NATIONAL INCOME NATIONAL INCOME ACCOUNTINGACCOUNTING

Measuring the EconomyMeasuring the EconomyMeasurement of aggregate economic activity helps answer such questions as:◦How much output is being produced?

◦What is it being used for?◦How much income is being generated?

◦What’s happening to prices and wages?

What is National Income What is National Income Accounting?Accounting?

Measurement of aggregate economic activity, particularly national income and its components

It measures the indicators of national output/income; .e.g. GDP, GNP

What is National Income?What is National Income?National income (also referred to as net

national product) may be defined as “ a measure of the money value of the total flow of goods and services produced in an economy over a specified period of time.”

The owners of economic resources are engaged in earning incomes by allowing their resources to be used in producing goods and services.

Changes in the incomes they receive indicate changes in the level of economic activity.

National income consists of the following:

1.Wage or salary – those generated by labor;

2.Interest – those generated by lenders of funds;

3.Rent – those generated by owners of real state;

4.Profit – those generated by the entrepreneurs;

5.Net factor – income from abroad.

Important Terms Used in Important Terms Used in Measuring National IncomeMeasuring National IncomeIn measuring national income, an

understanding of the following terms are important:

1.Gross Domestic Product (GDP)2.Gross National Product (GNP)3.Market Value4.Value Added5.Consumption6.Investment7.Consumer Durables8.Government Expenditures9.Net Factor Income from Abroad

GROSS DOMESTIC GROSS DOMESTIC PRODUCTSPRODUCTSThe GDP is a measure of the total flow

of goods and services produced by the economy over a particular time period.

The factors of production must be located in the domestic economy regardless of who owns these factors.

The owners of the factors of production consist of citizens of the local economy and those of foreign countries.

Measurement ProblemsMeasurement Problems Methods of calculating GDP entail

measurement problems in accounting for all economic activity:

Non-Market Activities- goods and services produced that are not sold/does not go through in a market or formal market sectors.

Unreported Income – market activities not reported to tax or census authorities. They are “illegal” activities like drug trafficking, prostitution, moonlighting

GDP per CapitaGDP per CapitaGDP per capita: Total GDP divided by total

population; average GDPGDP per capita is commonly used as a

measure of a country’s standard of livingMeasures how much output or income was

produced or received, on the average, by an individual in an economy

Measures of per capita GDP tell us nothing about how GDP is actually distributed or used

Useful for comparing the performance of a country overtime and a country’s performance relative to its neighbors

Per capita GDPPer capita GDP

Item 1990 1998 2002

GDP at constant (million pesos)

720,700 888,000 1,046,100

Population (millions)62.0 75.2 81.8

Per capita GDP at constant prices 11,624.20 11,808.5 12,788.5

GDPGDP per capita

population

Real Versus Nominal GDPReal Versus Nominal GDPNominal GDP: The value of final

output produced in a given period, measured in the prices of that period (current prices)

Real GDP: The value of final

output produced in a given period, adjusted for changing prices

Computing Real GDPComputing Real GDPInflation: An increase in the

average level of prices of goods and services◦Inflation tends to uncertain actual

declines in real outputBase year: The year used for

comparative analysis; the basis for indexing price changes

Inflation RateInflation Rate

1

1

Inflation Rate t t

t

CPI CPI

CPI

YearYear Consumer Price index(CPI)

Inflation rate(in percent)

1990 62.7 --

1991 75.6 20.6

1992 83.8 10.8

1993 91.6 9.3

1994 100.0 9,2

1995 108.2 8.2

1996 117.3 8.4

1997 125.1 6.6

1998 137.9 10.2

Estimates of the CPI and Inflation Rate, 1990-98Estimates of the CPI and Inflation Rate, 1990-98

Computing Real GDPComputing Real GDPThe general formula for

computing real GDP is:

The price index represents a price level change as an index with a base of 100

nominal GDP in year Real GDP in year

price index

tt

100 price index

100

percentage change

Computing Real GDPComputing Real GDP  2005 2006

1.  Nominal GDP (in billions) P12,456 P13,245

2.  Change in nominal GDP   + P789

3.  Change in the price level, 2005 to 2006   3.30%

4.  Real GDP in 2005 pesos P12,456 P12,822

5.  Change in real GDP   + P366103.3100

$13,245

Real GDP is the inflation-adjusted value of nominal GDP.

