Macroeconomic

Measurement : The Current

Approach

- Deepak Varshney
Measuring a Nation’s Income
Macroeconomics answers questions like the following:

Why is average income high in some countries and low in others?

Why do prices rise rapidly in some time periods while they are more stable in others?

Why do production and employment expand in some years and contract in others?
National Accounting

• Indian Context:
Central Statistical Organization,
Ministry of Statistics and Programme Implementation.

• US Context:
Bureau of Economic Analysis: agency in-charge of compiling and publishing
national accounts
National Income and Product Accounts (NIPA)=A set of statistics compiled by BEA
concerning production , income , spending, prices and employment.
National Income Accounts : India

The Government of India set up an Expert Committee in 1949 known

as "National Income Committee" under the chairmanship of Prof. P.C.
Mahalanobis with Prof. D.R. Gadgil and Prof. V.K.R.V. Rao as members.
The first official estimates of national income were prepared by the
CSO with base year 1948-49 at constant prices.
National Accounting : USA
The idea of creating a system of national accounting to guide U.S. economic
policies first took place during the Great Depression in 1930s.
President Herbert Hoover and Franklin Roosevelt felt that national production
came down during Depression but they had no idea of the fact that how much
was the decrease.
Also they wanted to know that the policies they were following for the country’s
growth were actually helping the country in terms of income rise or not.
The Department of Commerce commissioned Simon Kuznets to begin to develop
national income accounts.
The first set of accounts was presented in 1937.
Interest in the national income increased in 1940s because there was a need for
national income mobilization during World War II.
Now every country compiles national accounts using standardized approach.
National Accounting conventions
• The entire economy is broken down into four national accounting sectors-
 Household and institutions sector: This includes both household and
nonprofit institutions that serve household such as nonprofit hospitals,
universities, charities etc.(located domestically).
 Business sector: The business sector concept is broader than just for
profit business. Certain business serving non-profit organizations, such
as trade associations and chambers of commerce, the govt. agencies
like postal service, railway etc. are also included(located domestically).
 Government sector: includes all federal, state and local govt. entities
except business like govt. enterprises.(located domestically).
 Foreign sector: All of the above located abroad. Eg. An individual in
another country buying goods imported from India, will figure in Indian
accounts as a part of foreign sector.
Conventions about capital stock
Although natural, manufactured, human and social capital is crucial resources for
economic activity.
It is mainly the manufactured capital that is currently included in accounting of the
country’s income.
It is due to the fact that when the national accounts were originally devised ,
manufacturing , machinery and factory buildings were main roads to prosperity.
Manufactured capital
Fixed assets: Equipment owned by businesses and governments-structures, residences and
software.
Inventories: stocks of raw materials or manufactured goods held until they can be sold or
used.
Consumer durable goods: Cars, Stoves, etc. used in Household production : consumer good
that are expected to last more than 3 years.
Conventions about Investment

Gross investment: All flows into the capital stock over a period of time OR all
addition to non-financial capital stock. It means new buildings constructed,
machinery purchased this year.
Net Investment: If out of Gross Investment an adjustment is made for
depreciation, then whatever is left is called as Net Investment.
Depreciation: Consumption of fixed capital, a decrease in quantity or quality of
stock capital
Discussion Questions
• A local city government-owned golf course that charges fees similar to
those at local private courses
• A large non-profit hospital
• A government owned business entity whose office is abroad

• Would spending on education can be counted as Investment?

• Would buying shares in a company be considered investment?
GDP: Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and expenditures of an

economy.

