2007 Thomson South-Western

Measuring a Nations Income

Microeconomics is the study of how individual
households and firms make decisions and how
they interact with one another in markets.
Eg price of proton cars, demand for pizza and supply of rice

Macroeconomics is the study of the economy as a

whole. Its goal is to explain the economic
changes that affect many households, firms, and
markets at once.
Eg economic growth (real GDP growth), inflation and unemployment

2007 Thomson South-Western

Measuring a Nations Income

Macroeconomics answers questions like the
following:
Why is average income high in some countries and
low in others?
Why do prices rise rapidly in some time periods
while they are more stable in others?
Why do production and employment expand in
some years and contract in others?

2007 Thomson South-Western

THE ECONOMYS INCOME AND

EXPENDITURE
When judging whether the economy is doing
well or poorly, it is natural to look at the total
income that everyone in the economy is
earning.

2007 Thomson South-Western

THE ECONOMYS INCOME AND

EXPENDITURE
For an economy as a whole, income must
equal expenditure because:
Every transaction has a buyer and a seller.
Every ringgit of spending by some buyer is a
ringgit of income for some seller.

2007 Thomson South-Western

Figure 1 The Circular-Flow Diagram

MARKETS
FOR
GOODS AND SERVICES
Firms sell
Goods
Households buy
and services
sold
Revenue

Wages, rent,
and profit

Goods and
services
bought

HOUSEHOLDS
Buy and consume
goods and services
Own and sell factors
of production

FIRMS
Produce and sell
goods and services
Hire and use factors
of production

Factors of
production

Spending

MARKETS
FOR
FACTORS OF PRODUCTION
Households sell
Firms buy

Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars

2007 Thomson South-Western

THE MEASUREMENT OF GROSS

DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure of
the income and expenditures of an economy.
GDP is the total market value of all final goods
and services produced within a country in a
given period of time.

2007 Thomson South-Western

THE MEASUREMENT OF GROSS

DOMESTIC PRODUCT
The equality of income and expenditure can be
illustrated with the circular-flow diagram.

2007 Thomson South-Western

THE MEASUREMENT OF GROSS

DOMESTIC PRODUCT
GDP is the Market Value . . .
Output is valued at market prices.

. . . Of All. . .
Includes all items produced in the economy and legally sold in
markets

. . . Final . . .
It records only the value of final goods, not intermediate goods
(the value is counted only once).

. . . Goods and Services . . .

It includes both tangible goods (food, clothing, cars) and
intangible services (haircuts, housecleaning, doctor visits).
2007 Thomson South-Western

THE MEASUREMENT OF GROSS

DOMESTIC PRODUCT
. . . Produced . . .
It includes goods and services currently produced, not
transactions involving goods produced in the past.

. . . Within a Country . . .
It measures the value of production within the geographic
confines of a country.

. . . 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).
2007 Thomson South-Western

THE COMPONENTS OF GDP

GDP includes all items produced in the
economy and sold legally in markets.
What Is Not Counted in GDP?
GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
It excludes items produced and sold illicitly, such
as illegal drugs.
2007 Thomson South-Western

THE COMPONENTS OF GDP :

Expenditure approach
GDP (Y) is the sum of the following:

Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)

Y = C + I + G + NX
2007 Thomson South-Western

THE COMPONENTS OF GDP :

Expenditure approach
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.

2007 Thomson South-Western

THE COMPONENTS OF GDP :

Expenditure approach
Government Purchases (G):
The spending on goods and services by state and
federal governments.
Does not include transfer payments because they
are not made in exchange for currently produced
goods or services.

Net Exports (NX):

Exports minus imports.
2007 Thomson South-Western

Malaysia GDP and Its Components, 2007

This table shows total GDP for the Malaysian economy in 2007 and the breakdown of GDP among its four
component. When reading this table, recall the identity Y = C + I + G + NX
(Note : The population of Malaysia is approximately 27.17 million people in 2007).

Gross domestic product, Y

Consumption, C
Investment, I
Government purchases, G
Net exports, NX

Total
GDP per capita Percent
(in millions of RM)
(in RM)
of Total
RM
641,863
23,624
100 %
292,724
10,774
46
140,796
5,182
22
78,297
2,882
12
130,046
4,786
20

Source : Department of Statistics, Malaysia.

