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National Income

National Income Accounting

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IntroductionNational 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.

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Firm ConsumersFactor Owners

Factor Market Product Market

Factor services Goods & services

ExpenditureRevenueCostFactor Income

Real Flow

Money Flow

The flow of economic activities in a 2-sector economy

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GNP v.s. GDPGross 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 & GDPFlow 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 IncomeOutput Approach GDP at factor cost

Expenditure Approach GDP at market Prices

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GDP at market price-

Indirect sales tax+

Indirect subsidies

GDP at factor cost+

Net income from abroad

GNP at factor cost-

Depreciation

NNP at factor cost

Expenditure Approach

C+I+G+X-M

Income Approach

W+I+R+P

Output Approach

Factor Income-from abroad

Factor Income paid abroad

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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 ApproachW+I+R+P = NNP at factor costProfits are stated net of depreciation / capital consumption allowancesIf the figures exclude net income from abroad, NDP at factor cost can be obtained.NDP at factor cost + Net income from abroad =

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Output ApproachThe 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 ApproachPeople 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 ApproachPrivate Consumption Expenditure (C)Gross Investment Expenditure (I)Firms : plant (in progress) / unused raw materialsHouseholds : residential buildingInventory 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 paymentsat the cost to taxpayers, NOT at market pricesNet Exports (X-M)the value of imports is included in C, I, G, XExports include domestic exports & re-exports

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Items excluded from National Income

AccountingSecond-hand goodsIntermediate goodsNon-marketed goods / servicesVolunteer work / Housework

Unreported / Illegal market transactions

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Merits & Uses of National Income Statistics

Reflecting & comparing the standards of living of different countriesPer capita real GNP standard of livingProviding information to the government and firms for economic planningReflecting 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 welfareExclusion of the value of leisureSame 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 welfareUndesirable Side-effects of ProductionAir 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 Leveluse real GNP eliminate the effect of inflation

Size of Population use per capital GNP

Income Distributionmore even distribution higher welfare

Composition of National incomemore consumption, less national defence higher welfare

Exchange Ratesexpressed in the same currencywhether the exchange rates reflects the purchasing power of the 2 currencies

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InflationA general and sustained increase in the prices of all goods and servicesGNP deflator / GDP deflatorConsumer Price Index (CPI)Producer Price Index (PPI)When constructing price indicesdifferent weighting will be given to different commodities reflecting their relative importance on the consumers’ expenditureA base year is chosen during which the economy experiences no economic crisis

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Calculating a Price IndexItem Expenditur

e1991

Weight

Prices1991

Price Relatives1991

Prices1992

Price Relatives1992

Transport 1000 10 15 100 15 100Clothing 2000 20 100 100 100 100Housing 3000 30 500 100 650 130Food 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=100Price 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 IndicesOnly consumer goods are includedPersistent increase in the CPI implies an increase in the cost of living unless there is a compensating rise in money incomeCPI(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 CPIIn 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 income

Real income

1991 90 7650 8500=(7650/90)*100

1992Base year

100 8820 8820=

1993 105 9555 9100=

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Limitations of the CPIOnly 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 DeflatorTo 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%= 21%1992 121

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UnemploymentWorking Population OR Labour ForceWorking Population=Employed+Unemployed+Self-employed

Un-employment Rate=(Unemployed/Labour Force)*100%Under-employment Rate

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Method of AnalysisEndogenous variablethe value of the variable is determined inside the model ( x, y)Exogenous variablethe 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

C I IY Y Y

Y YY

C=f(Y) C=a C=a+cY C=a+c’Y C=c*Y

I=f(Y) I=I* I=I*+iY