GDP refers to the total market value of all final goods and services produced
within a country in a given period of time.
GDP: Gross Domestic Product
• “GDP is the Market Value . . .”
Output is valued at market prices. GDP measures all g & s using same the unit.
For example, how bread can be added to furniture items as these goods are different in nature
and these have different standards of measurement.
• “. . . Of All Final . . .”
It records only the value of final goods, not intermediate goods (the value is counted only once).
Final goods are intended for end consumers.
Example: Chair, Bread are final goods whereas wood, flour, wheat are considered as the
intermediary goods.
Here the value of chair or bread is to be considered and not wood and flour as these have become
a part of the final goods and to consider their value will result in double counting and in certain
cases it can be triple counting even.
• “. . . Goods and Services . . . “
It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, movie
tickets, dry cleaning, doctor visits).
GDP: Gross Domestic Product
• “. . . Produced . . .”
It includes goods and services currently produced, not transactions involving goods produced in the
past.
Market transactions of goods produced in the previous year’s such as old cars, houses, factories built
earlier are not included in GDP of the current year.
Similarly purchase and sale of assets such as stock and bonds do not involve current production of
goods and therefore are excluded from the GDP of the year.
• “ . . . Within a Country . . .”
It measures the value of production within the geographic confines of a country, whether done by own
citizens or by foreigners located there.
If Indian citizen goes abroad to work, whatever he produces is not a part of India’s GDP.
On the other hand the work of Japanese citizen at Japanese owned factory in India is a part of India’s
GDP.
• “. . . 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).
GDP: Gross Domestic Product
GDP includes all items produced in the economy and sold legally in markets.

What Is Not Counted in GDP?

GDP excludes most items that are produced and consumed at home and that
never enter the marketplace. Example ?
It excludes items produced and sold illicitly, such as illegal drugs.
Measuring Gross Domestic Product

• Imagine a simple economy with no government and foreign sector, no depreciation and no
banking sector-

Value of production= Value of spending= Value of income

• Three Approaches for Measuring GDP:

 Production Approach
 Spending Approach
 Income Approach
Circular-Flow Diagram

MARKETS
Revenue FOR Spending
GOODS AND SERVICES
Goods • Firms sell Goods and
and services • Households buy services
sold bought

FIRMS HOUSEHOLDS
• Produce and sell • Buy and consume
goods and services goods and services
• Hire and use factors • Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, • Households sell Income
and profit • Firms buy
= Flow of inputs
and outputs
= Flow of dollars
The Product Approach: The Value
Added Approach

• In this method, the contribution of each enterprise to the generation of the output is
measured. Under this method economy is divided in to different sectors such as
industry, agriculture, trade, fishing mining, transport etc. Then the net value added by
each productive enterprise or sector is estimated.
• This method consists of three stages:
1-Estimating the sales of each firm;
2-Determining the intermediate value, i.e., the cost of material, supplies, and
services used to produce final goods or services;
3-Deducting intermediate value from gross value, and add the change in inventories.
The Product Approach: The Value
Added Approach

• Gross value added = Value of the total sales of goods and services + Value of changes in the
inventories.

• Net value added = Gross value of output – Value of intermediate consumption.

• This method is normally applied in the unorganized sectors like agriculture where there are no proper
accounts are maintained.
• This method can be used with the other methods to arrive at national income.
• The advantage of this method is that it reveals the relative importance of the different sectors of the
economy.
The Spending Approach

• GDP = C + I + G + X – M

C= Consumption of the private sector/household sector.

 The spending by households on goods and services, with the exception of purchases of new
housing.
 For renters, consumption includes rent payments; for owners, consumption includes
imputed rent value of the house but not the purchase price or mortgage payments.
 Includes spending on durables (cars, TV etc.), non-durables (food, fuel etc.) and services
(transportation, education etc.).
The Spending Approach
• I= Investment of the business sector/private sector.
 The spending on capital equipment, inventories, and structures, including new
housing that will be used for future production. It’s not financial investment!
 Includes spending on capital equipment (e.g. machines, tools), structures
(factories, office building), inventories (goods produced but not yet sold).
• G= Consumption and investment of the government sector.
 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.
• X= Expenditure of the foreign sector on the goods and services of the domestic
economy: Export
• M=Expenditure of the household, business and government sector on the goods
and services of the foreign sector: Import
The Spending Approach
• Based on the spending by different sectors, we can summarize the
spending approach with the identity :
• GDP=Household and institution spending +Business +Government
spending+spending+Net foreign sector spending

