ACC 818 — Module 8: The Measurement of National Income
How GDP is actually measured, and the introduction of the Keynesian cross model — the first real macroeconomic model that determines equilibrium output.
Learning Outcomes
- Consider GDP from the expenditure side AND the income side
- Explore real vs. nominal GDP
- Recognize the simple aggregate expenditure model
- Investigate how the actual level of GDP is determined
- Distinguish between actual and potential GDP
- Examine desired aggregate expenditure
- Use the simple multiplier
Two Ways to Measure GDP
- Expenditure side: GDP = C + I + G + NX
- Income side: sum of all wages, profits, rents, interest earned in producing GDP
- A third equivalent: total value added across all firms (avoids double-counting intermediate goods).
- These three approaches yield the same number — they’re three views of the same circular flow.
Topic 1: Aggregate Expenditure (Keynesian Cross)
AE = C + I + G + NX
- C — household consumption
- I — business investment in capital goods
- G — government spending on goods/services
- NX — net exports (exports minus imports)
Equilibrium is where the AE curve crosses the 45° line (where AE = real GDP). At that point, total spending equals total output — no unintended inventory build-up or depletion.
When AE > GDP: firms see inventories drop → expand production. When AE < GDP: firms see inventories pile up → cut production.
Topic 2: Consumption and Investment Functions
Consumption function: how household consumption rises with income.
- MPC (marginal propensity to consume) — fraction of an extra dollar of income spent.
- MPS (marginal propensity to save) — fraction saved.
- MPC + MPS = 1.
The consumption function can shift (parallel shift) or change slope (different MPC).
Investment function: investment depends on expected rates of return, not current GDP. So investment is treated as horizontal (constant) on the GDP axis. It shifts with technology, growth prospects, interest rates, input prices, tax incentives.
Topic 3: The Multiplier
A change in autonomous spending produces a larger change in equilibrium GDP — because the spending becomes someone else’s income, which is partly re-spent, and so on.
Simple multiplier = 1 / (1 − MPC) = 1 / MPS
Leakages that shrink the multiplier:
- Saving (don’t re-spend)
- Taxes (don’t re-spend)
- Imports (re-spent abroad, not domestically)
Larger leakages → smaller multiplier.
Actual vs. Potential GDP
- Potential GDP — what the economy could produce at full employment of resources.
- Output gap = Actual GDP − Potential GDP.
- Negative gap → recessionary gap.
- Positive gap → inflationary gap.
Key Terms
GDP · Aggregate Expenditure · Keynesian Cross · 45° Line · MPC · MPS · Multiplier · Autonomous Spending · Leakages · Potential GDP · Output Gap