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Gross Domestic ProductGross Domestic Product

MD Siyam HossainMD Siyam Hossain

Bangladesh Institute of Business & TechnologyBangladesh Institute of Business & Technology

Narayangonj,DhakaNarayangonj,Dhaka

Dhaka,BangladeshDhaka,Bangladesh

www.facebook.com/mdsiyamhossain

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1. CONCEPTS OF NATIONAL INCOME  Explaining national income following five concepts are needed:        Gross National Product      Gross Domestic Product       Net National Product       National Income       Personal Income, and        Disposable Income

 1.1 Gross National Product (GNP) Gross National Product measures the total output or aggregate supply of  goods  and  services.  Gross  National  Product  is  the  total  market value of all  final goods and services produced in a year at home and abroad. 

 

GNP is the market value of final goods and services produced in a year at home and abroad

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 Regarding GNP following issues must be noted:

GNP is a monetary measure For calculating gross national product accurately all goods and services 

produced  in  any  given  year  must  be  counted  once,  but  not  more  than once.  Most  of  the  goods  go  through  a  series  of  production  before reaching  it  market.  As  a  result,  parts  components  of  many  goods  are bought and sold many times. 

Hence, to avoiding double counting, GNP includes only the market value of final goods and ignores intermediate goods 

The goods those are purchased for final use are final goods  The goods those are purchased for  further processing or  for resale are 

not final goods The  value  of  final  goods  includes  the  value  of  all  intermediate  goods 

used in their production GNP measures the market value of the annual output

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1.2 Gross Domestic Product (GDP)  Gross  Domestic  Product  is  the  market  value  of  all  final  goods  and 

services produced domestically in a country in a year  In  GDP  only  domestically  produced  products  and  services  are 

accounted  Gross Domestic Product = Products + Services 

1.3 Net National Product (NNP) Net National Product = Gross National Production - Depreciation  The value of capital depreciates due to use  The charges for depreciation are deducted from GNP to get NNP NNP is called national income at market prices 

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1.4 National Income (NI)  National Income = Net National Product - Indirect Taxes + Subsidies

For calculation national income following issues are considered: National  income  at  market  prices  and  national  income  at  factor  cost 

differ.  National  income  at  factor  cost  shows  how  much  it  costs  society  to 

produce it.  We use the term National Income for national income at factor cost.  The  difference  between  national  income  at  market  prices  and  net 

national  product  at  factor  cost  arises  because  of  indirect  taxes  and subsidies.

Example: Let a meter cloth sold for TK 50 includes TK 5 sales tax.  In this case, the market price of the cloth is TK 50 per meter. However, the cost of factors engaged in its production and distribution 

is only TK 45 (50 – 5 = 45). The value of cloth at factor cost in this case TK 45.  So,  value  at  factor  cost  is  equal  to  its  value  at  market  price  less  the 

indirect taxes on it. 

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Example: Let a meter cloth sold for TK 50 includes TK 5 sales tax. In this case, the market price of the cloth is TK 50 per meter. However, the cost of factors engaged in its production and distribution is

only TK 45. The value of cloth at factor cost in this case TK 45. So, value at factor cost is equal to its value at market price less the

indirect taxes on it.

Example: Let a ton of rice sold for TK 20 000 which includes TK 1000 subsidies. (The factors of production fertilizer, pesticides, and irrigation are

subsidized) If there were not subsidized, the sale value would become TK 21 000 So, value at factor cost is equal to its value at market price plus the

subsidies for it. National income = Wages + Salaries of employees + rent of land +

Interest on capital + profits of entrepreneurs + undistributed profits of joint stock companies + Income of self employed‑ ‑

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1.5 Personal Income (PI) PI is the income actually the individuals have in a year. National income differs from personal income Because a part of income is deduced (social security contributions) Conversely individuals receive some income that is not earned (social

security transfer) PI = National Income – Corporate Income Taxes – Retained Earning

of the Corporate Social Security Contributions + Social Security ‑Transfer

1.6 Disposable Income (DI) DI is the income that could be either be consumed or saved. Apart of personal income is paid to government in the form of personal

taxes like income tax, personal property taxes, etc., what remains is disposable income. So:

DI is the income that could be either be consumed or saved. Disposable Income = Personal Income Personal Taxes‑ ‑ Disposable Income = Consumption + Saving.

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2. MEASUREMENT OF NATIONAL INCOME

There are following three possible methods for calculating national income: Calculating Aggregate Outputs (Aggregate Output Method) Calculating Aggregate Income (Aggregate Income Method), and Calculating Aggregate Expenditures (Aggregate Expenditures

Method)

2.1 Aggregate Output Method This method calculates national income from the output side Economy is divided into different sectors such as agriculture, mining,

manufacturing, small enterprises, transport, communication, commerce, and other services

Gross domestic product is found out by adding up net values of all production The purchases of one industry from other industries are deducted from the

gross value of production of that industry

The aggregate values of all industries plus the net income from abroad give the Gross National Product

This method enables to trace the origin of the national income of the economy. So, this method is also called national income by industrial origin This method reveals the relative importance of the different industries showing

their contribution to the national income

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2.2 Aggregate Income Method This method measures national income by summing up of the

incomes of all Individuals in a country Individuals earn income by contributing their own services and the

services of their property such as land and capital to the national production.

So, national income is defined as: National Income = Wages & salaries of employees + rent of land +

interest on capital + profits of entrepreneurs + retained earning of the corporate + income of self employed‑

This method shows the distribution of national income among different income groups such as entrepreneurs, workers, professionals, etc.

Example Calculate from following GNP, GDP, NNP, NI, and Disposable income.

