Measuring a Nation’s Well-Being

By
Dr Bijoy Rakshit
Economics and Business Environment
Indian Institute of Management Jammu
Email id: [email protected]
Measuring a Nation’s Income
Income is equated with a standard of living-The total amount of
goods and services that can used to purchase better housing,
healthcare, fancier cars, by population.
Same logic can applied to overall national economic well being.
When judging whether the economy is doing well or poorly, it is
natural to look at the total income that the economy is earning.
GDP by country ( source: worldometer)
The Economy’s Income And
Expenditure
GDP measures two things at once:
total income of everyone in an economy,

and
total expenditure on economy’s output of goods and
services.

Total income = total expenditure

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In an Economy Why Total Income
Must Equal Total Expenditure

Total income must equal expenditure because:

Every transaction has a buyer and a seller.
Every euro of spending by some buyer is a euro of income
for some seller.
The equality of income and expenditure can be illustrated
with the circular-flow diagram.
Figure 1 The Circular-Flow Diagram

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Explanations

Households buy goods and services from firms; firms use

this money to pay for resources purchased from households.
When households receive income, some of the income is:
saved (S) providing funds for financial institutions
taxed (T). The taxes can be used by the government in making purchases
(G) such as education, health and infrastructure.

Some products and services maybe purchased from other

countries as imports (M) and some services and products
maybe sold abroad as exports (X).
Some businesses will invest (I) in new capital.
Leakages are T + S + M
Injections into the economy come from G, X and I
GDP is the Market Value….
GDP is the market value of all final
goods and services produced within a
country in a given period of time.
1. “GDP is the market value…”
Output is valued at market prices.
2. “. . . of all final . . .”
It records only the value of final goods, not intermediate goods (the value
is counted only once).
3. “. . . goods and services . . . “
It includes both tangible goods (food, clothing, cars) and intangible
services (haircuts, house cleaning).
GDP is the Market Value….
1.

1. “. . . produced . . .”
It includes goods and services produced in the period we’re considering,
not transactions involving goods produced in the past.
2. “ . . . within a country . . .”
It measures the value of production within the geographic confines of a
country.
3. “. . . in a given period of time.”
It measures the value of production that takes place within a specific
interval of time, usually a year or a quarter (three months).
Other Measures of Income
1. Gross national product (GNP) is the total income
earned by a nation’s permanent residents (called
nationals).
2. Net national product (NNP) is the total income of a
nation’s residents (GNP) minus losses from depreciation.
Depreciation is the wear and tear on the economy’s stock of
equipment and structures, such as lorries rusting and computers
becoming obsolete.

3. National income (NY) is the total income earned by a

nation’s residents in the production of goods and services
4. Personal income is the income that households and
non-corporate businesses receive.
5. Disposable personal income is the income that
households and non-corporate businesses have left after
satisfying all their obligations to the government.
GDP and GNP
While GDP looks at the value of good and services
produced within a country’s borders, GNP is the market
value of goods and services produced by all citizens of a
country- BOTH DOMESTICALLY AND ABROAD
while GDP is an indicator of the national economy, GNP
represents how its nationals are contributing to the
country’s economy. It factors in citizenship but overlooks
location.
For this reason, its important to note that GNP does not
include the output of foreign residents
GNP = GDP+ Net income earned from abroad
GDP and GNP
 Three approaches to GDP estimation

There are three generally accepted ways to calculate

GDP:
Product approach: adding up the market values of all
final goods/services.

Expenditure approach: adding up the total expenditure

of different sectors of the economy.

Income approach: adding up the income generated by

the production of final goods/services.
Value added
Value added

1. Value-added is the increase in the market value at each

stage of production
2. Measuring value-added in each stage of production
avoids “double-counting” the values of the intermediate
goods
3. In previous example, if we add up all the market values
of each good produced, we would get 1 + 5 + 12 + 20 = $38
4. However, if we only count the value-added in each stage,
we would get 1 + 4 + 7 + 8 = $20, which is equal to the
market value of the final good
Product method

Production approach estimates the total value of economic output and

deducts the cost of intermediate goods that are consumed in the
process (like those of materials and services).

modern economy, we have large numbers of goods: Apples, bread,

shirts, pens, chairs, etc…

Services: Medical, legal, educational, domestic, etc…

Lets assume that different types of final outputs in given year: Q1, Q2,
Q3, …..Qn and their respective price are P1, P2, P3, …..Pn.
As per the product method, the size of GVA will be equal to the sum
of annual flow of final goods and services valued at their respective
market prices:

