Download The National Income Accounts: Measuring the

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The National Income Accounts: Measuring the Circular Flow of Income
National Income: is the sum total of all final goods and services
produced within an economy in a year and measured in money
terms.
‘Flow’ versus ‘stock’: because it is measured over time, national income is a ‘flow’. A
‘stock’ is a measure at a point of time. So your own personal wealth is a stock concept- it
is the sum of all things of an economic value that you own at a point of time whereas
personal income is a flow concept as it is a measure of your total income from wages,
interest, rent and profit over a period of time.
Task: Place the following financial terms as a flow or stock concept:
Rent of house, pocket money, value of stock held by business, debt of a country, value of
mortgage, business revenue, business profit, value of capital in an economy, capital
investment, personal savings
FLOW CONCEPTS:
STOCK CONCEPTS:
The circular flow of income is a simple model of the economy showing flows of goods
and services and factors of production between firms and households. In the absence of
government and international trade this simple model shows that households provide the
factors of production for firms who produce goods and services. In return the factors of
production receive factor payments, such as wages, which in turn are spent on the output
of firms. This basic flow is shown in the diagram below.
The Circular Flow of Income
In reality the households do not spend all their current income. Some is saved. This
represents a leakage from the circular flow. In addition to the consumer spending, firms
also carry out investment spending. This is an injection to the circular flow of income, as
it does not originate from consumers' current income.
In the real world the government and international trade sectors must also be included.
Economic systems are in reality five sector open economies. Consequently there will be
additional leakages and injections. Government spending will be ____________ into the
circular flow and __________ will leak from it. Export flows will be injected and imports
flows leaked. A full circular flow with leakages and injections is shown below.
The Circular Flow of Income with leakages and injections
Measuring national income
National income accounting is the process whereby countries attempt to measure these
flows of INCOME = EXPENDITURE = OUTPUT. The result of each of the three
methods is the Gross Domestic Product. An examination of the national income
accounts gives an insight into the economy.
To measure how much output, spending and income has been generated we use National
Income accounts. These accounts measure the:
1. Total value of the output of goods and services produced in an economy
2. Total amount of expenditure taking place in an economy
3. Total amount of income generated through production of goods and services
National Income is a term used to measure the monetary value of the flow of output of
goods and services produced within the economy over a period of time. Measuring the
level and rate of growth of National Income (Y) is important to economists when they are
considering:



The rate of economic growth and where the economy is in the business cycle
Changes to overall living standards of the population
Looking at the distribution of national income (i.e. measuring income and wealth
inequalities)
The three measures of National Income are not only equal; they must be equal; by the
way they are defined. In practice there are many errors and omissions in attempts to
measure National Income. However they must always be equal by definition and a figure
for error is included to make them equal.
National Income = National Output = National Expenditure
Income (wages)
=
Output (goods)
=
Expenditure (household)
GDP (GROSS DOMESTIC PRODUCT) measures the value of output of final goods
and services produced within the domestic boundaries of a country over a period of
time. When people talk of the National Income of Hong Kong, or any other country, they
often refer to GDP.
The Methods:
i) The Expenditure Method (Aggregate Demand)
This is the sum of the final expenditure on final goods and services measured at current
market prices. The full equation for GDP using this approach is
GDP = C + I + G + (X-M)
C: Household spending (Consumption)
I: Capital Investment spending (by firms)
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services
ii) The Income Method (Sum of Factor Incomes)
Here GDP is the sum of the final incomes earned through the production of goods and
services and earned by the owners of land, labour, capital and enterprise.
Gross Domestic Product (by factor income) = _________ from employment and selfemployment + ___________ of companies + _________ income for the productive use
of land resources + ___________ income for the productive use of capital
Only factor incomes generated through the production of output are included in the
calculation of GDP by the income approach. Therefore, we exclude from the accounts the
following items
:
 Transfer payments (e.g. the state pension, unemployment benefit)
 Private Transfers of money from one individual to another
 Income that is not registered with the government (The parallel economy where
goods and services are exchanged but the value of these transactions is hidden
from the authorities and therefore does not show up in the official statistics)
iii) The Output Method
This measures the value of output produced by each of the productive sectors in the
economy. Only the value of final goods and services are added. We use this approach to
avoid the problems of double-counting the value of intermediate inputs such as the value
of steel used in making cars or flour used in making bread at a bakery. The main sectors
of the economy are the service industries, manufacturing and construction, and extractive
industries such as mining and agriculture
Some distinctions in National Income accounting
‘Gross’ National Income and ‘Net’ National Income
Gross ‘National’ Income and Gross ‘Domestic’ Income
The flow of income into the country from Chinese companies operating abroad
minus the flow of foreign profits leaving China is call NET PROPERTY INCOME
FROM ABROAD.
GNP = GDP + net property income from abroad
‘Nominal’ National Income and ‘Real’ National Income
Real GDP = Nominal GDP adjusted for inflation
Total and per capita