The Government

and the national

economy
Chapter 9
 Gross Domestic Product
• Market value of all final goods and
services produced within a country.
• Within geographical boundary
• GDP is measured in amount not in
numbers.
• PXQ
• Avoid double counting
 Gross National Product
• Market value of all final goods and
services produced by country’s owned
factors of production.
• Income earned from abroad.(A)
• Income paid to abroad.(B)
• Net property income from abroad(NPIA) = (A)-(B)
 Net National/Domestic
Product
• Subtract depreciation of national
capital from GNP.
• Wear and tear of capital depreciate
the value
• Some part of GNP is required to
replace worn-out capital.
 Measuring the National
Income
• Output: Total amount of goods and
services produced in a country.
• Spending: Total amount of
expenditure taking place in the
economy.
• Incomes: Total income generated
through production of goods and
services.
 Measuring the National
Income
Output Method
• This measure of GDP adds together
the value of output produced by each
of the productive sectors in the
economy using the concept of value
added. 
 Measuring the National
Income
Index of Gross Value Added by selected industry
  Mining and Manufacturi Constructio Distribution, Business
quarrying, inc ng n hotels, and services
oil & gas catering; and
extraction repairs finance
2001 weights 28 172 57 159 249
in total GDP
(out of 1000)
2001 100 100 100 100 100
2002 100 97 104 105 102
2003 94 97 109 108 106
2004 87 98 113 113 111
 Measuring the National
Income
• Income Method:
• Sum of income earned by factor of
production
 Measuring the National
Income
• Exclude transfer payment

• Transfer payments e.g. the state

pension paid to retired people;
income support paid to families on
low incomes.
 Measuring the National
Income
expenditure method
• This is the sum of spending on produced goods and services measured at
current market prices
C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services
Exclude taxes
Include subsidies
 Measuring the National
Income

•If there are imports

those should be
excluded

•Taxes on goods and

Services should also
be excluded
Measure of National Income
Money National Income and
real National Income
• Monetary National Income: When we
calculate the amount of goods and
services in monetary unit i.e. $ 100, this is
called monetary national income.
• Real National Income: When we calculate
the Physical amount of goods and services
i.e. 10 tables & 20 chairs, this is called real
national
Year income.
Output Prices National Changes Changes
Income in price in
($) quantity
2001 50,000 Rs. 20 1,000,000

2002 60,000 Rs. 40 1,800,000 50% 20%

The value of this year's output at constant prices

• Measuring real national income from
nominal income
• Find quantities of year 2001
• Find national income of 2001 by
multiplying quantities of goods by price
of year 2000.
• You will find real value of national
Year National Prices
income Income
2001 10,000 100
2002 15,000 140
 Reasons for measuring
national income
• To provide government with
essential information
• To indicate changes in the standard
of living
– By measuring real income per head
– Do not tell
• how distribution of wealth is taken place
• What types of products are sold
• Social cost
• To compare the standards of living in
different countries (based on common
currency)
• Misleading because of:
– Difference of climate, taste and life style
– Government expenditure pattern
– Different working hours
Circular flow of Income
 Circular flow of income
(more realistic model)
• Includes
– Withdraw and injection of income in flow
– Government and foreign trade sector
 Households do not
spend their whole
Savings income so they save
part of it. It is leakage
Taxes in the income flow

Imports

Leakages
 Savings Government levies
taxes on income and
Taxes spending so these
withdraws are
Imports leakages in the flow

Leakages
 Savings

Taxes Residents of country

buys some of the
Imports foreign products so
money goes out of
income flow of
Leakages country,
 Investment on capital
Injections goods. Firms borrow
money from banks
Investments where consumers
have saved their
Government remaining income.
spending

Exports

Savings

Taxes

Imports

Leakages
 Injections

Investments Government buys

goods and services
Government
from firms.
spending

Exports

Savings

Taxes

Imports

Leakages
 Injections

Investments
Government
spending

Exports When firms sell their

products to foreign
countries then money
from outside to inside.

Savings

Taxes

Imports

Leakages
Government
employees many
people from the
country and gives
them income and
wages.

Government
spending on
services
 Savings
Taxes
Imports

Leakages
Government
employees many
people from the
country and gives
them income and
wages.

Government
spending on
services
Injection
Economics policy
• Economics objectives
of government and the
ways in which it tries
to achieve those
objectives
 Instruments of economic
policy
• Methods that government uses to
achieve economic objectives
1.Fiscal policy
2.Monetary policy
3.Direct control
4.Public ownership
 1. Fiscal Policy
• Use of government expenditure and
revenue collection to influence the
economy.
• Controlling rate of taxes
• Budget
 2. Monetary Policy
• Government influences interest rate
and controlling banks’ ability to make
loans.
• Controlling supply of money.
 3. Direct controls
• Legal control over wages, prices and
rents.
• Granting types and number of
buildings etc.
 4. Public ownership
• Nationalizing industries
• Heavy investments in different
sectors
• Influence cost of production.
End of chapter