Chapter 8

5.1. National Income Accounting

• National income accounting is measuring economic
activities/performance
• Economic performance is measured by GDP/GNP
• Gross Domestic Product (GDP) is the market value of
all final goods and services produced in a country in a
given year.
• Gross National Product (GNP) is the total market
value of goods and services produced by the
resources (nationality) of a given country for a given
period of time.
• GNP = GDP+ Net factor payment
• Net factor payment / income/= factor payment
from aboard minus factor payment to foreigners
 GDP GNI NFP/I (current
Year (current LCU) (current LCU) LCU)
2011 515,078,541,000 513,958,341,000 -1,120,200,000
2012 747,326,498,000 745,666,698,000 -1,659,800,000
2013 866,921,083,000 864,978,283,000 -1,942,800,000
2014 1,060,814,376,000 1,057,899,776,000 -2,914,600,000
2015 1,297,961,440,000 1,292,686,340,000 -5,275,100,000
2016 1,568,097,000,000 1,562,975,000,000 -5,122,000,000
2017 1,832,786,000,000 1,821,901,900,000 -10,884,100,000
2018 2,200,121,000,000 2,190,270,000,000 -9,851,000,000
2019 2,690,751,000,000 2,674,210,500,000 -16,540,500,000
2020 .. ..

Where LCU is local Currency unit (in birr)

Source: World Bank Data
Net factor income /payment

k
Ban
orld
:W
rce
Sou
5.2. Real and Nominal GDP
• Nominal GDP- measuring economic performance
using prevailing (current ) market price
• In nominal measure, GDP may increase due to
increase in Price (P) or Quantity (Q) produced
GDP   PcQc where c is current price
• So to avoid the impact of price we use real GDP
• Real GDP- is the value of goods and services
measured using constant or base (b) year price
GDP   PbQc
• Currently Ethiopian base year price is 2010 (world
Bank data)
• Example: Assume in Ethiopia only two products are
produced ; which are Cement and Coffee
• Hypothetical data from 2010-2019 is given below
Year Price of Quantity of Price of Quantity of
Cement Cement (in Coffee Coffee (in
(birr) million tons) (birr) million tons)
2010 1,900 6 21,500 3.5
2011 1,920 8 22,000 4
2012 1,930 9 22,500 4.5
2013 1,950 10 23,000 5
2014 2,000 11 23,500 5.5
2015 2,100 12 24,000 6
2016 2,300 14 24,500 6.5
2017 2,600 16 25,000 7
2018 3,000 20 26,500 7.5
2019 3,500 25 27,000 8
 In the above example the base year price is price of 2010.
Q: Find nominal GDP and real GDP of 2015
Answer:

NGDP  2,100 x12  24, 000 x6  169, 200

RGDP  1,900 x12  21,500 x6  151,800

 Have you noticed the difference in NGDP and RGDP?

NGDP  RGDP  169, 200  151,800  17, 400

 The exaggeration in nominal GDP is not because productivity
of the country increases but because of price
• The following table and graph show the nominal and real GDP
of Ethiopia from 2011 to 2019 G.C. in LCU (Birr)

GDP GDP
Year (current LCU) (constant LCU)
2011 515,078,541,000 979,870,781,100
2012 747,326,498,000 1,064,608,160,500
2013 866,921,083,000 1,177,267,871,000
2014 1,060,814,376,000 1,298,026,040,000
2015 1,297,961,440,000 1,432,922,916,200
2016 1,568,097,000,000 1,568,097,451,000
2017 1,832,786,000,000 1,718,073,265,000
2018 2,200,121,000,000 1,835,179,678,000
2019 2,690,751,000,000 1,988,675,679,000
Source: World Bank
 The difference is
due to inflation

Source: World Bank

5.3. Flow of Economic activities
The concept of flow and stock
5.4. Approaches of measuring GDP
• There are three approaches of measuring GDP
– Income approach
– Expenditure approach
– Value added approach
A) Income approach
• GDP is the summation of returns (income) to factors
of production.
• It includes:-
 – Wage and salary of labors
– Rent of land and physical capitals
– Interest of saving and financial capital
– Profit of proprietor (sole proprietorship and partnership
firms)
– Undistributed corporate profit (corporate income tax +
dividend +retained earning)
– Indirect business tax (VAT, sales tax, excise tax)
– Depreciation of fixed capital
– Statistical discrepancy (error in measuring)
• In order to make comparison easy we use the US
dollar value of GDP where base year is 2010 GC
 Ethiopian GDP

