National and Domestic terms used for different analysis.
National Income at Factor Cost / Market Prices
Market Prices: Best available measure of market goods. It does not account for taxes and subsidies made by government, distorting the real price and the true incomes received by firms.
Factor Cost: The actual cost of all the factors of production used to make a product, before taxes and subsidies.
Nominal / Real National Income MONEY IS NOT A STABLE MEASURE OF OUTPUT AS ITS VALUE CHANGES.
Nominal: the national income at current prices (cannot compare price to other years)
Real: the national income adjusted to allow for price changes (can compare to other years)
National Income Total and Per Capita
Total: overall national income
Per Capita: average income per person (divide total by population)
National Income Calculation Process:
- Gross and Domestic to…
- Net figures then to…
- National figures adjusted to…
- Expenditure figures at market prices adjusted too…
- Factor Cost at total income method divided by population for…
- Per Capita figures then…
- Nominal to Real figures
Methods for Finding N.I.:
Because National Income = National Output = National Expenditure
Expenditure Method: Shows national income using the four economic groups. Found by adding total spending in the economy minus the total import spending
C + G + I + X – M = Gross Domestic Product (AT FACTOR COST)
Where...
C = Consumer expenditure: durable goods, non-durable goods and services
G = Government consumption: central regional and local governments buying final goods and services
I = Investment: Fixed investment (expenditure on capital goods) + Change in stocks (the increase or decrease in stocks in a year) + Work in progress (work of accounting year included in current national income)
M = Exports – Imports = export expenditure minus import expenditure finds the actual domestic import spending because it is part of other nations GDPs.
Income Method: Households provide land/labor/capital/enterprise; in return, they receive rent/wages/interest/profit. The sum of these four incomes is National Income.
It accounts for public and private owned sectors as well as stock level and value changes
Output Method: The sum of total final outputs = the income figure.
The reward to risk, capital, balances the equation.
Calculating…
Gross National Product (GNP) from Gross Domestic Product (GDP)
Gross Domestic Product – Net Property from Abroad = Gross National Product
Where Net Property from Abroad = property income – property income paid from abroad
Gross National Product (GNP) Per Capita from Total Gross National Product (GNP)
GNP population = GNP per capita
Real GDP from Nominal GDP
Real GDP =
National Income Account Pros and Cons:
Used to...
- Forecast changes
- Plan for future
- Hypothesize economy functions
- Compare economic performance
- Show economic welfare
Con…
- Economic structure changes making comparison ineffective
4.) Summary IB Economics Companion – p.147-157
Measuring National Income
Macroeconomics – allocation of nation’s resources with five main variables.
Circular Flow of income model
Circular Flow model has two sectors. Households, which buy nation,’s output of goods and services. Households provide the four main economical factors of production and receive for that a payment.
The basic circular flow model
Theory: 1.Households provide the factors of production
2. Households buy the goods and services.
3. These goods and services are produced by the firms and the households pay them by the income they received by the firm.
Leakages and injections:
Two-sector model is simplified. Households do not spend all their income. Main factors/leakages are not mentioned in the model.
- Savings: Households can save some of their income. It is a leakage of the basic circular flow model because, as households receive income, households do not use the financial expenditure to buy goods and services at a certain time. Households do not buy all the stock then firm will have surplus and will reduce their output.
- However, Firms still have access to the Savings of the households by borrowing money from financial institutions like Banks. They can use the money to increase their stock of capital and expand their output. This is an injection to the circular flow model it allows income, which is not directly paid by the households to come back to the firms. Those called “investments” allow the amount of income circulating in the economy to rise.
- Households buy goods and services from other countries, then income flows to the other countries economy so it is out of the basic circular flow model. Thus, Imports are also known as a leakage because they represent expenditure of income not returning to the firms.
- Exports are also not represented in the basic circular flow model. They are an injection in the economy because they represent a source of income, which is not provided by the household sector.
- Government intervention. Some of the income earned by the household sector has to be paid to the government in form of taxes. Government spends money in the economy for a wide range of things- schools, hospitals, roads. Government spending represents an injection into the circular flow model. Transfer Payments are payments that are payments to individuals that are not the result of an increase in output (Pensions, unemployment payments…). These transfer payments are not included in the circular flow diagram as an injection.
This is an example of a better circular flow model:
Even though the five-sector model remains a simplification, you can conclude problems with it.
