Measuring domestic output

and national income

Lecture 2

What is spent on making a product is income to

those who helped make it!
 Circular flow of income & expenditure – open
economy, with government

Leakages
Import exp. (M)
Domestic
households Net Taxes. (T)
Net Saving (S)

Consumption exp. (Cd)

Factor payments

interest, profit)

Financial
(wages, rents,

Government Abroad
system
Investment (I)
Government exp. (G)

Injections
Domestic Export exp. (X)
producers
Income (w, r, i, ) Expenditure (Cd + I+G+(X-M))
What is spent on making a product is income to
those who helped make it!
Approach
 Start with a description of the main links among the
key role players in an economic system.
 Discuss the main measures and determinants of the
key indicators of the value of national output
 Discuss the main measures and determinants of the
key indicators of national unemployment rate as well
as key government policies to deal with problems
associated with changes in the unemployment rate.
 Discuss the main measures and determinants of the
key indicators of overall price level as well as
principal government policies to deal with problems
associated with changes in the price level
 Discuss the functions of the main role players in the
financial system and how they relate to some
macroeconomic goals
 Introduce you to public sector economics: how & why
government intervenes in the operation of the
markets.
Learning objectives
How gross domestic product (GDP) is
defined and measured.
The relationships among GDP, net domestic
product (NDP), national income (NI),
personal income (PI), and disposable
income (DI).
The difference between nominal GDP and
real GDP.
Some limitations of the GDP measure.
The difference between stock and flow
variables
What is spent on making a product is income to
those who helped make it!
Importance of NI Accounting
• National Income Accounting (NIA)- measures
the economy’s performance by measuring the
flows of income and expenditures over a period of
time.
• Statistics Botswana (www.cso.gov.bw) compiles
the National Accounts for the Botswana economy
• NIA helps
• Assess the health of the economy by comparing the
levels of production at regular intervals and in
comparison to other countries

• Track the long-run course of the economy to see

whether it has grown, stagnated or declined

• provide a basis for appropriate

What is spent on making apublic
product is policies
income to to
improve economic performance.
those who helped make it!
Assessing Economy’s Performance
• Gross Domestic product (GDP) is a monetary measure
of the total market value of all final goods and
services produced within a country in a given year – it is
location based.
• Final goods are consumption goods, capital goods &
services that are bought by their final users, rather than for
resale or further processing or manufacturing
• GDP includes only final products and services; it avoids
double/multiple counting, by eliminating any
intermediate goods used in production of these final
goods & services.
• Intermediate goods are goods & services that are bought
for resale or for further processing or manufacturing.
• Multiple counting could also be avoided by cumulating
only the value added at each stage
• Value added is the market value of a firm’s product minus
the value (cost) of the inputs the firm has bought from others
What is spent on making a product is income to
(used
those whoin themake
helped production
it! approach
to measurement of GDP)
Note on GDP
• Gross Domestic product (GDP) is a flow
concept/variable. That is, it is measured over
a period of time.
• A stock variable is a measure of a variable at
a point in time, e.g., wealth, debt

What is spent on making a product is income to

those who helped make it!
Assessing Economy’s Performance
• A related measure, Gross National Product (GNP)- ) is a
monetary measure of the total market value of all final
goods and services produced by a country’s owned resources
within in a given year irrespective of where production takes
place – it is ownership based
 GNP = GDP + NFFI
 Where
 NFFI = income earned by citizens supplying resources abroad
minus income earned by foreigners supplying resources in
Botswana
 NFFI is positive if income earned by citizens abroad is greater
than income earned by foreigners in Botswana & (GNP>GDP)
 Conversely, NFFI is negative if income earned by citizens
abroad is less than income earned by foreigners in Botswana
& (GNP<GDP)
• GDP & GNP are flow variables, not stock variables
• Since GNP is harder to measure, economists tend to favor the
What is spent on making a product is income to
use ofwho
those GDPhelped make it!
Example (agrarian economy)
Output (bags) Price per bag Market value
(P) (GDP)

Year Orange Tomatoe Orange Tomato

s s s es
1 4 3 75 100 (4x75)+(3x100)=
600
2 3 4 75 100 (3x75)+(4x100)=
625
3 3 3 100 110 (3x100)+(3x110)
=630