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Malaysias GDP and Its Components (2007)

Consumption, C

Investment, I

Government purchases, G

Net exports, NX

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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.

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REAL VERSUS NOMINAL GDP

An accurate view of the economy requires
adjusting nominal to real GDP by using the
GDP deflator.

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Table 2 Real and Nominal GDP

Year

2006
2007
2008

Price of
Fish balls
20 sen
40 sen
60 sen

Prices and Quantities

Quantity of
Price of
Fish balls
Chicken sausages
100
150
200

50 sen
75 sen
RM1

Quantity of
Chicken sausages
40
80
120

2007 Thomson South-Western

Table 2 Real and Nominal GDP

Calculating Nominal GDP

2006 (20 sen per fish ball x 100 fish balls) + 50 sen per sausage x 40 sausages) = RM40
2007 (40 sen per fish ball x 150 fish balls) + 75 sen per sausage x 80 sausages) = RM120
2008 (60 sen per fish ball x 200 fish balls) + RM1 per sausage x 120 sausages) = RM240

2007 Thomson South-Western

Table 2 Real and Nominal GDP

Calculating Real GDP (base year 2006)

2006 (20 sen per fish ball x 100 fish balls) + 50 sen per sausage x 40 sausages) = RM40
2007 (20 sen per fish ball x 150 fish balls) + 50 sen per sausage x 80 sausages) = RM70
2008 (20 sen per fish ball x 200 fish balls) + 50 sen per sausage x 120 sausages) = RM100

2007 Thomson South-Western

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 what portion of the rise in nominal
GDP that is attributable to a rise in prices rather
than a rise in the quantities produced.

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The GDP Deflator

The GDP deflator is calculated as follows:

N o m in a l G D P
G D P d e fla to r =
100
R eal G D P

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The GDP Deflator

Nominal GDP is converted to real GDP as

follows:

R e a l G D P20X X

N o m in a l G D P 20X X

100
G D P d e f la to r2 0 X X

2007 Thomson South-Western

Table 2 Real and Nominal GDP

2006
2007
2008

Calculating the GDP deflator

(RM40 / RM40) x 100 = 100
(RM120/RM70) x 100 = 171
(RM240/RM100) x 100 = 240

2007 Thomson South-Western

Real GDPof Malaysia

Millionsof Ringgit
(2000=100)
5000
4000
3000
2000
1000
0
1980

1985

1990

1995

2000

2005

2010
Year

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IS GDP A GOOD 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 income and
expenditure of the average person 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.
2007 Thomson South-Western

GDP AND 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.
2007 Thomson South-Western

Country

GDP per capita

Life Expectancy

Adult Literay

Internet users

(PPP US$)

(years)

(% of ages 15 and above)

(per 1,000 people)

2005

2005

1995 - 2005

2005

United States

41,890

77.9

99.0%

630

United Kingdom

33,238

79.0

99.0

473

Japan

31,267

82.3

99.0

668

Singapore

29,663

79.4

92.5

571

Germany

29,461

79.1

99.0

455

Malaysia

10,887

73.7

88.7

435

China

6,757

72.5

90.9

85

Indonesia

3,843

69.7

90.4

73

India

3,452

63.7

61.0

55

Vietnam

3,071

73.7

90.3

129

Nigeria

1,128

46.5

69.1

38

806

41.8

34.8

Sierra Leone

Source : Human Development Report 2007/2008, United Nations.

2007 Thomson South-Western

Summary
Because every transaction has a buyer and a
seller, the total expenditure in the economy
must equal the total income in the economy.
Gross domestic product (GDP) measures an
economys total expenditure on newly
produced goods and services and the total
income earned from the production of these
goods and services.

2007 Thomson South-Western

Summary
GDP is the market value of all final goods and
services produced within a country in a given
period of time.
GDP is divided among four components of
expenditure: consumption, investment,
government purchases, and net exports.

2007 Thomson South-Western

Summary
Nominal GDP uses current prices to value the
economys production. Real GDP uses
constant base-year prices to value the
economys production of goods and services.
The GDP deflatorcalculated from the ratio
of nominal to real GDPmeasures the level of
prices in the economy.

2007 Thomson South-Western

Summary
GDP is a good measure of economic wellbeing because people prefer higher to lower
incomes.
It is not a perfect measure of well-being
because some things, such as leisure time and
a clean environment, are not measured by
GDP.

2007 Thomson South-Western