National Income and Balance of Payments Accounts

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Key Principles of National Income Use of National Income

1. Only output produced during a particular year is included 1. Standard of living measurement
2. Includes only official market transactions 2. Economic growth rate measurement
3. Transfer payments (no output generated) are not included 3. Economic sectors analysis
4. Expenditure pattern analysis
Gross Domestic Product (GDP) 5. Income distribution analysis
6. Business planning by firms
1. Total monetary value of all final goods and services produced
by residents within the geographical boundary of the country Statistical Basis in Comparisons using National Income
2. Singapore measures its GDP using the (i) Product-based
approach and (ii) Expenditure approach, as it better reflects 1. Time comparison
Singapore’s move towards a service-based economy a. Use real GDP per capita
b. Compare between different time periods
GDP vs GNP 2. Space comparison
a. Use real GDP per capita in US$
1. National – owned by the nationals of the country b. Compare between different countries
2. Domestic – located within the geographical boundaries of the
country Limitations in Measuring Standard of Living
3. Difference: Inclusion/exclusion of factor payments from
abroad Measurement problems

Nominal vs Real 1. Statistical accuracy differs between two countries

2. Under-declaration and non-accountability of activities
1. Nominal GDPPrice Index of the
Real GDP = 3. Poor administration and lack of communication (in developing
countries)
given yearX 100
Interpretation problems
Per Capita
1. Income distribution
2. Quality and type of goods and services produced
1. Real GDP per Capita = Real GDPTotal
3. Externalities are ignored
PopulationX 100 4. Composition of output
2. Standard of living refers to the amount of goods and services 5. Leisure and human costs of production are not taken into
at one’s disposal to enjoy (income earned as it represents his account
purchasing power)
Purchasing Power Parity
Account Methods
1. Measures the amount of foreign currencies needed to buy the
1. Product approach same basket of goods and services in the 2 countries
a. Measures the value added at each stage of 2. Eliminates differences in price levels between countries
production 3. Preferable because it reflects the relative costs of goods and
b. Value added – increase in the value of a product at services in various countries
each successive stage of the production process
c. Value added = Value of output – Value of Limitations
intermediate inputs
2. Income method 1. Quality of products not taken into account
a. Measures the sum of the final incomes earned 2. Difference in basket of goods consumed (different lifestyles)
through the production of goods and services
3. Expenditure Method Alternative Indicators of Standard of Living
a. Sum of the final expenditure on a country’s goods
1. Physical Quality of Life Index (PQLI)
and services produced within the country
a. Life expectancy at age 1
b. GDP = C + I + G + (X-M)
b. Infant mortality
c. GDP derived is at market priced value, where
c. Literacy rates
output value is distorted by net taxes (taxes –
2. Measure of Economic Welfare (MEW)
subsidies). Taxes are removed and subsidies are
a. Value of leisure
included to convert to factor cost value.
b. Value of non-marketed activities
Accounting Concepts c. Discounting for externalities
3. Human Development Index (HDI)
Gross vs Net a. Life expentancy
b. Literacy
1. Capital replacement is needed for depreciation of existing c. PPP-adjusted GNP per capita
capital assets
2. Net investment = Gross investment – Depreciation Theories of Trade

Market Prices vs Factor Costs Theory of Absolute Advantage

1. Market prices show the valuation at prices actually paid on 1. Countries export goods which they can produce cheaper and
the market import goods which other countries can produce cheaper
2. Factor cost shows the factor incomes generated from the 2. Limitation: No free trade if one country can produce all the
production of goods and services goods cheaper
3. GDP at Factor Cost = GDP at Market Prices – Indirect Taxes +
Subsidies Theory of Comparative Advantage

Personal Income 1. Countries export goods which they have a relative cost
advantage and import goods which they have a cost
1. Personal Disposable Income = Personal Income – Taxes disadvantage
2. Relative cost = Opportunity cost
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3. As long as a country finds it cheaper to import a good from 2. Weights assigned to the currencies reflect the relative
another country than producing it at home, imports will importance of each country in trade
continue – as long as import price < domestic opportunity
cost Main Exchange Rate Regimes
4. Dynamic, not static concept
1. Free floating
2. Fixed
3. Managed float system

Free Floating

1. Appreciation
a. An increase in the external value of the domestic
currency
2. Depreciation
a. A decrease in the external value of the domestic
currency

Fixed

1. Revaluation
2. Devaluation

Benefits of Comparative Advantage

Factors of Demand of Currency

1. Whole world enjoy greater number of goods

1. Foreign demand for country’s exports
2. Each country enjoys more of both goods (consume outside of
2. Foreign investments in the country
PPC)
3. Short term capital inflows

Free Trade
Factors of Supply of Currency

Benefits of Free Trade

1. Imports
2. Local firms investing overseas
1. Consumption above PPC
3. Short term capital outflows
2. Competition will improve efficiency
3. Competition will lower prices
NB. Demand of Domestic Currency Determined by
4. Economies of scale
5. Larger consumer surplus 1. Factors affecting export performance
6. Reduces monopoly power in country 2. Factors affecting inflow of foreign direct investments

Problems of Free Trade Factors Affecting Exchange Rate

1. Vulnerability to external economic conditions 1. Relative rates of inflation

2. Unemployment if country has over-specialisation 2. Relative rates of interest
a. Structural unemployment 3. Relative investment climate
3. Unfair trade practices 4. Structural changes in pattern of trade
4. Speed up exhaustion of irreplaceable natural resources 5. Expectations
6. Country’s economic fundamentals
Reasons why Real World not Fully Practising Comparative
7. Relative rates of growth
Advantage

1. Resources are not perfectly mobile

2. Developing countries are gaining comparative advantage at a
rapid rate
3. Value incompatibility between goods

Balance of Payments

Structure of BOP

1. Current account
2. Capital account

Position of BOP

1. Surplus BOP – Net gain of foreign currencies

2. Deficit BOP – Net loss of foreign currencies

Factors to Assess a Country

1. Trade balance
2. Current account balance
3. Capital account balance (net official reserves transactions)
4. Overall BOP

Foreign Exchange

Trade-weighted Exchange Rate

1. The average exchange rate of a currency with respect to a

basket of currencies express as an index