ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

Measuring National Output and National Income

1. Measuring Production: Gross Domestic Product (GDP)

 Gross Domestic Product (GDP): The total market value of all final goods and services
produced within an economy in a given period of time.

 total market value

o Goods and services are counted in GDP at their market values, i.e. their market prices.

𝐺𝐷𝑃 = ∑ 𝑃𝑖 × 𝑄𝑖

o It allows adding the production of different goods and services.

o But it excludes non-market production: goods and services that are produced but not sold
in a market

o A few exceptions that requires imputations:

 Government services, such as police services and national defense.
 Valuing at costs.
 Housing services enjoyed by people living in their own houses.
 Estimates of what the market rent for a house would be if it were rented.

 final goods and services

o GDP only includes the final goods and services that are sold to the final users (i.e. the end
products of a production process).
o Exclusion of intermediate goods and services that are used up in the production of other
goods and services to avoid double-counting (or multiple-counting).

o The value-added approach:

 Add up the value-added, which is defined as the value of the firm’s output minus the
amount paid for intermediate goods, at each stage of production.

Example: Apple sold its iPhone 11 Pro Max at $1,099. Apple bought the following
components from various suppliers: screen ($66.50), battery ($10.50), processor,
modems, and memory ($159), sensors, outer case and others ($181). What is the value-
added of Apple? What is the sum of the value-added by all suppliers and that of Apple?

o How about capital goods (such as machines and equipment)?

 Goods that are used to produce other goods in future (last for many years), but are not
used up in the production process.
 Newly purchased capital goods are included as final goods.

 produced
o Transactions that involve no production are excluded from GDP.
o Exclusion of purely financial transactions:
 Public and private transfer payments
 Transactions of financial assets
 How about the brokerage fees (transaction fees) the buyers and sellers pay for
the services provided by the brokers, dealers and so on?

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ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

 in a given period of time

o GDP only includes goods and services that are newly produced within the current period.
o Exclusion of purchases or sales of goods produced in previous periods.
o How about the unsold goods?
 Stocks of unsold finished goods, goods in process, and raw materials held by firms.
 The inventories are treated as being “purchased” by the firms themselves and are
included in current GDP.
 What happens later when the firm sells them out of inventory?

 within an economy
o GDP measures those output produced within a nation.
o Gross National Product (GNP) or Gross National Income (GNI) measures those output
produced by domestic factors of production.

2. Three Approaches to Computing GDP

 The government statistical units responsible for measuring national production use several
different ways to calculate GDP
o Different approaches provide us with different insights into the structure of the economy.
o It is more prudent and accurate to use more than a single measure.

 GDP can be measured in terms of:

o the amount of output produced – The product (value-added) approach
o the amount of spending by the ultimate purchasers of output – The expenditure
approach
o the incomes received by the households (factor owners) – The income (or the factor
payment) approach

 Circular Flow Diagram

o It depicts the operation of a simple economy consisting of households and firms only.
Income Factor Payments
Resource
(Production Factors)
Markets

Labor, Capital, Land, Entrepreneurship

Households Firms
(Consumers) (Producers)

Goods and Services

Goods Markets

Expenditure Revenue (Product)

o Total Production (Output) = Total Income = Total Expenditure

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 ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

3. The Expenditure Approach: Components of Expenditure

 Consumption expenditure (C)

o Goods and services bought by households
o Includes durable goods, nondurable goods and services.

 (Private) Investment expenditure (I)

o Goods bought by firms for future production, which includes:
 Fixed investment (or fixed capital formation)
 Mainly production plants and equipment.
 Newly produced residential houses (why?)

 Inventory investment (or change in inventories)

 Unsold goods are treated as capital goods as they will provide service in the
future when they are finally sold and used.
 How about unsold computer chips (supposed to be an intermediate good in
gadgets production)?
 Including this component guarantees that GDP equals total expenditure by
definition.