P

Changes in GDP: Nominal Changes in GDP: Nominal Versus RealVersus Real

Increases in nominal GDP reflect higher prices as well as more output.

Increases in real GDP reflect more output only.

Net Domestic ProductNet Domestic ProductWe won’t be able to produce as

much output next year unless we replace factors of production we use this year

Depreciation: The consumption of capital in the production process; the wearing out of plant and equipment

Net Domestic ProductNet Domestic ProductNet domestic product (NDP):

GDP less depreciation

◦The amount of output we could consume without reducing our stock of capital

–NDP GDP depreciation

Net Domestic ProductNet Domestic ProductInvestment: Expenditures on

(production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories

Net Domestic ProductNet Domestic ProductThe distinction between GDP and

NDP is mirrored in the difference between gross investment and net investment◦Gross investment: Total

investment expenditure in a given time period

◦Net investment: Gross investment less depreciation

Net Domestic ProductNet Domestic ProductThe stock of capital — the total

collection of plant and equipment — will not grow unless gross investment exceeds depreciation

GROSS NATIONAL GROSS NATIONAL PRODUCTPRODUCTThe GNP is a measure of the market value of the final goods and services produced only by nationals or citizens of a country in a particular time period.

This includes production within and outside of the country under consideration.

EXCLUSIONS FROM THE EXCLUSIONS FROM THE GNPGNPThe GNP is a measure of the total production of the economy for a specified year.

It follows therefore, that the nonproductive transactions must be excluded.

Nonproductive transactions consist of the following:

1.Purely financial transactions and2.Secondhand sales

Purely financial transactions consist of the following:

1.Public transfer payments2.Private transfer payments3.Buying and selling of securities.

Secondhand sales – do not involve current production and so, they are excluded from the GNP.Ex: when an appliance was bought last

year, that transaction was included in last year’s GNP.

Public transfer payments – those given by the government to individuals or households but which do not contribute to current production.Ex: old-age pensions, welfare payments,

and widow’s pensions.

Private transfer payments – involve the transfer of funds from one private individual to another and which does not entail production.

Ex: gift checks from friends or relatives

Buying and selling of securities – do not directly involve current production. As such, they are excluded from the calculation of the GNP.

MARKET VALUEMARKET VALUERefers to the current price of goods

and services produced in the economy.

It is important because they facilitate computing for aggregate value of the various goods and services produced.Ex: It would be difficult to determine the

total value of 10,000 metric tons of fish and 50,000 cavans of rice. Computing will be easier if market values are assigned to commodities.P5,000 for fish and P14,000 for rice.

VALUE ADDEDVALUE ADDEDRefers to “the difference between the value

of goods produced and the cost of materials and supplies used in producing them.

Ex: a newly constructed house is valued at P1 M. if the cost of materials and supplies used in constructing the house is worth P650 T, value added is equal to P350 T.

The production of most goods and services involves a series of stages

To accurately measure GDP we must distinguish between intermediate and final goods.

Value AddedValue AddedIntermediate goods: Goods or

services purchased for use as input in the production of final goods or services

Value added: The increase in the market value of a product that takes place at each stage of the production process

Value Added in Various Value Added in Various Stages of ProductionStages of Production

Stages of ProductionValue of Market

Transactions

Value Added

1.  Farmer grows wheat, sells it to miller $0.12 $0.12

2.  Miller converts wheat to flour, sells it to baker 0.28 0.16

3.  Baker bakes bagel, sells it to bagel store 0.60 0.32

4.  Bagel store sells bagel to consumer 0.75 0.15

Total $1.75 $0.75

The value added at each stage represents a contribution to total output.

