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National income accounting
(NIA)

is the measurement of indicators of
national output/income; .e.g. GDP,
GNP
Circular flow diagram


summarizes the transactions between
the different economic agents
agents: households, firms (business),
government, and foreigners (rest of
the world)
Circular flow diagram



Assumption: The economy composed of
households and firms only
Households: own factors of production,
consume goods and service
Firms: hire factors of production to produce
goods and services
payments for goods and services
goods and services
FIRMS
HOUSEHOLDS
factor services
factor payments
(wages, interest, rent, profit)
FIGURE 8.1. Circular flow diagram. The diagram above represents the transactions between
firms and households in a simple economy.
In the upper loop, the arrow emanating from firms to households represents the sale by firms of
goods and services to households. On the other hand, the arrow from households to firms
represents the payments.
n the lower loop, the arrow originating from the households to the firms shows that firms hire
labor and capital from households in order to produce goods and services. The arrow
emanating from the firms indicates their payments for the use of the factors of production.
Revenue
(=GDP)
Good and
services sold
Spending
(=GDP)
MARKETS FOR
GOODS AND
SERVICES
Good and
services
bought
HOUSEHOLDS
FIRMS
Inputs for
Production
MARKETS FOR
FACTORS OF
PRODUCTION
Land, labor
and capital
Wages, rent,
interest and
profit (=GDP)
Income (=GDP)
Flow of goods & services
Flow of money: pesos
THE CIRCULAR FLOW DIAGRAM
Circular flow diagram



Assumption: The economy composed
of households and firms only
Households: own factors of
production, consume goods and
service
Firms: hire factors of production to
produce goods and services
Circular flow diagram


Upper loop of the circular flow
diagram: transactions in the goods
and services markets
Lower loop: transactions in the factor
markets
With government and
foreign agents

Need to account for :
a. Government purchases of goods and services.
b. Government payments for factor services
(wages, rent, interest).
c. Transfer payments between different agents.
d. Firms and households pay taxes to
government.
e. Taxes paid on income, property, goods and
services.
f. Transactions with the foreign sector.
Transfer payments


Transfer payments – are transactions
wherein one party is not obliged to
deliver a good or service in return for
the payment.
Examples: retirement benefits,
unemployment benefits, scholarships,
and donations.
Transactions with foreign
sector



Includes sales of goods and services,
assets, and transfers
Exports - sales of domestically
produced goods to other countries
Imports - goods bought from other
countries
Measurement of economy’s output:
The Gross Domestic Product (GDP)



The GDP measures the market value of all final
goods and services produced within an economy in
a given period.
GDP only measures current production. Transfer
payments and transactions involving goods
produced in other periods are not included in the
calculation of GDP.
GDP is usually expressed in the currency of a
particular country, e.g., Philippine peso….indicates
the market value of the goods and services
Definition of GDP


The market value of good i (Vi) is
equal to PiQi
GDP = sum of the market values
of all final goods and services
produced within the year.
GDP 
n
n
 V  P
i1
i
i1
i
 Qi
GDP includes final goods
and services only

Final goods - goods and services that are
not purchased for the purpose of producing
other goods and services or for resale
– Eg. Rice (final) and palay or unhusked rice
(intermediate product)

Including intermediate goods and final
goods will result in “double counting”.
3 Approaches for
measuring GDP
1. Expenditure Approach (upper loop) –
measures GDP as the sum of expenditures
on final goods and services.
2. Income Approach (lower loop) – measures
GDP as the sum of incomes of factors of
production (wages, rent, interest and
profit.
3. Value-added Approach – measures GDP as
the sum of value added at each stage of
production (from initial to final stage)
Expenditure Approach


Uses the upper loop of the circular flow
diagram.
Example: Suppose the economy has
only one product, namely, rice.
Good
Rice
Price per
unit
Q sold
Expenditure
20
1000
20,000
GDP
20,000
Income Approach


Uses the lower loop of the circular flow diagram: sum of payments
to the various factors of production.
Suppose that in the production of rice the sales and expenses are as
follows:
Sales
P 20,000
Expenses:
Wages
8000
Rent
4000
Interest
2000
Total
Profit
GDP=Sum of Payments to
factors
14,000
6,000
20,000
P 20,000
Value Added Approach

Suppose that rice is the only final product of an
economy: It goes through several (3) stages of
production.
Stage of Prod’n
Value of
intermediate
good
Farmer - Palay
Value of
Sales
Value-added
12,000
12,000
Rice Miller -Milled
Rice
12,000
15,000
3,000
Retailers - Rice
15,000
20,000
5,000
GDP= Total Value
Added
20,000
Notes of the 3 approaches




The expenditure approach, income approach, and the valueadded approach all come up with the same estimate of the
GDP. They are equivalent approaches.
In the income approach, profit is also considered a payment
to the entrepreneur. So the incomes are (1) wages, (2) rent,
(3) interest, and (4) profit. Profit adjusts to make the sum
equal to the final value of the good.
In the value added approach, only the value added in each
stage of production are included. If we add the value of
intermediate product with the value of the final product, we
commit the sin of “double-counting.”
At each stage of production, the value-added is equal to
wages, interest, rent, and profit. Therefore the value of the
final product is likewise the same of all payments to the
factors of production.
Additional Topics