What is spent on making a product is income to

those who helped make it!
Example: industrialized economy
Suppose the economy becomes more
sophisticated and
The 4 bags of oranges are sold to a processor
(@P75), who in turn use them to produce 100
litres of orange juice, which he sells to a retailer
@P9.00 per litre. The retailer re-sells the juice
@P10.00 per litre to the final consumer
The 3 bags of tomatoes are sold to a processor
@P100 per bag, who in turn produces 90 bottles
of tomato source and sells it for P8.00 per bottle
to a retailer. The retailer re-sells the source at
P10.00 per bottle to the final consumer.
Calculate GDP for this country (use output
approach/expenditures
What is spent on making a product is income to
those who helped make it!
approach and
production (value added) approach)
GDP
Oranges side Tomatoes side
Stage Sales Value Stage Sales Value
value added value added
(P) (P) (P)
Farmer 300 300 Farmer 300 300
Processo 900 600 Processo 720 420
r r
Retailer 1000 100 Retailer 900 180
GDP(O) 1000 1000 GDP (T) 900 900
Total GDP
GDP (O) GDP (T) Total GDP (All)
1000 900 1900

What is spent on making a product is income to

those who helped make it!
 Repeat: GDP- Current market value of all
Final goods
GDP is the market value of all final goods
produced within the country
Assuming Botswana is producing only three goods
like Bread, cloth and computers in 2015.
Bread:10,000 loafs – Market price of each loaf =
P6 (Market value = 10,000XP6 = P60,000)
Cloth: 1000 meters- Market price of one meter =
P10 (Market value = 1000XP10 =P10,000)
Computers: 100 pieces – Market price of one
Computer = P2000 (Market value = 100XP2000 =
P200,000)
What is the GDP of the country?
GDP is the sum of the market value of all final
goods produced.
 Repeat: GDP excludes intermediate goods

GDP is the value of what has been produced in the

economy over the year, not what was actually sold.
GDP includes only the market value of final
products (G) and services (S) by eliminating the
value of any intermediate goods used in
production of these final G & S. This is done to
avoid double/multiple counting.
•Intermediate goods & services are semi-finished
goods and goods which cannot be used
independently; they are bought for resale for
further processing or manufacturing.
 Repeat: Double counting
•Double counting/Multiple counting could be
avoided by cumulating only the value added at
each stage
•Value added is the market value of a firm’s product
minus the value of the inputs the firm has bought
from others.

Stage of Sales Value of Value

Production Materials of Added
Product
Firm-A- Maize P1.5 P1.5
Firm-B- Maize P2.5 P1.0
processing mill
Firm-C- Maize flour P4.5 P2.0
seller
Firm-D- Bakery P5.0 P0.50
Nonproduction Transactions excluded
• Repeat: GDP is the value of what has been produced in
the economy over the year, not what was actually sold.
• Excludes Nonproduction Transactions – 2 types
 Purely financial transactions
 Public transfer payments, like social security or cash
welfare benefits
 Private transfer payments, like student allowances or
child maintenance payments, remittances to parents
 Stock market transactions, sale of stocks and bonds
represent a transfer of existing assets. (However, the
brokers’ fees are included for services rendered.)
 Secondhand sales since they do not represent current
output (However, any value added between purchase
and resale is included, e.g. used car dealers).
What is spent on making a product is income to
those who helped make it!
Two Approaches to GDP
Income Approach – incomes created
producing the goods and services
Wages
Rental Incomes
Interest Incomes
Profits
Expenditures Approach - sum of all the
money spent on buying output
Final-Product or Value-Added (production
approach)
The Sum of the Money Spent to Buy the Output
Illustrate with circular flow diagram
Important identity – what is spent on a
product isWhat
the income to those who helped
is spent on making a product is income to
to produce and
those sell
who helped makeitit available!
 Circular flow of income & expenditure – open
economy, with government

Leakages
Import exp. (M)
Domestic
households Net Taxes. (T)
Net Saving (S)

Consumption exp. (Cd)

Factor payments

interest, profit)

Financial
(wages, rents,

Government Abroad
system
Investment (I)
Government exp. (G)

