TOPIC 2

MEASURING THE NATIONAL INCOME ACCOUNTS

National income accounts

(NIAs) are fundamental
aggregate statistics in
macroeconomic analysis. The
ground-breaking development
of national income and
systems of NIAs was one of
the most far-reaching
innovations in applied
economics in the early
twentieth century. NIAs
provide a quantitative basis for
choosing and assessing
economic policies as well as making possible quantitative macroeconomic
modeling and analysis. NIAs cannot substitute for policymakers’ judgment or allow
them to evade policy decisions, but they do provide a basis for the objective
statement and assessment of economic policies.

Combined with population data, national income accounts can provide a measure
of well-being through per capita income and its growth over time. Also, NIAs,
combined with labor force data, can be used to assess the level and growth rate
of productivity, although the utility of such calculations is limited by NIAs’ omission
of home production, underground activity, and illegal production. Combined with
financial and monetary data, NIAs provide a guide to inflation policy. NIAs provide
the basis for evaluating government policy and can rationalize political challenges
to incumbents by people who are dissatisfied with measurable aspects of the

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government’s policies. In emerging and transition economies, implementing a
dependable and accurate system of NIAs is a crucial step in developing economic
policy. National income measures the monetary value of the flow of output of
goods and services produced in an economy over a period of time. National
accounts, sometimes called macroeconomic accounts and abbreviated as NA,
are statistics focusing on the structure and evolution of economies. They describe
and analyze, in an accessible and reliable way, the economic interactions
(transactions) within an economy. There are an almost unimaginable large number
of these transactions.

MEASURING THE LEVEL AND RATE OF GROWTH OF NATIONAL INCOME

IS IMPORTANT FOR KEEPING TRACK OF:

• The rate of economic growth

• Changes to living standards
• Changes to the distribution of income between groups within the
population

A variety of measures of national income and output are used in economics to

estimate total economic activity in a country or region, including gross domestic
product (GDP), gross national product (GNP), net national income (NNI), and
adjusted national income (NNI adjusted for natural resource depletion – also called
as NNI at factor cost). All are specially concerned with counting the total amount
of goods and services produced within the economy and by various sectors. The
boundary is usually defined by geography or citizenship, and it is also defined as
the total income of the nation and also restrict the goods and services that are
counted. For instance, some measures count only goods & services that are
exchanged for money, excluding bartered goods, while other measures may
attempt to include bartered goods by imputing monetary values to them.

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Gross Domestic Product (GDP) is the monetary value, in local currency, of all
final economic goods and services produced in a country during a specific period
of time. It is the broadest financial measurement of a nation’s total economic
activity. The total goods and services bought by consumers encompass all private
expenditures, government spending, investments, and net exports. GDP growth
rate is an important indicator of the economic performance of a country. On the
other hand, Gross National Product (GNP) is the total value of all finished goods
and services produced by a country’s citizens in a given financial year, irrespective
of their location. GNP also measures the output generated by a country’s
businesses located domestically or abroad. It can be defined as a piece of
economic statistic that comprises Gross Domestic Product (GDP), and income
earned by the residents from investments made overseas.

Simply put, GNP is a superset of the GDP. While GDP confines its analysis of the
economy to the geographical borders of the country, GNP extends it to also take
account of the net overseas economic activities performed by its residents.

Basically, GNP signifies how a country’s people contribute to its economy. It

considers citizenship, regardless of the location of the ownership. GNP does not
include foreign residents’ income earned within the country. GNP also does not
count any income earned by a foreign residents or businesses, and excludes
products manufactured in the country by foreign companies.

WHAT IS THE GDP FORMULA?

There are two primary methods or formulas by which GDP can be determined:

1. EXPENDITURE

The expenditure approach is basically an output accounting method. It focuses on

finding the total output of a nation by finding the total amount of money spent. This
is acceptable to economists, because, like income, the total value of all goods is
equal to the total amount of money spent on goods. The basic formula for domestic
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output takes all the different areas in which money is spent within the region, and
then combines them to find the total output.