• Or if you want to highlight the portions that are considered

consumption versus those considered investment, we can summarize
in the following way :
• GDP=Personal consumption+Private investment+Government
consumption+Government Investment+Net Exports
Example
• In each of the following (hypothetical!) cases, determine how much
GDP and each of its components is affected (if at all).
• Sonia spends ₹2000 to buy her husband dinner at the finest restaurant
in Sonipat.
• Atal spends ₹50000 on a new laptop to use in his marketing business.
The laptop was manufactured in China.
• Narendra spends ₹19999 on a computer from the secondary market to
use in his editing business.
• Manmohan Motors builds ₹500 crore worth of cars, but consumers
only buy ₹450 crore worth of them.
The Income Approach
• GDP = National Income – Net income payment of the foreign sector +
Depreciation

•National Income (NI)= Rent+ Wages+ Interest +Profit

• Net Factor Income from abroad which is the difference between factor
income received from abroad by normal residents of the country for
rendering services in the foreign countries on one hand and the factor
income paid to the foreigners for their services in our domestic
territory.
• Depreciation: Consumption of Fixed Capital
Which Approach is better?

• When all the requisite data is available, three approaches are equally good. But if
there are data limitations, then we have to choose method according to the
availability of data.

• If industries provide data on value added, then production approach is preferred.

• If expenditure data on consumption, Investment, govt. and export and imports is

available, then we apply expenditure method.

• Income approach is considered less reliable as proper information on wages and

salaries and profits etc. is not available.
Relationship between Savings
and Investment
• GDP = GDP = C + I + G + X – M
• GDP = Private Consumption + Private Investment + Government Investment + Government
Consumption + Net Exports
• GDP – Private Consumption – Government Consumption = Private investment + Government
Investment + Net Exports
• Savings = Investment + Net Exports
• Also, for Net figures, always subtract Depreciation:
Net Domestic Product = GDP – Depreciation
Net Saving = Gross Saving - Depreciation
GDP growth rate
• Percentage growth in GDP = [(Value of GDP in year 2 –
Value of GDP in year 1 )/ Value of GDP in year 1 ] * 100.
Example:
Nominal vs Real GDP
• Nominal GDP = Total production valued at current price

 Money value of all the final goods and services produced in a year. This money
value is obtained using current year market price of final goods and services
produced.

 Nominal GDP does not truly indicate the real performance or economic growth of
the economy if the prices are changing.

 It is possible while nominal GDP is increasing over time; the real quantity of the
goods is the same. So for finding out the real change, we have to eliminate the
effect of price change.
Nominal vs Real GDP
• Real GDP= Total production valued at a base year price
• Values the production of goods and services at constant prices/ base
year. It is corrected for inflation.
• An accurate view of the economy requires adjusting nominal to real
GDP by using the GDP deflator.
• Change in nominal GDP reflects both prices and quantities; change in
real GDP is the amount that GDP would change if prices were
constant (i.e., if zero inflation).
Nominal GDP
Real GDP
GDP Deflator
• An accurate view of the economy requires adjusting nominal to real GDP by using
the GDP deflator.
• Change in nominal GDP reflects both prices and quantities; change in real GDP is
the amount that GDP would change if prices were constant (i.e., if zero inflation).
• The GDP deflator measures overall price level calculated as the ratio of nominal
GDP to real GDP x 100.
• 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 calculated as follows:
• GDP deflator= Nominal GDP*100
Real GDP
• One way to measure the economy’s inflation rate is to compute the percentage
increase in the GDP deflator from one year to the next.
Computing GDP Deflator
2004 (base year) 2005 2006
Price Quantity Price Quantity Price Quantity

Good A ₹30 900 ₹31 1000 ₹36 1050

Good B ₹100 192 ₹102 200 ₹100 205

Use the above data to solve these problems:

