Macroeconomics sacrifices individual detail to focus on the interaction of broad sectors of
the economy. Households supply production inputs to firms that use them to make output.
Firms pay factor incomes to households, who buy the output from firms. This is the circular
flow.
Gross domestic product (GDP) is the value of net output of the factors of production located
in the domestic economy. It can be measured in three equivalent ways: value added in
production, factor incomes including profits or final expenditure.
Leakages from the circular flow are those parts of payment by firms to households that do
not automatically return to firms as spending by households on the output of firms.
Leakages are saving, taxes net of subsidies and imports. Injections are sources of revenue
to firms that do not arise from household spending. Investment expenditure by firms,
spending on goods and services by the government, and exports are injections. By
definition, total leakages equal total injections.
GDP at market prices values domestic output at prices inclusive of indirect taxes. GDP at
basic prices measures domestic output at prices exclusive of indirect taxes. Gross national
product (GNP), also called gross national income (GNI), adjusts GDP for net property
income from abroad.
National income is net national product (NNP) at basic prices. NNP is GNP minus the
depreciation of the capital stock during the period. In practice, many assessments of
economic performance are based on GNP since it is not hard to measure depreciation
accurately.
Nominal GNP measures income at current prices. Real GNP measures income at constant
prices. It adjusts nominal GNP for changes in the GNP deflator as a result of inflation.
Per capita real GNP divides real GNP by the population. It is a more reliable indicator of
income per person in an economy but only an average measure of what people get.
Real GNP and per capita real GNP are crude measures of national and individual welfare.
They ignore non-market activities, ‘bads’ such as pollution, valuable activities such as work
in the home, and production unreported by tax evaders. Nor do they measure the value of
leisure.
Because it is expensive – and sometimes impossible – to make regular and accurate
measurements of all these activities, in practice GNP is the most widely used measure of
national performance.
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