INTRODUCTION TO ECONOMICS

NATIONAL INCOME ACCOUNTING

National income accounting is the science of measuring the aggregate output and income of an
economy. Gauging the economic performance of an economy is a basic objective of any
government or society. As a private business firm owners want to know about the performance
of the firm over a year, the government and the society want to see how the economy did over
the time or how the economy is doing and what are the future expectations. If we think purely in
an economic way, the societies welfare increases if the availability of goods and services to the
public increases. Therefore, if we want to know whether the economy has improved over time,
we should see the level of production. If production of goods and services is greater than the
previous year then we can say that the performance of the economy is better. So we need a
measure of the production of goods and services during a year.
GROSS DOMESTIC PRODUCT (GDP): The size of the nations overall economy is typically
measured by its gross domestic product, which is the value of all final goods and services
produced within a country in a given year. This task can be done by taking the quantity of
everything produced, multiply it by the price at which each product sold, and add up the total. In
2014, the Pakistan GDP totaled $243.6 billion.
We can measure national income in three ways:
By looking at Production: Adding only the money value of all final goods and services
produced by firms.
By looking at Incomes: Total incomes earned by domestically located factors of
production.
By looking at Expenditures: Total expenditures on domestically produced final goods
and services.
CIRCULAR FLOW OF INCOME: If we assume that an economy is a two sector economy.
A two sector economy has a household sector (consumer) and a business sector (firm). In the
diagram below, the upper portion shows the flow of expenditure and the lower portion shows the
flow of income.

INTRODUCTION TO ECONOMICS

Expenditure View: The inner loop of the upper portion shows that the firm supply goods and
services to the household (consumer) and the outer loop of the upper portion shows the
household expenditures on the goods and services, which they pay to the firm.
Income View: The inner loop of the lower portion of the diagram shows that the household
sector provides inputs (factor of production) in the shape of labour, capital, land and entrepreneur
(owner) to the firm for which they receive a reward or flow of income (wages, interest, rent and
profit) from the firm which is shown by the outer loop of the lower portion of the circular flow.
Conclusion: In such case, buyer (household)s expenditures become the seller (firm)s income.
And firms expenditures for using factor of production become households income. This means
that all expenditures in the economy must be equal to the all incomes in the economy.
EXPENDITURES = OUTPUT = INCOMES

Expenditures

Goods &
Services

FIRM

HOUSEHOLD

Factor of
Production

Incomes

INTRODUCTION TO ECONOMICS

MEASURING GDP ON DEMAND SIDE

Who buys all the production of economy? This demand can be divided into four main
components: consumer spending (consumption), business spending (Investment), government
spending on goods and services and spending on net export. These four components added up to
the GDP.
GDP = Consumption + Investment + Government + Trade Balance
GDP = C + I + G + (X-M)
Consumption Expenditure by households refers to the consumers spending on goods and
services. Investment Expenditure refers to purchase of physical plant and equipment, primarily
by businesses. However a small portion of investment expenditure is also done by the household
in form of new homes, plats etc. Government Expenditure counted in demand is government
purchases of goods and services produced in the economy. Examples include the government
spending on infrastructure and development projects (new highways, new bridges, new airport,
new fighter jets, new school, new hospitals etc). When thinking about the demand for
domestically produced goods in a global economy, it is important to count spending on exportsdomestically produced goods that are sold abroad. By the same token, we must also subtract
spending on imports-goods produced in other countries that are purchased by the residents of this
country. The net export component of GDP is equal to the dollar values of export (X) minus the
dollar value of imports (M). The gap between the exports and imports is called a Trade Balance.
WHAT GDP DOES NOT COUNT/ THINGS NOT INCLUDED IN GDP
Intermediate Goods: which are goods that go into the production of other goods, are excluded
from GDP calculations. Statistician who calculate GDP must avoid the mistake of double
counting, in which output is counted more than once as it travels through the stages of
production. To avoid this problem, which would overstate the size of economy considerably,
government statisticians just count the value of final goods and services in the chain of
production.
Illegal Goods and Services: are not counted for GDP calculations. For example, smuggled
goods, drug production etc.

INTRODUCTION TO ECONOMICS

Government Transfer Payments: are not included in GDP calculations. For example, pension
funds, social security payments etc.
Non-Market Activities: It doesnt count the value of products that are produced but not sold in
any market. For example, home production, housewifes services, friends services etc.
Used Goods: Sale of used goods is not counted because it doesnt represent new production. For
example, second hand car, old laptop, old house etc.
GROSS NATIONAL PRODUCT (GNP):
GNP defined as the market value of all final goods and services produced by a nation during a
year, in and outside the country.
GNP = GDP income of foreigners working in a country + countrymen working abroad
GDP includes only what is produced within a countrys borders. GNP adds what is produced by
domestic businesses and labor abroad, and subtracts out any payments sent home to other
countries by foreign labor and businesses located in the Pakistan. In other words, GNP is based
more on the production of citizens and firms of a country, wherever they are located, and GDP is
based on what happens within the geographic boundaries of a certain country. Pakistan GNP is
$791.91 billion in 2014.
NET NATIONAL PRODUCT (NNP):
The value of the nations output minus the capital used to obtain it is called net national product.
The process by which capital ages and loses value is called depreciation.
NNP = GNP Depreciation
This concept is used to look at the net addition in the production in a year.
GDP PER CAPITA:
GDP per capita is gross domestic product divided by midyear population.
GDP per Capita = GDP / Population
Pakistan GDP per capita is $1316.6 for the year 2014

INTRODUCTION TO ECONOMICS

REAL GDP VS NOMINAL GDP:

When examining economic statistics, there is a crucial distinction worth emphasizing. The
distinction is between nominal and real measurements, which refer to whether or not inflation
has distorted a given statistic. Similarly, if you do not know the rate of inflation, it is difficult to
figure out if a rise in GDP is due mainly to a rise in the overall level of prices or to a rise in
quantities of goods produced. The nominal value of any economic statistic means the statistic is
measured in terms of actual prices that exist at the time. The real value refers to the same statistic
after it has been adjusted for inflation. Generally, it is the real value that is more important.
Nominal GDP is defined as the quantity of every good or service produced multiplied by the
price at which it was sold, summed up for all goods and services. And Real GDP is the value of
GDP that is adjusted for inflation. In order to see how much production has actually increased,
we need to extract the effects of higher prices on nominal GDP. This can be easily done, using
the GDP deflator. GDP deflator is a price index measuring the average prices of all goods and
services included in the economy.
Real GDP = Nominal GDP Price Index/100
This is what we deflate nominal figures to get real figures (by dividing the nominal by the
price index).