Measuring a Nation’s Income:
The GDP
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Press Briefing: World Economic Outlook, October 2023
October 10, 2023
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Questions on Societal Well Being
● What is Gross Domestic Product (GDP)?
● How is GDP related to a nation’s total income and
spending?
● What are the components of GDP?
● How is GDP corrected for inflation?
● Does GDP measure a society’s well-being?
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Micro vs. Macro
● Microeconomics
The study of how individual households and firms make
decisions, interact with one another in markets.
● Macroeconomics
The study of the economy as a whole.
○ We begin our study of macroeconomics with the country’s total income
and expenditure.
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Income and Expenditure
● Gross Domestic Product (GDP) measures total income of
everyone in the economy.
● GDP also measures total expenditure on the economy’s
output of Goods & Services
For the economy as a whole,
income equals expenditure
because every Rupee a buyer spends
is a Rupee of income for the seller.
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The Circular-Flow Diagram
● a simple depiction of the macroeconomy
○ illustrates GDP as spending, revenue, factor payments, and income
● Preliminaries:
○ Factors of production are inputs like labor, land, capital, and
natural resources.
○ Factor payments are payments to the factors of production (e.g.,
wages, rent).
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The Circular-Flow Diagram
Households:
own the factors of production,
sell/rent them to firms for income
buy and consume goods &
services
Firms Households
Firms:
buy/hire factors of
production,
use them to produce goods
and services
sell goods & services 8
The Circular-Flow Diagram
Revenue (=GDP) Spending (=GDP)
Markets for
G&S Goods &
G&S
sold Services bought
Firms Households
Factors of Labor, land,
production Markets for capital
Factors of
Wages, rent, Production Income (=GDP)
profit (=GDP)
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What This Diagram Omits
● The government
○ collects taxes, buys g&s
● The financial system
○ matches savers’ supply of funds with borrowers’ demand for loans
● The foreign sector
○ trades g&s, financial assets, and currencies with the country’s
residents
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Gross Domestic Product (GDP) is…
● …the market value of all final goods & services produced within
a country, in a given period of time
● Goods are valued at their market prices, so:
○ All goods measured in the same units
(e.g. Rupees in India)
○ Things that don’t have a market value are excluded, e.g., housework you do
for yourself.
● Final goods: intended for the end user
● Intermediate goods: used as components or ingredients in the
production of other goods
○ GDP only includes final goods – they already embody the value of the
intermediate goods used in their production
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Gross Domestic Product (GDP) Is…
● GDP includes tangible goods (like DVDs, mountain bikes, beer)
and intangible services (dry cleaning, concerts, cell phone
service)
● GDP includes currently produced goods, not goods produced in the
past
● GDP measures the value of production that occurs within a
country’s borders, whether done by its own citizens or by
foreigners located there
○ Usually a year or a quarter (3 months)
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The Components of GDP
● Recall: GDP is total spending.
● Four components:
○ Consumption (C) Y = C + I + G + NX
○ Investment (I)
○ Government Purchases (G)
○ Net Exports (NX)
● These components add up to GDP (denoted Y)
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Consumption (C)
● is total spending by households on g&s.
● Note on housing costs:
○ For renters, consumption includes rent payments.
○ For homeowners, consumption includes the imputed rental value of the
house, but not the purchase price or mortgage payments.
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Investment (I)
● is total spending on goods that will be used in the future to
produce more goods.
● includes spending on
○ capital equipment (e.g., machines, tools)
○ structures (factories, office buildings, houses)
○ inventories (goods produced but not yet sold)
Note: Investment does not
mean the purchase of financial
assets like stocks and bonds.
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Government Purchases (G)
● is all spending on the g&s purchased by govt at the
union/central, state, and local levels
● Includes investment in roads, parks, hospitals by the government
● Includes salary to its employees
○ G excludes transfer payments, such as
Social Security or unemployment insurance benefits
○ They are not purchases of g&s.
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Net Exports (NX)
● NX = exports – imports
● Exports represent foreign spending on the economy’s g&s.
● Imports are the portions of C, I, and G that are spent on
g&s produced abroad.
● Adding up all the components of GDP gives:
Y = C + I + G + NX
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India’s GDP
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live-updates-indias-gdp-grows-at-135-in-
q1-fy23-346057-2022-08-31
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Poll
● In each of the following cases, determine how much GDP and each of its
components is affected (if at all).
i. Shivangi spends Rs 2000 to buy her friend dinner at the finest restaurant
in Bengaluru.
ii. Amol spends Rs 45,000 on a new mobile phone built by Micromax in India
iii.Vikram spends Rs 12,000 on a computer; it was the last year’s model which
he got on sale for a great price from a local retailer
iv. Tata Motors manufactures Rs. 500 crore worth of cars, but consumers only
buy cars worth Rs. 470 crores in the year
v. Anmol buys a Lenovo laptop for Rs. 50,000/- made in China
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Real versus Nominal GDP
● Inflation can distort economic variables like GDP, so we
have two versions of GDP: One is corrected for
inflation, the other is not.