Injections
Domestic Export exp. (X)
producers
Income (w, r, i, ) Expenditure (Cd + I+G+(X-M))
What is spent on making a product is income to
those who helped make it!
 Approaches to GDP
Expenditure Income
Approach Approach
Wages
Consumption by
Households +
+
Investment by
Rents
Businesses +
G Interest
+
Government = D= +
Purchases Profits
P +
+
Expenditures
Statistical
Adjustments
By Foreigners
What is spent on making a product is income to
those who helped make it!
Expenditure Approach
• We add up all the spending on final goods and services
that has taken place through the year
• GDP is divided into the categories of buyers in the
market; household consumers, businesses, government,
and foreign buyers
• Personal Consumption Expenditures (C )
– Durable Consumer Goods (cars, stoves, beds, etc)
– Nondurable Consumer Goods (bread, sugar, movies, etc)
– Consumer Expenditures for Services (doctors, lawyers, etc
• Gross Private Domestic Investment (Ig)
– Machinery, Equipment, and Tools by business enterprises
– All Construction (includes residential because they can be
rented out to earn income)
– Changes in Inventories (if output exceeds current sales,
inventories build up).
What is spent on making a product is income to
those who helped make it!
Expenditure Approach – more on Investment
• Gross investment includes investment in replacement &
in added capital
• Net investment (In) includes only investment in the form
of added capital
• Net Investment= gross investment- depreciation
– Depreciation is the amount of capital that is used up over
the course of a year
– Typically gross investment is greater than depreciation, so
net investment is positive and the nation’s stock of capital
rises by the amount of net investment
– When gross investment = depreciation, net investment will
be zero and there wont be any change in the stock of capital
– When gross investment is less than depreciation, net
investment will be negative and the nation’s stock of capital
shrinks. The economy will be disinvesting – using up more
capital than it is producing
What is spent on making a product is income to
those who helped make it!
Expenditure Approach
Government Purchases (G)
Expenditures on Goods and Services (labor &
other services)
Expenditures for Social Capital (schools, roads

Net Exports
Xn = Exports (X) – Imports (M)

Putting It All Together:

GDP = C + I + G + Xn

What is spent on making a product is income to

those who helped make it!
Botswana GDP 2014 (2006=100) – source: Statistics
Botswana
P
Expenditure Type million
18015.
Government Final Consumtion 6
43475.
Household Final Consumption 5
29156.
Gross Fixed Capital Formation 1
Change in Inventories 1071.9
51680.
Exports 3
What is spent on making a product is income to 52748.
Imports
those who helped make it!
9
Income Approach to GDP
• Demonstrates how the expenditures on final products are
allocated to resource suppliers
• Compensation of employees includes wages, salaries,
fringe benefits, etc
• Rents: payments for supplying property resources
• Interest: payments from private business to suppliers of
money capital
• Corporate profits: earnings of owners of corporations,
sole proprietorships, partnerships & cooperatives. It
includes
• Corporate income taxes – taxes levied on corporations’ net
earnings & it flows to the government
• Dividends – part of profits that are paid to corporate
stockholders & thus flow to households
• Undistributed corporate profits – monies saved by
corporations to be invested later in equipment
What is spent on making a product is income to
those who helped make it!
GDP Approaches Compared
Receipts Allocations
Expenditures Approach Income Approach
Personal $ 8746 Compensation $
Consumption (C) 7125
Gross Private 2105 Rents 73
Domestic Investment
(Ig)
Government 2363 Interest 498
Purchases (G)
Net Exports (Xn) -727 Proprietor’s Income 939
Corporate Profits 1352
Taxes on Production 917
and Imports
National Income $1090
4
Net Foreign Factor -34
Income
What is spent on making a product is income to
Statistical 43
those who helped make it!
Discrepancy
Definitions & some relationships between measures
• From National Income to GDP - some
definitions
– Net Foreign Factor Income
– Income earned by nationals abroad less income earned by foreigners locally
(can be positive or negative)
– Statistical Discrepancy
– Added to national income to equalize the two approaches

– Consumption of Fixed Capital

– Depreciation allowance (set aside to replace machinery & equipment used
up). We need to know how much output was available for consumption and
for additions to the stock of capital
– Net Investment = gross investment – consumption of fixed capital
– Net domestic product – measures the total annual output that
the entire economy can consume without impairing its capacity to
produce in the future
– National income – income earned by a nation’s owned resources
– Personal income – includes all income received, whether earned
or unearned What is spent on making a product is income to
those who helped make it!
Relationships between measures
• From GDP to Disposable Income
– Net Domestic Product (NDP)
– GDP – depreciation allowance (consumption of fixed capital)

– National Income (NI) : NDP - net foreign factor

income
– Income earned by nationals domestically & abroad.