Wages and salaries 9,564. Net interest earnings 844; profits of the companies 760; undistributed profits 240; corporate income tax 292; Indirect taxes 1,872; Social security transfer 92; Social security Contributions $100, Subsidies 92; Depreciation 1,620.

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Solution

National Income: Wages and salaries 9,564 + Net interest earnings 844+ Profits of the companies 760 + Undistributed profits 240 =

Personal Income = National Income - Corporate income tax 292 + Social security transfer 92 - Undistributed profits 240 - Social security Contributions $100 =

Disposable Income = Personal Income – Personal Tax =

NNP = National Income - Indirect taxes 1,872 + Subsidies 92 =

GNP = NNP - Depreciation 1,620 =

GDP = GNP – Income Abroad =

(Let income from abroad is 10% of GNP)

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2.3 Aggregate Expenditure Method

Aggregate Expenditure Method calculates national income by adding up all the expenditure made on goods and services during a year.

Income can be spent either on consumer goods, investment goods, government expenditure, or net export.

Net export equals the difference between export and import Hence, the gross national product is found by adding up:

o Consumption Expenditure: This is what private individuals spend on consumer goods and services?

o Investment Expenditure: This is what private businesses spend on replacement, renewals, and new investment?

o Net Export Expenditure: This is what foreign countries spend on goods and services of the national economy less what national economy spends on the output of the foreign countries?

o Government Expenditure: This is what the government spends on the purchase of goods and services?

Gross National Product = Consumption Expenditure (C) + Gross Domestic Private Investment (I) + Government Purchases (G) + Net Export (NX)

[GNP = C + I + G + NX]

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The best way to calculate national income is to use all these three methods and cross checks the result.‑

Example: By the Expenditure Method, we can get the same result. Total GNP

18,564 consists of Personal Consumption Expenditure 13,488, Gross Private Domestic Investment 1,804, Government Purchases of Goods and Services 3,096, Net Foreign Investment 176.

3. Difficulties of Measurement There are some conceptual problems for measuring national income.

They are:

Non magnetized economic activities such as the services of‑ housewives. If any body employs a home servant for household work, the payment

appear in national income. Treatment of the payment made by the government sector. Treatment of income arising out of activities of the foreign firms in a

country.

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7. INFLATION, PRICE INDEXES AND GDP

Let a country produces and consumes only wheat

In this case, it is easy to measure GDP

Let it produces 100-ton wheat

Let the price of 1-ton wheat is $1

The quantity of GDP would be 100-ton wheat

The value of GDP would be $100

Let now suppose that next year the prices double, i.e. price of 1-ton wheat is $2

So, next year the value of GDP would be $2000

But clearly nothing real has changed.

While nominal GDP has doubled

Real GDP is unchanged which is what we care about

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Calculation of Real and Nominal GDP

Calculation of Real GDP Real GDP measured at the prices of base year say 2000

That means, in calculating real GDP, today's physical output is multiplied by the prices base year 2000

It means:

Real GDP is what today's output would have been worth had it been sold at the prices of base year, say 2000

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Calculation of Nominal GDP

Nominal GDP measures the value of output in a given period in the prices of that period

Or, Nominal GDP is the value of output in current dollars

Thus 1990 nominal GDP measures the value of goods produced in 1990 at prices prevailing in 1990

And 2005 nominal GDP measures the value of goods produced in 2005 at the market prices that prevailed in 2005

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Nominal GDP changes from year to year for two reasons:First, the physical output of goods changesSecond, market prices changes

Changes in nominal GDP that results from price changes do not tell anything about the performance of the economy

That is why we use real rather than nominal GDP for comparing GDP in different years

If all prices change in fixed proportion, then GDP changes in proportion of price change

However, normally some prices rise more than others Such differences are generally inconsequential for

understanding macro theory

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8. INFLATION, PRICES AND GDP Inflation is the rate of changes in price Let Pt-1 is the price level of the last year

Pt is today's price level

Then the inflation rate over the past year can be written as:

Where π stands for the inflation rateHence, today's price level equals:

Pt = Pt-1 + π × Pt-1

Alternative way to calculate inflation:

Where:ΣP1 = Sum of the prices from calculating year

ΣP0 = Sum of the prices from base year

1

1

−

−−=t

tt

PPPπ

0

1

PP

∑∑=π

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ProblemPrice essential goods in three groups A, B and C from 2005 and 2006 are given below. Calculate nominal and real GDP. Discuss the result.

Goods Q-05 Q-06 P-05 P-06

A 6 11 $.50 $.40

B 7 4 $.30 $1.00

C 10 12 $.70 $.90

 

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Calculation of Nominal GDPQ-05× P-05 Q-06× P-05 Q-05× P-06 Q-06× P-06

$3.00 $5.50 $2.40 $.4.40

$2.10 $1.20 $7.00 $4.00

$70 $8.40 $9.00 $10.80

Σ= $12.10 Σ= $15.10 Σ= $18.40 Σ= $19.20

Nominal GDP in year 2005: $12.10

Nominal GDP in year 2006: $19.20

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Calculation of Real GDP in 2006 considering price weight: Considering 05 as base year Real GDP in 06 = Σ[Q-06× P-05] =

$15.10

Growth of Real GDP from 05-06 considering price weight:

Growth from 05-06 = ×100 = = 124.79%

Growth of GDP giving weight to quantity:

= 104.34

Arithmetic average of the two growths is: (124.8+104.34)/2 = 114.57

Geometric average of two growths gives real GDP growth:

GDP Growth =

10.12

10.15

( ) 11.11434.10480.124 =×

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