GDP
Year (Constant USD)
2011 33,279,878,090
2012 36,157,859,259
2013 39,984,181,569
2014 44,085,556,179
2015 48,667,131,303
2016 53,258,136,694
2017 58,351,845,888
2018 62,329,193,946
2019 67,542,461,143
The top 10 countries with the largest GDP in 2019 (in billion U.S.D)

© Statista 2020
 B) Expenditure Approach
• GDP is measured by aggregating expenditure made on
domestically produced final goods and services in the
product market
• The expenditure approach includes the following
components
– Domestic consumption expenditure)  C
– Business Investment expenditure  I
– Government expenditure  G)
– Net Foreign expenditure  NX=Export-Import
Consumption spending (C)
Personal consumption spending includes
 durable goods, e.g. TV, car, house, etc.
 nondurable goods, e.g. bread, oil, etc. and
 Services e.g. health care, haircut, etc.
Consumption = durable +nondurable + service
Gross Domestic private Investment (I)
• Investment is addition to the physical stock of capital
• Includes:-
Business fixed inv’t – expenditure of business on
capitals that produce goods and services.
E.g. plants, equipments, tools, etc.
Residential inv’t – expenditure of business on
residential housing.
Inventory inv’t – investment on stored inventory to
be sold in the future.
 Government expenditure (G)
• Expenditure by any gov’t body – federal, state, local It includes:-
1. Expenditure on goods and services e.g. provision of public
goods, police, defense and health care service ...
2. Salary and wages of gov’t employees

Net export (NX)

• Export is demand of foreigners for domestic
product – so it is part of domestic GDP
• Import is domestic demand for foreign product
– so it is not part of domestic GDP
• NX = EX – IM
 GDP=C+I+G+NX
2500000000000

2000000000000

1500000000000

Final consumption expenditure

(constant LCU)
Gross capital formation (current LCU)
1000000000000
General government final consumption
expenditure (constant LCU)
Net trade in goods and services
(constant LCU)
GDP- Expenditure Approach-in Birr
500000000000

0
11 12 13 14 15 16 17 18
20 20 20 20 20 20 20 20
2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/
/1 /1 /1 /1 /1 /1 /1 /1
30 30 30 30 30 30 30 30

-500000000000
C) Product or value added approach
Value added: is the value of output minus the value of
the intermediate goods used to produce that output
In this approach GDP is the summation of value
added at each stages of production of all products
Summation of value added at all stages is equal to
price of final goods.
• Including price of intermediate and final goods in
GDP would be double-counting.
• The value added approach avoids the problem of
double counting.
• Example
 Stages of production of one Value of Value
quintal of bread. txn added

Farmer grows wheat and sell to 1500 birr 1500

miller birr
Miller converts (turns) the wheat 1530 birr 30 birr
to flour and sell to baker

The baker bake bread and sell to 1590 birr 60 birr

store owner

The store owner sells the bread to 1635 birr 45 birr

the final consumer
Final price and total value added 1635 birr 1635
birr
5.5. Other Social Accounts of GDP
Net domestic product (NDP)
It represent the value of total output of an economy
after net out depreciation.
NDP=GDP – depreciation
Net national product (NNP)
 It is also known as Adjusted national income
 It measures the value of total output produced by
resource of a given country after fixed capital
depreciation is deducted.
NNP=GNP – Depreciation
NNP=GDP+NFI – Depreciation
 In Green NNP, depreciation of Natural resources
also deducted
National Income (NI)
 National income measures how much everyone in the economy
has earned (excluding foreign nationals and foreign firms).
NI is total income earned by resource owners from current
production.
It is economic value of resources
Calculated in two ways
1) NI=NNP - indirect business tax ( IBTX)
NI= NDP-Indirect business tax +net foreign factor income
2) NI = Employees’ compensation (wage/salary)
+ Rental income
+ Net Interest
+ Proprietors’ income
+ Corporate profit
+NFP
Personal income
PI is the amount of income that households receive
PI = National Income
− Corporate Profits
− Social Insurance Contributions
− Net Interest (public and personal)
+ Dividends
+ Government Transfers to Individuals
+ Personal Interest on Income
Disposable personal income- (DI)
It is the money spend or saved by house holds
DI = personal income
- Personal income tax and
- non-tax payments
DI = Consumption + Saving
GDP Per-capita income
 Per-capita income measures the average income
earned per person in a given country in a year.
It is calculated by dividing the GDP by its total
population.
 • The following table shows the per-capita income of an
Ethiopian in a year
Year 2015 2016 2017 2018 2019
GDP (constant 2010
US$) 48,667,131,303 53,258,136,694 58,351,845,888 62,329,193,946 67,542,461,143
Population, total 100,835,458 103,603,501 106,400,024 109,224,559 112,078,730
Per-capita GDP per year 482.64 514.06 548.42 570.65 602.63