 Government purchases (G)

o All goods bought by government (including government investment)
o How about transfer payment (such as social security, unemployment benefits)?

 Net Exports (NX)

o NX = Exports (X) – Imports (M)
o Exports are goods and services produced domestically but purchased by foreign countries.
o Imports are goods and services produced in foreign countries but purchased domestically.

 The expenditure approach to measuring GDP: GDP = C + I + G + NX

GDP (by Expenditure Components) at current market prices, in Hong Kong, 2021 - 2023.
2021 2022 2023
Millions of % of Millions of % of Millions of % of
$ GDP $ GDP $ GDP
Private Consumption Expenditure (C) 1,863,524 65% 1,863,515 66% 2,103,948 71%
Gross Private Investment (I) 481,145 17% 427,804 15% 460,717 15%
Gross Domestic Fixed Capital Formation 483,054 17% 451,397 16% 499,969 17%
Changes in Inventory -1,909 0% -23,593 -1% -39,252 -1%
Government Expenditure (G) 363,591 13% 402,722 14% 395,436 13%
Net Exports (NX) 159,713 6% 114,940 4% 21,500 1%
Exports of Goods 5,236,005 183% 4,812,517 171% 4,498,541 151%
Exports of Services 615,069 21% 650,549 23% 771,733 26%
Imports of Goods 5,211,334 182% 4,852,975 173% 4,627,682 155%
Import of Services 480,027 17% 495,151 18% 621,092 21%
GDP (Y) 2,867,973 100% 2,808,981 100% 2,981,601 100%

 What would happen to GDP and its expenditure components when a local consumer buys a
mirrorless camera imported from Japan?
 How about purchases of a smartphone produced last year?

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ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

4. The Income (Factor Payments) Approach

 In the simple circular flow diagram, Total Production (Output) = Total Income = Total
Expenditure. However, in real world, households only receive part of the total revenue or
expenditure.
o To understand the income approach to measuring GDP, we need to understand how
income transfers from businesses to households.

o Consider a single firm in the economy:

Revenue
less: (the firm’s) expenditure:
 Intermediate goods
(the firm’s) value-added
 Wages (for labor)
 Interest (for capital)
 Rent (for land)
 ?
 ?
= Profits

 The income approach to measuring GDP:

o National Income (NI)
 Total of all sources of household income:

Wages + Interest + Rent + Profits + indirect business taxes (as part of the profits have
been transferred to government)

GNI (or GNP) = National Income + depreciation

GDP = GNI – Net income from abroad1

where Net income from abroad = Income earned abroad – Income paid abroad

 In practice, statistical discrepancy is intentionally added to match the GDP computed by

expenditure approach and income approach.

5. Nominal versus Real GDP

 Nominal GDP
o The values of the total current output measured at the current prices.

𝐺𝐷𝑃𝑁 = ∑ 𝑃𝑖𝐶𝑈𝑅𝑅𝐸𝑁𝑇 × 𝑄𝑖𝐶𝑈𝑅𝑅𝐸𝑁𝑇

 Real GDP
o The values of the total current output measured at the constant (base-year) prices.

𝐺𝐷𝑃𝑅 = ∑ 𝑃𝑖𝐵𝐴𝑆𝐸 × 𝑄𝑖𝐶𝑈𝑅𝑅𝐸𝑁𝑇

1
In HK, GNI is computed by GDP – Net income paid abroad, where Net income paid abroad =
Income paid abroad – Income earned abroad.

