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Economic Theory

wheat, flour to make loaf of bread). Intermediate goods, which are goods
that go into the production of other goods, are excluded from GDP
calculations;

 GDP measures the production that takes place within the
geographical boundaries of a particular country (e.g. the US);
 GDP measures the production that takes place in a given period of

time (a quarter or a year).
Gross national product (GNP) is the total value of income acquired
by a country’s citizens both domestically and abroad in a given year, no

matter where business production occurs. GNP measures economic
wellbeing of a country’s citizens.

3. Measuring National Income (GDP)

The circular flow model tells us that an economy’s total spending will
be equal to the income earned by its citizens. Because of this reason, GDP
can be calculated two ways. One way to view GDP is as the total income

of everyone in the economy. Another way to view GDP is as the total
expenditure on the economy’s output of goods and services. From either
viewpoint, it is clear why GDP is a gauge of economic performance. GDP
measures something people care about – their incomes. Similarly, an

economy with a large output of goods and services can better satisfy the
demands of households, firms, and the government.
How can GDP measure both the economy’s income and its

expenditure on output? The reason is that these two quantities are really
the same: for the economy as a whole, income must equal expenditure.
That fact, in turn, follows from an even more fundamental one: because

every transaction has a buyer and a seller, every dollar of expenditure by a
buyer must become a dollar of income to a seller.
The income approach measures GDP by summing the incomes that

firms pay households for the factors of production they hire.

GDPincome = S + R + I + P + SA, (3.1)

S – salary (wages) – accounts for the largest share of national income;
R – rents includes the income received by firms and households for
the supply of property resources;
I – interests includes the interest households receive on savings

accounts, certificate of deposit (CD) accounts, and corporate bonds. It also
includes the money or fee firms pay for use of capital;

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