BUSINESS ECONOMICS II

THE MEANING ANDMEASUREMENT OF NATIONAL

INCOME

What Is National Income Measurement?

National income measurement is themeasuring of the performance of theeconomy within a given period usually oneyear.Production is a continuous process andtherefore measure can only be done up to acertain point and this is usually a period ofone year.It is a statistical measure of the nation’sproductive performance. This statisticalknowledge of the nation’s performance isvery necessary

Why Measure National Income?

Measuring economic growthGovernment/policy makers must know how theeconomy is performing in order to decide when,how, and how much stimulus or constraint to apply.For comparing the economic capacity of countriesEvaluating the economic climateAssessing the capacity of the nation to mobilizeresourcesAssessing the national potential for aggression,domination, and or defense against it.

Market As A Way Of Measuring Production

Physical units of different productscannot be added together. Thereforeto add outputs of different goods andservices together to get a meaningfulsum requires a commondenominator (money or market price)Total Output = Qty * Price. This is thecedi measure of national outputduring the year

Gross Domestic Product (GDP)

GDP is the current value of the total final goodsand services produced within a given period by

factors of production located within a country The term final goods and services refers togoods and services produced for final use Intermediate goods are goods produced by onefirm for use in further processing by anotherfirm. These are not used in the computation ofGDP

GDP Vs GNP

GDP is the value of output produced by factorsof production located within a country (deals

with locality)

Gross National Product (GNP) on the otherhand measures the output produced by acountry’s citizens, regardless of where theoutput is produced (deals with ownership ofresources)

GNP = GDP + value of goods and services produced by thecountry’s owned resources abroad – value of goods and

services produced by foreign resources in the country

What Is Not To Be Added ToNational Income Measure

Only final goods and services produced in an economy during aperiod of time are added

Value added to goods and services must be added to the NImeasure. Value added is the difference between the value of agood when it enters the production cycle and the value of thegood when it leaves it.

Intermediate goods must be excluded as their value is part ofthe final value of the product or service

Non-productive transactions (i.e. transfer of money or theownership of used goods) must be excluded

Transfer Payments

Buying and Selling shares (only brokeragefee is added to the measure of NI)Government transfer payments – socialsecurity payments, old age pensions,student grants, interest payments onnational debtPrivate transfer payments – money fromparents and or relativesTransfer of used goods – sale of a newcar (no current production is involved.

Wealth, Capital and Income

Wealth and Capital are stock conceptsIncome is a flow concept measured for aperiod of time National Wealth = all assets which havevalueNational capital stock (NCS) is that part ofthe national wealth which is capable ofproductive use

Wealth, Capital and Income

All capital is wealth but not all wealth iscapitalNational capital stock includes;

Social capital – roads, schoolsPrivate capital – machines, raw materials,stocks, and factoriesHuman capital – value of labor skillspossessed by the population

National capital stock is thus a measureof the physical wealth assets which arecapable of producing more wealth

Some types of goods

Consumption goods and services – goodsand services required for immediatesatisfaction of wants Capital goods – goods or output notintended for immediate consumption andwhich are usually capable of more orfurther production. E.g. factories,machines, roads, railways, ships, houses,schools etc

Meaning of Investment

The term investment has many meanings but for thepurpose of our discussion, Investment – is the

process of creating capital goodsCirculating capital – is the stock of raw materialsand finished goods necessary for the efficientworking of the economic systemGross capital – is the total output of capitalDepreciation/consumption capital – is the part ofcapital required for replacementNet Investment = additions to the existing stock ofcapitalGross Investment – depreciation = Net investment

Money and Capital

Money is a claim on goods and servicesMoney is therefore not capitalForeign currency is the only money that can beregarded as capital because it is a claim of othercountry’s goods and servicesMeasuring real output can only be effectivelycarried out in money terms. i.e. all goods andservices have prices.Using money gives rise to problems since thevalue of money in itself changes over time

Some Assumptions

All consumption goods and services arepurchased by individuals using –HOUSEHOLDSAll investment goods are purchased by FIRMSThere is no government activity and no foreigntrade at this pointAll economic activity is confined to householdsand firms

Calculating GDP

There are three approaches to calculatingGDP or National Income:

Expenditure approachIncome approachOutput approach

All of these should sum to the same amountsince by identity:National Output = National Expenditure (AD) =

