 National income accounting refers to a set of rules and

CHAPTER-TWO
techniques that are used to measure the national income of
NATIONAL INCOME ACCOUNTING

a country.
 National income: is the sum of all individual incomes
such as:
1.The total sum of all wages, salaries, commissions and
labor incomes before payment of taxes and social security
contributions
2.Interest income from Bonds, mortgages, loans etc. After
deducting interest paid on government debts
3.Rental income from real property and royalties and
4. Profit of corporation, partnership or proprietorship
before deduction of taxes
In short, national income is the monetary
value of all goods and services produced
in a country in one year.
The most widely used measure of NI are
GDP and GNP.
In the modern approach, NI has three
aspect:
1. Product aspect
2. Income aspect
3. Expenditure aspect
NI is viewed as a flow of output, income and
expenditure. i.e., there is a circular flow of
production, income and expenditure.
These three flows are always equal per unit
of time.
Hence,
Total output= total income=total expenditure
 Main features of national income
concepts
The main features of the concept of
national income are:
1.National income(NI) is a flow not a stock
2.NI, in real terms, is the flow of goods and
services produced during a particular period
by an economy
3.NI, in monetary terms, is the money value
of the aggregates of all G&S available to
the nation in a particular period
4. NI is always expressed with reference
to a particular period of time usually a
year
5. the concept of NI is visualized as a
flow of national output, national income
and expenditure.
The concepts of GDP and GNP
GDP- is the market value of all final goods
and services produced by resources located
within a country regardless of ownership of
the resources during a year.

GNP-is the market value of all final goods

and services produced by resources owned
by citizens of a country during a year.
Rules for Computing GDP
1) Tocompute the total value of different
goods and services, the national income
accounts use market prices.
Thus, if:
$0.50 $1.00

GDP = (Price of apples  Quantity of apples)

 + (Price of oranges  Quantity of oranges)
 = ($0.50  4) + ($1.00  3)
GDP = $5.00
2)Used goods are not included in the
calculation of GDP.
3) The treatment of inventories depends on
if the goods are stored or if they spoil.
If the goods are stored, their value is
included in GDP.
If they spoil, GDP remains unchanged.
When the goods are finally sold out of
inventory, they are considered as used
goods (and are not counted).
 4) Intermediate goods are not counted in GDP– only
the value of final goods.
 Because: the value of intermediate goods is already
included in the market price of final goods.

 Value added of a firm equals the value of the firm’s
output less the value of the intermediate goods the
firm purchases.

 5) Some goods are not sold in the marketplace and

therefore don’t have market prices. We must use their
imputed value as an estimate of their value. For
example, home ownership and government services.
 NB. However, there is no imputation for the goods
and services sold in the underground economy.
Real GDP versus Nominal GDP
Nominal GDP- is the value of all final goods
and services measured at current prices.
 It can change over time, either because there
is a change in the amount (real value) of
goods and services or a change in the prices
of those goods and services.
Hence, nominal GDP Y = P  y, where P is
the current price level and y is real output.
Real GDP -is the value of goods and services
measured using a constant set of prices.
To estimate real GDP, we first select a
base year prices. Then ,we use the base
year prices to calculate GDP.

Since prices are constant, real GDP varies

from year to year only if the quantities
produced vary.

In general, real GDP is a better measure

of economic well-being than nominal
GDP.
 GDP deflator
GDP deflator, also called the implicit price
deflator for GDP , measures the price of
output relative to its price in the base year.
It reflects what’s happening to the overall
level of prices in the economy.

GDP Deflator = Nominal GDP

Real GDP
 Components of expenditure
The national income accounts divide GDP into four
broad categories of spending:
 Consumption (C)
 Investment (I )
 Government purchases (G)
 Net exports (NX).

