Key Points

Final goods are meant for final use and will not pass through any more stages of production, like a car sold to a consumer. Intermediate goods, like steel sheets for making cars, are used as inputs for producing other commodities.

Consumption goods like food and clothing are purchased for final consumption. Capital goods are durable goods like machinery and tools used in the production process.

Stocks are variables measured at a particular point in time, such as capital or wealth. Flows are variables measured over a period of time, such as income, investment, or depreciation.

Gross Investment is the total addition to the capital stock in an economy. Depreciation is the wear and tear of capital stock. Net Investment is calculated as Gross Investment minus Depreciation.

This model shows how income flows between firms and households. Firms make factor payments (wages, rent, profit, interest) to households, who then spend this income on goods and services produced by firms.

National Income can be calculated using three equivalent methods: the Product (or Value Added) Method, the Expenditure Method, and the Income Method.

This method measures national income by summing up the Gross Value Added (GVA) of all firms in the economy. GVA is the value of a firm's output minus the value of intermediate goods used, which avoids double counting.

This method measures GDP by summing up all final expenditures in the economy. The formula is GDP = C + I + G + (X - M), representing Consumption, Investment, Government spending, and Net Exports.

This method measures national income by summing up all factor incomes earned within the domestic territory. It includes wages, profits, interest, and rent.

Gross Domestic Product (GDP) is the value of final goods and services produced within a country's geographical boundary. Gross National Product (GNP) is GDP plus Net Factor Income from Abroad (NFIA).

Market Price is the price paid by consumers, which includes indirect taxes and excludes subsidies. Factor Cost is the income received by factors of production. To get from Market Price to Factor Cost, we subtract Net Indirect Taxes (Indirect Taxes - Subsidies).

National Income (NI) is the Net National Product (NNP) at Factor Cost. It is calculated as GNP at Market Price minus Depreciation minus Net Indirect Taxes.

Personal Income (PI) is the income received by households from all sources. Personal Disposable Income (PDI) is the income remaining with households after paying personal taxes and non-tax payments, which they can either consume or save.

Nominal GDP is the value of goods and services measured at current year prices. Real GDP is the value of goods and services measured at constant base-year prices, which reflects the actual change in output.

The GDP Deflator is a price index that measures the change in the average price level of all goods and services produced in an economy. It is calculated as (Nominal GDP / Real GDP) multiplied by 100.

The Consumer Price Index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households. It includes the prices of imported goods, unlike the GDP deflator.

GDP does not reflect the distribution of income. A rising GDP can be concentrated in the hands of a few, while the majority of the population may have become worse off.

Many valuable economic activities are not included in GDP because they are not traded in the market. Examples include services provided by homemakers and transactions in the informal barter system.

Externalities are the positive or negative impacts of an economic activity on others, for which no price is paid. Negative externalities like pollution reduce welfare but are not subtracted from GDP, leading to an overestimation of well-being.