SESSION 2

Reading
1. This set of slides
2. From the text material :
Chapter 2 page 21-23
Chapter 3 page 45-48

Measuring
the economys performance

GDP
= GROSS DOMESTIC PRODUCT
= value of all final goods and services (at current market
prices) produced within the economy at the current year
GNP
= GROSS NATIONAL PRODUCT
= value of all final goods and services (at current market
prices) produced by domestically owned factors at home or
abroad at the current year
= GDP + income earned by domestically owned factors abroad
income earned at home by foreign owned factors
= GDP + net factor income from abroad
See
https://rbi.org.in/Scripts/PublicationsView.aspx?id=16445
https://
rbi.org.in/Scripts/AnnualPublications.aspx?head=Handbook%20of
%20Statistics%20on%20Indian%20Economy

Only final products are measured

Intermediate inputs are excluded to avoid double counting
Whether a good is final or intermediate depends on the use.
Intermediate products produced this year but not consumed
this year are included.
Exported intermediate goods are included.
Transaction of old items are excluded.

Exercise

Suppose GDP is Rs.6000.

Domestic residents receive factor payments from
abroad of Rs. 200.
Foreigners receive Rs. 400 as factor payments from this
country.
What is the value of GNP?

GNP = 6000 + 200 400 = 5800

Exercise

The imputed rental income of owner occupied housing is

included in GDP but the market value of the house is not.
Why?

If you give Rs. 5 to a beggar should that be included in the

GDP?
What if he sings a song?

Exercise

What happens to the GDP if the govt. hires an unemployed

worker, who had been getting Rs.1000 per month as
unemployment benefit, as a govt. employee on Rs.1000 per
month?
What if this employee does not work at all?

What difference would it make to the national income

accounts if, instead of purchasing a car for the use of its
general manager, a company gives her extra salary to by
the car?

Measuring the Aggregate Income of the Economy

The total income of the economy can be measured in different

nodes in the circular flow.
1.

As total expenditure made on firms produce, which is

then transferred to households as income
- The Expenditure Approach

2.

As total earning of the household sector

- The Income Approach

3.

As The Total Value of Production

- The Production Approach

Circular flow of
Income
Wages w, rent r,
profit , interest
payments i etc.
Labour, land,
Capital etc.
Household
s

Firms

Goods and
services
Consumption expenditure
on goods and services C

Aggregate income as measured by The Income

Approach
Every earning citizen belongs to the
household sector. So total Earning of
the economy can be measured as
Financial
Institutions total earning of the household
sector. House hold earns in the form
of wages, profits, rents and interest
earnings.
Government

So Aggregate Income
= Wages + Profits + Interest
Payments + Rents

Households
1. The
Households
sector earns
income

=W+P+I+R
Firms
Rest of
the world

Aggregate income as measured by The

Expenditure Approach
W+I+R+P = income =
C+S +T
Financial
Income from all
4. Savings Institutions
possible Sources =
S
Income used up all
possible ways
3. Taxes
The is an identity. The
T
Government
two sides are equal by
definition of income.
Firms

Households
2.
Consumptio
n 1. The
Expenditure
Households
C sector earns
income

Rest of
the world

Aggregate income as measured by The

Expenditure Approach
The households earn
their income from the
Financial
firm sector. The
4. Savings Institutions
6.
revenue earned by
S
Investm firms are passed to the
ent
households as income.
Funds I
3. Taxes
C, I, G and X are
T
sources of the firms
Government5.
revenue.
Govt.
Exp.
Rest of
G
Firms
Households
the world
2.
Consumptio
n 1. The
Expenditure
Households
C sector earns
income

7.
Export
Earnin

Aggregate income as measured by The Expenditure

Approach (cont.)
The households also spends on
imports from the rest of the
Financial
world. Imports are made through
Institutions
the firm sector. So out of the total
C that the firm sector receives
from households, the import bill
M is passed to the rest of the
world.
Government
In effect the firm receives a net
expenditure of C M from the
households.
Rest of
2.
Firms
Households
the world
Consumptio
n
Expenditure
C
1. The
Households
sector earns
income

8.
Import
Bill M

Aggregate income as measured by The Expenditure

Approach (cont.)
Total expenditure
made on firms
Financial
produce
4.
Institutions
6.
=CM+I+G+
Savings S
Investm
X
ent
Funds I
=C+I+G+X
M
Government5.
3.
Govt.
Taxes
Exp.
T
Rest of
2.
G
8.
Firms
Households
the world
Consumpti
Import
on
Bill M
Expenditur
eC
1. The
7.
Households
Export
sector earns
Earnin
income

Aggregate income as measured by The Production

Approach
Value of its final products.
Say there are n final products
good n.
Quantity sold of good 1 Q1 at a
Quantity sold of good 2 Q2 at a
Quantity sold of good 3 Q3 at a

good 1, good 2.
price P1,
price P2,
price P3 .. And so on.

So, Total Value of final goods = P1.Q1 + P2. Q2 + +

Pn. Qn.
The value added by all production unit (including those
producing intermediate goods and services) can also
be added up to arrive at the value of final
production.

Value Added by a production unit (VA)

= value of output value of intermediate inputs (both domestic
and imported)

Value of output (VO)

= Sales (domestic and exports) + Change in stocks (that is
closing stock opening stock)
Value of final goods
= value added in all final and
intermediate goods
P1.Q1 + P2. Q2 + + Pn. Qn.
= VA1 + VA2+. VAm
n = number of final goods
(final or otherwise)

m = number of goods

In absence of any leakage all three measures of output should be identical

NO leakage : GDP of 1200 continues

Financial
Institutions
4. S =
400

6. I =
400

Government
3. T =
5. G =
200
200
Households

2. C =
600

1. Y = 1200

Firms

Rest of
8. M = the world
300

7. X=
300

Forms of leakage

The trade leakage

If export revenue and import bill are unequal.

The budget leakage

If governments receipt of taxes and spending are unequal.
The saving investment leakage
If savings hat flow into the financial institutions and the
investment fund that flows out from financial institutions
are unequal.

Trade leakage : GDP of 1200 becomes GDP of 1100

Financial
Institutions
4. S =
400

Y = C+S+T =
1200

6. I =
400

Government
3. T =
5. G =
200
200
Households

2. C =
600

1. Y = 1200

Firms

C+I+G+X-M =
1100

Rest of
8. M = the world
400

7. X=
300

Saving Investment leakage : GDP of 1200 becomes GDP of

1000
Financial
Institutions
4. S =
400

Y = C+S+T =
1200

6. I =
200

Government
3. T =
5. G =
200
200
Households

2. C =
600

1. Y = 1200

Firms

C+I+G+X-M =
1000

Rest of
8. M = the world
300

7. X=
300

Budget leakage : GDP of 1200 becomes GDP of 1400

Financial
Institutions
4. S =
400

Y = C+S+T =
1200

6. I =
400

Government
3. T =
5. G =
200
400
Firms
Households
2. C =
600

1. Y = 1200

C+I+G+X-M =
1400

Rest of
8. M = the world
300

7. X=
300