15-08-2025

Introductory
Macroeconomics

Prof. Sunny Bhushan

ED 205
Module 1
BIT Mesra

Road ahead

• National Income: Basics, definition of gross domestic product (GDP)

• Real versus Nominal GDP
• Measuring national income:
• The output approach
• The expenditure approach
• The income approach
• Distribution of national income
• GDP as a measure of welfare

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Why do countries measure National Income?

Understand Track • Without knowing

Welfare Growth the national
Are people actually Is the economy
better off? growing better
income, making
today? policy is like
driving
blindfolded.
Guide Design
Investment Policy • GDP gives us the
Should businesses Should the dashboard of the
expand or wait? government cut economy — speed,
Compare taxes? Spend fuel, temperature
Globally more? — all in one
Is India richer than Bangladesh? glance.”

GDP is more than a number — it’s the starting point of every macroeconomic decision.
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MEASURING OUTPUT
• Suppose there is a two-firm Steel company (firm 1) Car company (firm 2)
company for the whole economy:
• Steel Company (Firm 1)
Revenue (R) Rs. 100 Revenue (R) Rs. 200
• Car Company (Firm 2)

Expenses (E) (a) Rs. 80 Expenses (E) (a+b) Rs. 170

What is the aggregate output for this (a)wages Rs. 70

economy? (a) wages Rs. 80

(b)raw material
• Steel is an intermediate good [used (steel)
Rs 100
in the production of another good]
Total Profit (R –
Rs. 20 Total Profit (R – E) Rs. 30
E)

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Aggregate Output: Gross Domestic Product

• GDP: value of final goods and services produced in the economy during a given
period [count only final goods, not intermediate goods]

• Merge both firms into a new firm

Steel and car company

Revenue Rs. 200
Expenses (wage) Rs. 150
profit Rs. 50

GROSS DOMESTIC
PRODUCT (GDP)

1. A Monetary Measure:

2. Avoid Multiple Counting –

intermediate goods

3. Nonproduction transaction –
financial transaction
– secondhand sales

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Methods to measure GDP

1) Value added or Output method

2) Income method

3) Expenditure method

What is spent on making a product is income to those who helped make it.

Value Added Output Input Value

Method/Output Method Stage Value
(Rs.)
Cost
(Rs.)
Added
(Rs.)

GDP = Sum of value added at each Farmer sells cotton 100 – 100
stage of production within the domestic Spinner makes
territory of a country. 150 100 50
thread

Why Use Value Added? Weaver makes cloth 220 150 70

• Prevents double counting (don’t count full
output value at each stage). Retailer sells shirt 300 220 80
• Reflects true contribution of each
production stage.
Total GDP (Value
• Best used in primary and secondary ₹300
Added)
sectors (agriculture, industry)

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Income and Expenditure Method to GDP

WAGES Consumption Expenditures by household

plus plus
RENT Investment Expenditure by business
plus
= GDP = plus
INTEREST
plus Govt. Purchases of Goods & Services
PROFITS plus
plus Expenditures by Foreigners
STATISTICAL ADJUSTMENT

The Income Method

1. Compensation of Employees – wages, salaries by businesses and government to their
employees
2. Rents – income received by businesses and HH that supply property resources.
3. Interest – money paid by private businesses to the suppliers of loans used to purchase
capital.
4. Proprietors’ Income – net income of sole proprietorships, partnerships, and other
unincorporated businesses
5. Corporate Profits – earnings of corporations: corporate income taxes, dividends, and
undistributed profits
National income = all income that flows to an economy’s supplied resources, whether
domestically or internationally
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2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

150194
Agriculture and Allied Activities 1297556 1411634 1524289 1609198 1605715 1616146
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278970 316533 261035 262609 263107 288685
Mining & Quarrying 317974

140998
1269564 1486874 1560709 1683938
Manufacturing 1367258 5 1903850

160529 171947 186668 191635 199601 214047

Electricity, Gas, Water Supply & Other Utility 224158

4125218 5431034 5919748

Services 4437142 4747310 5080870 6429743

Construction 647639 687071 777334 780050 800771 835229 865335

Hotels, transport, communication and services related to

1188847 1328622 1413116 1551143 1652062 1807689 1992825
broadcasting

Financial, Real Estate and Professional Services 1399529 1465064 1530879 1680031 1867407 2073714 2294787

Public Administration, Defence and Other Services 889203 956385 1025982 1069646 1110794 1203115 1276797