• The world top 10 per-capita countries in 2017 (in USD)

Switzerland
Luxembour

Singapore
Denmark

Australia
Country

Norway

Ireland

Iceland

Qatar

USA
g

Per-capita
GDP
107 ,053

74,571

80,069

70,220
73,529

60,694

57,360

57,495

55,697
59,792
Rank 1 2 3 4 5 6 7 8 9 10
The new global poverty line is set at $1.90 per day and about
693.3 per year using 2011 prices
5.6. Fluctuation in Economic Activities
A) Measures of General Price level and Inflation
The general price level can be measured in three
different ways for different purposes
• GDP deflator
• Consumers’ price index
• Producers’ price index
i) The GDP deflator
• GDP deflator is also known as implicit price deflator
• It measures the current price of output relative to its
price in the base year.
Nominal GDP
GDP Deflator  x100% in percentage 
Real GDP
 Nominal GDP
GDP Deflator  in decimal 
Real GDP
• GDP Deflator shows whether the price level of
products is increasing or decreasing in reference to the
base year price.
• GDP deflator as its name indicates deflates Nominal
GDP to Real GDP.
Nominal GDP
Real GDP 
GDP Deflator (in decimal )
• Example
• In the following table nominal and real GDP are given.
• Calculate the GDP Deflator of the year 2018
Year GDP GDP GDP
(current LCU) (constant LCU) Deflator
2011 515,078,541,000 979,870,781,100 0.53
2012 747,326,498,000 1,064,608,160,500 0.70
2013 866,921,083,000 1,177,267,871,000 0.74
2014 1,060,814,376,000 1,298,026,040,000 0.82
2015 1,297,961,440,000 1,432,922,916,200 0.91
2016 1,568,097,000,000 1,568,097,451,000 1.00
2017 1,832,786,000,000 1,718,073,265,000 1.07
2018 2,200,121,000,000 1,835,179,678,000 1.20
2019 2,690,751,000,000 1,988,675,679,000 1.35
ii) Consumer price index (CPI)
• It represents price of a fixed basket of goods and
services purchased by a typical consumer relative to
the price of the same basket of goods and services in
some base year.
• Typical consumer is average consumer.
• Used to track changes in the typical household’s cost
of living
• What are in the CPI’s Basket? Basic products like -
housing, food, beverage, transportation, etc.
Pc1  Pc 2  Pc3  ... It can be calculated as
CPI  • For food
Pb1  Pb 2  Pb3  ...
• For non food or
• Generally
 In the following table CPI of Ethiopia for recent years are given
30/12/ 30/12/ 30/12/ 30/12/ 30/12/ 30/12/ 30/12/ 30/12/
Year 2010 2011 2012 2013 2014 2015 2016 2017
Consumer Price
Index 100.00 133.25 165.40 178.76 191.99 211.40 226.76 249.09

Consumer Price Index in percent (2010  100%)