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 ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

o Comparison based on real GDP eliminates the influence of changes in prices and reflect
the true changes in the output level.
o Note that at the base year, nominal GDP = real GDP

Example: Calculation of Nominal and Real GDP

2021 2022 2023
Price Quantity Price Quantity Price Quantity
Apple $2.00 10 $2.20 15 $2.50 20
Orange $1.00 30 $1.50 25 $2.00 20

2021 2022 2023

Nominal GDP $2 x 10 + $1 x 30 = $50 $2.2 x 15 + $1.5 x 25 = $70.5 $2.5 x 20 + $2 x 20 = $90
Real GDP (Base year = 2021) $2 x 10 + $1 x 30 = $50 $2 x 15 + $1 x 25 = $55 $2 x 20 + $1 x 20 = $60
Real GDP (Base year = 2022) $2.2 x 10 + $1.5 x 30 = $67 $2.2 x 15 + $1.5 x 25 = $70.5 $2.2 x 20 + $1.5 x 20 = $74

 (Implicit) GDP Deflator

o The ratio of nominal GDP to real GDP, which is a price index

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = × 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃

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 ECON 1006 Principles of Economics II (Macroeconomics) Semester 2, 2024/25

 The Chain Volume Real GDP

o The above computation of real GDP is called the fixed-weight procedure, because the
weights used (which are the prices), are the same for all years, once the base year is fixed.

 It may be misleading to use the prices that prevailed ten or twenty years ago in
computing real GDP with a fixed base year, but;
 base year revision (say every 5 years) induces changes all prior estimates of real
GDP and more importantly, annual growth rate, g.

o In our previous example, which base year is more appropriate in computing growth rate?

2021 2022 g2022 2023 g2023

Real GDP (Base year = 2021) $50 $55 10% $60 9.09%
Real GDP (Base year = 2022) $67 $70.5 5.22% $74 4.97%

o Chain volume real GDP, which was adopted by many countries, including HK (since
2007), largely overcomes the problem.
 A reasonable solution to the above problem is annual re-weighted chain linking, i.e.
always using the previous year as the base year in computing annual growth rate.

 If 2021 is chosen as the reference year (starting year):

 2021 real GDP = 2021 nominal GDP = $50
 2022 real GDP (at chained 2021 prices) = 2021 real GDP x (1 + g2022) = $55
 2023 real GDP (at chained 2021 prices) = 2022 real GDP x (1 + g2023) =
2021 real GDP x (1 + g2021) x (1 + g2022) = $57.73
 How about 2024 real GDP (at chained 2021 prices)?

2020 2021 2022

Nominal GDP $50 $70.5 $90
Real GDP (Base year = 2020) $50 $55 $60
Real GDP (at chained 2020 prices) $50 $55 $57.73

o It is called chain volume real GDP because the weights move forward from year to year.

6. Limitations of GDP

 Real GDP per capita (i.e. real GDP per person) is often used as a measure of the average
standard of living. However, there are some limitations of using it:
o as a measure of total output:
 Nonmarket activities
 Underground economy
o and as a measure of economic well-being:
 Quality changes
 Income distribution
 Other aspects of economic well-being, such as leisure, pollution, crime rate.

Readings:
 Chapter 18

6
Finance & economics | Severed from reality? replace their old cars and electrical goods with newer, greener versions. Sales of
China meets its official growth target. Not everyone is household appliances leapt by 39% year on year in December, the second-highest
convinced figure in data going back to 2007.

For one thing, 2024 saw the second-weakest rise in nominal GDP since the 1970s People, then, seem eager to buy new stuff for their homes. But are they also more
willing to buy new homes for their stuff? The answer is a tentative yes: the property
market appears to be stabilising. Developers sold 4% more residential floor space in
December than they did a year ago, the second monthly increase in a row. Prices
stabilised, too. The monetary stimulus unveiled since September 24th may have
helped, especially the central bank’s efforts to cut mortgage rates.

