LESSON 6

NATIONAL INCOME ACCOUNTING

Learning Outcomes

At the end of this lesson, you should be able to:

 Differentiate the GDP and GNP
 Calculation of national income using expenditure approach
 Calculation of national income using output approach
 Calculation of national income using income approach

6.1 Introduction

Macroeconomics is ultimately concerned with the determination of the economy's total output,
the price level, the level of unemployment, interest rate and other variables. A necessary step in
understanding how these variables are determined is national income accounting.

6.2 Gross Domestic Product (GDP) And Gross National Product (GNP)

GDP is the market value of all final goods and services produced by factors of production located
within a country like Malaysia. It excludes intermediate goods as well as output produced by
Malaysians' abroad. This would therefore include output produced by non-residents (foreign
workers) residing or working in the country.

GNP on the other hand refers to final goods and services produced by Malaysians' regardless
where they are. This will automatically exclude all output produced by foreign workers and would
include the output of Malaysians working overseas.

Thus, to get GDP from GNP, we have to the following:

minus factor income to abroad (this represent foreigners' income)

add factor income from abroad (this represent Malaysians' income working overseas)
or we just add net factor income from abroad.
GNP MP = GDPMP + INCOME RECEIVED FROM ABROAD
- INCOME PAID ABROAD
or GNP MP = GDPMP + NET FACTOR INCOME ABROAD
6.3 Market Price and Factor Cost

Market price refers to the prevailing price in the market through the forces of demand and
supply. It is the price that consumers have to pay to get the product or service. Usually the prices
of goods and services that we pay include some form of indirect taxes.

National income at factor cost means the sum of all income earned by all factors of production,
for instance, suppliers of land, labor and capital, which help to produce the year's national output
in the economy. Thus, the difference between national income at market price and national
income at factor cost arises from indirect taxes and subsidies. This can be explained by the
following example:

RICE (RM CASIO CALCULATOR (RM)

Market price 1.20/kg market price 60

+ subsidy 0.30/kg - indirect taxes 12 (20%)
= Factor cost 1.50/kg = factor cost 48

Note: other names for indirect tax are taxes on expenditure, excise tax or tax on consumption.

To get factor cost from market price, we have the following formula:

Market Price + Subsidies - Indirect Tax = Factor Cost

6.4 CALCULATING GROSS DOMESTIC PRODUCT

There are three ways of calculating:

1. Add up all the values of all the goods and services produced in the country, industry
by industry. Here we focus on firms and add up all their production. This is the product
approach.
2. The production of goods and services generated income for households in the form
of wages and salaries, profits, rent and interest. Adding up all these incomes brings us
to the income approach.
3. This focus on the expenditures necessary to purchase the countries production.
Whatever produced is sold. Therefore, no injections or withdrawals. The value of what
is sold must therefore be the value of what is produced. The expenditure method
measures this value of sales.
6.5 EXPENDITURE APPROACH

1. Consumption ( C )

Personal consumption expenditure is what household and individual purchases of both

durable and non-durable goods and services.

2. Investment ( I )

This is the purchase of final products by business firms for use in production or as additions
to inventories and the purchase of new homes by households. Investment involves the
production of new capital goods by business, including changes in inventories of unsold
goods, materials, and other parts over the year.

Investment here is both domestic as well as gross because it doesn't deduct the amount of
purchases to replace capital that wears out or becomes obsolete during the year. Gross
investment minus depreciation is net investment.

3. Government expenditure ( G )

This represents expenditure on final goods of business firms and all inputs costs, including
labor cost.

This also includes transfer payment that is payments for which no good or services are
currently received in return. Since transfer payments are not productive, they are not
included in national income accounting.

4. Net exports ( X-M )

This represents to any excess of expenditure on exports over imports.

Therefore aggregate expenditure = C + I + G + ( X - M ). These prices are valued at market prices.

The following are formulas used to calculate national income:

Gross Domestic Product (GDP) MP = C + I+ G + ( X - M )

Gross National Product (GNP) MP = GDPMP + Income Received From Abroad -
Income Paid Abroad
Gross National Product (GNP) FC = GNP MP + Subsidies - Indirect Taxes
National Income (NI) FC = GNP Fc - Depreciation

Sometimes we have to calculate personal income and disposable income. Disposable income is
income that we can actually spend. Personal income is income which tax has not been deducted.
The following formulas are used to calculate personal income as well as disposable income.
Personal Income = NNP FC (national income)
+ Transfer payment
+ Dividend
- Employment Provident Fund (EPF)
- Social Security (SOCSO)
- Insurance
- Retained Earnings
- Corporate tax.
Disposable income = Personal Income - Personal Income tax

The following table will illustrate how to calculate national income using the expenditure
approach.