National Income (This equation is often called thefundamental identity of national income accounting

THE OUTPUT APPROACH

This measure of GDP addstogether the value of outputproduced by each of theproductive sectors in theeconomy using the conceptof value added

Important Issues to note in the OutputApproach

Value added is the increase in the value of a product ateach successive stage of the production process. Only

the money values of final goods and servicesproduced in the economy are added

Stock Appreciation: Any additions to stocks must beadded but if the value of stocks vary during the year,an adjustment for stock appreciation is made toobtain the true measureMarket prices and factor cost: Market prices areaffected by indirect taxes and subsidies. Bysubtracting indirect taxes and adding subsidies, weobtain GDP/GNP at factor cost

Important Issues to note in theOutput Approach

Imports: some part of output is made up ofimported materials and a deduction must bemade for the value of imported contentSum of the values of final outputs of domesticindustries when adjusted for stock appreciationand important content = GDPGDP + net property income from abroad = GNPGNP – Depreciation = Net National Income (NI)

THE INCOME APPROACH

Here GDP is the sum of the incomes earnedthrough the production of goods and services.The main factor incomes are as follows:Income from people employment and in self-employment+Profits of private sector companies+Rent income from land=Gross Domestic product (by factor income)

Important Issues to note in theIncome Approach

It is important to recognize that only those incomesthat are actually generated through the production ofoutput of goods and services are included in thecalculation of GDP by the income approach.We exclude from the accounts the following items:Transfer payments e.g. the state pension paid toretired people; income support paid to families on lowincomes; the Jobseekers’ Allowance given to theunemployed and other forms of welfare assistanceincluding child benefit and housing benefit.Private transfers of money from one individual toanother.

Important Issues to note in theIncome Approach

Other corporate incomes that do not enter intothe total of personal income such as

Undistributed profits of companies and tradingsurpluses of publicly owned bodies must be

included in the national income since itrepresents payments to factors of productionThe Gap between the GDP/GNP obtained by theincome and expenditure approaches is oftenused to approximate the size of the “BlackEconomy”

Important Issues to note in theIncome Approach

Total Domestic Income – stockappreciation = GDP/GNPA residual error is added to make GDP/GNP obtained by income approach equalto that obtained by expenditure approach

THE EXPENDITURE APPROACH

This is the sum of spending on producedgoods and services measured at currentmarket prices. The full equation for GDP usingthis approach is GDP = C + I + G + (X-M) whereC: Household spendingI: Capital Investment spendingG: Government spendingX: Exports of Goods and ServicesM: Imports of Goods and ServicesThis method depends on the fact that incomesare earned only when someone spends.

PROBLEMS IN MEASURING GDP

a.

b.

Changes in Price : if prices are rising, GDPestimates will look larger, although the totalphysical output remains the same. Thereverse is true.Estimating output in the informal sectorChanges in quality over timeSelf – reliant activities:

Household services by wivesPeople taking care of themselves

The effect on the environmentCrime

Solving the Problem of Changes in Price

The methods used to measure output at marketprices gives us an estimate of nominal GDPbecause current prices are used.If prices are stable, then an increase in the GDPwill mean a real increase in the volume ofgoods and services produces.In the same vein, during times of inflation, mostprices would be increasing fast and so anynominal estimate of GDP will be increasingeven though output may be constant

Solving the problem of Changes in Price

Obtaining a real estimate is what solves theproblem of changes in price.Real GDP is an estimate of the value of nationaloutput devoid of the effect of changes in pricelevels.Steps taken to achieve real GDP estimate:

Select a base year or a point of referenceEstimate the retail price indexRemove the influence of changes in prices to obtainthe real GDP using the GDP Inflator if prices weregenerally falling or the GDP deflator if prices wererising

Purpose for Estimating GDP or GNP

Measuring Economic growthComparing countriesGovernment planningEvaluation of economic climate

Purpose of Information about GDP

Capacity for national mobilization ofresourcesPotential for aggression, domination ordefense against it.Potential for tradeMonitor promises of the governmentRequirements of membership in internationalorganizations.Requirements of ‘foreign aid” donors

Discussions

Difficulties Comparing Countries accountsNational Income as a measure of welfareComparisons over timeComparisons between countries