• Compute nominal GDP in 2004. ₹30 x 900 + ₹100 x 192 = ₹46,200

• Compute real GDP in 2005. ₹30 x 1000 + ₹100 x 200 = ₹50,000
• Compute the GDP deflator in 2006.
Nominal GDP = ₹36 x 1050 + ₹100 x 205 = $58,300
Real GDP = ₹30 x 1050 + ₹100 x 205 = $52,000
GDP deflator = 100 x (Nominal GDP) / (Real GDP)
= 100 x (₹58,300)/(₹52,000) = 112.1
Practice MCQs
1. Macroeconomics is
a. the study of market regulation. b. the study of economy-wide phenomena. c.
the study of how households and firms make decisions and how they interact. d.
the study of money and financial markets.
2. The goal of macroeconomics is a. to explain the economic changes that affect a
particular household, firm, or market. b. to explain the economic changes that
affect many households, firms, and markets at once. c. to devise policies to deal
with market failures such as monopoly, externalities, common resources, and
public goods. d. all of the above.
3. The best single measure of the economic well-being of a society is believed to
be a. the stock market index. b. consumption expenditures. c. life expectancy. d.
Gross Domestic Product.
…continued
4. In order to include many different products in a summary or
aggregate measure, GDP a. uses a combination of weights and
measures. b. uses a combination of price indexes and costs of
production of the products. c. uses only the cost of production of the
products. d. uses market prices.
5. Which of the goods and services produced in the economy are
included as part of GDP? a. all goods and services b. all final goods and
services bought and sold in legal markets c. all final goods and services
which are bought and sold in markets d. all final goods and services
bought and sold in legal markets plus the imputed value of some other
legal goods and services that are not bought and sold in markets
…continued
6. If total spending rises from one year to the next, then a. the
economy must be producing a larger output of goods and services. b.
prices at which goods and services are sold must be higher. c. either the
economy must be producing a larger output of goods and services, or
the prices at which goods and services are sold must be higher, or both.
d. net exports must be falling.

7. Recessions are associated with which of the following? a. rising

unemployment b. increased bankruptcies c. falling profits d. falling
output e. all of the above
…continued
8. Suppose you find out that the GDP of China is $1,000 billion and the
GDP of the United States is $10,000 billion. You should conclude that a.
the typical person in the United States is 10 times as well off as the
typical person in China. b. the typical person in the United States is
more than 10 times as well off as the typical person in China. c. the
typical person in the United States is less than 10 times as well off as
the typical person in China. d. it is not possible to make a good
comparison of the economic well-being of typical individuals in the two
countries without additional information.
…continued
9. Statistics such as GDP, the unemployment rate, the rate of inflation, and
the trade balance are a. microeconomic, since they affect individual
households and firms. b. macroeconomic, since they tell us something
about the economy as a whole. c. both microeconomic and
macroeconomic. d. neither macroeconomic nor microeconomic, but
properly in the realm of political science.
10. Statistics such as individual stock prices, salaries of business executives,
and prices of California wines are a. microeconomic, since they reflect
situations in individual businesses and markets. b. macroeconomic, since
they refer to the economy as a whole. c. both microeconomic and
macroeconomic. d. neither microeconomic nor macroeconomic.
…continued
11. In a simple circular-flow diagram, total income and total expenditure in an
economy a. are seldom equal because of the dynamic changes which occur in
an economy. b. are equal only when all goods and services produced are sold.
c. are always equal because every transaction has both a buyer and a seller. d.
are always equal because of accounting rules.
12. If you buy a new snowboard from the local sporting goods store, as a result
of your purchase a. the increase in expenditure in the economy will equal the
increase in income in the economy. b. the increase in expenditure in the
economy will exceed the increase in income in the economy. c. the increase in
income in the economy will exceed the increase in expenditure in the economy.
d. it is impossible to tell whether the increase in income in the economy will
equal the increase in expenditure.
…continued
13. Gross Domestic Product is defined as a. the market value of all final goods
and services produced within a country in a given period of time. b. the market
value of all final goods and services produced by a country's citizens in a given
period of time. c. the market value of all goods and services produced within a
country in a given period of time. d. the market value of all goods and services
produced by a country's citizens in a given period of time.
14. The real economy is more complicated than the one illustrated in a simple
circular-flow diagram because a. households do not buy all goods and services
produced in the economy, and households do not spend all of their income on
goods and services. b. saving should be counted as part of expenditure. c. taxes
should be included as part of expenditure. d. the income government gives
poor people should be counted as government production of human capital.
 …continued
15. Chris lives in Utah, where gambling is illegal. Chris becomes a professional gambler, going to
work each week in Idaho, where gambling is legal. In 2001, he earns $100,000 from his profession.
What will be the effect of his earnings on GDP? a. None of his earnings will be included in GDP
because gambling is illegal in his home state. b. Only the part of his earnings spent in Idaho will be
included in GDP. c. GDP will increase by $100,000 because the income was earned legally. d. GDP
will increase by a fraction of $100,000, equal to the fraction of the time Chris spends in Idaho.
16. Latrell decides to hire Cynthia to mow his lawn, instead of mowing it himself, as he is
accustomed to doing. As a result of this transaction, a. GDP will increase. b. GDP will decrease. c.
GDP will be unaffected because the same service would be performed in either case. d. GDP could
increase or decrease, depending on whether Cynthia mows Latrell's lawn as well as Latrell could
mow it himself.
…continued
17. GDP includes the value of final goods and not intermediate goods
because a. the value of intermediate goods is already included in the
value of final goods. b. the value of intermediate goods is too difficult
to measure. c. the value of intermediate goods is measured by GNP. d.
the value of intermediate goods depends on the number of separate
production processes.
…continued
18. The government reports that GDP "increased by 2 percent in the last
quarter." a. GDP increased by 8 percent for the year. b. GDP increased at an
annual rate of 8 percent during the last quarter. c. GDP increased at an annual
rate of 2 percent during the last quarter. d. GDP increased at an annual rate of
.5 percent during the last quarter.
19. Which of the following headlines would be more closely related to what
microeconomists study than what macroeconomists study? a. Unemployment
rate rises from 5 percent to 5.5 percent. b. Real GDP grows by 3.1 percent in
the third quarter. c. Retail sales at stores show large gains. d. The price of
oranges rises after an early frost.
 Consumer Price Index
• Index number is a figure that measures the change in magnitude of a
variable such as a quantity or price , compared to another period.
• Consumer Price Index: An index measuring the change in prices of goods
and services bought by households.
Example