GDP 7131836 7704514 8106946 8546275 9063649 9712133 10491870

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The Expenditure Method

1. Personal Consumption Expenditure (C): CONSUMPTION EXPENDITURES BY HOUSEHOLD: -
• durable goods (automobiles, video recorders, etc.),
• nondurable goods (bread, milk, pencils, toothpaste, etc.), and
• services (lawyers, doctors, mechanics, barbers, etc.)
2. Gross Private Domestic Investment (I):
i. all final purchases of machinery, equipment, and tools by business enterprise
ii. all construction
iii. change in inventories
3. Government Purchases (G): government consumption expenditures and gross investment
4. Net Exports (NX): export less than import

An important identity:

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Consumption (C)
Definition: The value of all goods and
services bought by households, including:

• Durable goods
last a long time.
Examples: cars, home appliances

• Nondurable goods
last a short time.
Examples: food, clothing

• Services
are intangible items purchased by
consumers.
Examples: dry cleaning, air travel

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Consumption in India 2500000

Private Final Consumption Expenditure

Private Final Consumption Expenditure: 2000000

includes final consumption expenditure

of 1500000

(a) households and

(b) non-profit institutions serving 1000000

households (NPISH) like temples,

gurdwaras. 500000

0
2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4

Source: Reserve Bank of India (RBI)

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Investment (I)
Gross Fixed Capital Formation
1400000

• Spending on capital, a physical asset 1200000

used in future production 1000000

• Includes:
800000

• Business fixed investment—

Spending on plant and equipment 600000

• Residential fixed investment— 400000

Spending by consumers and

200000

landlords on housing units

• Inventory investment—The 0

2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4
change in the value of all firms’ GFCF

inventories
Source: Reserve Bank of India (RBI)

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Government Spending (G)

Government Fixed Consumption Expenditure
• G includes all government spending 500000

on goods and services. 450000

400000

350000

• G excludes transfer payments 300000

(e.g., unemployment insurance 250000

payments) because they do not

200000

150000
represent spending on goods and
100000

services. 50000

0
2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4

GFCE

Source: Reserve Bank of India (RBI)

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Net Exports (NX) 1000000

Net Exports

900000

NX = exports – imports
800000

700000

• Exports: the value of g&s (goods 600000

and services) sold to other countries 500000

• Imports: the value of g&s purchased 400000

from other countries 300000

200000

• Hence, NX equals net spending from 100000

abroad on our goods and services. 0

2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4
Export of goods & Services Import of goods & Services

Source: Reserve Bank of India (RBI)

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NOW YOU TRY: An expenditure-output

puzzle?
Suppose a firm:
• produces $10 million worth of final goods
• sells only $9 million worth
Does this violate the expenditure = output identity?

Why output = expenditure?

• Unsold output goes into inventory and is counted as “inventory investment” . . .
whether or not the inventory buildup was intentional.
• In effect, we are assuming that firms purchase their unsold output.

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Few Concepts
Stocks vs. Flows Investment vs. capital

• A stock is a quantity measured at a point in time. Note: Investment is spending on new capital.

Example: Example (assuming no depreciation):

“The U.S. capital stock was $10 trillion on January 1, • 1/1/2018: Economy has $10 trillion worth of
2016.” capital

• A flow is a quantity measured per unit of time. During 2018: investment = $2 trillion

Example: • 1/1/2018: Economy will have $12 trillion worth of

“U.S. investment was $2 trillion during 2016.” capital

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Connecting Output with Income

• Net Domestic Product (NDP): counting for depreciation
NDP = GDP – Deprecation…….(eqn. 1)

• Payments are made to different factors of production.

• Firms also have to pay indirect taxes.
NDP – Indirect Taxes = Aggregate Domestic Income……(eqn. 2)

• Combining eqn. 1 and eqn. 2

GDP = Aggregate Domestic Income + Indirect Taxes + Depreciation

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GNP vs. GDP

• Gross national product (GNP):
• Total income earned by the nation’s factors of production, regardless of where located.

• Gross domestic product (GDP):

• Total income earned by domestically located factors of production, regardless of nationality.

GNP – GDP = factor payments from abroad minus factor payments to abroad

• Examples of factor payments: wages, profits, rent, interest and dividends on assets

In your country, which would you want to be bigger: GDP or GNP? Why?