GDP = C + G + I + (X – M)

where:

C = household consumption expenditures / personal consumption expenditures

I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services
Note: (X - M) is often written as XN or less commonly as NX, both stand for "net
exports".
Example:
Transfer Payments $54
Interest Income $150
Depreciation $36
Wages $67
Gross Private Investment (I) $124
Business Profits $200
Indirect Business Taxes $74
Rental Income $75
Net Exports (X-M) $18
Net Foreign Factor Income $12
Government Purchases (G) $156
Household Consumption (C) $304

By using the data in the Table, we can calculate the GDP using the expenditures
approach. As you can see, the table contains more data than is necessary so you
have to look for the parts which make up the expenditures approach to calculating
GDP. The necessary data is highlighted within the table.

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Remember the formula:

GDP = C + G + I + (X – M)

• In this case the C is represented by Household Consumption which is $304.

• The G refers to Government Spending which is $156.
• I is gross private investment and is $124.
• (X - M) is the net exports and in the table is shown to be $18.

Therefore:

GDP = $304 + $156 + $124 + $18

GDP = $602

2. INCOME APPROACH

This GDP formula takes the total income generated by the goods and services
produced.

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign

Factor Income

Total National Income – the sum of all wages, rent, interest, and profits.

Sales Taxes – consumer taxes imposed by the government on the sales of goods
and services.

Depreciation – cost allocated to a tangible asset over its useful life.

Net Foreign Factor Income – the difference between the total income that a
country’s citizens and companies generate in foreign countries, versus the total
income foreign citizens and companies generate in that country.

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Example:
Transfer Payments $54
Interest Income (i) $150
Depreciation $36
Wages (W) $67
Gross Private Investment $124
Business Profits (PR) $200
Indirect Business Taxes $74
Rental Income (R) $75
Net Exports $18
Net Foreign Factor Income $12
Government Purchases $156
Household Consumption $304

In this case we use the formula:

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign

Factor

NI = W + R + i + PR

• W is the wages that are represented by $67 in the table.

• Rental income is the R and is $75.
• Interest income is i and is $150.
• PR are business profits and are $200.

Therefore:

NI = $67 + $75 + $150 + $200

NI = $492

GDP = NI + Indirect Business Taxes + Depreciation

GDP = $492 + $74 + $36

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 GDP = $602

What are the Types of GDP?

GPD can be measured in several different ways. The most common methods
include:

Nominal GDP – the total value of all goods and services produced at current
market prices. This includes all the changes in market prices during the current
year due to inflation or deflation.

Real GDP – the sum of all goods and services produced at constant prices. The
prices used in determining the Gross Domestic Product are based on a certain
base year or the previous year. This provides a more accurate account of
economic growth, as it is already an inflation-adjusted measurement, meaning the
effects of inflation are taken out.

Calculation of Nominal and Real GDP

Formula: Price x Quantity

BREAD BUTTER NOMINAL NOMINAL REAL REAL

PRICE QUANTITY PRICE QUANTITY GDP GDP GDP GDP
(2011) (2011) (2012) (2012) 2011 2012 2011 2012
$3 100 $4 125 300 500 300 375
$2 50 $2.50 60 100 150 100 120
TOTAL 400 650 400 495

NOTE: This is not million but trillion dollars

The GDP Deflator

The GDP deflator is a price index that measures inflation or deflation in an

economy by calculating a ratio of nominal GDP to real GDP. It is calculated by

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dividing Nominal GDP by Real GDP and then multiplying by 100. (Based on the
formula).

• Nominal GDP: A macroeconomic measure of the value of the economy’s

output that is not adjusted for inflation.
• Real GDP: A macroeconomic measure of the value of the economy’s output
adjusted for price changes (inflation or deflation).

Formula:

APPLYING THE FORMULA:

In 2011: In 2012:

GDP = 400/400*100 GDP = 650/495*100

GDP = 100% GDP = 131%

Implication:

The GDP deflator will equal more than 100% whenever nominal GDP is greater than real
GDP. Because the price level is generally increasing while the base year remains
unchanged, nominal GDP is usually greater than real GDP for all years.

On the other hand, GDP is important because it gives information about the size of the
economy and how an economy is performing. The growth rate of real GDP is often used
as an indicator of the general health of the economy. In broad terms, an increase in real
GDP is interpreted as a sign that the economy is doing well.

[end]

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