CPI2 = (250/200)*100 = 125

Macroeconomic Measurement :
Environment and Social
Decisions
Broader View of National
Income Accounting
It is a general tendency to consider national income as a proxy for national
success.
But the economists dating back to Simon Kuznets have warned that GDP is a
specialized tool of measuring economic activity and should not be confused
with national wellbeing.
In the recent years doubts have been expressed about the validity of
national income as a measure of economic welfare.
It has been asserted by several modern economists that national income is
not a satisfactory measure of economic welfare.
 Even if increase in GDP may increase welfare if all other things are constant,
there are many other factors which are equally or more important.
Three Important Questions?
• What should we measure?
• What should be used as the unit of measurement?
• How should we combine?
Measuring “economic production” to
measuring “well being”!
• Multidimensionality: Satellite Account
• Additional or parallel accounting systems that provide measure for
social and environmental factors in physical terms without necessarily
including monetary valuation.
• Monetary valuation: Neither feasible nor desirable
• Example: Changes in Health/ loss of Productivity, Changes in violence
• Crude Oil
• Dashboard approach
• Material living standards, health, education, political voice, social
connections and the environment.
Subjective Well Being approach
• Subjective Well-Being (SWB): A measure of welfare based on survey questions asking questions
on their own degree of life satisfaction.

• Quantification of subjectivities…on the scale of 1(not satisfied at all) to 10 (extremely satisfied),

rate how happy are you with your life these days?

• World Happiness Report from Columbia University, the Gallup World Poll and the European Social
Survey.

• Despite limitations SWB gives useful information about quality of life.