Equilibrium: Leakages=Injections
Leakages> National Output (less income circulating)
Injections>Economy moves to a new equilibrium
How is national income measured?
GDP (Gross Domestic Product) most common indicator of national income.
Three Different Methods are used to calculate the figures
- The output method: Value of goods and services. All services produced by firms summed up. If we mean summed up we deduct the cost of inputs so we do not double count.
- The income method: Value of all incomes.
- The expenditure method: All spending on goods and services in the economy. Including:
- Spending by households, consumption
- Spending by firms, investment
- Spending by governments
- Spending by foreigners on exports minus imports. (Net Exports)
Definition of GDP: The total value of all final goods and services produced in an economy in a year.
Algebraically: GDP=C+I+G+(X-M)
National Output = National income = National expenditure
Gross Domestic Product (GDP) and gross national Product (GNP)
GDP is the total value of all economic activity in a country, regardless of who owns the productive assets.
Gross National Product (GNP) is the total income that is earned by a country’s factors of production regardless of where the assets are located. Thus, GNP is equal to GDP plus income earned from assets abroad minus income paid to foreign assets domestically. Income earned by assets in foreign countries is called property income. Property income – income to foreign assets = net property income from abroad.
GNP=GDP + net property income from abroad
Gross national Product (GNP) and net national product (NNP)
Throughout a year, country’s capital stock will lose some of its value. This is known as depreciation of capital or capital consumption. Several reasons:
- Wear and Tear of machinery is used
- Damage to capital equipment
- Technology might make machinery obsolete
Capital gets used up and GDP takes no account of depreciation of capital.
Net national product (NNP) considers those.
NNP= GNP – depreciation
Nominal GDP and real GDP
GDP does not consider inflation.
Prices rise = overstate of the GDP.
Nominal GDP adjusts prices to inflation level to get the GDP at constant prices.
Real means adjusted for inflation.
Real GDP = Nominal GDP adjusted for inflation
GDP per Capita
GDP per Capita is the total GDP divide by size of population
Why are national income statistics gathered?
- “Report Card” for a country. Economic Growth is an increase in a country’s national income over time. Used as judgment over success.
- To develop policies
- To develop models for the economy and make forecasts about the feature.
- Businesses use it to make forecasts about future demand.
- Analysis of performance of an economy over time
- Rising national income equated with rising standard of living, use as a evaluation tool to find the standard of living or quality of life
- Basis of comparing countries
Limitations of the Data
- Inaccuracies: Data comes from a wide range of sources, including tax claims by households and firms, output data and sales data. Figures tend to become more accurate after lag of time as they are revised and additional data are included.
- Unrecorded or under-recorded economic activity – informal markets:
Only official economic activity is recorded. They therefore do not include do it yourself work or other work done at home. Even though the output is identical the only services consumer paid for will be included.
Hidden Economy:
This includes activity that is unrecorded because the actual work is illegal, such as drug trafficking. It also includes unrecorded activity that is legal but people are doing it illegally for example foreign workers without work permissions. It also includes work that is not recorded because people want to evade paying taxes, f.e cigarettes.
High indirect and direct taxes, along with government health and safety regulations, give employers the incentive to avoid the official economy and hire workers unofficially.
Percentage of hidden economy is measured in percentage of the GDP.
Countries with higher tax burdens have a higher amount of hidden economic activity.
- External costs: GDP figures do not take into account the costs of resource depletion. Cutting down trees leads to an increase in GDP, but there is no measure to account for the loss of these trees.
- Other quality of life concerns: GDP may grow if people work longer and more. While people earn higher incomes as a result, they might not enjoy higher standards of living.
GDP accounting does not include volunteer work
- Composition of output: Large part of country’s output might not benefit consumers, such as defense goods and capital goods. If this is the case, then it would be hard to argue that a higher GDP will raise standards of living.
5)The Good the Bad & the Economist
3.1 Measure National Income P.304-325
- Economic activity in an economy is commonly measured by gross domestic product (GDP) and gross national product (GNP).
Circular Flow of Income
-
Assuming a 'two person economy' as above, we see that total expenditure equals income (in money terms) which equals output. As a result of how we define expenditure, income and output in national income accounting, the three flows resulting from the simple economic transaction above are per definition identities, i.e. E=O=Y.
