Measuring A Nation's Income

Measuring a Nation’s
Income
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.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Economy’s
Income and Expenditure
 For an economy as a whole, income

must equal expenditure because:
 Every transaction has a buyer and a
seller.
 Every rupee of spending by some buyer
is a rupee of income for some seller.
The Circular-Flow Diagram
The equality of income and

expenditure can be illustrated
with the circular-flow diagram.
The Circular-Flow Diagram
Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought
Firms
Households
Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and profit
Gross Domestic Product
 Gross domestic product (GDP) is a

measure of the income and
expenditures of an economy.
 It is the total market value of all final
goods and services produced within a
country in a given period of time.
The Measurement of GDP
GDP is the market value of all

final goods and services
produced within a country in a
given period of time.
 Output is valued at market prices.

 It records only the value of final goods,
not intermediate goods (the value is
counted only once).
 It includes both tangible goods (food,
clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits).
 It includes goods and services currently

produced, not transactions involving
goods produced in the past.
 It measures the value of production
within the geographic confines of a
country.
 It measures the value of production

that takes place within a specific
interval of time, usually a year or a
quarter (three months).
What Is Counted in GDP?
GDP includes all items

produced in the economy
and sold legally in markets.
What Is Not Counted in GDP?
 GDP excludes most items that are

produced and consumed at home and
that never enter the marketplace.
 It excludes items produced and sold
illicitly, such as illegal drugs.
The Components of GDP
GDP (Y ) is the sum of the following:

 Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)
Y = C + I + G + NX
 Consumption (C):
 The spending by households on goods and
services, with the exception of purchases of
new housing.
 Investment (I):
 The spending on capital equipment,
inventories, and structures, including
new housing.
 Government Purchases (G):

 The spending on goods and services by local,
state, and federal governments.
 Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
 Net Exports (NX):
 Exports minus imports.
Other Measures of Income
 Gross National Product (GNP)

 Net National Product (NNP)
 National Income
 Personal Income
 Disposable Personal Income
Gross National Product
 Gross national product (GNP) is the total

income earned by a nation’s permanent
residents (called nationals).
 It differs from GDP by including income
that our citizens earn abroad and
excluding income that foreigners earn
here.
Net National Product (NNP)
 Net National Product (NNP) is the total

income of the nation’s residents (GNP)
minus losses from depreciation.
 Depreciation is the wear and tear on
the economy’s stock of equipment and
structures.
National Income
 National Income is the total income

earned by a nation’s residents in the
production of goods and services.
 It differs from NNP by excluding indirect
business taxes (such as sales taxes) and
including business subsidies.
Personal Income
 Personal income is the income that
households and noncorporate businesses
receive.
 Unlike national income, it excludes retained
earnings, which is income that corporations
have earned but have not paid out to their
owners.
 In addition, it includes household’s interest
income and government transfers.
Disposable Personal Income
 Disposable personal income is the income

that household and noncorporate
businesses have left after satisfying all
their obligations to the government.
 It equals personal income minus personal
taxes and certain nontax payments.
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
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
GNP & GDP
 Flow concept

Resale of existing houses 

Sale of used cars / existing shares 

Commission / Brokers’ fee 

Imputed rents of owner-occupied dwellings 

Unreported / Illegal market transactions 

Volunteer Work / Household Work 
 Capital gain is not income (Irving Fisher)
Only the interest earned from the capital gain is considered as
income
Real versus Nominal GDP
 Nominal GDP values the production of

goods and services at current prices.
 Real GDP values the production of
goods and services at constant prices.
Real versus Nominal GDP
An accurate view of the economy

requires adjusting nominal to real
GDP by using the GDP deflator.
GDP Deflator
 The GDP deflator measures the current

level of prices relative to the level of
prices in the base year.
 It tells us the rise in nominal GDP that is
attributable to a rise in prices rather
than a rise in the quantities produced.
GDP Deflator
The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =  100
Real GDP
Converting Nominal GDP to Real
GDP
Nominal GDP is converted to real

GDP as follows:
(Nominal GDP20xx )
Real GDP20xx = X 100
(GDP deflator20xx )
Real and Nominal GDP
Price of Quantity of Price of Quantity of

Year Hot dogs Hot dogs Hamburgers Hamburgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Calculating Nominal GDP:

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200
Calculating Real GDP (base year 2001):

Calculating the GDP Deflator:

2001 ($200/$200) x 100 = 100
2002 ($600/$350) x 100 = 171
2003 ($1200/$500) x 100 = 240
Real GDP in the United States
Billions of
1992 Dollars
8,000
(Periods of falling real GDP)
7,000
6,000
5,000
4,000
3,000
1970 1975 1980 1985 1990 1995 2000
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
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
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
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

Measuring A Nation's Income

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Measuring A Nation's Income

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Measuring a Nation’s

 National income accounting provides us

 For an economy as a whole, income

The equality of income and

Inputs for Labor, land,

 Gross domestic product (GDP) is a

GDP is the market value of all

 Output is valued at market prices.

 It includes goods and services currently

 It measures the value of production

GDP includes all items

 GDP excludes most items that are

GDP (Y ) is the sum of the following:

 Government Purchases (G):

 Gross National Product (GNP)

 Gross national product (GNP) is the total

 Net National Product (NNP) is the total

 National Income is the total income

 Disposable personal income is the income

 Nominal GDP values the production of

An accurate view of the economy

 The GDP deflator measures the current

The GDP deflator is calculated as follows:

Nominal GDP is converted to real

Price of Quantity of Price of Quantity of

Calculating Nominal GDP:

Calculating Real GDP (base year 2001):

Calculating the GDP Deflator:

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