– Personal Income (PI): NI + transfer payments

– (taxes on production & imports, social
contributions income taxes, corporate profit
taxes, undistributed corporate profits)
– Income received by households (whether earned or unearned)

– Disposable Income (DI) : PI – personal

(income, property & inheritance) taxes
DI = C + S (allocated to consumption and
saving)
What is spent on making a product is income to
those who helped make it!
The Income Approach
Gross Domestic Product (GDP) $ 12,487
Consumption of Fixed Capital -1,574
Net Domestic Profit (NDP) $ 10,913
Statistical Discrepancy -43
Net Foreign Factor Income 34
National Income (NI) $ 10,904
Taxes on Production and Imports -917
Social Security Contributions -871
Corporate Income Taxes -378
Undistributed Corporate Profits -460
Transfer Payments +1,970
Personal Income (PI) $ 10,248
Personal Taxes -1,210
Disposable Income (DI) $ 9,038

What is spent on making a product is income to

those who helped make it!
Botswana’s National Accounts 2012 current prices
Receipts Allocations
Expenditures Approach Income Approach
Personal Consumption P Compensation
(C) 59151.5
m
Gross Private P37988.2 Rents
Domestic m
Investment (Ig)
Government Purchases P21195.6 Interest
(G) m
Net Exports (Xn) - Proprietor’s Income
P6090.5
m
Net errors & omissions -P1734.2m Corporate Profits
Taxes on Production
and Imports
National Income
Net Foreign Factor
What is spent on making a product is income to Income
those who helped make it!
Statistical
Nominal Versus Real GDP
 Go back to slides 10-12
 Nominal GDP – market value of all final goods and
services produced in a year measured at the prices that
prevailed when the output was produced (PxQ).
 Real GDP – is market value of all final goods and
services measured at base year’s prices
Allows comparison of physical output between years
 Nominal GDP is calculated using the current prices
prevailing when output was produced but real GDP is a
figure that has been adjusted for price level changes
 One method to adjust GDP is to first determine a price
index and then adjust the nominal GDP by dividing by the
price index (in hundredths, i.e., in decimal form)
 Price Index- a measure of the price of a market basket
in a given year compared to the price of a similar basket
in reference year (base year).
What is spent on making a product is income to
those who helped make it!
Nominal Versus Real GDP
 Price index in a given year = (Price of market
basket in specific year/Price of same basket in
base year)x100
This also known as consumer price index (CPI)
E.g., from table next slide, in year 2006 price of a
basket containing pizza is P10.00
If 2006 is base yr then Price Index is 100
In 2007 Price Index is (20/10)x100 = 200
The price of pizza rose from 2006 to 2007 by 100%
[(200-100)/100]*100
Real GDP = Nominal GDP/Price Index (in
hundredths, i.e., price index/100)
Real GDP (2007) = [140/(200/100)]=70
Real GDP (2009) = [300/(300/100)]=100

What is spent on making a product is income to

those who helped make it!
 Calculating Real GDP (Base Year = Year
1)
Year Units Price of Price Unadju Adjuste Real
of pizza Index sted or d or GDP
output (P) (Year 1 Nomina real (colum
= 100) l GDP GDP n1x
(P) (P) P10)
1 5 10 100 50 50 50
2 7 20 200 140 70 70
3 8 25 250 200 80 80
4 10 30
5 11 28
6 13 32

What is spent on making a product is income to

those who helped make it!
Real GDP alternative method
Gather data on physical outputs & their prices
Determine market value of output in
successive yrs as if base yr price had
prevailed (see column 7) previous slide
To get Price index for a given year divide
nominal GDP by the real GDP for that year
Price Index (in hundredths)= Nominal GDP/
Real GDP . This is also called GDP deflator
You can then multiply it by 100 to get the
index similar to in the previous method.