Two Ways to Calculate Two Ways to Calculate GDPGDPYou can compute the value of final output in one of two ways:◦Count only market transactions entailing final sales and sum over all

◦Count only the value added at each stage of production and sum over all

The Uses of OutputThe Uses of OutputThe major uses of total output conform to the four sets of market participants: ◦Households → consumption◦Business Firms → investment◦Government → government spending

◦International participants → net exports

CONSUMPTIONCONSUMPTIONRefers to “expenditures by consumers

on final goods and services.”“the total amount spent by consumers

on newly produced goods and services (excluding purchases of new homes, which are considered investment goods).”

Goods and services used by households are called consumption goods, which includes all household purchases made in product markets

CONSUMER DURABLESCONSUMER DURABLESRefers to “consumer goods, such as appliances and furniture, that is usually last for several years.”

Expenditures on consumer durables are meant not for current but for future satisfaction.

INVESTMENTINVESTMENTAn activity that uses resources now

in such a way that they allow greater production in the future, and hence, greater consumption in the future.

It includes “output of capital goods, net change in business inventories, and residential construction.”

Investment goods are the plant, machinery, and equipment that we produce

INVESTMENTINVESTMENTInvestment are of two types:

1. Fixed investment – a good that is purchased to be used in order to make other goods and services. Ex: equipment purchase.

2. Inventory investment – are those used to increase the amount of inventories of finished products.

GOVERNMENT GOVERNMENT EXPENDITUESEXPENDITUESRefers to “the sum of government payrolls and purchases, which is the cost of government output.”

Such expenditure are used for the day-to-day operations and projects of the government.

Resources purchased by the public sector are unavailable for consumption or investment purposes

NET FACTOR INCOME FROM NET FACTOR INCOME FROM ABROADABROADThis is the difference between the

income earned by citizens who own resources used in the production process abroad and the income of foreigners who own resources used in the production process here in the Philippines.

If the difference is positive, it means the residents of this country earn more from their transactions overseas compared to what foreigners earn from their transactions in this country.

Net ExportsNet ExportsNet exports: The value of exports minus the value of imports◦Exports: Goods and services sold to international buyers

◦Imports: Goods and services purchased from international sources

APPROACHES TO APPROACHES TO NATIONAL INCOME NATIONAL INCOME

ACCOUNTINGACCOUNTING

3 Approaches for measuring 3 Approaches for measuring GDPGDP1. Expenditure/Product Approach –

measures GDP as the sum of expenditures on final goods and services.

2. Income Approach – measures GDP as the sum of incomes of factors of production (wages, rent, interest and profit).

3. Value-added/Industrial Origin Approach – measures GDP as the sum of value added at each stage of production (from initial to final stage)

PRODUCT APPROACHPRODUCT APPROACHReferred to as the expenditure

approach, is also a way of estimating national income.

It involves calculating the sum of all expenditures on final goods.

The formula used in estimating national income using the product approach is:

GNP (PCE,GDI, GCE, NFIFA) - Capital consumption allowances (Depreciation,Obsolescence,Accidental Damage)

Net National Product (NNP)- Indirect Taxes- Subsidies= National Income

To compute for the GNP To compute for the GNP using the product or using the product or expenditure approach:expenditure approach:GNP = C + I + G + (X-M)Where:

GNP= Gross National ProductC=Consumption (PCC)I=InvestmentG=Government ExpenditureX=ExportsM=Imports

Brief explanations Brief explanations of the terms used of the terms used is required to a full is required to a full understanding of understanding of

the formulathe formula

PRIVATE (OR PERSONAL) PRIVATE (OR PERSONAL) CONSUMPTION EXPENDITURES CONSUMPTION EXPENDITURES (PCE)(PCE)Refers to the spending by

households on the ff. types of goods:

1.Durable consumer goods2.Nondurable goods such as candies,

newspapers, toilet papers, soft drinks and ball pen.