The Circular Flow in a simple two-sector economy
- Households and firms - no financial institutions, government or other countries exist. The flows involved are shown in figure 3.1.1. Firms create the output (O) which is consumed by households - this is consumption expenditure (E). (Note that since only a household sector exists, all expenditure (E) is in fact consumption expenditure (C).) Households are the actual owners of production factors and rent these out to firms for which an income is received (Y).
- National income is thus a flow concept since we are measuring how much money is passing through the system during a given amount of time (normally one year) to handle all the economic transactions.
- Simple circular flow above match each other since we are making a number of assumptions in this simple model; there are no taxes, savings or imports so households cannot do anything but spend their income. In addition, there are no exports, government spending or investment, which means that firms cannot sell their goods/services anywhere but to domestic households.
- The monetary flow (outer grey circular flow-arrows) shows how households are rewarded with wages, rent, interest and profits (Y) from firms while firms are on the receiving end of households' expenditure (E).
Adding financial institutions, government and a foreign sector
- Household receives an income of, say, 100 money units. Household will not spend all of this on output from domestic firms.
- Tax (T), savings (S), imports (M) = Leakage (L) of 50 out of the system.
- These inflows are called injections (J).
- The taxes (T) will provide governments with funds needed for hospitals, defense etc, and the public sector. This is government expenditure (G) which flows back into the system, i.e. to the firms providing these goods.
-
Following the remaining flows, households 'savings will provide financial institutions with loan able funds which firms use for investment expenditure (I), and finally, there will be expenditure from the foreign sector which is an inflow of export expenditure (X) from abroad.
- Total injections are equal to total leakages.
- the circular flow model thus renders two sets of identities: O = E = Y and EJ = EL
- Leakage has a 'mirror image' or 'counterpart', this most assuredly does not mean that the values will be identical.
- G>T, an all too frequent occurrence unfortunately. Loans provided by financial institutions... funds are supplied by depositors' incomes... are supplied by firms... taxes are not the same as government spending; savings do not necessarily equal investment; and imports are not equal to exports. Sum of these in- and outflows that must be the same.
Transfer Payments
- Social welfare system, transfer payments are NOT included in government spending.
- Already been accounted for in the national income accounts and does not represent additional expenditure, so adding it anew to the flow of G would be to double count it. The basic rule is that only the expenditure flows which have a corresponding output are included in national income.
Methods of measurement - income, expenditure and output
•Compute the money value of aggregate output during a year, i.e. GDP
• Adjust for the use of foreign factors of production to arrive at gross national product;
•Subtract depreciation of capital (often-called capital consumption) to show net addition to GNP; net national product; NNP
• Take into consideration changes in the price level to show real output; GDPreal/GNPreal
• Starting with computing GNP, the three methods of calculating GDP at factor cost are as follows:
Factor income method of accounting
• Employment income is readily understandable; it is the flow of payments to providers of labor for their services, called either wages or salaries.
• Self-employment income is the income generated by own businesses. It is accounted for and contains a profit element since an owner-operated business will generate value-added element which goes to paying the owner's wages
• Rental income is generated which owners of land, housing and property receive payments for other economic agents; use.
• Private and public profits are commonly separated in the accounts, but I have lumped them together here since the concept is the same; surpluses created by firms which are then paid back to the owners. This can be done directly (in small companies) or indirectly via dividends (=payouts) to shareholders
• The concept of interest in national income accounts is not bank interest. Instead, it is the imputed (=attributed, estimated) value of the consumption of non-trading capital, which is a complicated way of saying that when the public sector utilizes wholly owned buildings (i.e. non-tradable assets) it is 'freely' using capital which would have to be paid for in the private sector. This is therefore imputed in the national accounts.
• deduct stock appreciation in order to use a truer value since unsold goods and half-finished products lying in warehouses for lengthy periods would be given a higher value when added to the GDP figures than when originally produced.
• The final figure is then adjusted for a statistical discrepancy, which is assessed by comparing the values in all three methods and adding/subtracting an error component arrived at by comparing to an average based on all three accounting methods.
Expenditure method of accounting
• Consumption: amount of personal money spent on domestically produced goods and services during the year. It is divided into durable (cars, refrigerators), non-durables (beer) and services (car repairs)
• Investment: Firm expenditure on capital goods like machines often referred to as fixed capital formation. It includes change in stocks and circulating capital. Circulating capital also includes the elements of completed work in long-term projects, 'works in progress', such as airports and roads.
