Chapter 7:
National Income Analysis
MACROECONOMICS : The Big Picture
ECONOMICS: The study of the production and
distribution of goods and services.
MICROECONOMICS: Specific areas or sectors of the
economy.
MACROECONOMICS: The economy as a whole.
MACROECONOMICS:
Circular Flow Model
WAGES, INTEREST,
RENT, PROFIT
Businesses Households
CONSUMER SPENDING
MACROECONOMICS:
Circular Flow Model
Exports Imports
WAGES, INTEREST,
RENT, PROFIT
Businesses Government Households
CONSUMER SPENDING
LOANS SAVINGS
Financial
Intermediaries
MACROECONOMICS : The Big Picture
Economic Goals:
• OUTPUT - at or near capacity
• EMPLOYMENT - at or near full
• INFLATION - at a minimum
Measuring Performance:
• OUTPUT - Gross Domestic Product (GDP)
• EMPLOYMENT - Unemployment Rate
• INFLATION - Consumer Price Index (CPI)
GDP
GROSS DOMESTIC PRODUCT
The value of all final goods and services
produced in a country in one year.
MACROECONOMICS:
Measuring GDP
TWO METHODS:
1. Expenditures Approach
2. Income Approach
How GDP Is Measured?
Income (wages, salary, rent, interest, profits)
Flow of Income Value of what is
Approach produced
Firms Same As Households
Expenditures Value of what is
Approach spent
Expenditures by Consumers, Investors, Government, and Net Exports
(GDP = C + I + G + Xn )
MACROECONOMICS:
Expenditures Approach
GDP = C + I + G + X
1. Consumption - C:
• Personal consumption expenditures
• Durable and nondurable goods, consumer
services
2. Investment - I:
• All final purchases of machinery, equipment,
and tools
MACROECONOMICS:
Expenditures Approach
GDP = C + I + G + X
3. Government - G:
• Government spending on products and
resources, including labour
• Excludes transfer payments
4. Net Exports - X:
• All foreign purchases of Canadian goods and
services
• LESS all Canadian purchases of foreign
goods and services
MACROECONOMICS:
Expenditures Approach
Application Question:
Last year, the Diminishing Republic’s total consumer
spending was $35 million. Total investment was $12 million,
and government spending was $15 million. Exports were $9
million and imports were $7 million.
What was the Diminishing Republic’s GDP?
Gross Domestic Product Calculation
Income Approach Expenditure Approach
($ billions) ($ billions)
Wages and salaries 597.3 Personal consumption (C)
Corporate profits 143.4 656.2
Interest Income 49.4 Gross investment (I) 218.9
Proprietors’ incomes & rents71.1 Government purchases (G)
Indirect taxes 138.2 230.0
Depreciation 155.0 Net exports (X – M) 50.3
Statistical discrepancy 0.5 Statistical Discrepancy 0.5
Gross Domestic Product1154.9
Gross Domestic Product
1154.9
GNP
GNP:
• A measure of national output closely related to
GDP
GDP measures the total output produced in a country and
the total income generated as a result of that
production.
GNP measures the total output produced by the factors
owned by a country, no matter where it was produced.
MACROECONOMICS:
Real v. Money GDP
Nominal GDP:
• Production measured in current prices
• Includes inflationary increases
• Also called “Money GDP”
Real GDP:
• Production measured in constant prices
• Adjusted for price increases due to
inflation
NOMINAL GDP vs. REAL GDP
Nominal Values
• Deflate GDP when prices rise
• Inflate GDP when prices fall
• Nominal GDP
• Calculating Real GDP
(4)
(2) (3) Unadjusted, (5)
(1) Price Price Index or Nominal, Adjusted,
Units of Pizza Year 1 = GDP, Or Real,
Year Output Per Unit 100 (1)x(2) GDP
1 5 $ 10 100 $ 50 $ 50
2 7 20 200 140 70
3 8 25 250 200 80
4 10 30 - - -
5 11 28 - - -
MACROECONOMICS:
Real GDP
100
Real GDP = Nominal GDP x GDP Deflator
GDP deflator = Nominal GDP
Real GDP x 100
MACROECONOMICS:
Real GDP
Application Question:
Fill in the blanks for Real GDP, GDP
deflator, and Nominal GDP
on the chart below.
Nominal Real GDP
YEAR GDP GDP Deflator
1997 882.7 100.0
2000 1075.6 105.37
2002 1155.09 1074.5
Gross Domestic Product and Net National Product
• Capital wears out, or depreciates, while
being used to produce output.
• Inclusion of depreciation in reporting the
value of national income necessitates
differentiating Gross National Product
(GNP) from Net National Product (NNP).
That is,
NNP GNP – D
• NNP thus comes closer to measuring
only the flow of output available for
consumption and capital accumulation.
Net National Product and National Income
• The addition of a government that imposes taxes upon the
production process requires that NNP be differentiated from
national income.
• National Income is the sum of all factor payments received by the
owners of productive resources. That is,
NI wages + rental payments + interest payments + profits
or
NI NNP – indirect taxes
• Indirect taxes are taxes, which are levied on particular
products and transactions and are paid for (indirectly) every time
a sale is made on these products.