Table 1: Calculation National Income Using The Expenditure Approach

COMPONENTS RM MILLION
1. PUBLIC CONSUMPTION 20 000
2. PRIVATE COMSUMPTION 30 500
3. PUBLIC INVESTMENT 10 600
4. PRIVATE INVESTMENT 15 000
5. CHANGE IN STOCK 150
6. GOODS AND SERVICES EXPORTED 1 000
7. GOODS AND SERVICES IMPORTED 700
8. NET PAYMENTS ABROAD 100
9. INDIRECT TAXES 200
10. SUBSIDIES 500
11. DEPRECIATION 50
12. EMPLOYEES' PROVIDENT FUND (EPF) 200
13 TAX ON PERSONAL INCOME 400
14. TRANSFER PAYMENT 100
15. SOCIAL SECURITY 100
16. RETAINED EARNINGS 10
17. INSURANCE PREMIUM 100

1. To calculate gross domestic product at market price, these are the steps.
Add public consumption plus private consumption plus public as well as private investment
plus change in stock plus goods and services exported minus goods and services imported.

Thus, GDP MP = C + I + G + (X-M)

= 20000 + 30500 + 10600 + 15000 + 150 + 1000 - 700
= 76550 million
2. To calculate gross national product at market price, these are the steps.

GNP MP = GDP MP + net factor income abroad

= 76550 + 100
= 76650 million

3. To calculate gross national product at factor price, these are the steps.

GNP FC = GNP MP + subsidy - indirect taxes

= 76650 + 500 - 200
= 76950 million

4. To calculate national income, the steps are:

NNP FC = GNP FC - depreciation

= 76950 - 50
= 76900 million
= national income

5. To calculate personal income, the steps are:

Personal income = national income + transfer payment - EPF - SOCSO

- Insurance Premium - retained earnings
= 76900 + 100 - 200 - 100 - 100 - 10
= 76590 million

6. To calculate disposable income, the steps are:

Disposable income = Personal income - personal income tax

= 76590 - 400
= 76190 million
Example 1:

COMPONENTS RM MILLION
Exports 500
Personal consumption expenditure 1400
Changes in stock - 40
Indirect business tax 30
Retained earnings 220
Government expenditure 990
Investment 1000
Personal income tax 80
Subsidies 30
Imports 400
Factors income paid abroad 80
Transfer payment 10
Factor income received from abroad 90
EPF 50
Depreciation 40

Calculate:

a. Gross domestic product (GDP) at market price

b. Gross national product (GNP) at factor cost
c. Net domestic product (NDP) at market price
d. National income
e. Disposable income

Solution:

a. GDE mp = Consumption + Investment + Changes in stock + Government

expenditure + export - Import
= 1400 + 1000 - 40 + 990 + 500 - 400
= 3450 million

b. GNE fc = GDE mp + Factor income from abroad - Factor income paid

abroad + subsidies - Indirect business tax
= 3450 + 90 - 80 + 30 - 30
= 3460 million

c. NDE mp = GDE mp - depreciation

= 3450 - 40 = 3410 million

d. National income = GNE fc - Depreciation

 = 3460 - 40 = 3420 million

e. Disposable income = Personal income - personal income tax

Personal income = National income + transfer payment - EPF - Retained earnings
= 3420 + 10 - 50 - 220
= 3160 million

Disposable income = 3160 - 80

= 3080 million

Example 2:

Given the data below, answer the following questions.