GVA
Income method
Aggregate income flows of factors earnings generated by the
production of the final output:


Where i stands for goods

R=rents 
W=wages
I=interest
P=profits

Expenditure Method

1. Household expenditure
2. Business sectors expenditure
3. Government expenditure
4. Net export


GDP AND NDP
NDP ( Net domestic product) = GDP -Depreciation
NDP is the value we get when depreciation is subtracted from GDP

Depreciation refers to the wear and tear occurring in the process of

production
Personal Income and Disposable
Personal Income
Personal income refers to all the earnings made by a household in a given year.
It includes various sources of revenue like salaries, wages, investment, dividends,
rent, contributions being made by an employer towards any pension plan, etc.

It is the household’s measure of income and includes income not necessarily

earned by them. It may take the form of social security benefits, unemployment
benefits, welfare compensation, etc.
Personal income is subject to taxation

PI = Salaries/Wages Received + Interest Received + Rent Received +

Dividends Received + Any Transfer Payments
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
The Components Of Gdp
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of new
housing.
Investment (I):
The spending on capital equipment, inventories,
and structures, including new housing.
Government Purchases (G):
The spending on goods and services by local and
central governments.
Does not include transfer payments because they
are not made in exchange for currently produced
goods or services.
The Components Of GDP
Net Exports (NX):
Exports minus imports.

GDP per capita is gross domestic

product divided by the population of a
country to give a measure of national
income per head.

F
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.

F
A Numerical Example
An accurate view of the economy requires adjusting
nominal to real GDP by using the GDP deflator.
Assume an economy produces only two goods – apples
and potatoes.
Table 2a shows the quantities of the two goods produced
and their prices in the years 2016, 2017 and 2018.
Table 2a Data example for calculating the real and nominal GDP
Table 2b Nominal and Real GDP

Part of the rise is attributable to the increase in the quantities of

apples and potatoes and part to the increase in the prices of
apples and potatoes. To take out the effect of changes in prices
we use real GDP

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The GDP Deflator
The GDP deflator is a measure of the price level
calculated as the ratio of nominal GDP to real GDP
times 100.
It tells us the rise in nominal GDP that is attributable to
a rise in prices rather than a rise in the quantities
produced.
The GDP Deflator
The GDP deflator is calculated as follows:
Table 2c Calculating the GDP deflator
For year 2016, nominal GDP is €200, and real GDP is
€200, so the GDP deflator is 100.
We now need the nominal GDP and the the real GDP
for the other two years to complete our calculations
(see table 2a).

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The GDP Deflator
Converting Nominal GDP to Real GDP
Nominal GDP is converted to real GDP as follows:

F
Find the base year
Calculate the following
1. GDP 2. Depreciation
Calculate the gross value added at
factor cost
Explain the initial effect of each of the
following events on GDP

(a) You sell your used car to a friend.

(b) The value of your AT&T stock holdings decreases.

(c) You buy a piece of land with the intention of building a new
house.

(d) A German tourist drinks Canadian beer in an American

restaurant.

(e) If nominal GDP in Germany increased by 2.8% last year, but U.S.
GDP increased by 4.2%, can we conclude that the welfare of U.S. citizens
increased by more than that of German citizens? Why or why not?
Comment on the following
statement
Assume a Hyundai dealership in Chicago bought 30 Hyundais
from Korea at a cost of $15,000 per car in September of 2012.
By December 31, 2013 they had sold 20 of the Hyundais at a
price of $18,000 each. The remaining Hyundais were sold in
January of 2014 at a price of $16,000 each. How exactly does
this affect the GDP in the U.S. in 2013 and 2014, and which
categories of GDP (C, I, G, or NX) are affected?
Calculate GNP, NNP and Personal savings
The Limitations Of GDP As A Measure Of
Economic Well-being
GDP is the best single measure of the economic well-
being of a society.
GDP per person tells us the mean income and expenditure
of the people in the economy.
Higher GDP per person indicates a higher standard of living.

GDP is not a perfect measure of the happiness or

quality of life, however.
THE LIMITATIONS OF GDP AS A MEASURE
OF ECONOMIC WELL-BEING
Some things that contribute to well-being are not
included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place outside of
markets, such as the value of the time parents spend with
their children and the value of volunteer work.

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The Limitations Of GDP As A Measure Of
Economic Well-being
Some things that contribute to well-being are not
included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place outside of
markets, such as the value of the time parents spend with
their children and the value of volunteer work.