– For instance, when a person pays to watch a movie, a part of
the price that he pays goes to the government as amusement
tax.
– The most important of these indirect taxes include import,
export, and domestic sales tax, local taxes on sales,
entertainment, business licenses, stamp taxes, and motor
vehicle taxes.
Components of National Income
• Wages and salaries are compensation
of employees and other fringe benefits;
• Profits and interest earning are income
from unincorporated enterprises, i.e.
earnings of partnerships and single-
proprietorships;
• Private corporate income which may be
broken down into total corporate profit
taxes, dividends paid, and corporate
undistributed profits or saving;
• Proprietary and corporate income of
government.
Two Income Concepts:
Personal Income and Personal Disposable Income
• Personal income (PI) is the total income from all
sources of households and non-profit institutions. It is
composed of compensation of employees, incomes of
unincorporated enterprises, dividends received from
households and private non-profit institutions.
• Transfer payments are payments that are made to
people without their providing current service in
exchange for the payments. Examples of transfer
payments are security benefits and unemployment
benefits.
• Personal income is smaller than national income.
Personal income is national income plus transfer
payments less the undistributed income of
corporations. That is,
PI = NI – corporate income + dividends paid by corporations +
net current transfer payments
Two Income Concepts:
Personal Income and Personal Disposable Income
• Personal disposable income (PDI) is a
concept derived from personal income.
– It refers to the income that households and
private non-profit institutions have for
spending and saving. Personal disposable
income is the same as personal income
after deduction of all direct taxes (DT) on
persons. Thus, personal disposable income
(PDI) is:
PDI = PI – DT
• Direct taxes consist of personal
income taxes, and inheritance taxes.
Table 7.2 : Numerical Example for the Computation
of GNP, NNP, NI, PDI, PI
(1) (2) (3) (4)
Compensation of employees P4222.7 Personal compensation expenditure P4924.9
Rent 122.2 Gross private domestic investment 1065.3
Interest 403.6 Gross expenditures 1358.3
Profit Net exports (94.7)
Proprietors’ income 478.4 Gross domestic product P7253.8
Corporate 586.6
National income 5813.5
Indirect business taxes 679.0
Net national product (NNP) 6492.5
Capital consumption allowances 754.2
Gross national product (GNP) 7246.7
Plus: Payments of factor income to
rest of the world 215.3
Less: Receipts of factor income
from the rest of the world (208.3)
Gross domestic product P7253.8
MACROECONOMICS:
Calculating GDP
GDP Excludes:
• Unpaid work
• Homemakers, parents, do-it-yourselfers,
volunteers
• Used goods
• Financial transactions
• Buying and selling of securities
• Government transfer payments
• Private transfer payments
• Underground economy
• Avoiding taxes, hiding illegal activity
MACROECONOMICS:
Calculating GDP
Example of Underground Economy:
• Ontario’s construction industry
• Average annual underground income 1998-
2000:
$2.395 billion
• Approximately 20% of total construction income
• Average annual loss to government:
$1.259 billion
• Income and other taxes
• Workers Compensation Board
From [Link]
MACROECONOMICS:
Shortcomings of GDP
Increase in GDP:
No effect on GDP:
• Car accidents
• Alcoholism • Helping a neighbor
• Natural disasters • Growing own food
• Bike for transportation
GDP measures economic activity,
not human welfare
MACROECONOMICS:
Measuring Human Welfare
1. Standard of Living:
• The quality and quantity of goods and
services available to people.
• Usually measured as GDP per capita
GDP per capita = Real GDP / population
MACROECONOMICS:
Measuring Human Welfare
2. Quality of Life:
• The well-being of a population
• Includes subjective factors such as leisure,
safety, social life, mental health,
environmental quality, etc.
• Human Development Index (HDI) – Pakistani
economist Mahbub ul Haq
MACROECONOMICS:
Shortcomings of GDP
Application Question:
Individually or in small groups, brainstorm as many
answers as possible to the following question:
What factors that you consider important to your
quality of life are NOT measured by GDP?
Human Development Index (HDI):
(adjusted for Purchasing Power Parity)
Measures 3 areas: Measured by:
Long and healthy life • Life expectancy at birth
Level of education • Adult literacy rate
• School enrollment ratio
Standard of living • GDP per capita
MACROECONOMICS:
Gross Domestic Product
Quick Review:
• GDP (Gross Domestic Product) is the value of all goods and
services produced in a country in one year
• Only final goods are included in GDP, to avoid double counting
• Expenditures Approach measures spending C + I + G + X
• Income Approach measures all income earned
• Money GDP is GDP in current money, not adjusted for inflation
• Real GDP is GDP in constant dollars, adjusted for inflation
MACROECONOMICS:
Gross Domestic Product
Quick Review:
• GDP excludes unpaid work, used goods, underground
economy, transfer of financial assets
• GDP measures economic activity, not human welfare
• Standard of living is the quantity and quality of goods and
services available to a society; usually measured as GDP per
capita
• Quality of life refers to the well-being of a society; includes
many diverse measures, including life expectancy, health,
safety, etc.