• Government simply your tax money buying goods and services; government spending.
• Export Expenditure is added, since we are estimating the total expenditure on goods produced in the country.
• Import Expenditure does not represent any domestic output and represents a flow of money out of the system.
- The result of the Net exports is the GDP at market prices which must be adjusted for two systematic inconsistencies; taxes and subsidies
- Indirect and direct taxes have to be subtracted from the GDP at market prices
- Subsidies have to be added to the GDP at market Prices
- GDP at factor cost is Y=C+I+G+X-M
Output Method of Accounting
- The GDP cannot be double counted that means the same good cannot be measured twice.
Distinction between…
GDP is the output created within the economy using domestic factors of production
GDP plus the net property income from abroad is the GNP
The GNP is higher than the GDP usually
Gross domestic product means ‘produced within country’s boundaries’ WHERE NOT WHO
Gross national product means ‘produced using a given country’s factors’ WHO NOT WHERE
Gross and Net
Definition Gross and Net national product
To account for net national product NNP or net national income NNY 1 deducts the total value of depreciation (consumer consumption) taken place during the time accounted for.
Thus: GNP- depreciation (consumer consumption) =NNP
Nominal and Real
Definition: Real and Nominal national Income
Nominal income is expressed in the current prices of the output period and thus contains an element of inflation (or even deflation=lower price level). Real national income is the nominal value put into base year, or constant, prices to allow real comparisons of output over time. The formula for deflating nominal values is:
Real GDP= nominal GDP of year measured x 100
Price index of year measured
The Consumer Price Index (CPI) and the GDP Deflator
A consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. It is one of several price indices calculated by national statistical agencies. The percent change in the CPI is a measure of inflation. The CPI can be used to index (i.e., adjust for the effects of inflation) wages, salaries, pensions, or regulated or contracted prices.
GDP deflator (implicit price deflator for GDP) is a measure of the change in prices of all new, domestically produced, final goods and services in an economy. GDP stands for gross domestic product, the total value of all final goods and services produced within that economy during a specified period.
Nominal GDP and real GDP
GDP does not consider inflation.
Prices rise = overstate of the GDP.
Nominal GDP adjusts prices to inflation level to get the GDP at constant prices.
Real means adjusted for inflation.
Real GDP = Nominal GDP adjusted for inflation
7)Read and summarise National income and their use
- Circular flow of income: a model of the economy, which shows the flow of goods, services and factors and their payments around the economy.
- Closed economy: an economy where there is no foreign trade.
- Gross Domestic Product and Gross National product (GNP): measures of national income which exclude and include respectively net income from investments abroad but do not include an allowance for depreciation of the nations capital stock
- Informal economy: economic activity where trade and exchange take place but which goes unreported to the tax authorities and those collecting national income statistics. Workers in the hidden economy are usually motivated by the desire to evade paying taxes.
- National income: the value of the output expenditure or income of an economy over a period of time
- National output: This is the value of the flow of goods and services from the firms to households.
- National Expenditure: This is the value of spending by households on goods and services.
- National Income: This is the value of income paid by firms to households in return for land, labor, and capital.
- Open Economy: an economy where there is trade with other countries
- Purchasing power parties: an exchange rate of one currency for another which compares how much a typical basket of goods in one country costs compared to that of another country.
- Transfer payments: income for which there is no corresponding output such as unemployment benefits or pension payments.
8) National Income Overhead
National income accounting
Calculating national income
Three methods of calculating national income:
- Expenditure method
- Income method
- Output method
If $100 worth of goods has been produced (output) this has generated $100 of income for the various factors of production (income) and will lead to $100 of spending (expenditure). Note. If no one else buys the goods, the firm will end up with stocks, and we count this as if it bought them itself. Therefore: OUTPUT=INCOME=EXPENDITURE
The expenditure method adds up spending in the economy.
- C consumers' expenditure
- +I investment spending by firms; this includes planned investment in capital and unplanned increases in stock (listed as grose fixed capital formation and the value of physical increases in stock)
- +G Government spending (usually listed as general Government consumption)
- +X export spending
- -M import spending
- Import spending must be deducted because it is spending on goods and services from outside the UK, i.e. this spending leaves the economy. Adding up C+I+X-M gives Gross Domestic Product (GDP) at market prices.