GDP vs GNP
Real vs current GDP
Inter-country comparisons of GDP
– Convert to international currency like US
dollars
– Convert to per capita measures
THE NATIONAL ACCOUNTS OF THE
PHILIPPINES


same principles as above but need to make
adjustments in order to accommodate the
realities in modern economies
Expenditure approach
– GDP = C + G + I + X –M+ SD
Table. Expenditures on GDP, 2002 in million pesos.
Item
Symbol
Value
Personal Consumption
Expenditure
C
2,750,9000
Government Consumption
Expenditure
G
488,700
Gross Domestic Capital Formation
I
776,200
Exports of Goods and Services
X
1,968,500
Less: Imports of Goods and
Services
M
1,989,100
Statistical Discrepancy
SD
27,500
GDP
4,022,700
Gross Domestic Product
Expenditure Approach






C - spending of households and private non-profit institutions on
goods and services
– Non-durables - goods and services that are consumed rapidly
– Durable goods - that last for a longer period of time
I - investment spending of domestic agents. Its major components
are “changes in” Fixed Capital and Changes in Stocks
G - government’s payments for the salaries of its workforce as well as
purchases of goods and services  used for the government’s day to
day operations and projects.
X - the spending of the rest of the world on goods and non-factor
services produced in the country
Mthe country’s purchases of goods and non-factor services
from the rest of the world.
SD - accounts for accounting and reporting errors in the accounts.
Needed to ensure that GDP value from all approaches are the same
Income Approach
ITEMS
SYMBOLS
VALUE
Compensation of
Employees
Net Operating Surplus
COE
1,093,800
NOS
2,215,100
Depreciation
Indirect Business Taxes less
Subsidies
Gross Domestic Product
D
IBTS
357,200
356,600
GDP
4,022,700
Income Approach






GDP = COE + NOS + D + IBTS
In a simple world, GDP = COE + NOS. In practice,
require two adjustments (D and IBTS)
D - accounts for the wear and tear of physical capital
“D” is treated as a business cost  not included in NOS.
However, “D” is part of “I” in the expenditure side of the
national accounts
IBTS - includes taxes on the use or purchase goods and
services and grants from government to firms. E. g
sales taxes, value added tax
Not included in NOS but is part of the market prices, of
which the items in the expenditure accounts are quoted
Value added or Industrial Origin approach

GDP = value added of different activities (sectors)
ITEM
Agriculture, Fishery and
Forestry
VALUE
519,400
Industry
1,307,400
Services
2,123,900
Gross Domestic Product
4,022,700
The distinction between GDP and
GNP


GNP = GDP + Net Factor Income from
the Rest of the World (NFIRW)
NFIRW - measures the difference
between the earnings of Philippine
residents in other countries and
foreign residents in the Philippines
The distinction between GDP and
GNP
Gross Domestic Product
Net Factor Income from the
Rest of the World
Gross National Product
GDP
NFIRW
GNP
4,022,700
267,500
4,290,200
Nominal and Real GDP




GDP at current prices or nominal GDP - GDP
measured using the prices of the year for which it is
calculated
Nominal GDP can be a misleading indicator of
changes in output or income because it also
embodies changes in the prices of goods and
services.
Real GDP or GDP at constant prices  measures the
total value of output using the prices of a selected
year (the base year).
Real GDP better for analysis overtime because it
eliminates the effects of price changes
Table 8.5
YEAR 1
YEAR 2
QUANTITY
Ice Cream
100
100
Buko Pie
100
100
Ice Cream
50
100
Buko Pie
100
200
Ice Cream
5,000
10,000
Buko Pie
10,000
20,000
15,000
30,000
PRICE
VALUE
NOMINAL GDP




GDPyear 1 = (100) (50) + (100) (100) = 15,000
GDPyear 2 = (100) (50) + (100) (100) = 15,000
In practice, calculating real GDP using the previous
approach is a tedious process because there are so
many goods and services are produced in an
economy. Can simplify the calculation process by
using the GDP deflator.
GDP deflator - a price index that allows us to
convert nominal GDP into real GDP. (note: price
index to be defined later)
Real GDP
Nominal GDP
Real GDP 
 100.
GDP deflator
Calculation of Real GDP
Item
1990
1998
2002
GDP at current
prices (million
PhP)
1,072,000
2,665,100
4,022,700
GDP deflator (base
year 1985)
149.5
300.1
384.6
GDP at constant
prices (million
PhP)
720,700
888,000
1,046,100
GDP Deflator, (1985=100), Philippines
500.0
450.0
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Inflation Rate, Philippines
18.0
16.0
percent per year
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
GNP for cross country comparisons


Convert a country’s GNP to US dollars,
or some common currency, by using
the country’s exchange rate
When comparing income across
countries, it also makes sense to use
per capita estimates  eliminates
differences in population size. E.g.
(data is for 1998)
Personal Disposable Income



Personal disposable income represents the
income that households are free to spend or
save.
It excludes the components of national
income that do not accrue directly to
households.
It also includes a few items that are not part
of national income but nonetheless
influence the amount of income that
households can spend.
Some Limitations of GDP or
GNP as measures of growth




Ignores income distribution
Ignores environmental degradation
Does not include activities that do not
go through the formal markets sectors
Does not include “illegal” activities like
drug trafficking, prostitution,
moonlighting