● Nominal GDP values output using current prices. It is
not corrected for inflation.
● Real GDP values output using the prices of
a base year. Real GDP is corrected for inflation.
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EXAMPLE:
Samosa Tea
year P Q P Q
2005 ₹10 400 ₹2.00 1000
2006 ₹11 500 ₹2.50 1100
2007 ₹12 600 ₹3.00 1200
Nominal GDP in each year:
Increase
2005: ₹10 x 400 + ₹2 x 1000 = ₹6,000
37.5%
2006: ₹11 x 500 + ₹2.50 x 1100 = ₹8,250
30.9%
2007: ₹12 x 600 + ₹3 x 1200 = ₹10,800
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EXAMPLE:
Samosa Tea
year P Q P Q
2005 ₹10
$10 400 ₹2.00
$2.00 1000
2006 ₹11 500 ₹2.50 1100
2007 ₹12 600 ₹3.00 1200
Real GDP in each year, using 2005 as the base year:
Increase
2005: ₹10 x 400 + ₹2 x 1000 = ₹6,000
20.0%
2006: ₹10 x 500 + ₹2 x 1100 = ₹7,200
2007: ₹10 x 600 + ₹2 x 1200 = ₹8,400 16.7%
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EXAMPLE: Year
Nominal
GDP
Real
GDP
2005 ₹6000 ₹6000
2006 ₹8250 ₹7200
In each year, 2007 ₹10,800 ₹8400
● nominal GDP is measured using the (then) current
prices.
● real GDP is measured using constant prices from the
base year (2005 in this example).
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EXAMPLE:
Nominal Real
Year GDP GDP
2005 ₹6000 ₹6000
37.5% 20.0%
2006 ₹8250 ₹7200
30.9% 16.7%
2007 ₹10,800 ₹8400
● The change in nominal GDP reflects both prices and
quantities.
The change in real GDP is the amount that
GDP would change if prices were constant
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
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Nominal and Real GDP of India
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The GDP Deflator
● The GDP deflator is a measure of the overall level of
prices.
● Definition:
nominal GDP
GDP deflator = 100 x
real GDP
One way to measure the economy’s inflation
rate is to compute the percentage increase in
the GDP deflator from one year to the next.
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EXAMPLE: Compute the GDP deflator in each year:
Nominal Real GDP
Year GDP GDP Deflator
2005 ₹6000 ₹6000 100.0
14.6%
2006 ₹8250 ₹7200 114.6
2007 ₹10,800 ₹8400 128.6 12.2%
2005: 100 x (6000/6000) = 100.0
2006: 100 x (8250/7200) = 114.6
2007: 100 x (10,800/8400) = 128.6
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GDP and Economic Well-Being
● Real GDP per capita is the main indicator of the average
person’s standard of living in a country
● But GDP is not a perfect measure of well-being
○ “….. does not allow for the health of our children, the quality of their education, or the joy of
their play. …….. does not include the beauty of our poetry or the strength of our marriages, the
intelligence of our public debate or the integrity of our public officials.” (Robert Kennedy)
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GDP Does Not Value:
● the quality of the environment
● leisure time
● non-market activity, such as the child care a parent
provides his or her child at home
● an equitable distribution of income
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Then Why Do We Care About GDP?
● Having a large GDP enables a country to afford better
schools, a cleaner environment, health care, etc.
● Many indicators of the quality of life are positively
correlated with GDP.
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GDP and Life Expectancy in 12 countries
Indonesia
Japan
China
Life expectancy (years)
U.S.
Mexico Germany
Brazil
Pakistan
Russia
India
Bangladesh
Nigeria
Real GDP per capita 31 31
GDP and Literacy in 12 countries
China Russia U.S.
Germany Japan
Mexico
(% of population)
Adult Literacy Brazil
Indonesia
Nigeria
India
Pakistan
Bangladesh
Real GDP per capita 32 32
GDP and Internet Usage in 12 countries
Japan
U.S.
(% of population)
Internet Usage
Germany
Brazil
Indonesia
Mexico
Pakista
Russia
n
China
Nigeria India
Bangladesh Real GDP per capita 33 33
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