Items RM(million)
Depreciation 10
Net Factor income from abroad 25
Transfer payment 15
Exports 150
Personal Consumption expenditure 180
Changes in stock 50
Indirect business tax 40
Public Investment 330
Imports 130
Subsidies 15
Personal income tax 40
Private investment 500
Retained Earnings 20
Government expenditure 600
Social security payments 10
Corporate income tax 20

Calculate:
a. Gross domestic product (GDP) at market price
b. Gross national product (GNP) at factor cost
c. National income
d. Personal income
e. Disposable income
Solution:
a. GDE mp = Personal Consumption + Private Investment + Changes in stock +
Government expenditure + Public Investment + export - Import
= 150 +180 +50 +330 - 130 + 500 + 600
= 1680 million
b. GDE fc = GDE mp + + subsidies - Indirect business tax
= 1680 + 15 - 40
= 1655 million
GNE fc = GDE fc + Net Factor income from abroad
= 1655 + 25
= 1680 million

c. National income = GNE fc - depreciation

= 1680 - 10
= 1670 million

d. Personal income = National income + transfer payment - social security payments -

Retained earnings - Corporate tax
= 1670 + 15 - 20 - 10 - 20
= 1635 million

e. Disposable income = Personal income - personal income tax

= 1635 - 40
= 1595 million
6.6 INCOME APPROACH

As we have discussed in the circular flow, when the household supplies the factors of production
needed by the firms for production, the firms will pay in terms of wages, rent, interest and
dividend. The household will then spend this income on the goods and services provided by the
firms.

Thus, GDP (Gross Domestic Product) = GDI (Gross Domestic Income)

GDI is the aggregate income earned annually from production. Aggregate expenditure on final
goods becomes the aggregate income of the nation. The major income components of GDI are:

1. Compensation of employees
This refers to the income from the sale of labor services during the year. It includes wages,
salaries and fringe benefits.
It is the labor cost of producing final products and it is the largest income components of GDP.

2. Net interest
This is the portion of business receipts used to pay for borrowed funds that finance
investment purchases. Interest payment provides earnings for savers and other suppliers of
loanable funds for investment purposes.

3. Rental income
This is the income earned by those who supply the services of land, mineral rights, and
buildings for use by others.
Also included in rental income is an estimate of the imputed rent earned by homeowners
who lived in their own homes less the expenses of maintaining their homes.

4. Profits
Before we can calculate profit, we have to make two deductions.

i. Indirect business taxes

Examples of these are sales tax, excise tax. These are considered as costs to firms.
Indirect business taxes are the portion of the receipts collected by business firms
that are claimed by governments rather than used to pay for input costs or to be
included as profits.

ii. Consumption of fixed income

This refers to depreciation.
6.7 Real and Nominal Income

Nominal income measures the value of the output in a given period in the prices of that period,
or, as it is sometimes put in current Ringgit. Thus 1999 nominal income measures the value of
the goods produced in 1999 at the market prices that prevailed in 1999. Nominal income changes
from year to year for two reasons.
 The physical output of goods changes. In other words, goods increase or decrease.
 The market prices changes.

Real income measures changes in physical output in the economy between different time periods
by valuing all goods produced in the two periods at the same prices, or in constant dollars.

The following table shows how national income is calculated using the income approach.

Table 2: National Income Calculation Using The Income Approach.

COMPONENTS RM IN MILLION
1. Income from employment and self 25 000
employment
2. Income from rent , dividend and interest 10 000
3. Companies profits
i. Distributed profits 12 000
ii. undistributed profits 11 000
4. Depreciation 1 000
5. Transfer payment 100
6. Personal income tax 200
7. Private expenditure 10000
8. Employees' provident fund (EPF) 100
9. Net factor income abroad 17 000

We must first identify that this is from income approach. Any item that is not relevant must be
ignored. ( eg. Entry no. 7 since expenditure is from expenditure approach)

1. To calculate gross domestic product, these are the steps:

GDP = income + rent + dividend + interest + profits

= 25000 + 10000 +12000 +11000
= 58000 million
2. To calculate gross national product, these are the steps:

GNP = gross domestic product + net factor income abroad

= 58000 + 17000
= 75000 million

3. To calculate national income, these are the steps:

NNP = gross national product - depreciation

= 75000 – 1000
= 74000 million
Note: The figures given are all in factor cost. There are no subsidy or indirect taxes given.

4. To calculate personal income, these are the steps:

Personal income =national income + transfer payment - EPF - undistributed profit

= 74000 + 100 - 100 -11000
= 63000 million

5. To calculate disposable income, these are the steps:

Disposable income = personal income minus personal income tax
= 63000 - 200
= 62800 million

Example 3:

The following table shows items collected at random of a certain country. Select the appropriate
items to calculate the national income for that particular year.

