National Accounting & Role of Governments

What is Macro Economics?

Macro Economics is the study of the aggregated effects of decisions of individual economic
units.
It looks at a complete national economy as a whole.
An economy include the following units in it,
o Households
o Business firms
o Government
o Foreign Sector

Macro-Economic Objectives
An economy as a whole will have the following objectives to achieve.
 Economic Growth
 Economic Stability
 Full Employment
 Price Stability
 Financial System Stability
 Balance of Payment Stability

Price Stability
To achieve price stability it is necessary to manage the economy without inflationary or
deflationary pressures. Average price level in the economy is considered as stable when economy
experiences very lower rates of inflation.
Full Employment
An economy achieves full employment level when all the resources in the economy are utilized in
the full with maximum efficiency. When aiming at achieving full employment level it is necessary
to minimize labour unemployment by increasing employment opportunities.
Equilibrium in Balance of Payment (BOP)
In order to achieve Balance of Payment equilibrium it is important to manage the economy without
Balance of Payment crises when having exchanges across the boundaries.
Fair distribution of income
Ensuring fair levels of income distribution among its population, a country is able to achieve
equality. Income and wealth should be distributed in a way to ensure that every citizen of a country
should have the ability to fulfill his/her wants and needs.
Sustainable Development
Enhancing the levels of production while protecting the quality of environment and also ensuring
that benefits of development are distributed among the population, a country is able to achieve
sustainable development. All aspects of development such as environment, economy and social is
sustainable development.
Economic Growth
Continuous increase in a country’s Gross National Product (GNP) is identified as Economic
Growth

Business Cycle/ Trade Cycle

The Short Run and Long run Behavior of an economy can be explained through a Business
Cycle. The Straight Line shows the potential output of an Economy where the economy uses all
the resources efficiently.
 1. Peak : - Peak is considered as the top of the business cycle. In other words it is
the highest point on national output.
2. Recession : - It is the time period where the total domestic production continuously
coming down for a period of 6 months. If this situation persists over a time period of 1 year
it is called a Depression.
3. Trough : - It is the point where the Recession ends and Economy starts growing.
4. Expansion : - It is the period where the national production increasing gradually.
During this time Economic Growth will be at Satisfactory Level.

Boom
 During the boom, the production capacity and labour will be fully utilised.
 This will create a rise in demand and can lead to shortage in resources
 Further increase in demand leads to rise in price
 Investments will rise creating more opportunities for the businesses
Recession
 During recession, demand and investment starts to fall
 Projects become unprofitable
 Inventory level will fall and businesses fail
 Production falls and unemployment increases
Trough
 Depression is the extreme of recession
 There will be no stimulus for aggregate demand
Expansion
 After Depression, economy starts to recover
 The employment and production starts to rise gradually
 Expectations of business rise leading to increase in investment
 Profits and sales starts to rise and increase in demand may lead to rise in price level slowly
Circular flow of Income

Firms must pay households for the factors of production; this generally means that firms
pay wages to members of households. Households must pay firms for goods and services. The
income of firms is the sales revenue from the sales of goods and services.
Households earn income because they have provided labor which enables firms to provide
goods and services. The income earned is used as expenditure on these goods and services that are
made.
This is a basic closed economy, without foreign trade. It assumes the economy has only
two sectors (firms and households), with no government intervention and no imports or exports.
When the government enters the economy, it collects the taxes from the households and
firms and provide subsidies.
Further the involvement of the foreign sector influences the flow of incomes through the
imports and exports
Household Sector
Households own all the factors of production in an economy, i.e. land, labour, capital and
entrepreneurial ability and they earn income by supplying these factors of production to firms.
Income so generated is spent by the households to purchase goods and services produced by the
firms. Households pay taxes to the government and obtain benefit from common services and
transfer payments provided by the government. Household sector generate savings too, in an
economy.
Business Sector
Private and government establishments that produce goods and offer services for sale utilizing the
factors of production offered by households with the intention of generating profits are identified
as business sector. Part of the profit generated is reinvested and part is used to pay government
taxes and another part is set apart to pay dividends if it is a public limited organization.
Government Sector
Government institutions that provide law and order, national security, education & health services,
public welfare categorize under this sector. In addition the government sector institutions provide
consumer’s subsidies to household sector and production subsidies to the business firms.
Foreign / International Sector
Exchanges that take place with economies of other countries, across the borders, i.e. importation
and exportation of goods and services and also movement of capital take place through this sector.
Estimation of National Accounts
There are three main Economic Activities in an Economy. There are
1. Production of Goods and Services
2. Factor Income Received
3. Expenditure incurred for those goods and services
Estimating the value of these three Economic Activities is Called National Accounts.
There are three methods of calculating the National Accounts,
1. Output Approach/ Production Approach
2. Income Approach
3. Expenditure Approach