%
250.000

200.000

150.000

Consumer Price Index

100.000

50.000

ank
B
0.000
o rld
10 11 12 13 14 15 16 17 18
:W
rce
0 0 0 0 0 0 0 0 0
2 /2 2 /2 2 /2 2 /2 2 /2 2 /2 2 /2 2 /2 2 /2
0/
1
0/
1
0/
1
0/
1
0/
1
0/
1
0/
1
0/
1
0/
1
u
3 3 3 3 3 3 3 3 3
So
iii) Producer price index
• It measures the general price level of price of
typical basket of goods bought by firms relative to
the general price level at the base year.
Pc1  Pc 2  Pc3  ...
PPI 
Pb1  Pb 2  Pb3  ...
• It can be calculated for different sectors
differently
• the following graphs show quarterly producer
price index of Ethiopia for agriculture and
manufacturing industry
Difference between GDP deflator and CPI
• GDP deflator measures the price of all product
bought by consumer, producer and government that
are produced in the economy
• CPI measurers price of products consumed by the
consumer only
• GDP deflator does not include imported goods.
• CPI includes imported goods
• GDP deflator is flexible (what is produced is
included)
• CPI is computed using fixed basket of good not
newly produced consumer good
 Inflation
• Inflation is a sustained rise in the general level of prices
• Increment sustained … it is not simply a once for all increase
in prices
• General level of price rises
• General level of prices
• GDP Deflator
• CPI
• PPI
• However, prices of some products
– may increase,
– decrease or
– Remaining constant
• But, on average price level is increasing. i.e.
• Inflation is one of the economic fluctuation
 Inflation Rate (πt)
πt measures the rate at which inflation is increasing
 pt  p( t 1) 
t    100%
 p( t 1) 
 
p is general price level (GDP Deflator, CPI or PPI)
Ethiopian overall Inflation using GDP-Defl.
40.0

35.0

30.0

25.0

20.0 Inflation GDP-Defl.

15.0

10.0

5.0

0.0
10 11 12 13 14 15 16 17 18
20 20 20 20 20 20 20 20 20
2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/
/1 /1 /1 /1 /1 /1 /1 /1 /1
30 30 30 30 30 30 30 30 30
 Food inflation
Non food inflation
General inflation

2017 2018 2019

Producer Price Index (For all Manufacturing Items)
Base year 2011

Source: CSA
 Producer price index (for agriculture )

2010 2011 2012

Source: CSA
 Causes of inflation
I) Demand pulls factors
 Is due to rapid increase in demand for goods and
services than supply of goods and services
 Classical Economists - Demand increases due to
increase in money supply
 Keynesian Economists - aggregate demand increase
(expenditure increases) due to increase in wage and
income
II) Cost push (supply side) factors
• When cost of production increases supply decreases
and shifted to the left
III) Structuralists theories of inflation
• The structuralists says that the above standard
theories of inflation cannot be applied to the
economies of developing countries like Ethiopian
Economy.
• Because it is based on the implicit assumption behind
the theories which the economy of LCD cannot
fulfill.
Assumptions behind the other theories
• Balanced and integrated structure of the economy
• Smooth inter-sectoral flows of resources in response
to market signals
• Quick adjustment between consumption, production
(investment.)
• Smooth and free play of market forces
• Especially classical economists assume full
employments of resources
Characteristics of Economy of Developing countries
• Sectoral imbalances with surplus in some sector and
shortage in the other sectors.
• immobility of factors of production (input)
• wage rigidities
• highly fragmented market and high market imperfection
• high unemployment
• As a result developing economies are characterized by
high rate of inflation with large scale of unemployment
which is a paradox.
• From these reasons standard theories of inflation and
anti inflationary policies built for developed economies
have little relevance to developing economies.
• According to structuralists Causes of inflation of
developing economies is the structural imbalances in
the economies
• The major structural imbalance includes:
– Food shortage (low food supply)
– Resources imbalance in different sectors
– Foreign exchange bottle necks:
– Infrastructural bottle necks
 Economic effect of inflation
1. It reduces real money balance (purchasing power of money)
2. inflation increases the nominal interest rate and cost of holding
money.
Fisher’s equation r = I- П, where
I- nominal interest rate,
r-real interest rate
П expected inflation.
3. People buy more durable goods during inflation b/c purchasing
power of durable goods is non declining
4. Inflation decreases expenditure on domestic goods and
services.
5. Inflation increases uncertainties
6. Inflation redistributes wealth: Unanticipated inflation hurts
individuals with fixed income (like pension).
7. Shoes leather cost of inflation
8. Menu cost of inflation.
 B) Business Cycle
• It is the recurrent ups and downs of the economy in
the short run
• It is a regular pattern of expansion and contraction in
economic activity around trend growth
• Trend growth is full employment in the long run
• Business cycle shows fluctuation of all
macroeconomic variables mainly Real GDP
• Upswings and downturns of the business cycle are
gauged (measured) in terms of changes in total output
(real GDP)
• In the short run some times there is over employment
and some times under employment
 Growth Trend
(potential out put)
at full employment
Peak
Actual
output
m, ssion
Bo o ce
Re
Depression
Trough
Recovery,
Peak
s sion Expansion
ece
oo m, R
B
Depression,
Contraction Trough