What is spent on making a product is income to

those who helped make it!
Botswana’s economic performance
Botswana GDP (Millions of Pula)
GDP_Constant (2006)
Year GDP_Current Prices Prices GDP deflator
1996 16115 37515 42.9
1997 18328 40527 45.2
1998 20244 40819 49.59
1999 25361 44765 56.65
2000 29531 45655 64.68
2001 32066 45770 70.06
2002 34416 48548 70.89
2003 37182 50793 73.2
2004 42037 52168 80.58
2005 50752 54545 93.05
2006 59107 59107 100
2007 67153 63999 104.9
2008 74721 67996 109.9
2009 73462 62793 117
2010 86867 68170 127.4
2011 107243 72293 148.3
2012 What is spent111896
on making a product is income75515
to 148.2
2013 those who helped make it!
124311 82961 149.8
Botswana’s National Accounts 2012- 2006 prices
Receipts Allocations
Expenditures Approach Income Approach
Personal Consumption P Compensation
(C) 39188.8
m
Gross Private P27232.1 Rents
Domestic m
Investment (Ig)
Government Purchases P13564.7 Interest
(G) m
Net Exports (Xn) - Proprietor’s Income
P8178.6
m
Net errors & omissions P1753.3m Corporate Profits
Taxes on Production
and Imports
National Income
Net Foreign Factor
What is spent on making a product is income to Income
those who helped make it!
Statistical
 Shortcomings/problems in the
preparation of National Income Accounts

The accuracy of GDP figures is always

questioned because of two sets of problems
that arise in the estimation of GDP of a
country
Conceptual problems
Practical problems

35
Difficulties in Measurement of National
Income
Conceptual Difficulties
Inclusion of services – Some economists (Marxian) argue
that services do not count as output and should be excluded
from national income
Identifying intermediate goods – sometimes is hard
categorize goods into intermediate and final
Identifying factor incomes – it can be difficult to distinguish
between factor incomes and non-factor incomes
Services of Housewives & other similar services – NI includes
those goods & services for which payment has been made,
but there are many welfare improving activities for which
money is not paid, e.g., maintaining own garden, house ,
etc.,
Practical Difficulties
Unreported illegal income -
Non monetized sector – use of barter system, payment in
kind, etc.
What is spent on making a product is income to
those who helped make it!
Shortcomings of GDP Summarized
• Nonmarket Activities – home makers’ services,
• Leisure – improves living conditions, but is not
included
• Improved Product Quality
• The Underground Economy
• GDP and the Environment – harmful effects of
pollution not subtracted from GDP
• Composition and Distribution of the Output –
makes no difference between guns or tractors
• Noneconomic Sources of Well-Being – crime
prevention not covered in GDP

What is spent on making a product is income to

those who helped make it!
Shortcomings of GDP: Echo's from Davos 2016
 GDP a poor measure of progress, say Davos economists
 Three leading economists and academics at Davos agree: GDP is a poor
way of assessing the health of our economies and we urgently need to
find a new measure.

 Speaking in different sessions, IMF head Christine Lagarde, Nobel Prize-

winning economist Joseph Stiglitz, and MIT professor Erik Brynjolfsson
stressed that as the world changes, so too should the way we measure
progress
 (http://www.weforum.org/agenda/2016/01/gdp).

 But what economists really need to look at, says Lagarde, is the way the
economy is measured. Currently, it's inadequate. “We have to go back to GDP,
the calculation of productivity, the value of things – in order to assess, and
probably change, the way we look at the economy,” she says.
 In this, she echoes the stance of economist Joseph Stiglitz, who said in a
previous session:
 “GDP in the US has gone up every year except 2009, but most Americans are
worse off than they were a third of a century ago. The benefits have gone to
the very top. At the bottom, real wages adjusted for today are lower than they
were 60 years ago. So this is an economic system that is not working for most
people.”
What is spent on making a product is income to
those who helped make it!
Botswana’s economic performance
GDP growth (Current
Year Prices) GDP growth (Constant Prices)
1996 22.9 5.8
1997 13.7 8.0
1998 10.5 0.7
1999 25.3 9.7
2000 16.4 2.0
2001 8.6 0.3
2002 7.3 6.1
2003 8.0 4.6
2004 13.1 2.7
2005 20.7 4.6
2006 16.5 8.0
2007 13.6 8.7
2008 13.0 3.9
2009 -4.7 -7.8
2010 29.1 8.6
2011 12.0 6.0
2012 5.7 4.5
2013 11.1 9.9
2014 14.6 3.2
Average
What is spent on making a product is income to
those who helped make it!
Botswana’s economic performance
35

30

25

20

15

10

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-5

-10

GDP growth (Current Prices) GDP growth (Constant Prices)

What is spent on making a product is income to

those who helped make it!
Botswana’s economic
perfomance

GDP Growth Rates

30.0

25.0

20.0

15.0

10.0

5.0

0.0
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 21 23
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20
-5.0

-10.0

-15.0

-20.0

What is spent on making a product is income to

those who helped make it!