Measuring National Income

When starting our Macroeconomics Unit, we need to first familiarize ourselves with the terminology of what we are actually studying. What Macroeconomics is all about is the whole economy - all of it - and how well or poorly it is doing.

That's quite a lot to look at. As economists, we narrow down the basic health of an economy (or 'economic growth') to being how much GDP has grown. That sounds simple. Until we want to define GDP. In order to help us, we generate what is known as the 'Circular Flow of Income Model'. Have a look at it below.

What the diagram shows us is simple. We - as people - trade our factors of production (in this case labour) for money, in the resource market. We go to work and receive income.

We then spend that same income and receive goods and services (in this example a car) in return.

What does this show us? Well, in a perfect economy, the amount we receive in wage is equal to the amount we spend on goods and services, which is equal to the value of the good/service.

Think of it this way: if a producer knew he gave you \$100, he would set the value of his car at \$100 and then you would have to spend \$100.

In this way:

National Income = National Expenditure = National Value of Goods and Services.

When we talk of measuring economic growth, we can therefore calculate any of the above and reach the same conclusion - theoretically.

As economists, it's easiest to calculate National Expenditure. We do this by adding together what everyone in the economy has spent - or bought.
Consumers - buy goods and services
Goverments - who pay for merit goods and public projects
Exporters and Importers - we calculate how much we gain from selling abroad, and how much we spend abroad.

This can be written as:
C+I+G+(X-M)

Consumption + Investment + Government Spending + (Exports - Imports)

The total value of goods and services in a country in a certain time frame can thus be generated using the above knowledge. Quite simply C+I+G+(X-M) is just the easiest way to calculate Gross Domestic Product (the value of final goods and serives in a country in a certain time frame). It's the same thing.

GDP is thus our yardstick for measuring economic growth. But the problem is there are many types of GDP. Have a look at the examples below to see their differences.

Notice the difference between GDP and NDP - this is where many people go wrong. The flash file below helps you work it out.

We must also be careful to stress the FINAL aspect in GDP. Final goods and services, means that we calculate their value when they are sold at their last use. We do not add up all the values before this, as these values are already hidden in the final value as costs. Look at the Life and Times of Tim the Chicken for more clarity.

The main economic growth indicator we use is Real GDP per capita. We take it as a %. In order to make it a %, we need two different time frames to compare it to. You can't say real GDP per capita in 1999 was 2.2%... what does that mean?? But you can say real GDP per capita increased by 2.8% in 1999 from 1998.

We therefore use the following formula:

Economic Growth = GDP Indicator Final Time Frame - GDP Indicator Orginal Time Frame

divided by GDP Indicator Original time frame

We call it 'Measuring National Income'. Really, we could call it 'Measuring National Expenditure' or 'Measuring National Value of Goods and Services' - it doesn't matter, they should (barring statistical differences) give us the same answer. GDP is just the easiest way to measure national income, and thus economic growth.

Problems with Measuring National Income