 Relationship between SWB and
GDP
• Are average SWB levels higher in countries with higher GDP per capita?
• As GDP per capita increases in a particular country over-time, do SWB
levels rises?
Critiques of GDP
Household production
Leisure
Human and social capital formation
Interaction of economy and environment
Defense expenditure
Product or production method that reduce than increase well-being
Financial Debt and GDP
Inequality and GDP
Alternative Approaches
The Genuine Progress Indicator (GPI)
Gini Coefficient
• In economics, the Gini coefficient is a measure of statistical dispersion intended
to represent the income or wealth distribution of a nation's residents, and is the
most commonly used measure of inequality.
• The Gini coefficient measures the inequality among values of a frequency
distribution (for example, levels of income).
• A Gini coefficient of zero expresses perfect equality, where all values are the
same (for example, where everyone has the same income). A Gini coefficient of 1
(or 100%) expresses maximal inequality among values (e.g., for a large number of
people, where only one person has all the income or consumption, and all others
have none, the Gini coefficient will be very nearly one).
GPI and GDP : USA

United States of America

Better Life Index
1. Income, Wealth and Inequality
2. Jobs and Earnings
3. Housing conditions
4. Health status
5. Work and Life Balance
6. Education and Skills
7. Social Connections
8. Civic Engagement and Governance
9. Environmental Quality
…Continued
10. Personal Security
11. Subjective Well-Being
The Better Life Index (BLI)
Human Development Index (HDI)

• Life expectancy at birth

• Years of formal education
• Real per capita GDP
HDI Calculation (Old Method)
The HDI combined three dimensions last used in its 2009 Report:
Life expectancy at birth, as an index of population health and
longevity to HDI
Knowledge and education, as measured by the adult literacy rate
(with two-thirds weighting) and the combined primary, secondary,
and tertiary gross enrollment ratio (with one-third weighting).
Standard of living, as indicated by the natural logarithm of gross
domestic product per capita at purchasing power parity.
…continued
In general, to transform a raw variable, say x into a unit free index between 0 and 1,
the following formula is used :
x index= (x-a)/(b-a)

where a and b are the lowest and highest values the variable can attain,
respectively.
HDI Calculation (New Method)

Life Expectancy Index (LEI), Same as old method

Education Index : Mean Years of School Education (15 years), Mean
Years of College Education (18 Years)
EI=(MYSI+MYCI)/2
Income Index , Same as old method except GNI instead of GDI

HDI is the geometric mean of above three indicators

Other National Accounting
Alternatives
• Happy Planet Index : The Happy planet Index asserts that the goal of
society is to create long and happy lives for its members.
• Average Life Expectancy
• Average Subjective Well Being
• Ecological Footprint

• HPI=Happy Life Years/Ecological Footprint

Discussion Questions
Give examples of each of the following :
• Efforts to supplement GDP
• Efforts to adjust GDP
• Efforts to replace GDP
Measuring Household Production

• How to measure unpaid productive activities?

• Time Use Surveys?

Replacement –cost method: valuing hours at the amount it would be necessary

to pay someone to do the work.
Opportunity-cost method: valuing hours at the amount that the unpaid worker
could have earned at a paid job.
Accounting for Environment

• Environmentally adjusted net domestic product: GDP less

depreciation of both manufactured and natural capital.
• EDP = GDP – D(m) – D(n)
• Valuing environmental factors /services-
• Damage Cost Approach: Assigning a monetray value to an environmental service that is
equal to the actual damage done when the service is withdrwan.
• Maintenance Cost Approach: assigning a monetary value to an environmental service that
is equal to what it would cost to maintain the same standard of services using an
alternative method.
Conclusion
• No single approach has emerged as the best substitute, adjust or compliment
GDP.
• Any macroeconomic indicators involve several assumptions.
• With new indicators, it is interesting to note how results change under different
assumptions.
Exercis
eI
Exerci
se II
Inflation Rate

CPI1 is assumed 100

CPI2 = (250/200)*100 = 125

Inflation Rate= ((125-100)/100)* 100 = 25%

Difference between GDP
Deflator and CPI
• The GDP deflator measures a changing basket of commodities while CPI always indicates the price
of a fixed representative basket.

• GDP deflator frequently changes weights while CPI is revised very infrequently.

• CPI will consider imported goods because they are still considered as consumer goods while GDP
deflator will only contain prices of domestic goods.
Best Wishes!