Answer to Question #89073 in Macroeconomics for vitus jonas

Question

1:What is GDP deflator and how does it differ from the consumer price index
2:discuss the three approaches of measuaring national income? and show that approaches gives indentical result.

Answer 1

1. The GDP price deflator is an economic measure that accounts for inflation by converting output measured at current prices into constant-dollar GDP. It shows how much a change in the base year's GDP relies upon changes in the price level.

The main differences between the GDP deflator and the consumer price index (CPI) are following:

1) while the CPI measures the prices of only the goods and services bought by consumers, the GDP deflator measures the prices of all goods and services produced;

2) the GDP deflator includes only those goods produced domestically.

2. There are three Approaches to measuring National Income:

1) Value Added Method

GDP= ∑ (P × Q)

where,

P- Market price of goods and services

Q- Total volume of Output

2) Factor Income Method

GDP= Rent + Wages/Salaries+ Interest + Undistributed Profit + Dividends+ Direct taxes+ Depreciation

3) Expenditure Method

GDP= C + I + G + (X – M)

where, 

C- Consumption Expenditure

I- Investment Expenditure 

G- Government Expenditure 

(X-M)= Net Export (Difference between import and export)

All three methods give the same result because the total cost of production in the economy is always equal the wages paid to labourers, rent to the landowner, interest on capital and profit to the entepreneurs. At the same time all this combines to form the income of the economy. Consequently, production equals income.