3.1 Measuring economic activity and illustrating its variations

National income accounting measures production, income and expenditure; output, income and spending are linked views of the circular flow.

Definitions handle imports, inventories and depreciation to avoid double counting.

State the approach and period, then exclude intermediate goods.

Expenditure GDP is C+I+G+(X−M); imports are subtracted because they were not produced domestically.

An account total is a convention, not a welfare score.

In the circular flow, firms produce output, households supply factors of production and receive income, and expenditure purchases that output; this is why total output = total factor income = total expenditure for the same period. Saving, taxes and imports are leakages from the core flow, while investment, government spending and exports are injections. A labelled diagram should show households and firms plus these flows; do not add the three approaches as if they measured separate activity.

GDP measures production within borders; GNI measures income earned by residents, including net income from abroad.

Foreign-owned production can raise GDP while profits leave, so GDP and GNI diverge.

Identify location versus residency before choosing the measure.

A foreign factory adds host GDP; remitted profits reduce host GNI relative to GDP.

Neither measure is automatically better.

Use the expenditure approach: $GDP=C+I+G+(X-M)$. For example, if consumption is $400 billion, investment$90 billion, government spending $120 billion, exports$70 billion and imports $80 billion, nominal GDP is$400+90+120+(70-80)=600$billion. Then$GNI=GDP+\text{net primary income from abroad}$: if residents receive$25 billion from abroad and non-residents receive $35 billion domestically, net income from abroad is$-10$billion and GNI is$590$ billion. GDP uses the production location; GNI uses resident income.

Real GDP removes price changes; per-capita GDP divides output by population.

Nominal growth can be inflation, and per-capita output can fall while total GDP rises.

State price basis and population denominator.

GDP rises 5% while prices rise 4%, so real growth is roughly 1% before population adjustment.

Per-capita GDP is an average.

Deflate before comparing quantities: $\text{real value}=\text{nominal value}/(\text{price deflator}/100)$. If nominal GDP is $525 billion and the deflator is 105, real GDP is$525/1.05=$500 billion in base-year prices. Then$\text{real GDP per capita}=\text{real GDP}/\text{population}$; with 10 million people, this is$50,000 per person. Apply the same steps to GNI. PPP conversion uses a common purchasing-power price basis for cross-country comparison; it does not make income distribution equal or turn an average into every person's income.

The business cycle describes expansions, peaks, contractions and troughs around a trend.

Output, employment and inflation need not move together; shocks and policy affect duration.

Use multiple indicators to identify the phase.

Falling output with rising unemployment suggests contraction even if one sector grows.

A recession rule is not a universal law.

Plot real output against time with a rising long-run trend labelled potential output. Actual output moving above and below that trend creates short-term expansions and contractions: a peak precedes contraction and a trough precedes recovery. The vertical distance from potential output is an output gap, while movement of the trend itself represents a change in productive capacity. Do not confuse a slower expansion with an absolute fall in real output.

GDP/GNI measure marketed production or income; well-being also includes health, education, distribution, leisure and environment.

Unpaid care, inequality and pollution may be missing from totals.

Use the measure for its question, then add welfare indicators.

GDP per capita rises while pollution and inequality worsen; output alone cannot show welfare.

Higher GDP is not synonymous with quality of life.

For comparisons over time, use real rather than nominal data and preferably a per-capita measure when population changes; for comparisons between countries, also consider PPP. Even then, national-income averages omit distribution, unpaid work, leisure, environmental damage and many health or education outcomes. Complement them with multidimensional measures: the OECD Better Life Index compares several living-condition and quality-of-life dimensions; a Happiness Index uses reported life evaluation; the Happy Planet Index relates well-being and longevity to ecological impact. Each involves indicator and weighting choices, so use a dashboard rather than treating any one index as complete.