National Income

National Income Accounting

Introduction
National income accounting provides us with ex-post data about national income, it cannot explain the level and determinants of national income. The following identities are true for any level of income. In order to explain and predict the level of national income, models are constructed.
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Factor Market

Product Market

Factor services

Goods & services

Real Flow

Factor Owners

Firm
Money Flow

Consumers

Factor Income

Cost

Revenue

Expenditure

The flow of economic activities in a 2-sector economy

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GNP v.s. GDP

Gross National Product (GNP) The total value at market prices of final goods and services produced by the citizens in an economy in a specified period. Gross Domestic Product (GDP) The total value at market prices of final goods and services produced within the domestic boundary of a territory in a specified period
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GNP & GDP

Flow concept
Resale of existing houses

Sale of used cars / existing shares Commission / Brokers fee

Imputed rents of owner-occupied dwellings Capital gain is not income (Irving Fisher) Only the interest earned from the capital gain is considered as income
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Real GNP & Nominal GNP & Per capita GNP

Real GNP=(Nominal GNP/GNP Deflator)*100 Per capita GNP = GNP / Population size

Measurement of National Income

Income Approach NNP at factor cost OR National Income Output Approach GDP at factor cost Expenditure Approach GDP at market Prices

Expenditure Approach
C+I+G+X-M GDP at market price Indirect sales tax + Indirect subsidies GDP at factor cost + Net income from abroad GNP at factor cost Depreciation NNP at factor cost

Output Approach

Factor Income- Factor Income from abroad paid abroad

Income Approach W+I+R+P

NNP at factor cost Retained profits Social insurance / Mandatory Provident Fund Direct business Tax +

Transfer payments
Personal income Direct personal taxes Disposable personal income - Consumption = Saving
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Income Approach
W+I+R+P = NNP at factor cost Profits are stated net of depreciation / capital consumption allowances If the figures exclude net income from abroad, NDP at factor cost can be obtained.
NDP at factor cost + Net income from abroad =

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Output Approach
The total value of the final goods and services produced by the primary / secondary / tertiary industries In order to avoid double counting, the value-added method is adopted to exclude intermediate goods.
GDP at factor cost + Indirect Taxes Indirect Subsidies =

Distinguish between Indirect / Direct / Business / Personal Taxes

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Expenditure Approach
People spend their income. Thus, the total expenditure on final goods and services must be equal to the total value of final goods and services produced domestically. Any output that is not sold to consumers is bought by producers in the form of unintended inventory investment.
C+I+G+(X-M) = Aggregate / Total expenditure

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Private Consumption Expenditure (C) Gross Investment Expenditure (I)

Expenditure Approach

Firms : plant (in progress) / unused raw materials Households : residential building Inventory investment : intended unintended (reduce information cost)

- gross domestic fixed capital formation* - change in stocks & work in progress *gross national fixed capital formation GNP Government Expenditure (G)

at market prices

roads/education/medical & health services/law & order/public works/

salary to civil servants, NOT transfer payments at the cost to taxpayers, NOT at market prices Net Exports (X-M) the value of imports is included in C, I, G, X Exports include domestic exports & re-exports
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Items excluded from National Income Accounting

Second-hand goods Intermediate goods Non-marketed goods / services
Volunteer work / Housework

Unreported / Illegal market transactions

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Merits & Uses of National Income Statistics

Reflecting & comparing the standards of living of different countries Per capita real GNP standard of living Providing information to the government and firms for economic planning Reflecting the economic growth of a country % change in real GNP over a period of time

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Limitations of National Income Statistics

Factors that may understate the standard of living / the welfare Exclusion of the value of leisure
Same Q produced with fewer working hours higher welfare

Exclusion of non-marketed / unreported transactions

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Limitations of National Income Statistics

Factors that may overstate the standard of living / the welfare Undesirable Side-effects of Production Air pollution / traffic congestion / Understate the real / social costs to society externality /divergence between social costs & private costs
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When comparing economic performances using national income statistics,

Price Level
use real GNP eliminate the effect of inflation

Size of Population
use per capital GNP

Income Distribution
more even distribution higher welfare

Composition of National income

more consumption, less national defence higher welfare

Exchange Rates
expressed in the same currency whether the exchange rates reflects the purchasing power of the 2 currencies
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Inflation
A general and sustained increase in the prices of all goods and services GNP deflator / GDP deflator Consumer Price Index (CPI) Producer Price Index (PPI) When constructing price indices different weighting will be given to different commodities reflecting their relative importance on the consumers expenditure A base year is chosen during which the economy experiences no economic crisis
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Calculating a Price Index

Item Expenditure Weight 1991 Prices 1991 Price Relatives 1991 Prices Price 1992 Relatives 1992
Transport

1000 2000 3000 4000

10 20 30 40

15 100 500 200

100 100 100 100

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100

Clothing

100 100 650 130 220 110

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Housing

Food

Calculating a Price Index (contd)

Price Index in 1991 =0.1*100+0.2*100+0.3*100+0.4*100 =100 Price Index in 1992 = = The general price level in 1992 has increased by % Only persistent increase in the price indices implies inflation
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Consumer Price Indices

Only consumer goods are included Persistent increase in the CPI implies an increase in the cost of living unless there is a compensating rise in money income CPI(A), CPI(B), HSCPI are constructed to measure the change in the cost of living of different income groups since they have different consumption patterns. Different weights are assigned to different categories of goods to reflect their relative importance.
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In the following table, the real income is increasing, this implies that the standard of living is also increasing for a typical citizen Year CPI Nominal Real income income

Uses of the CPI

1991
1992 Base year 1993

90
100 105

7650
8820 9555

8500 =(7650/90)*100 8820 = 9100 =

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Limitations of the CPI

Only consumer goods are included
CANNOT reflect the inflation rate accurately

Change in consumption pattern

the weights are fixed misleading

Change in quality of goods

CPI due to better quality overstate inflation

Possibility of Substitution
overstate the impact of inflation if consumers substitute cheaper goods for dearer goods
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To measure inflation, this is a better indicator as it has a wider coverage of commodities

Implicit GNP Deflator

GNP deflator Inflation Rate between .
90 100 121

Year
1990 1991 1992

1991 &1992 [(121-100)/100]*100% = 21%

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Unemployment
Working Population OR Labour Force
Working Population=Employed+Unemployed+Self-employed

Un-employment Rate =(Unemployed/Labour Force)*100% Under-employment Rate

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Method of Analysis
Endogenous variable the value of the variable is determined inside the model ( x, y) Exogenous variable the value of the variable is determined by forces outside the model ( m, c) any change is regarded as autonomous
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C=f(Y) I=f(Y)

Y C=a I=I*

Y C=a+cY I=I*+iY C=a+cY

Y
C=c*Y
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