Production Approach
The value of goods and services produced within the geographical boundary of an
Economy in a year is estimated.
The final value of goods and services or value addition in goods and services during the
production is taken when calculating the national accounts.
Outcomes of National Accounts under Production Approach are,
• Gross Domestic Production
• Gross National Production
• Net National Production
The following Economic Activities are excluded from the estimation of National Accounts.
• Net Cash Exchange / Monetary Exchange
E.g. Government Securities, Lottery etc.
• Reselling / Second time Selling
E.g. Real Estate Selling, Land Sales etc.
• Unilateral Transactions / Transfers
E.g. Pensions, Samurdhi Payments etc.
 According to the Central Bank of Sri Lanka, the total production in Sri Lanka can be
divided in to 3 Sectors
 Agricultural Sector ( Agriculture, Fishery,)
 Industrial Sector ( Construction, Manufacturing)
 Service Sector (Wholesale, Financial, health tourism)
Production Approach values the national income based on the output of each sector
An economy can use one of the following method to value the production
 Final Output method
 Value addition method
Problems with Final output method.
When using the final output to value the national production, sometimes the final output of
one firm may be input for another. Hence there is a possibility of double counting the output which
results in the over valuation of output.
Double counting means counting the value of the same item more than once and this
naturally leads to over estimation of GDP value.
To overcome the problem Value addition method is used.

Computation of National Accounts

 Gross Domestic Production (GDP)

It is the final monetary value or the value addition in the production of goods and services
produced within a geographical boundary of an economy within a year.
 Gross National Production (GNP)
It is the final monetary value or the value addition in the production of goods and services
produced within a geographical boundary by the resources of an economy within a year.
 Net National Production (NNP)
The value of production after deducting the Capital Depreciation (consumption of fixed
capital) is called Net National Production
 Under production approach the national production is valued under factor price (Base Price)
To identify the market price of the production the value should be adjusted with the Net Indirect
Taxes (Indirect Taxes – Subsidies)

Net National Production = Net National Production + Indirect Taxes - Subsidies

Market Price Factor Cost

Net National Production = Net National Production - Indirect Taxes + Subsidies

Factor cost Market Price
Income Approach
Income can be classified in to two,
I. Transfer Income
II. Earned Income
Transfer Income
Transfer income does not make any production. Hence, it is not taken in to the
calculation of National Accounts.
E.g. Samurdhi Payments, Pension
Earned Income
Earned Income can be classified in to five.
Employee Compensation
Employment income is based on 3 factors
 Salaries or Wages
 Employer’s payment for social Security contribution
 Insurance services, Health facilities, labour compensation Etc.

