- Equality of income and expenditure is with the circular-flow diagram
- Households buy goods and services from firms; these expenditures flow through the markets for goods
- The firms in turn use the money they receive from sales to pay workers’ wages, landowners’ rent, and
firm owners’ profit; this income flows through the markets for the factors of production
- money flows from households to firms and then back to households
- We can compute GDP for this economy in one of two ways: by adding up the total expenditure by
households or by adding up the total income (wages, rent, and profit) paid by firms
- Because all expenditure in the economy ends up as someone’s income, GDP is the same regardless of
how we compute it
Gross national product (GNP) - is the total income earned by a nation’s permanent residents (called
nationals) regardless of where they were located when the income was earned.
- For example, when a British citizen works temporally in Canada, his production is part of Canada’s
GDP because it was earned within the geographic boundaries of Canada. It is not part of Canada’s
GNP, however, because he is a British citizen. The value of his production is part of Britain’s GNP.
Net national product (NNP) - is the total income of a nation’s residents (GNP) minus losses from
- Depreciation is called the “capital consumption allowance.”
National income - is the total income earned by a nation’s residents in the production of goods and
- It differs from net national product by excluding indirect business taxes (sales taxes) and
including business subsidies. NNP and national income also differ because of a “statistical
discrepancy” that arises from problems in data collection.
Personal income - is the income that households and non-corporate businesses receive
Disposable personal income - is the income that households and non-corporate businesses have left after
satisfying all their obligations to the government.
- It equals personal income minus personal taxes and certain nontax payments (such as traffic
GDP – is the market value of all final goods and services produced within a country in a given period of time
- Market value – GDP adds together many different kings of products into a single measure of the
value of economic activity.
- Of All – includes all the produced goods and services in the economy and sold legally in market.
However, some goods are not accounted because it is difficult to measure them. GDP excludes
most items produces and sold illegally, products those are produced and consumed at home and
never enter the market place (Vegetables that grow in your garden). Paradoxical results; Karen
pays Bob to mow her lawn = GDP rises, but if they were married = GDP falls. This can be seen as
an underestimation of true amount of productive activity taking place in the economy.
- Final – (intermediate goods); paper --------> (final goods); cards: the value of intermediate goods is
already included in the price of the final goods. However, an important exception is when an intermediate replaces the final good when it is sold to another company for a period of time but it is
later adjusted accordingly.
- Goods and Services – includes both tangible and intangible goods and services
- Produced – includes goods and services that are currently produces. When GM produces a new car
and sells it = GDP rises. However, if a car owner sells a used car, it is not part of the GDP.
- Within a country – when a Canadian citizen works temporarily in China, his production is part of
China’s GDP. The items are included in a nation’s GDP if they are produced domestically, no matter
of the producer’s nationality
- In a given period of time – GDP measures the economic flow during the interval 4 months, 6
months, 1 year
THE COMPONENTS OF GDP
• Consumption (C)
• Investment (I)
• Government Purchases (G)
• Net Exports (NX)
These components add up to GDP (denoted Y): Y = C + I + G + NX
The equation is an identity—an equation that must be true by the way the variables in the equation are
- each dollar of expenditure included in GDP is placed into one of the four components of GDP
- total of the four components must be equal to GDP
It is total spending by households on g&s.
Examples: Cars, cloths, food, concerts, haircuts
There is an exception on housing costs:
• For renters, consumption includes rent payments.
• For homeowners, consumption includes the imputed rental value of the house, but not the
purchase price or mortgage payments.
It is total spending on goods that will be used in the future to produce more goods.
It includes spending on
• capital equipment (e.g., machines, tools)
• structures (factories, office buildings, houses)
• inventories (goods produced but not yet sold)
It is the sum of purchases of capital equipment, inventories, and structures
Include spending on goods and services by local, territorial, provincial, and federal governments.
It includes the salaries of government