GDP and its determinants

Economic Environment of Business

Session 1
Decision making at macro level
based
New investment decision of a firm is
determined by
GDP growth in the economy
Aggregate demand in an economy
Inflation rate
Interest Rate
Business expectations
Objectives of economic policy
Sustained growth in GDP
Price stability
Economic tools for achieving objectives
Fiscal Policy Government expenditure,
Taxes
Monetary Policy Money supply in the
economy


Macro variables affected by
Govt. Policies
Aggregate demand
Prices
Interest Rates
Tax Rates
Exchange Rates
Savings
Investment
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.
Gross Domestic Product
The Measurement of GDP
Output is valued at market prices.
It records only the value of final goods, not
intermediate goods (the value is counted only once).

It includes goods and services currently
produced, not transactions involving goods
produced in the past.
It measures the value of production within the
geographic confines of country.
What Is and What Is Not Counted in
GDP?
GDP includes all items produced in the economy and sold legally in
markets.
Non-Market Activities: GDP does not include items produced and
consumed at home that never enter the marketplace.
Underground Activities: It does not include items produced and sold
illicitly, such as illegal drugs, smuggling etc.
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 rupee of spending by some buyer is a
rupee of income for some seller.
Factor Payments
(Wages, rent, and profit)
The circular flow of income
The inner flow
(1) Incomes
(2) Production
(3) Expenditure
The Circular-Flow
Diagram
Prices of Products
Supply of Factors
The Circular Flow of Income
The inner flow
Withdrawals
net savings
net taxes
import expenditure
Injections
investment
government expenditure
export expenditure
Factor
payments
Consumption of
domestically
produced goods
and services (C
d
)
BANKS, etc
Investment (I)
Net
saving (S)
The Circular Flow of Income
The inner flow
Withdrawals
net savings
net taxes
import expenditure
Injections
investment
government expenditure
export expenditure
Factor
payments
Consumption of
domestically
produced goods
and services (C
d
)
BANKS, etc GOV.
Investment (I)
Net
saving (S)
Net
taxes (T)
Factor
payments
Consumption of
domestically
produced goods
and services (C
d
)
BANKS, etc GOV.
Investment (I)
Government
expenditure (G)
Net
saving (S)
Net
taxes (T)
The circular flow of income
The Circular Flow of Income
a) The inner flow
b) Withdrawals
net savings
net taxes
import expenditure
c) Injections
investment
government expenditure
export expenditure
Factor
payments
Consumption of
domestically
produced goods
and services (C
d
)
BANKS, etc GOV. ABROAD

Investment (I)
Government
expenditure (G)
Net
saving (S)
Net
taxes (T)
Import
expenditure (M)
The circular flow of income
Factor
payments
Consumption of
domestically
produced goods
and services (C
d
)
BANKS, etc GOV. ABROAD

Investment (I)
Government
expenditure (G)
Export
expenditure (X)
Net
saving (S)
Net
taxes (T)
Import
expenditure (M)
The circular flow of income
WITHDRAWALS
INJECTIONS
3- Methods of Computing An
Economys Income
1. Resource Cost or Income Approach:
Sum the total wages and profit paid by firms
for resources (see the circular flow).
2. Value Added or Production Method
Sum the value added at each stage of
production process
3. Expenditure Approach:
Sum the total expenditures by households
(from the top portion of the circular flow).
Gross National Product
The total market value of all
final goods and services
produced during a given
period of time by the nations
residents, regardless of the
place produced.

National Income & Related Aggregates

Between a Gross Concept and a Net Concept
GDP Vs NDP (Depreciation)
Between GNP (GDP) at Factor Costs Concept and
GNP (GDP) at Market Prices Concept GNPfc Vs
GNPmp (Net Indirect Taxes)
Between a domestic Concept and a National
Prices Concept - GDP Vs GNP (NFIA)
Real and Nominal concept - Inflation
Four Important distinctions
Three Other Measures of Income
1. Net National Product (NNP):
Total income of residents of a nation after subtracting
capital consumption allowances.

2. Personal Income:
The income that households and non-corporate businesses receive.

3. Disposable Personal Income:
The income that households and non-corporate businesses have left after
taxes.
Real versus Nominal GDP
1. GDP is the market value of the economys
current production, referred to as Nominal
GDP.
2. Real GDP measures any given years total
output in constant prices.
3. An accurate view of the economy requires
adjusting nominal to real GDP, using the GDP
Price Deflator.
GDP (Implicit) Price Deflator
1. The GDP Price Deflator is a price index that
uses a bundle of all final goods and services.
It tells us the rise in nominal GDP that is
attributable to a rise in prices.
2. Converting Nominal GDP to Real GDP:
Real GDP
200x
=
(Nominal GDP
200x
) (GDP deflator
200x
)X100
The Components of GDP
GDP (Y) is the sum of:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX) or Exports minus Imports
Y = C + I + G + NX
Consumption, Savings and
Investment
That part of the disposable income that is not
consumed immediately is called as savings.
Savings are the deferment of current
consumption in favor of future consumption.

The main determinant of C is disposable income (Y
D
)

The consumption function
C = C(Y
D
)
(+)
(+) -- increases in disposable income (Y
D
) leads to
increases in consumption (C)

Consumption (C)
The Four Components of GDP
1. Consumption (C): Is the spending by households on goods and
services
e.g. buying clothing, food, movie tickets
2. Investment (I): Is the purchases of capital equipment and structures,
e.g. factory, houses, etc.
3. Government Purchases (G):Includes spending
on goods and services by local, provincial and
federal governments (e.g. roads, police, etc.).
Does not include transfer payments, because it is
not made in exchange for currently produced
goods or services.
4. Net Exports (NX): Exports minus imports.
C = a + bYD
b = propensity to consume
Change in C from a rupee change
in income
0 < b < 1
C = a when YD is zero

Consumption Function
Saving and Investment in the National
Income Accounts
Recall: GDP is both total income in an economy and the total
expenditure on the economys output of goods and services:
Y = C + I + G + NX
Assume a closed economy:
Y = C + I + G
National Saving or Saving is equal to:
Y - C - G = I = S
Saving and Investment in the National
Income Accounts
National Saving or Saving is equal to:
Y - C - G = I = S or
S = (Y - T - C) + (T - G)
where T = taxes net of transfers
Two components of national saving:
Private Saving = (Y - T - C)
Public Saving = (T - G)
Saving and Investment
Private Saving is the amount of income that households have left after
paying their taxes and paying for their consumption.
Public Saving is the amount of tax revenue that the government has left
after paying for its spending.
For the economy as a whole, saving must be equal to investment.

Export minus imports
Oil economy