Rent Income
Rent Income is based on the following
 Rent income earned from fixed and rented property
 Opportunity cost of own dwelling
 Income on intellectual property
Net Interest
Net interest is obtained by adjusting interest received and interest paid.
Interest payment by the government sector and interest paid on consumption loans are
excluded.
Corporate Profit
Corporate Profit can be divided in to 3
 Dividends given to owners
 Undivided Profits
 Corporate income taxes

Self-Employment and Professional Income

It includes the followings
 Sole proprietorship
 Partners and Cooperatives
 Farmer's Income
 Private Income
 Various professionals employed in other jobs
 Professionals

Computation
Net Domestic Income (at Factor Cost) = Employment Income + Rent Income + Net Interest +
Corporate Profits + Self Employment and Professional Income

Gross Domestic Income (at Factor Cost) = Net Domestic Income + Capital Depreciation

Gross Domestic Income (at Market price) = Gross Domestic Income (at Factor Cost) + Net Indirect Taxes

Gross National Income (at Market price) = Gross Domestic Income (at Market price) + NFFI

Net National Income = Gross Domestic Income (at Factor Cost) – Capital Depreciation
Expenditure Approach
Expenditure in an Economy can be classified as follows,
1. Transfer Expenditure
2. Expenses on 2nd time selling
3. Purely monetary Expenditure
4. Expenditure on Final Output
When computing the national accounts only the expenditure on final output is considered as the
others do not add value.
Expenditure on final output can be classified as,
1. Consumption Expenditure of Households -C
2. Investment Expenditure of Firms -I
3. Government Expenditure on goods and services -G
4. Net Exports of Foreign Sector (x-m) - Nx

Consumption Expenditure of Households - C

Expenditure on final consumer goods and services by households is explained as
Consumption Expenditure of Households.
It is of three types
 Expenditure on Durable Goods
 Expenditure on Non- Durable goods
 Expenditure on Services
Investment Expenditure of Firms (Gross Domestic Capital Formation) - I
Gross Investment includes all expenditure of purchasing of Capital Assets.
It can be classified as,
 Gross Domestic Fixed Capital Formation
 Change in Inventories
Net Capital Formation = Gross Capital formation – Capital Consumption (Depreciation)
Government Purchase - G
It is the Expenditure on goods and services by government. Transfer payment and
interest payment by government are not included in government expenditure
 Net Exports - Nx
Net exports is obtained as,
Net Exports (Nx) = Exports (X) – Imports (I)

 Gross Domestic Expenditure

Gross Domestic Expenditure = Private consumption + Gross + Government
Expenditure (C) Investment (I) Expenditure (G)

 Expenditure on Gross Domestic Product

Gross Domestic Product = Gross Domestic Expenditure + Net Exports
GDP = C + I + G (X-M)

 Expenditure on Gross National Product

Gross National Product = Expenditure on Gross Domestic Product + NFFI

 Expenditure on Net National Product

Net National Product = Expenditure on Gross National Product – Capital Depreciation
Current Price GDP and Constant Price GDP
Current Price GDP, which is also referred as Nominal GDP is the value of national
Production valued at present Prices which includes the price level changes
Constant Price GDP, also known as the Real GDP is computed by eliminating the price
changes and valuing the production based on the prices in a base year.
Constant Price GDP is used to decision making as it does not include the Price level
Changes.

Per Capita Income

Per Capita income is the income per person in a country and it is a useful measurement to
compare standard of living among different countries and usually stated in terms of an international
currency that is commonly used, e.g. Dollar.
Per Capita income = Gross Domestic Production / Mid-year population

Economic Growth Rate

• Economy growth is continues improvement in the real national production.
• Economic Growth Rate is calculated by comparing current year GDP (Constant Price) with
previous year GDP (Constant Price).
Importance of preparing national accounts.
 To assess the economic performance
 To make comparisons with other countries in the world
 To measure economic growth
 To understand the economic structure of the country
 To estimate per capita national income
 To have an understanding about economic context and utilization
 To forecast the behavior of macroeconomic variables
 To identify functional relationships among economic factors.

Limitations on national income accounts

 Non-inclusion of productive activities taking place in informal economy
 Non-inclusion of dependent economic activities in national production
 Non-inclusion of services provided by housewives in national production
 Non-inclusion of interest paid on public debts in national production calculations
 Non consideration of damage to environment due to production activities
 Non consideration of changes of productivity in public services
 Inclusion of expenditure on defense and wars under productive activities
 Non-inclusion of some consumer goods with long lifespan in national production by
categorizing them as investments.