Nurturing this recovery will be difficult. Although the central bank seems keen to cut
interest rates further, that would weaken the yuan, which is already under pressure as
American government-bond yields rise and Chinese yields tumble. If Mr Trump starts
a new trade war, exports will suffer, shrouding one of the economy’s bright spots. In
light of such dangers, the government has said it will increase its official budget
deficit this year to boost demand. But its traditional channels of fiscal stimulus, such
as infrastructure investment, face diminishing returns. And its less conventional
Jan 17th 2025|Hong Kong schemes, such as the upgrading programmes, have limitations. There are only so many
times a household can trade in a fridge.
The company at the heart of “Severance”, a celebrated TV show that just began its
second season, features a department of “Macrodata Refinement”. Its workers must Moreover, despite the efforts of China’s macrodata refiners, some troubling statistics
spot disconcerting numbers and lock them away in a digital bin. Does China’s remain. The economy’s apparently brisk growth was accompanied by sustained
National Bureau of Statistics (NBS) have a similar department? If so, it excelled itself deflation. Nominal growth, which makes no adjustment for price changes, was only
this week. 4.2% last year, once revised data from China’s recent economic census is factored in.
That was the second-weakest figure since the 1970s. It implies prices across the
economy fell by more than 0.7% last year.
On January 17th the NBS reported that
China’s economy grew by exactly 5% in The mismatch between strong GDP and weak inflation strikes many economists as
2024. The lovely round number was bigger odd. Some believe China’s official growth figures have become severed from reality.
than expected, but precisely in line with the “My own speculation is that in the past two to three years, the real [growth] number
official growth target. China’s economy on average might be around 2% even though the official number is close to 5%,”
managed this feat despite an ongoing property said Gao Shanwen of SDIC Securities last month. His comments upset China’s
slump, dismal consumer leaders, who do not want scepticism about their statistics to undermine confidence in
morale and demographic decline: the the economy’s recovery. Mr Gao’s WeChat social-media account was blocked and,
population shrank by almost 1.4m last year. according to the Wall Street Journal, he has been banned from public speaking for the
The NBS attributed the recovery to stimulus time being.
policies rolled out since September. “Major
development targets” were achieved This will do nothing to lift spirits, of course: good economic news will not be credible
successfully, it said. The government is likely if bad news is unmentionable. To sustain its economic recovery, China needs stimulus
to approve a similar growth target for 2025 when its rubber-stamp legislature gathers not censorship. The best approach to locking away doubts about China’s macrodata is
in March. to tangibly improve China’s macroeconomy. ■

Other, more granular data suggest the economy did gain some momentum towards the
end of last year. Exporters rushed to fulfil orders in the expectation that America will
raise tariffs on China soon after Donald Trump returns as president. Retail sales also
benefited from an old-for-new upgrading scheme that encourages households to
Source: Schneider, F. New COVID-related results for estimating the shadow economy in the global
economy in 2021 and 2022. Int Econ Econ Policy 19, 299–313 (2022). https://doi.org/10.1007/s10368-
022-00537-6

Fig. 2: Size of the shadow economy of 31 European countries in 2021 (in % of off. GDP).
2015/1/6 National accounts: Sex, drugs and GDP | The Economist 2015/1/6 National accounts: Sex, drugs and GDP | The Economist

and development as an investment rather than a cost, among other things which will attract
rather less public attention.

Britain’s Office of National Statistics was due to release its estimate of the new rules’ impact
as The Economist went to press. Italy is still working on its figures, but the treasury says
National accounts effects will be negligible. Gian Paolo Oneto, director of Istat’s national-accounts department,

Sex, drugs and GDP admits that tracking such activities is a difficult business, but notes that Italy was a pioneer
in estimating the shadow economy: the methodologies it introduced before the sorpasso
Italy’s inclusion of illicit activities in its figures excites much interest subsequently became a point of reference.

