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Measuring a Nation's Income - Coggle Diagram
Measuring a Nation's Income
Microeconomics versus macroeconomics
Microeconomics
Microeconomics is the study of how individual households and firms make decisions (choices) and how they interact with one another in markets.
Macroeconomics
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.
Macroeconomics deals with the performance, structure, and behaviour of the entire economy.
National Income
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.
THE ECONOMY’S INCOME AND EXPENDITURE
For an economy as a whole, income must equal expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar of income for some seller.
The equality of income and expenditure can be illustrated with the circular-flow diagram.
THE MEASUREMENT OF GROSS DOMESTIC PRODUCT
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.
“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 (the value is counted only once)
“. . . Goods and Services . . . “
It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).
. . . 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).
THE COMPONENTS OF GDP
GDP includes all items produced in the economy and sold legally in markets.
This includes output of foreign owned businesses that are located in a country following foreign direct investment. For example, the output produced at the Intel plant in Penang and by foreign owned banks (standard chartered, HKSB) all contribute to the Malaysia’s GDP.
Expenditure approach
GDP (Y) (aggregate demand) is the sum of the following:
Consumption (C): Household spending on goods and services
Investment (I) : capital investment spending
Government Purchases (G)
Net Exports (NX) : Export and import of goods and services
Y = C + I + G + NX
Another term for consumption spending means demand. So total spending in Malaysia in a year is known as aggregate demand.
Consumption (C):
The spending by households on goods and services, with the exception of purchases of new housing.
Durable goods - The consumption of durable goods is considered similar to a consumer investment. Durable goods are purchased with the intention of keeping them for a sustained duration of time. Examples of durable consumer purchases include washing machines, refrigerators, automobiles, and toaster ovens.
Nondurable goods - In contrast to durable goods, nondurable items have a shorter life span. An example of a nondurable consumer purchase is groceries. The life span of the typical food is short, especially compared with the refrigerator (durable item) in which perishable foods are kept. Other examples of purchases that are considered nondurables include newspapers, magazines, clothing, and hats (which are always flying off with the wind).
Services - include medical treatment, lawyers, and dry cleaners.
Investment (I):
The spending on capital equipment, inventories, and structures, including new housing.
Business Investment - This includes the actual purchases of goods used in the production process. Business investment includes the construction of new offices and factories, and the purchase of machinery, production facility (computers, and any other equipment) used to assist labor in the production of goods and services.
Residential Construction - This part of overall investment tracks the actual construction of housing, not the sale of homes. A new home that is built during a given year is counted in that year's GDP, while the purchase of a previously owned house has already been counted in the GDP of the year it was constructed. In this way, only those residences that add to the overall housing stock count towards GDP.
Changes in inventories - Firms invest in inventories, which are produced goods held in storage in anticipation of later sales. Firms also stockpile raw materials and intermediate goods used in the production process. Goods held in inventories are counted for the year produced, not the year sold.
Government Purchases (G):
The spending on goods and services by local, state, and federal governments.
Does not include transfer payments because they are not made in exchange for currently produced goods or services, interest payment on its debt.
Net Exports (NX):
Exports minus imports
Differences between nominal and real 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.
An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.
GDP Deflator – to adjust nominal GDP to real GDP
It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.
The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.
GDP deflator = (Nominal GDP/Real GDP)*100
GDP AND ITS LIMITATION AS ECONOMIC WELL-BEING
Some things that contribute to well-being are not included in GDP:
Transfer payment that you received from NGO, government
Income distribution
Goods and services that sold in the black market
It ignores important factors that make people happy:
value of leisure; environment quality;
work-life balance, value of the time parents spend with their children or the quality of interpersonal relationships
GDP is the best single measure of the standard of living (economic well-being) of a society.
Limitation of GDP as economic wellbeing of a society
Many things that society values, such as good health, high-quality education, enjoyable recreation opportunities, and desirable moral attributes of the population, are not measured as part of GDP.
GDP is not a perfect measure of the happiness or quality of life.
GDP per capita
A better measure of the economic well-being of individuals in society is GDP per capita.
GDP per person (GDP per capita) tells us the income and expenditure of the average person in the economy.
Higher GDP per person indicates a higher standard of living.