Chap 10, Mankiw – Measurement of

national income

• Introduction and definition of the GDP

• Gross domestic product – meaning of the term
• Circular flow diagram and the methods of
calculating GDP
• Other measures of national income
• Quality of life and GDP

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I. Introduction and definition of the GDP
Several definition of national income are possible. We shall
use the GDP defintion.
GDP definition = market value of all final goods and services
produced within a country in a given period of time.
2 ways of measuring GDP:
the expenditure method
the income method
The equivalence of the 2 methods can be shown by the
circular flow diagram. The diagram implies that for the
economy as a whole, income must equal expenditure.
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II. GDP – what is included and what is not
GDP = market value of all final goods and services produced within a
country in a given period of time.
market value: market prices are used to evaluate goods because they
reflect the value to the buyers and the cost to the sellers at the same
time;
only marketed goods are included although we also benefit from non-
marketed goods: ex:
final goods and services not intermediate goods are included; ex:
produced: only goods produced in the current year are included not
goods which are resold: ex:
within a country: “domestic” production not “national” production
in a given period of time: an accounting period
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 III.The Circular-Flow Diagram –
methods of estimating GDP
Revenue Spending
Market for
Goods
Goods & Goods &
Services and Services
Services
sold bought

Firms Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, of Production Income
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rent, and
expenditure method: add different categories of
expenditures by households, firms and government
together
Y = C + I + G + (X – M)
Y = GDP, C = consumption expenditure, I = investment
expenditure, G = Government expenditure, X = exports, M
= imports
income method
add “value-added” by all firms together; value-added =
value of the output produced by a firm – value of the
intermediate goods used to produce it.
sum of value added by all firms = wages + rents + interests
+ profits. 5
 IV. Other ways of defining Income

• Gross National Product (GNP)

• Net National Product (NNP)
• National Income
• Personal Income
• Disposable Personal Income

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• Gross national product (GNP) is the total income earned by
a nation’s permanent residents (called nationals).
• It differs from GDP by including income that our citizens
earn abroad and excluding income that foreigners earn
here.

• Net National Product (NNP) is the total income of the

nation’s residents (GNP) minus losses from depreciation.
• Depreciation is the wear and tear on the economy’s stock
of equipment and structures.

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•National Income is the total income earned by a
nation’s residents in the production of goods and
services.
•It differs from NNP by excluding indirect business
taxes (such as sales taxes) and including business
subsidies.
•Personal income is the income that households and
non-corporate businesses receive.
•Unlike national income, it excludes retained earnings,
which is income that corporations have earned but have
not paid out to their owners.
•In addition, it includes household’s interest income and
government transfers.
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• Disposable personal income is the income that
household and noncorporate businesses have left after
satisfying all their obligations to the government.
• It equals personal income minus personal taxes and
certain nontax payments.

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Real GDP: goods are evaluated at constant (base year)
prices
Nominal GDP: goods are evaluated at current year prices
GDP deflator = (nominal GDP/real GDP) × 100,
measures price movement over time.
long run trend in GDP vs. short run fluctuations
recessions or slumps
expansions or booms

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 Real and Nominal GDP

Price of Quantity of Price of Quantity of

Year Hot dogs Hot dogs Hamburgers Hamburgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150

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 Real and Nominal GDP

Calculating Nominal GDP:

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200
2002 ($2 per hot dog x 150 hot dogs) + ($3 per hamburger x 100 hamburgers) = $600
2003 ($3 per hot dog x 200 hot dogs) + ($4 per hamburger x 150 hamburgers) = $1200

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 Real and Nominal GDP

Calculating Real GDP (base year 2001):

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200
2002 ($1 per hot dog x 150 hot dogs) + ($2 per hamburger x 100 hamburgers) = $350
2003 ($1 per hot dog x 200 hot dogs) + ($2 per hamburger x 150 hamburgers) = $500

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 Real and Nominal GDP

Calculating the GDP Deflator:

2001 ($200/$200) x 100 = 100
2002 ($600/$350) x 100 = 171
2003 ($1200/$500) x 100 = 240

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 Real GDP in the United States

Billions of
1992 Dollars
8,000
(Periods of falling real
GDP)
7,000

6,000

5,000

4,000

3,000
1970 1975 1980 1985 1990 1995 2000
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V. Quality of life vs. GDP
GDP has a positive correlation with but is not the same
thing as economic welfare – Why?

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 GDP and Its Components (1998)

Government
Investment Purchases Net Exports
16% 18% -2 %

Consumption
68 %

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