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Other Measures of Income

GNP = GDP + Factor Payments from Abroad − Factor Payments to Abroad

Net factor income from abroad

NNP = GNP – Depreciation
 NNP stands for Net National Product

National Income = NNP−Statistical Discrepancy

 Statistical discrepancy: arises because different data sources may not be completely
consistent

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Personal Income = National Income

− Indirect Business Taxes
− Corporate Profits
− Social Insurance Contributions
− Net Interest
+ Dividends
+ Government Transfers to Individuals
+ Personal Interest Income.

Disposable Personal Income = Personal Income − Personal Taxes

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GNPMP

- NET FACTOR
INCOME FROM
ABROAD GNPFC
NNPMP
GDPMP
INCOME FROM
- NET FACTOR
INCOME FROM
- NET FACTOR

ABROAD
ABROAD

NNPFC

NDPMP GDPFC

NDPFC

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Question 1: What components of GDP (if any) would each of the following transactions affect? Explain.

a. A family buys a new refrigerator.

• Consumption increases; because refrigerator is a good purchased by a household

b. Aunt Jane buys a new house.

• Investment increases; because a house is an investment good.

c. Aston Martin sells a DB7 from its inventory.

• Consumption increases, Investment decreases; because car had been counted as an investment good
when it was built and put into stock, and now it is counted as negative investment

d. You buy a pizza.

• Consumption increases; because pizza is a good purchased by a household

e. The government builds a new motorway.

• Government purchases increase; because the government spent money to provide a good to the public.

f. You buy a bottle of Californian wine.

• Consumption increases, Net Exports decreases

g. Honda expands its factory in Derby, England.

• Investment increases

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Question 2: One day Boris the barber collects $400 for haircuts. Over this day, his
equipment depreciates in value by $50. Of the remaining $350, Boris sends $30 to
the government in sales taxes, takes home $220 in wages, and retains $100 in his
business to add new equipment in the future. From the $220 that Boris takes home,
he pays $70 in income taxes. Based on this information, compute Boris’ contribution
to the following measure of income:

a. Gross Domestic Product

b. Net National Product

c. National Income

d. Personal Income

e. Personal Disposable Income

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Solution
a. GDP equals the dollar amount Boris collects, which is $400.

b. NNP = GDP – depreciation = $400 – $50 = $350.

c. National income = NNP = $350.

d. Personal income = national income – retained earnings – indirect

business taxes
= $350 – $100 – $30 = $220.

e. Disposable personal income = personal income – personal income

tax
= $220 – $70 = $150

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Real and Nominal incomes

Per Capita Income Percentage Increase
Year
(INR) (Per Decade)
1960 – 1961 395.6 42.9
1970 – 1971 844.3 113.4
1980 – 1981 2117.3 150.8
1990 – 1991 6778.0 220.1
2000 - 2001 20,650.6 204.7
Source: Central Statistical Organisation, Government of India

 real income: incomes measured in physical terms, that is, in terms of the quantities of
goods and services.
 nominal income: income measured in terms of current rupee values.

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Comparing income across time

Year 0 Year 1
(base year) (current year)
Nominal Income INR 5000 INR 5625
Price (of pizza) INR 100 INR 125
Real Income 50 pizzas per year 45 pizzas per year

Pizzas Books
Quantity Price Quantity Price Real incomes with
Year 0 30 100 4 500 two goods (1 and 2)
Year 1 30 85 5 615

Can you compute the nominal and real expenditure here?

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GDP: Nominal vs. Real

• nominal GDP
⋇ Sum of quantitates of final goods ⨯ their current price
⋇ Increase for two reasons: [Q and/or P ]

• Our goal is to measure production and its change over time

• real GDP
⋇ Sum of quantitates of final goods ⨯ constant (not current) prices

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GDP: Nominal vs. Real

Real GDP
Year Quantity Price Nominal GDP
(in 2009 price)
2008 10 Rs. 20,000 -- --
2009 12 Rs. 24,000 -- --
2010 13 Rs. 26,000 -- --

Real GDP
Year Quantity Price Nominal GDP
(in 2009 price)
2008 10 Rs. 20,000 Rs. 200,000 Rs. 240,000
2009 12 Rs. 24,000 Rs. 288,000 Rs. 288,000
2010 13 Rs. 26,000 Rs. 338,000 Rs. 312,000

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GDP: Nominal vs. Real

GDP at Current Price GDP at Constant Price
5000000

4500000

4000000

3500000
RUPEES CRORE

3000000

2500000

2000000

1500000

1000000

500000

QUARTER

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GDP Deflator

• GDP deflator: the ratio of nominal GDP to real GDP in year t

GDP Deflator = ∗ 100

,
• In our example – the GDP deflator is = ∗ 100 = 102.27
,

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NOW YOU TRY – GDP deflator

Nominal
Real GDP GDP Inflation
GDP
(INR) Deflator Rate
(INR)
2015 46,200 46,200 -- NA
2016 51,400 50,000 -- --
2017 58,300 52,000 -- --

• Use your previous answers to compute the GDP deflator in each year.

