Summary

Circular flow of income: In a two-sector economy, the flow of goods, services, and factor payments between households and firms is circular — what one sector spends, the other earns. Injections (investment, government spending, exports) and leakages (savings, taxes, imports) disturb this balance.

Three methods of measuring GDP:

• Product (value-added) method: Sum of gross value added ($GVA$) across all sectors = $GDP_{MP}$.
• Income method: Sum of factor incomes (rent, wages, interest, profit) + mixed income + net indirect taxes + depreciation.
• Expenditure method: $GDP_{MP} = C + I + G + (X - M)$, where $C$ = private consumption, $I$ = investment, $G$ = government spending, $X$ = exports, $M$ = imports.

Key aggregates and their relationships:

• $GDP_{MP}$ (market prices) = $GDP_{FC}$ (factor cost) + net indirect taxes.
• $NDP_{MP}$ = $GDP_{MP}$ – depreciation.
• $NNP_{FC}$ (National Income) = $NDP_{MP}$ – net indirect taxes + net factor income from abroad ($NFIA$).
• $GNP_{MP}$ = $GDP_{MP}$ + $NFIA$.

Real vs. nominal GDP: Nominal GDP uses current prices; real GDP uses base-year prices. The GDP deflator = $\frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$ — it measures the price level change.

Depreciation and capital stock: Depreciation (consumption of fixed capital) is the wear and tear of capital goods. Net investment = Gross investment – Depreciation. Capital stock increases only when net investment is positive. …