The income method involves adding up:
- Wages & salaries
- Self-employed income
- Trading profits
- Rent (includes 'imputed rent’, e.g. the rental value of owner-occupied housing is estimated and included).
- Interest =Total domestic income- stock appreciation (of stocks increase in value over the year this exaggerates their value).
- =GDP
- Note: transfer payments should be excluded; these are payments for which no corresponding good or service is produced, e.g. social security payments.
Market prices to factor cost
If the spending of different groups in the economy is added up, this will show the spending at current or market prices. This does not reflect the income earned by the factors of production because:
- The market price is too high because of indirect tax
- The market price is too low because of subsidies
- Market price-indirect tax + subsidies= factor cost
The output method
- Adds up the added value of every firm's output (i.e. the value of the output minus the value of the input); this avoids double counting, e.g. counting the value of steel and the value of the car which also includes the value of the steel
- OR adds up the output of final goods and services
Gross Domestic product (GDP) shows the value of final goods and services produced by factors of production within a country.
Gross national product (GNP) shows the value of final goods and services produced by factors of production owned by a country’s citizens, regardless of where in the world this is earned.
GNP=GDP plus net property income from abroad
Gross national product to net national product (NNP)
Out of the income earned in the economy some will be spent replacing equipment that has depreciated. To measure the additional (or new or net) income earned, we deduct the amount spent simply on replacement of items.
Gross national product- Depreciation (also called 'capital consumption) = Net national Product (NNP) (also called 'net income')
Summary
- GDP market prices net property income from abroad= GNP market prices
- GNP market prices- indirect taxes + subsidies= GNP factor cost
- GNP factor cost-depreciation= NNP
Problems comparing national income figures between countries
The income figures of each country have to be converted into a common currency. It can be difficult deciding what exchange rate to use, because the value of the exchange rate is often changing all the time
- Accounting techniques vary between countries, which can alter the way in which income is calculated
- It is important to take the price level into account, as well as the nominal income figure- a country may have less average income but also lower prices
- You should consider factors such as climate- one country may have to produce heat; another may get it for free
- The consumption of output may vary considerably - in country may be spending on defense, another may be producing consumer goods
- The distribution of income is likely to vary
- Some economies have much more barter and a greater black economy (illegal) than others.
GDP deflator
Real national income is calculated by adjusting national income figures for inflation. The Retail Price index is not used as it only considers consumer prices; a more complex measure of inflation is used, called the GDP deflator.
Standard of living
Often measured by real GDP per capita
Real GDP per capita = real GDP (which adjusted for inflation)
Population
But
- This ignores the value of goods and services, which are not, traded, e.g. goods, which are swapped in a barter economy; housework; the black economy (work which is not declared to the government); DIY.
- It ignores the distribution of income- although the average real GDP per person may be quite high, there could be a few extremely rich people and many poor.
- It does not take account of what is produced - one economy might be producing capital goods, which involves less consumption now but should lead to more future income; another might be producing consumption goods which involves high levels of consumption today but less in the future.
- There are problems comparing over time, e.g. the price of videos and personal computers has gone down over the years. This might reduce the value of national income, even though the quality of the goods and the number of features has improved
- Economic "bads" can increase the figure even though the 'quality of life' has fallen, e.g. a traffic jam causes more consumption of petrol and increases output and income of the country.
- Valuation problems, e.g. some output such as defense or the health service does not have market price; the value of these services is assumed to be the cost of providing them, which may over or under-value them
- The quality of life: if we take longer holidays or work fewer hours, output and income may fall but we may enjoy life more; similarly, tougher restrictions on pollution might reduce output but increase the quality of our lives
Other indicators of standard of living
Given the problems using national income figures to compare standards of living between countries or over time some commentators use other indicators, such as number of doctors per 100 populations, adult literacy, and life expectancy.
Net Economic Welfare (Tobin and Nordhaus)
Measure of economic welfare; adjusts GNP by deducting economic 'bads' (e.g. pollution) and adding value of non-marketed activities (such as barter) and the value of leisure.
Lorenz curve
This illustrates the distribution of incomes in an economy, e.g. in the diagram 30%of the families in the country have only 15% of the income. The gini coefficient measures the income equality by measuring the area between absolute equality and the line of actual distribution of income. The bigger this area, the more unequal the distribution.
