2. Economy’s Income and
Expenditure
• When judging how a person is doing
economically, we might first look at his/her
income.
• Similarly, 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.
• This is the task of “GDP”.
3. Economy’s Income and
Expenditure
Cont…
• GDP measures two things at once:
– The total income of everyone in the economy
– The total expenditure on the economy’s output of
goods and services.
• The reason that GDP can perform this trick of
measuring both total income and total
expenditure is that these two things are
really the same.
• “Therefore, for an economy as a whole ,
income must equal expenditure”.
4. Economy’s Income and
Expenditure
Cont…
• Why is this true???
– An economy’s income is the same as its
expenditure because every transaction has two
parties: A ‘buyer’ and a ‘seller’.
– E.g. A pays B Rs. 500 to clean her lawn.
– In this case, B is the seller of a service and A is the
buyer.
– B earns Rs. 500 and A spends Rs. 500.
– Thus, this transaction contributes equally to the
economy’s income and to it’s expenditure.
• Hence, GDP, whether measured as total
income or total expenditure, rises by Rs. 500.
5. Economy’s Income and Expenditure
Cont…
• The equality of income and expenditure can
be illustrated with the circular-flow diagram:
7. Measurement of GDP
• In simple terms, Gross Domestic Product
(GDP) is a measure of the income and
expenditures of an economy.
“It is the total market value of all final goods
and services produced within a country in a
given period of time”.
8. Measurement of GDP
Cont…
• Break-up of Definition:
– “GDP is the Market Value . . .”
Output is valued at market prices.
– “. . . Of All Final . . .”
It records only the value of final goods, not
intermediate goods.
– “. . . Goods and Services . . .”
It includes both tangible goods (food, clothing,
cars) and intangible services (haircuts,
housecleaning, doctor visits).
9. Measurement of GDP
Cont…
– “. . . Produced . . .”
It includes goods and services currently
produced, not transactions involving goods
produced in the past.
• E.g. When Toyota produces and sells a new car, the
value of the car is included in GDP.
• But when a person sells a used car to another
person, the value of the used car is NOT included
in the GDP.
– “ . . . Within a Country . . .”
It measures the value of production within the
10. Measurement of GDP
Cont…
– “. . . In a Given Period of Time.”
It measures the value of production that takes
place within a specific interval of time, usually a
year.
11. Components of GDP
• GDP includes all items produced in the
economy and sold legally in markets.
• GDP excludes items that never enter the
marketplace.
• It excludes items produced and sold illicitly,
such as illegal drugs.
12. Components of GDP
Cont…
• GDP is divided into four components:
• Consumption (C)
• Investment (I)
• Government Purchases (G)
• Net Exports (NX)
• GDP (Y) is the sum of these and is
calculated as per the following equation:
Y = C + I + G + NX
13. Components of GDP
Cont…
• Consumption (C):
– The spending by households on goods
and services.
• Investment (I):
– The purchase of goods and services to be
used in future.
– The spending on capital equipment,
inventories, and structures etc.
14. Components of GDP
Cont…
• Government Purchases (G):
– The spending on goods and services by
local, state, and federal governments.
• Net Exports (NX):
– Is the difference between the monetary
value of exports and imports.
– In simple terms, it refers to exports minus
imports.
15. GDP and Economic Well-Being
• GDP is the measure of the economic well-
being of a society.
• GDP tells us the income and expenditure of
the people in the economy.
• Higher GDP indicates a higher standard of
living.
• However, GDP is not a perfect measure of the
happiness or quality of life.
16. GDP and Economic Well-Being
Cont…
• Following factors contribute to well-being
but are not included in GDP.
– The value of leisure.
– The value of a clean environment.
– The value of certain activities such as the
value of the time parents spend with their
children and the value of volunteer work
etc.