National Income

National Income Accounting

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 Introduction
National income accounting provides us
with ex-post data about national income,
it cannot explain the level and
determinants of national income. The
following identities are true for any level
of income. In order to explain and
predict the level of national income,
models are constructed.

2
 Factor Market Product Market

Factor services Goods & services

Real Flow

Factor Owners Firm Consumers

Money Flow

Factor Income Cost Revenue Expenditure

The flow of economic activities in a 2-sector economy

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 GNP v.s. GDP
Gross National Product (GNP)
The total value at market prices of final goods
and services produced by the citizens in an
economy in a specified period.
Gross Domestic Product (GDP)
The total value at market prices of final goods
and services produced within the domestic
boundary of a territory in a specified
period

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 GNP & GDP
Flow concept
Resale of existing houses 
Sale of used cars / existing shares 
Commission / Brokers’ fee 
Imputed rents of owner-occupied dwellings 
Capital gain is not income (Irving Fisher)
Only the interest earned from the capital gain
is considered as income
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 Real GNP & Nominal GNP
& Per capita GNP

Real GNP=(Nominal GNP/GNP Deflator)*100

Per capita GNP = GNP / Population size

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 Measurement of National
Income
Income Approach
 NNP at factor cost OR National Income
Output Approach
 GDP at factor cost
Expenditure Approach
 GDP at market Prices

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 Expenditure Approach
C+I+G+X-M GDP at market price
-
Indirect sales tax
+
Indirect subsidies

GDP at factor cost  Output Approach
+
Factor Income- Factor Income
from abroad paid abroad  Net income from abroad

GNP at factor cost
-
Depreciation
 Income Approach
NNP at factor cost  W+I+R+P

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NNP at factor cost
-
Retained profits
-
Social insurance / Mandatory Provident Fund
-
Direct business Tax
+
Transfer payments

Personal income
-
Direct personal taxes

Disposable personal income - Consumption = Saving
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 Income Approach
W+I+R+P = NNP at factor cost
Profits are stated net of depreciation /
capital consumption allowances
If the figures exclude net income from
abroad, NDP at factor cost can be
obtained.
NDP at factor cost + Net income from abroad =

10
 Output Approach
The total value of the final goods and services
produced by the primary / secondary / tertiary
industries
In order to avoid double counting, the value-added
method is adopted to exclude intermediate goods.
GDP at factor cost + Indirect Taxes – Indirect Subsidies =
Distinguish between Indirect / Direct / Business /
Personal Taxes

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 Expenditure Approach
People spend their income. Thus, the total
expenditure on final goods and services must
be equal to the total value of final goods and
services produced domestically.
Any output that is not sold to consumers is
bought by producers in the form of
unintended inventory investment.
C+I+G+(X-M) = Aggregate / Total expenditure

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 Expenditure Approach
Private Consumption Expenditure (C)
Gross Investment Expenditure (I)
Firms : plant (in progress) / unused raw materials
Households : residential building
Inventory investment : intended unintended (reduce information cost)
- gross domestic fixed capital formation*
- change in stocks & work in progress
*gross national fixed capital formation GNP at market prices
Government Expenditure (G)
roads/education/medical & health services/law & order/public works/…
salary to civil servants, NOT transfer payments
at the cost to taxpayers, NOT at market prices
Net Exports (X-M)
the value of imports is included in C, I, G, X
Exports include domestic exports & re-exports
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Items excluded from National
Income Accounting
Second-hand goods
Intermediate goods
Non-marketed goods / services
Volunteer work / Housework
Unreported / Illegal market transactions

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 Merits & Uses of National
Income Statistics
Reflecting & comparing the standards of
living of different countries
Per capita real GNP  standard of living
Providing information to the government and
firms for economic planning
Reflecting the economic growth of a country
% change in real GNP over a period of time

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Limitations of National Income
Statistics
Factors that may understate the
standard of living / the welfare
Exclusion of the value of leisure
Same Q produced with fewer working hours
 higher welfare
Exclusion of non-marketed / unreported
transactions

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Limitations of National Income
Statistics
Factors that may overstate the standard
of living / the welfare
Undesirable Side-effects of Production
Air pollution / traffic congestion /…
Understate the real / social costs to
society  externality /divergence
between social costs & private costs

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 When comparing economic performances
using national income statistics,
Price Level
use real GNP  eliminate the effect of inflation
Size of Population
 use per capital GNP
Income Distribution
more even distribution  higher welfare
Composition of National income
more consumption, less national defence  higher welfare
Exchange Rates
expressed in the same currency
whether the exchange rates reflects the purchasing power
of the 2 currencies
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 Inflation
A general and sustained increase in the prices
of all goods and services
GNP deflator / GDP deflator
Consumer Price Index (CPI)
Producer Price Index (PPI)
When constructing price indices
different weighting will be given to different
commodities reflecting their relative
importance on the consumers’ expenditure
A base year is chosen during which the
economy experiences no economic crisis

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 Calculating a Price Index
Item Expenditure Weight Prices Price Prices Price
1991 1991 Relatives 1992 Relatives
1991 1992
Transport
1000 10 15 100 15 100
Clothing
2000 20 100 100 100 100
Housing
3000 30 500 100 650 130
Food
4000 40 200 100 220 110

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 Calculating a Price Index
(cont’d)
Price Index in 1991
=0.1*100+0.2*100+0.3*100+0.4*100
=100
Price Index in 1992
=
=
The general price level in 1992 has increased
by %
Only persistent increase in the price indices
implies inflation
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 Consumer Price Indices
Only consumer goods are included
Persistent increase in the CPI implies an
increase in the cost of living unless there is a
compensating rise in money income
CPI(A), CPI(B), HSCPI are constructed to
measure the change in the cost of living of
different income groups since they have
different consumption patterns. Different
weights are assigned to different categories
of goods to reflect their relative importance.

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 Uses of the CPI
In the following table, the real income is
increasing, this implies that the standard of
living is also increasing for a typical citizen
Year CPI Nominal Real income
income
1991 90 7650 8500
=(7650/90)*100
1992 100 8820 8820
Base year =
1993 105 9555 9100
=
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 Limitations of the CPI
Only consumer goods are included
 CANNOT reflect the inflation rate accurately
Change in consumption pattern
 the weights are fixed  misleading
Change in quality of goods
 CPI due to better quality  overstate inflation
Possibility of Substitution
 overstate the impact of inflation if consumers
substitute cheaper goods for dearer goods

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 Implicit GNP Deflator
To measure inflation, this is a better indicator as
it has a wider coverage of commodities
Year GNP deflator Inflation Rate
between ….
1990 90

1991 100 1991 &1992

[(121-100)/100]*100%
1992 121 = 21%

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 Unemployment
Working Population OR Labour Force
Working Population=Employed+Unemployed+Self-employed
Un-employment Rate
=(Unemployed/Labour Force)*100%
Under-employment Rate

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 Method of Analysis
Endogenous variable
the value of the variable is determined
inside the model ( x, y)
Exogenous variable
the value of the variable is determined
by forces outside the model ( m, c)
any change is regarded as autonomous

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C C C

Y Y Y
C I I

Y
Y Y
C=f(Y) C=a C=a+cY C=a+c’Y C=c*Y
I=f(Y) I=I* I=I*+iY
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