COMPONENTS RM IN MILLION
1. Wages and salaries 5 000
2. Income from rent , dividend and interest 1 000
4. Companies profits
iii. Distributed profits 1 000
iv. undistributed profits 1 000
4. Depreciation 500
5. Transfer payment 100
6. Personal income tax 250
7. Private Investment 10000
8. Employees' provident fund (EPF) 50
9. Government expenses 2500
10. Corporate tax 100
11. Net factor income abroad 4 000
Calculate:
1. Gross domestic product (GDP)
2. Gross national product (GNP)
3. National income
4. Personal income
5. Disposable income

Solution:

We must first identify that this is from income approach. Any item that is not relevant must be
ignored. ( eg. Entry no. 7 and 9 since items are from expenditure approach)

1. To calculate gross domestic product, these are the steps:

GDP = wages and salary + rent + dividend + interest + profits

= 5000 + 1000 +1000 +1000
= 8000 million

2. To calculate gross national income, these are the steps:

GNP = gross domestic product plus net factor income abroad

= 8000 + 4000
= 12 000 million

3. To calculate national income, these are the steps:

NNP = gross national income - depreciation

= 12 000 – 500
= 11 500 million
Note: The figures given are all in factor cost. There are no subsidy or indirect taxes given.

4. To calculate personal income, these are the steps:

Personal income = national income + transfer payment - EPF - undistributed profit -

corporate tax
= 11 500 + 100 - 50 – 1000 - 100
= 10 450 million

5. To calculate disposable income, these are the steps:

Disposable income = personal income - personal income tax

= 10 450 - 250
= 10 200 million
6.8 THE PRODUCT OR OUTPUT APPROACH

This involves adding up the value of everything produced in the country during the year. One
problem faced in this approach is double counting. To avoid double counting which exaggerates
national income, we use the concept of value added. Value added refers to the increase in the
value of goods as a result of the production process. This is calculated by deducting from the
value of the firms ‘output the cost of the inputs goods used up in the producing that output.

Final Goods and Intermediate Goods

Final goods are goods purchased by the ultimate user, either consumer goods purchased by
households or capital goods such as machinery purchased by firms. Intermediate goods are partly
finished goods, which form inputs to another firms’ production process and are used up in that
process. An illustration to show the process of value added.

Process of Value Added

Cotton Thread Cloth T-shirt

RM 3.00 RM 7.00 RM 15.00 RM 21.00

 The prices showed for one unit each. For example, to produce one T-shirt, we need cotton
as the basic material, which cost RM3. Cotton is then process to form thread, which cost
RM7. Thread is then woven to form cloth worth RM15. Cloth is then cut to make the T-
shirt, which is sold, for RM21.00.

 If we add all the prices (RM3+RM7+RM15+RM21), and conclude that this is the value of
national income, we are doing double counting. RM46 is not the value of national income.
National income is only RM21, which is the price of T-shirt, the final product.

 To get the correct figure, we must only add the value added for each input as they go for
one process to another. Cotton to thread, the value added is only RM4 (7-3), thread to
cloth is only RM8 (15-7) an from cloth to T-shirt is RM6 (21-15).

 Thus, if we add up the price of cotton plus all the value added, we will get the national
income (3 +4+8+6=21).

In summary, the value added to the final product at each stage of production is the difference
between what the firm sells its product for and what it pays for the intermediate materials or
goods it processes at that production stage. The sum of the value added at each stage of
production equals the sale price of that final good or service.
Example 4:

The table below contains a selection of items from the national account of a country that
engages in international trade.

Items RM(million)
Government services 100
Net Factor income from abroad 25
Transfer payment 15
Exports 150
Mining and Quarrying 180
Manufacturing 150
Indirect business tax 40
Depreciation 10
Imports 130
Subsidies 15
Personal income tax 40
Private investment 500
Electricity, gas and water 70
Banking and tourism 300
EPF 10
Rent 20

Calculate:
a. Gross domestic product (GDP) at market price
b. Gross national product (GNP) at factor cost
c. National income
d. Personal income
e. Disposable income

Solution:

First identify that this is from product approach. Select only the relevant item to be included in
computing national income.

a. GDP mp = Government services + Mining and quarrying + Manufacturing +

Electricity, gas and water + Banking and tourism
= 100 +180 +150 +70 + 300
= 800 million

b. GDP fc = GDP mp + subsidies - Indirect business tax

= 800 + 15 - 40
= 775 million
 GNP fc = GDP fc + Net Factor income from abroad
= 775 + 25
= 800 million

c. National income = GNP fc - depreciation

= 800 - 10
= 790 million

d. Personal Income = national income + transfer payment - EPF

= 790 + 15
= 795 million

e. Disposable income = Personal income - personal income tax

= 795 - 40
= 755 million

6.9 REAL VS NOMINAL INCOME AND GROWTH RATE

Nominal income is the value of all final goods and services produced in a given year valued at
current price.
Real income is value of all final goods and services produced in a given year valued at constant
price.
National income may increase due to nominal increase in GNP and not due to real GNP. Thus,
there is no physical increase in goods and services to be enjoyed by the people.