3.Services such as those provided by teachers, architects, interior decorators and electrician.

GROSS DOMESTIC GROSS DOMESTIC INVESTMENT(GDI)INVESTMENT(GDI)

These are expenditures for newly produced capital goods like machinery, equipment, tools, buildings, and additional inventory.

Not included are transfers of papers assets and secondhand tangible assets.

DEPRECIATIONDEPRECIATIONThis term refers to the reduction in value of asset through wear and tear.

NET NATIONAL PRODUCTNET NATIONAL PRODUCTThis refers to the GNP less the part of the output needed to replace the capital goods worn out in producing the output.

INDIRECT TAXESINDIRECT TAXES

These are taxes such as sales, excise, and business property taxes, license fees and tariffs which firms treat as costs of producing product or service and pass on (full or partial) to buyers by charging them high prices.

SUBSIDIESSUBSIDIES

This is the payment of funds, goods, or services by a government, business, or household for which it receives no good or service in return.

INCOME APPROACHINCOME APPROACHCurrent production is made possible

through the use of economic resources of land, labor, capital, and entrepreneurship. The owners of these resources receive earning in the form of rent, wages and salaries, interest and dividends, and profit.

When the total amount of earning of the owners are aggregated into a single amount, the objective of determining the national income is achieved.

ESTIMATING ESTIMATING DISPOSABLE INCOMEDISPOSABLE INCOME

DISPOSABLE INCOMEDISPOSABLE INCOME

That part of the national income that is available to household for consumption or savings, is referred to as disposable income.

It is estimated by deducting from GNP all taxes, business saving, and depreciation; then adding government and other transfer payments and government interest payments.

GOVERNMENT TRANSFER GOVERNMENT TRANSFER PAYMENTPAYMENTThose that are made by the government to individuals for which the individuals perform no current service in return.

Examples are retirement and gratuity payments and unemployment insurance.

Formula for estimating Formula for estimating disposable income:disposable income:DI=GNP-(TBD)+(GTP+GIP)Where:DI=disposable incomeGNP=gross national productTBD=all taxes, business saving, and

depreciationGTP=govt and other transfer

paymentsGIP=government interest payments.

INDUSTRIAL ORIGIN INDUSTRIAL ORIGIN APPROACHAPPROACHIt measures national income by determining the sum of the market value of the total production of all major industries comprising the economy.

The major industries consist of the ff:1. agriculture, fisheries and forestries2. Industrial sectors3. Service sector

INDUSTRIAL ORIGIN INDUSTRIAL ORIGIN APPROACHAPPROACH The market value consist of the

value added of the sector, the indirect taxes net of subsidies, and the capital consumption allowance for each sector.

The sum of the market value of the total production of sectors is referred to as the Gross Domestic Product (GDP).

Add:

Notes of the 3 approachesNotes of the 3 approachesThe expenditure approach, income approach, and

the value-added approach all come up with the same estimate of the GDP. They are equivalent approaches.

In the income approach, profit is also considered a payment to the entrepreneur. So the incomes are (1) wages, (2) rent, (3) interest, and (4) profit. Profit adjusts to make the sum equal to the final value of the good.

In the value added approach, only the value added in each stage of production are included. If we add the value of intermediate product with the value of the final product, we commit the sin of “double-counting.”

At each stage of production, the value-added is equal to wages, interest, rent, and profit. Therefore the value of the final product is likewise the same of all payments to the factors of production.

Some Limitations of GDP or GNP as Some Limitations of GDP or GNP as measures of growthmeasures of growthIgnores income distributionIgnores environmental

degradationDoes not include activities that

do not go through the formal markets sectors

Does not include “illegal” activities like drug trafficking, prostitution, moonlighting