• Use the GDP deflator to compute the inflation rate from 2015 to 2016 and from 2016 to 2017

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Understanding the GDP deflator – 1

• Example with three goods: For good i = 1, 2, 3
 Pit = the market price of good i in month t
 Qit = the quantity of good i produced in month t
 NGDPt = nominal GDP in month t
 RGDPt = real GDP in month t
The GDP deflator is a
weighted average of prices.
NGDPt P1t Q1t  P2t Q2t  P3t Q3t The weight on each price
GDP deflatort  
RGDPt RGDPt reflects
that good’s relative
 Q1t   Q2t   Q3t  importance in GDP.
  P1t    P2t    P3t
 RGDPt   RGDPt   RGDPt  Note that the weights change
over time.

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Chain-weighted real GDP

• Over time, relative prices change, so the base year should be updated
periodically.

• In essence, chain-weighted real GDP updates the base year every year, so it
is more accurate than constant-price GDP.

• Your textbook usually uses constant-price real GDP

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Factor Market
• HHs sell
• Firms buy

Households Firms
• Sell resources • Buy resources
• Buy products • Sell products

Goods Market
• Firms sell
• HHs buy

Circular flow of income

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Income Factor Payments

Factor Markets

Private Savings
Financial Markets

Public Savings

Taxes
Households Government Firms

Investments
Governments
Purchases
Consumption Revenue
Goods and Services
Expenditure
Markets

Circular flow of income with leakages

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GDP can be Deceiving

• GDP does not take into account the distribution of
income or wealth.

• GDP does not account for the black market nor does
it recognize the non-monetary economy (e.g.,
housework, volunteering, etc.).

• GDP does not account for externalities like crime,

divorce, and natural disasters. In fact, it treats them
as economic gain.

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What’s Wrong with GDP As A Measure of

Progress?
• In the words of one critic, GDP “works like a calculating machine
that adds but cannot subtract. It treats everything that happens in
the market as a gain for humanity, while ignoring everything that
happens outside the realm of monetized exchange, regardless of the
importance to well-being.”

• Simon Kuznets, the Nobel Prize-winning economist and creator of

the GDP as a measurement tool, warned against treating GDP as a
gauge of progress.

Simon Kuznets
Nobel Prize Winner in Economics (1971)

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The World Bank’s Income Inequality

Rankings (May, 2025)
Ranking Region Gini Index 2018 Ranking Region Gini Index 2018
11 Norway 27.6
1 Slovenia 24.6
12 Algeria 27.6
2 Czech Republic 25
3 Belarus 25.3 13
What’s Kazakhstan
the 27.8 Anyway?
Economy for,
4 Moldova 25.7 14 Netherlands 28.1
United Arab 15 Denmark 28.2
5 26
Emirates 16 Malta 28.7
6 Iceland 26.1
16 Timor Leste 28.7
7 Azerbaijan 26.6
18 Iraq 29.5
7 Ukraine 26.6
9 Belgium 27.2 19 Hungary 29.6
10 Finland 27.3 20 Croatia 29.7

111 United States (41.4)

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A Sampling of Alternative Measures of Economic and Social

Well-Being

• Human Development Index • Index of Sustainable Economic

Welfare
• Canadian Index of Well-Being
• Sustainable Society Index
• Ecological Footprint
Should •the
Living
IndiaPlanet Index
develop an
• Calvert-Henderson Quality of LifeIndian Index• of Well-Being
Measure to replace
of Domestic Progress
Indicators or supplement GDP? If so, what
• Sustainable National Income
indicators should it include?
• Genuine Progress Indicator • Environmental Performance Index
• Happy Planet Index

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Measuring of Economic Activity – Night

Lights
• Night time lights data have been used to
study economic activities for the last two
decades.

• There exists many studies which find a

direct relation between the GDP and night
lights data. [Click here]

source: NASA

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