When nominal GNP increases, to find the actual increase of goods and services, we have to
deflate the general price level of the current year. This is called the GNP deflator. GNP deflator is
the ratio of nominal GNP to real GNP multiplied by 100.

For example, if nominal GNP is $6,000 and the real GNP is $4,000, the GNP deflator is ($6,000 /
$4,000) x 100 = 150.

To find the real GNP, the formula is:

Base year index X current year index

Consumer price index
*Price index in the base year = 100
For example, current GNP is RM300 million and consumer price index (GNP deflator) is 105. The
real GNP is:
100 x 300 = 285.71
105
In other words, nominal GNP increases to 300 million while real GNP increases only to 285.71
million.

GNP growth rate:

GNP growth rate = Real GNP t ̶ Real GNP t - 1 x 100

Real GNP t - 1

Example:
Items 2017 2018

Gross National Product at current prices (RM million) 150 180

Consumer price index (CPI) 103 105

Calculate:
Real GNP for 2017 and 2018.

Real GNP 1997 = (100 ÷ 103) X 150 = 145.63 (million)

Real GNP 1998 = (100 ÷ 105) X 180 = 171.43 (million)

The rate of growth from 2017 to 2018:

171.43 − 145.63
Growth rate = ( ) x 100
145.63

= 17.72%
 TUTORIAL 6: NATIONAL INCOME ACCOUNTING

1. Refer to the following national income data for country X for year 2007.

Items RM millions
Wages and salary 1,060
Rent 870
Interest 880
Distributed profit 1,200
Proprietor’s income 780
Depreciation 210
Undistributed profit 150
Transfer payment 90
Social security contribution 80
Personal income tax 130

Calculate:
a) Gross Domestic Income.
b) Gross National Income.
c) National Income.

2. The following data refers to the National Income statistics of a country.

ITEMS RM (MILLION)
Government Expenditure 450
Change In Inventories 20
Household Expenditure 224
Private Gross Investment 670
Subsidies 100
Net Export Of Goods And Services 272
Net Factor Income From Abroad 40
Depreciation 100
Taxes On Expenditure 60

Based on the above table, calculate:

a) Gross Domestic Product at market price.

b) Gross National Product at market price.
c) Gross National Product at factor cost.
d) National Income.
3. The table below contains a random selection of items from the national account of a country.

ITEMS RM (MILLIONS
Finance and insurance 4 750
Private expenditure 10 000
Rent 20 000
Government expenditure 6 000
Agriculture, forestry and fishing 11 400
Mining and quarrying 4 000
Communication 3 700
Dividends received by individual 650
Hotels and restaurant 6 300
Manufacturing 12 500
Capital consumption 1 000
Business taxes 6 250
Taxes on expenditure 7 500
Net factor income received from abroad 3 450
Subsidies 445
Personal income taxes 125
Social contribution 50
Employee provident funds 170
Transfer payment 700

Calculate:
a) Gross Domestic Product at market price.
b) Gross National Product at market price.
c) Net National Income at factor cost.
d) Personal income
e) Disposable income.
4. Given the following data of a country, for the year ended December 2019.

ITEMS RM (MILLION)
Manufacturing 270
Forestry 180
Fishing 120
Agricultural 410
Factor income from abroad 450
Factor payment to abroad 400
Physical increase in stock 60
Construction 400
Banking and insurance services 270
Depreciation 200
Other services 70
Taxes on expenditure 240
Subsidies 250

Calculate:
a) GDP at market price.
b) GDP at factor cost.
c) GNP at factor cost.
d) Net National Product at factor cost.

5. Why do economists prefer real GDP rather than nominal GDP as a measure of economic well-
being?

6. "An increase in the Gross National Product (GNP) does not necessarily reflect an increase in
the standard of living and economic welfare of a country". Discuss the above statement.