Thus, letting Y stand for GDP,

Y = C + I + G + NX
That is; GDP is the sum of consumption, investment,
government purchases, and net exports.
This equation is called the national income accounts
identity.
Consumption(C)
consists of the goods and services bought by
households.
It is divided into three subcategories:
nondurable goods, durable goods, and
services.
Nondurable goods are goods that last only a
short time, such as food and clothing.
Durable goods are goods that last a long time,
such as cars and TVs.
Services include the work done for consumers
by individuals and firms, such as haircuts and
doctor visits.
Investment(I)
 Consists of goods bought for future use.
 Investment is also divided into three
subcategories: business fixed investment,
residential fixed investment, and inventory
investment.
 Business fixed investment is the purchase of
new plant and equipment by firms.
 Residential investment is the purchase of new
housing by households and landlords.
 Inventory investment is the increase in firms’
inventories of goods (if inventories are falling,
inventory investment is negative).
Government purchases(G)
 Are the goods and services bought by federal, state, and
local governments.
 This category includes military equipment, highways, and
the services provided by government workers.
 However, it does not include transfer payments to
individuals, such as Social Security and welfare.
 Because transfer payments reallocate existing income and
are not made in exchange for goods and services, they are
not part of GDP.
Net exports(NX)
 Net exports are the value of goods and services sold to
other countries (exports) minus the value of goods and
services that foreigners sell us (imports).
 Net exports are positive when the value of our exports is
greater than the value of our imports and negative when the
value of our imports is greater than the value of our exports.
 Other measures of income
 The national income accounts include other
measures of income that differ slightly in
definition from GDP.
 To see how the alternative measures of income
relate to one another, we start with GDP and
add or subtract various quantities.
 GNP = GDP + Factor Payments from Abroad -
Factor Payments to Abroad, or GNP=GDP+NFI
Net national product (NNP)= GNP–Depreciation
In the national income accounts, depreciation
is called the consumption of fixed capital.
Personal income(PI): is the amount of
income that households and non-corporate
businesses receive.
To get the personal income we need some
adjustments to NI.
PI = National Income
-Corporate Profits
-Social Insurance Contributions
-Net Interest
+Dividends
+Government Transfers to Individuals
+Personal Interest Income.
Disposable personal income: is the amount
households and non-corporate businesses
have available to spend after satisfying
their tax obligations to the government.

Disposable Personal Income=PI-Personal Tax and

None tax Payments
Consumer Price Index(CPI)
Inflation: is the increase in the overall level
of prices.
The most commonly used measure of the
level of prices is the consumer price
Index.
CPI turns the prices of many goods and
services into a single index measuring the
overall level of prices.
To aggregate the many prices in the economy
into a single index that reliably measures the
price level, economists use the weighted
average of all prices(since goods are not
equally purchased).
That is; we give weights to different items by
computing the price of a basket of goods and
services purchased by a typical consumer.
The CPI is the price of this basket of goods
and services relative to the price of the same
basket in some base year.
Example: suppose that the typical consumer
buys 5 apples and 2 oranges every month.
Then the basket of goods consists of 5
apples and 2 oranges, and the CPI is:

CPI = (5 × Current Price of Apples) + (2 × Current Price of Oranges)

(5 × 2009 Price of Apples) + (2 × 2009 Price of Oranges)

In this CPI, 2009 is the base year.

The index tells us how much it costs now to
buy 5 apples and 2 oranges relative to how
much it cost to buy the same basket of fruit
in 2009.
Although CPI is a good measure of the
cost of living, it is believed to overstate
inflation due to a number of reasons.
First, substitution bias: since CPI
measures the price of a fixed basket of
goods, it does not reflect the ability of
consumers to substitute toward goods
whose relative prices have fallen.
Thus, when relative prices change, the true
cost of living rises less rapidly than the
CPI.
Second, introduction of new goods.
When a new good is introduced into the
marketplace, consumers are better off,
because they have more products from
which to choose. In effect, the introduction
of new goods increases the real value of
money.
Yet this increase in the purchasing power
of money is not reflected in a lower CPI.
Third; unmeasured changes in quality.
When a firm changes the quality of a good
it sells, not all of the good’s price change
reflects a change in the cost of living.
 The CPI Versus the GDP Deflator
 Both CPI and GDP deflator deals with how quickly
prices are rising.
 However, there are three key differences between
the two measures.
 First, the GDP deflator measures the prices of all
goods and services produced, whereas the CPI
measures the prices of only the goods and services
bought by consumers.

 Thus, an increase in the price of goods bought only

by firms or the government will show up in the GDP
deflator but not in the CPI.
Second, GDP deflator includes only those
goods produced domestically. Imported
goods are not part of GDP and do not show
up in the GDP deflator.

Hence, an increase in the price of a Toyota

made in Japan and sold in this country
affects the CPI, because the Toyota is
bought by consumers, but it does not affect
the GDP deflator.
Third, the way the two measures aggregate
the many prices in the economy. The CPI
assigns fixed weights to the prices of
different goods, whereas the GDP deflator
assigns changing weights.
In other words, the CPI is computed using
a fixed basket of goods, whereas the GDP
deflator allows the basket of goods to
change over time as the composition of
GDP changes.
END