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Measuring National Income and Output
Flashback! Anyone recall this model?
Relationship Between Outcome and
Income
The Circular Flow Model shows two distinct monetary
flows. Households offer factors of production to firms in return
for household income. Households then use this income to
make expenditures on goods and services.
Example: Mr Teacher offers his labour to CIS in return for (not
that much) money. Mr. Teacher uses this income to buy (not a
lot of) goods and services.
Important Point!
The income flow from firms to households (Mr. Teacher's
salary) = the expenditures of Mr. Teacher for goods and
services.
Income from the factors of production must equal the
expenditures by households on goods and services.
In addition, the income flow and the expenditure flow will be
equal to the value of total output produced by firms.
So the income flow= expenditure flow=value of output
Leakages and Injections
Leakages
Leakages occur when people take actions
that decrease the flow of money through the
circular flow diagram.
What effect does this have on the size of the
economy?
Can you recall a few of the types of leakages
that you learned about last year?
Injections
Injections occur when people take actions that
increase the flow of money through the
circular flow diagram.
What effect does this have on the size of the
economy?
Can you recall a few of the types of leakages
that you learned about last year?
Leakages
Saving money is a leakage to the circular flow because it is
money that could have been used to buy goods and
services.
Taxes are a leakage because they too represent money
that might have been spent on goods and
services. Instead of buying a new car, I have to pay taxes.
:(
Imports are also a leakage because money spent on
foreign goods represent expenditures that could have been
made at home in the domestic economy.
Injections
Investing money is an injection to the circular flow because
it is money that is invested by firms to purchase additional
capital goods.
Government spending is an injection because the
government uses tax money to purchase many goods and
services
Exports are an injection because we are selling goods to
foreigners who might have purchased domestically
produced goods instead.
Leakages and Injections
If leakages exceed injections, the economy shrinks!
Leakages and Injections
If injections exceed leakages, the economy
expands
National Income Accounting
The Circular Flow Model shows us that the value of total
output is equal to the total income generated in producing
that output is equal to the expenditures made to purchase
that output.
National Income Accounting is the way we measure an
economy's output. It allows us to:
• assess the performance of the economy
• compare one economy with another
• help create economic policies
Value
When measuring the size of an economy, we refer to the value
of the output that the economy has created. Why don't we just
measure the quantity of output created?
There are three ways to measure the value of aggregate
output:
• the expenditure approach
• the income method
• the output method
The Expenditure Method
The expenditure approach measures the total amount
of spending on final goods and services within a
country during a period of time. Sound familiar?
What are intermediate goods and why are they not
included in this method?
Can you recall the four components of the expenditure
approach? They should roll right off your
C + I + G + (X-M)
Consumption--by households of all final goods (durable and
non-durable) and services
Investment--by firms on capital goods and all new spending on
construction
Government--all spending on goods and services by the
government at all levels
Net Exports--Value of all exports - value of all imports. May be
a negative value!
So C + I + G + (X-M)=GDP!
The Income Method
The Income method adds up all income earned by
the factors of production within a country in a given
time period.
Included in this is wages earned by labour, rent from
land use, interest earned from capital goods, and
profits earned by entrepreneurs.
When we add up all these levels of income we arrive
at national income, which when adjusted for
depreciation and other things becomes equivalent to
GDP
The Output Method
The Output method measures the value of each good
and service produced in the economy over a
particular time period, and then adds them all up to
obtain the value of output produced.
This method also includes only final goods and
services to avoid double counting. This method
calculates output by particular sector so we know
how each sector is performing.
Nominal vs. Real
Anybody remember the difference between nominal and real
figures? I bet you do...........(think nominal GDP vs. real GDP)
Nominal vs. Real
Nominal figures are at present day prices, not
adjusted for inflation.
Real figures are adjusted for inflation by referring
back to a base year which all following years are
compared to.
When we wish to compare year to year, we must use
real figures to get an accurate comparison. Let's take
a look out a handout so we remember how to
calculate nominal GDP and real GDP.
Gross Domestic Product
What's gross about GDP?
Gross Investment
One of the components of GDP is investment, which is
spending on capital goods. Some investment is on new capital
goods, while other investment is to replace older capital goods.
So gross investment can be divided into two parts:
• net investment (spending on new capital goods)
• depreciation (spending on worn out capital goods)
Gross investment = depreciation + net investment
Gross investment - depreciation = net investment
Two More Formulas
Net Domestic Product (NDP) = C + I(n) + G + (X-M)
where I(n) = new investment, so
NDP= GDP - depreciation
GDP and GDP per capita
GDP figures tell us the size of a country's economy without
really telling us anything about the amount of income received
by the people of that country. For instance, India and Italy
might have similar GDPs, but with India's population 15X that of
Italy, the numbers are deceiving!
GDP per capita
GDP per capita takes a country's GDP and divides by the total
population, giving us a better idea of the standard of living for
the people in those countries. So if Chad and Nigeria had GDP
of $500,000,000 we can calculate both GDP per capita:
Nigeria GDP per capita = $500M/100M = $5
Chad GDP per capita = $500M/1M = $500
While these countries have the same GDP, their GDP per
capita is vastly different. But this too is an imperfect statistic,
isn't it?
GDP vs GNP
GDP includes all income earned within a country's borders,
regardless of who the owners of the factors of production
are. Therefore, if Toyota operates a plant in the U.S.A., that
would count as part of the GDP of the U.S.A.
GNP includes all income earned by citizens of a country
regardless of where they happen to be living or
working. Therefore, the Toyota plant operating in the U.S.A.
would be counted in Japan's GNP statistics.