = ×100 = = 124.79%
Growth of GDP giving weight to quantity:
= 104.34
Arithmetic average of the two growths is:
(124.8+104.34)/2 = 114.57
Geometric average of two growths gives real GDP growth:
GDP Growth =
10.12
10.15
( ) 11.11434.10480.124 =×
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