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01–OCTOBER 2014
MONTHLY NEWSLETTER
SpotNomics
Department of Economics
Content Editor: Dr. E. Azzopardi
National Income
Contributor: Mr. P. Libreri
This Issue
Great Economic Thinkers
National Income and its Measurement
GDP, standard of living and welfare
Great
Economic
Thinkers
Amartya Sen
Amartya Kumar Sen (born 3 November 1933), is an
Indian economist and philosopher who since 1972 has
taught and worked in the United Kingdom and the United States. He has made contributions to welfare economics, social choice theory, economic and social justice, economic theories of famines, and indexes of the
measure of well-being of citizens of developing countries. He was awarded the Nobel Memorial Prize in
Economic Sciences in 1998 for his work in welfare economics.
He is currently the Thomas W. Lamont University Professor and Professor of Economics and Philosophy
at Harvard University. He serves as the chancellor
of Nalanda University. He is also a senior fellow at
the Harvard Society of Fellows, distinguished fellow
of All Souls College, Oxford and a Fellow of Trinity
College, Cambridge, where he previously served as
Master from 1998 to 2004. He is also known for being
one of the strongest champions of rationalism, secularism and egalitarianism in India, and has condemned the
unfortunate ghettoization of Ambedkar as a Dalit leader.
Born: 3 November 1933, Santiniketan, India
Affiliation at the time of the award: Trinity College,
Cambridge, United Kingdom
Prize motivation: "for his contributions to welfare economics"
Field: welfare economics
Contribution: Research on fundamental problems in
welfare economics. Studies of social choice, welfare
measurement, and poverty.
(Source: www.nobelprize.org)
National income accounting deals with the aggregate measure of
the outcome of economic activities. The most common measure
of the aggregate production in an economy is Gross Domestic
Product (GDP). It is the market value of all final goods and services produced in an economy within a given period of time
(typically a year), whether or not those goods are sold to the final
consumer. It does not matter who owns the resources as long as it
is contained within the geographical border of a country. What is
happening to the GDP of a country over time is an important indicator of how well the economy is performing.
(Source - www.econport.org).
As can be observed from the Circular Flow of Income model:
National Output ≡ National Income ≡ National Expenditure
The GDP of a country can be measured by aggregating the value
added of output of all productive economic sectors (Output method); Total factor incomes earned by the factors of production
such as labour (Income method); Aggregate Expenditure, that is
summarised as C+I+G+Xn. where C is consumption spending, I is
investment spending by the private sector, G is total government
direct spending and Xn represents net exports (exports less imports). The difference between GDP and Gross National Product
(GNP) is Net Property Income from Abroad (net flows of factor
income to/from abroad).
GROSS DOMESTIC PRODUCT, STANDARD OF LIVING
AND WELFARE
Standard of living or material living standards are usually indicated by the GDP per capita. GDP per capita =
GDP/Total population.
Moreover, to eliminate the effects of inflation and allow a more realistic comparison between years, Real GDP per
capita is used. Real GDP is obtained by dividing Nominal GDP by a GDP Deflator.
However, Real GDP per capita is just an indicator and not an accurate measure of material living standards:
 GDP per capita is just an average. One must also consider the distribution of income in a country. For example
the Gini coefficient is used for this purpose.
 GDP figures understate the real level of national income due to the black economy. For example Malta’s black
economy is estimated around 25% of declared GDP.
 GDP figures also understate national income because they ignore the value of non-marketed output such as self
provided services.
 To make direct comparisons between different countries GDP figures have to be converted into a common currency such as the $US or €. Such conversions distort the GDP figures so the Purchasing Power Parity (PPP) rate
can be more appropriate. The PPP removes distortions in currency conversion by adjusting for price differentials
between countries.
 One must also consider that production is not made up consumption goods only. Standard of living is closely
linked to consumption levels. As significant part of national production is capital output. These are included in
GDP figures but do not directly contribute to current levels of material living standards.
While Real GDP per capita is indeed a good indicator of material living standards, welfare or wellbeing in a country
may be poorly reflected by such GDP statistics alone:
 Environmental factors. One must consider the severe impact on the wellbeing of the population of environmental
factors such as air and water quality, access to green spaces, preservation of biodiversity, traffic congestion and
over development. So in the case of Malta one must factor in such factors besides real GDP per capita to gauge
the level of wellbeing.
 Educational factors. It is important to consider educational factors such as literacy as well as numeracy skills of
the population. Increasingly important is also computer or IT skills. Important statistics are the number of students at primary, secondary and tertiary levels. Also the availability of educational institutions or the number of
teachers per ‘000 of the population.
 Health factors. This is a vital aspect of a country’s level of welfare or wellbeing. One must consider the access to
adequate healthcare facilities and in the case of Malta it places special weight on public healthcare services. Such
indicators as life expectancy and infant mortality rates are used with respect of healthcare services and their impacts on peoples’ wellbeing. Another example is having a relatively high per capita GDP but also a high rate of
obesity and lack of physical activity leading to high rates of heart disease and related deaths.
 Social factors. GDP per capita increases over time may hide underlying deterioration of the social environment.
Social ills such as crime, drug and alcohol abuse, violence and higher suicide rates may in fact indicate that while
GDP is rising the welfare and quality of life are declining.
 The real GDP per capital on its own does not reflect the extent of welfare provision in a country. Some countries
may have a lower real GDP per capita but a strong welfare state which is either “from the cradle to the grave” or
“from the womb to the tomb.”
The United Nations uses the Human Development Index (HDI) to assess the level of growth and development
in different countries.
The HDI includes the following factors:
 A decent standard of living as shown by the GDP per capita.
 Average life expectancy at birth to reflect quality of life (especially health).
 Knowledge levels of the population as reflected for example by the adult literacy rate.
Another indicator of living standards and development is the Index of Sustainable Development (ISEW).
The ISEW adjusts GDP figures by accounting for the decline in natural resources in bringing about growth in the
GDP and also the money spent on the correction of the negative externalities brought about the same increase in
GDP. By taking these factors into account it is hoped that this index gives a better indication of sustainable living
standards in the future.
Source: Anforme Economics Revision Guide