Growth trend
Phases of business cycle
Expansion (Recovery or upswing):
• Increase in the volume of goods and services produced (Real
GDP increasing)
Contraction (Downturn):
• Occurs when the volume of production is declining (Real GDP
declining).
Boom:
• A period of economic prosperity and growth.
• Occurs when national output is rising at a rate faster than the
trend rate of growth…i.e. faster than Gov’t expects!
• High out put (Real GDP)-- Actual Real GDP > Potential Real
GDP
• High employment (low un employment)
• Increasing in aggregate demand (C, I, G and NX)
Recessions :
• Is period when total output (real GDP) declines
• A phase of negative growth.
• A severe and persistent recession is called
slump/trough
• Declining aggregate demand (C, I, G and NX)
• High unemployment

Causes of business cycles

• Fluctuation in demand
• Fluctuation is supply
Source: World Bank
 C) Unemployment
• Unemployment is a situation in which able bodied
persons willing to work at prevailing wage rate but
do not able to find job
• Total population - All age people
• Adult population - Able bodied (15-64 age)
• Able bodied divided into labor force and out of
labor force
• Out of labor force includes
–full time student
--imprisoned
--those in mental institution
--discouraged labor
--unwilling to work labors
 Categories of the Adult population
Employed - working at a paid job
Unemployed - not employed but looking for a job
Labor force - the amount of labor available for
producing goods and services; all employed plus
unemployed persons
Non labor force- not employed, not looking for
work.
Unemployment rate - percentage of the labor force
that is unemployed
Labor force participation rate - is the fraction of
the adult population that ‘participates’ in the labor
force
Source: derived from World Bank Data
Year 30/12/2015 30/12/2016 30/12/2017 30/12/2018
Total Population 100835458 103603501 106400024 109224559
Adult Population
(age of 15-64) 54825799 56781182 58798112 60855430
Labor Force 46919914 48523830 50161105 51941541
Employed 45974946 47584893 49253189 51001918
Unemployed 944967 938936 907915 939622

• Given the following data about Ethiopia,

 calculate the unemployment rate of the year 2017
 Calculate the labor force participation rate of 2018
 Types of unemployment
i) Frictional unemployment
• Is the temporary layoff time until workers match
with jobs
• It includes
• the time of searching preferable job
• time taken by information flow b/n vacancies and
unemployed
• time taken in geographical movement.
• employment process,
ii) Structural unemployment
• Due to structural change in dynamic economy Some
skills become obsolete and mismatch between labour
demand and supply.
• It includes
• Change in the structure or sectoral composition of the
economy due to technological change.
• decline of old industries production and the emergence
of new industries.
Eg. Horse cart driver and Bajaj driver
iii) Cyclic unemployment
• It is due to short run fluctuation of the economy
• Workers become unemployed for some period when
their job evaporates due to recession and returns to
job when there is expansion in economic activities.
Costs of unemployment
• An increase in the unemployment rate decreases the
real GDP of an economy.
• It reduces living standard
• Causes psychological distress.
• Income distribution effect; It causes inequality among
employed and unemployment workers.
 Inflation and unemployment
• Some economists believes that moderate level of
inflation (2 to 3) percent per year is good to stimulate
the economy.
• That is a moderate level of inflation reduces real
wage and then increase level of employment
(decreases unemployment).
• When real wage rate (nominal wage minus inflation)
declines people want to get more wage so that supply
more labor
• unanticipated inflationary shock reduces real wages
and then expands level of employment and output.
 Measures to Control Inflation, Recession and
Unemployment
• The following policy measures are used in combination to
control economic fluctuation.
– Monetary measures - decreasing money supply (to
control demand pull inflation )
– Fiscal measures – decreasing government expenditure and
increasing tax that decreases aggregate demand (to control
demand pull inflation )
– Wage and price control – setting price and wage (to
control cost push inflation)
– Indexations - A system of economic regulation: wages and
interest are tied to the cost-of-living index in order to
reduce the effects of inflation, while deindexation is the
unwinding of indexation.
End of the Course!