May 31st 2014 | MILAN | From the print edition Enrico Giovannini, a professor of economic statistics at the University of Rome and a former

THE announcement on May 22nd by Istat, Istat president, quips that non-statisticians often suggest that measuring happiness and well-

Italy’s statistical body, that from October it being is a tricky task. His response: “Have you ever tried to measure GDP?”

would include drug trafficking, prostitution, From the print edition: Finance and economics
and alcohol-and-tobacco smuggling in its
economic-output numbers has generated a
stream of sniggering headlines. To some, it
smacks of 1987, when Italy started taking
account of its shadow economy, the off-the-
books business which makes up about a fifth of Italian GDP. As a result, the economy grew
by 18% overnight, surging past Britain to be the West’s fourth-largest economy. The event
was hailed as il sorpasso (the overtaking) and the source of much national joy, until two
decades of economic mismanagement sent Italy tumbling back down the league tables.

In fact, then as now, Italy was merely one of the first countries to announce its compliance
with international accounting standards. Reporting illegal economically productive activity
in which all parties take part voluntarily is required under EU rules known as the European
System of Accounts (ESA). But as the guidelines have not so far outlined how to measure
drug deals and fake cigarettes, and as such things are by their nature difficult to gauge, few
countries comply. That will change from this autumn, when an update of the ESA will
refresh guidelines on calculating revenues from the seedier side of the economy.

Some countries already include dope and bootleg booze in their statistics: in the Netherlands,
for example, cannabis sales may be counted as coffee-shop revenues. So the aim is to create
greater comparability in the GDP figures of member states, in part because this is the basis on
which EU funds are distributed. Though cocaine-fuelled GDP stats will in theory reduce the
subsidies Italy is entitled to, it will at least push ever-so-closer to (though still very far from)
meeting euro-zone rules on government indebtedness and deficits.

Insee, France’s statistical body, estimates that the ESA’s update will lead to an increase in
French GDP of 3.2%— equivalent to a couple of years’ growth at current rates. But little of
that is due to an uptick in debauchery: the accounting rule update also reclassifies research

http://www.economist.com/node/21603073/print 1/2 http://www.economist.com/node/21603073/print 2/2

China
The old development model drove rapid growth in China over the last four decades, but is
putting the world at "grave risk", the report said.
Economists urge China to think China is aiming to bring emissions to a peak by 2030, though it currently remains unclear at

'beyond GDP' to head off climate what level they will peak. Stern said it needed to set a specific numerical target in order to
bring "clarity" to its decision-making.

risks The report also called on China to give greater prominence to public transport and set a
By David Stanway timetable for the elimination of fossil-fuel vehicles. China should also promote low-carbon
February 23, 202311:54 AM GMT+8Updated a year ago agriculture, including plant-based meat and dairy, it said.

China began experimenting with "green GDP" in 2005 as concerns mounted about the
environmental damage done by rapid industrialization. A 2006 government report concluded
that environmental losses amounted to 3% of total GDP, but critics believed the actual figure
was much higher.

Though the green GDP project was cancelled in 2009, China promised in 2013 to abandon a
"growth at all costs" model and said GDP would no longer be the sole criteria on which
officials would be assessed.

Some provinces have recently resumed efforts to create new indicators reflecting the
environmental costs of development, with central China's Hubei using a pilot "gross
ecosystem product" that can be applied to individual districts, rivers or development projects.

China is home to 16 of the 20 global regions most vulnerable to climate change, data showed
on Monday.

Reporting by David Stanway; Editing by Simon Cameron-Moore

A person walks on a street in Beijing, China February 3, 2023. REUTERS/Tingshu Wang Acquire Licensing Rights

SINGAPORE, Feb 23 (Reuters) - A team of influential economists has urged China to adopt
a new development model based on "wellbeing" rather than GDP growth in order to fulfil its
2060 net-zero emissions goals and head off the mounting threats of climate change.

In a report published on Thursday, the team - which includes two former chief economists of
the World Bank - also called on China to cap total fossil fuel consumption and establish a
detailed "pathway" for reducing emissions.

The report and its recommendations have already been submitted to the Chinese government.
Co-author Nicholas Stern, chair of Britain's Grantham Research Institute on Climate Change
and the Environment, told reporters he hoped it would play a constructive role in China's
2026-2030 "five-year plan".