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National Income Accounting Lecture2 What is National Income? National income is defined as the total value of all goods and services produced within a country in a particular period usually 1 year. National Income definition The national income is a sum of monetary values that are obtained by individuals as a result of contributing to the production process Factors of production land labor Factors of production rent wages Payment + + capital entrepreneurial ability interest + National income profit + The importance of computing National Income The Economy Income and Expenditure For an economy as a whole, income must equal expenditure (aggregate demand) because: Every transaction has a buyer and a seller. Every dollar of spending by some buyer is a dollar of income for some seller. This process can be seen using a Circular Flow Diagram. The Circular-Flow income diagram (two sectors) Revenue Goods & Services sold Market for Goods and Services Firms Inputs for production Wages, rent, and profit Spending Goods & Services bought Households Market for Factors of Production Labor, land, and capital Income The Circular-Flow Income diagram National output from goods and services National income(factors of production income) The Circular-Flow Income diagram (Four Sectors) Consumers Producers Consumption spending (C) Taxation (T) Spending (G) Government Sector Imports (M) Exports (X) External world Sector Gross National Product Gross national product (GNP) :It is the total market value of all final goods and services produced within a country in a given period of time. National Product National product :It is the total market value of all goods and services produced within a country in a given period of time. What Is Counted and Not Counted in GNP? What is counted in the GNP Non-Market Activities : Goods and services that are produced and consumed at home and that never enter the marketplace. What is not counted in the GNP: Transfer payments. For example, social security and pensions. Unpaid and domestic activities. (example: If you cut your grass or paint your house…) Methods of measuring GNP To avoid the double account of GNP we will use the value-added approach Value-added Approach: measures GNP as the sum of value added at each stage of production (from initial to final stage) V.A = value of sales – value of intermediate goods Value Added Approach Example1: Suppose that bread is the only final good of an economy: It goes through several (3) stages of production. Stage of Production Value of Sales Value of intermediate good Wheat 700 0 Flour 1000 700 Bread 2000 1000 National output Value-added Value Added Approach Example2: Suppose that there are three final products of an economy: It goes through several (3) stages of production. Wheat value :700 final product Sales :200 The rest is used in the production of flour Flour value:800 final product Sales :150 The rest is used in the production of bread which Bread value sales :1000 Stage of Production Value of Sales Value of intermediate good Wheat 700 0 Flour 800 Bread 1000 National output Value-added Expenditure Approach Expenditure Approach: measures GNP as the sum of expenditures on final goods and services. GNP =C + I + G + (X - M) GDP n n V P i1 i i1 i Qi Direct and Indirect Taxes taxes – Direct taxes are applied to property, Tax liability cannot be passed onto someone else. (Example: income tax, business profit taxes..) Indirect taxes – an indirect tax can be passed on from the designate to the final consumer.(example: VAT, consumption, production, import and export…) Direct Gross investment / Net investment Gross investment represents additions to the stock of durable capital goods (buildings, equipment, inventories) during a year that increase production possibilities in the future. Depreciation measures the amount of capital that has been used up in a year. Net investment = gross investment depreciation Expenditure Approach Example: Suppose the economy has only one product, namely, rice. Good Price per unit Q sold Expenditure Rice 20 1000 20000 GDP 20000 Income Approach Income Approach: measures GNP as the sum of incomes of factors of production (wages, rent, interest and profit). Notice: we are computing GNP using the income approach .we need to add Indirect Taxes and Depreciation Income Approach (continued) GNP = rent + wages + interest + profit + indirect taxes + depreciation GNP = National Income + indirect taxes + depreciation Example: Suppose that in the production of rice the sales and expenses are as follows: Sales 20,000 Expenses: Wages 8000 Rent 2000 Interest 1500 Profit 6000 Indirect taxes 1000 Depreciation 1500 GNP=Sum of Payments to factors 20,000 20,000 Other Measures of Income Gross Domestic Product (GDP) Nominal and Real GDP Personal Income Disposable Personal Income Gross Domestic Product (GDP) GDP is geographically focused, including only output produced within a nation’s borders regardless of whose factors are used GDP = GNP - Net external(foreign) income Real and Nominal GDP Nominal GDP the production values of goods and services at current prices. Real GDP the production values of goods and services at constant prices. Computing Real GDP The general formula for computing real GDP is: nominal GDP in year t Real GDP in year t price index The price index represents a price level change as an index with a base of 100 100 percentage change price index 100 Net Domestic Product Net domestic product (NDP): GDP less depreciation NDP GDP – depreciation The amount of output we could consume without reducing our stock of capital Personal Income Personal income (PI): Income received by households before payment of personal taxes PI = NI – profits taxes – social security taxes – reserves +transfer payments Disposable Personal Income All disposable income is either consumed or saved DI personal income – personal taxes DI consumption saving
