Lecture 2

National Income – Measurement and Uses

Michael Insaidoo

Lecture 3After completing this lecture, you will:Understand the measurement of national incomeAlso understand the various approaches involved in the measurement of national incomeUnderstand the uses of national incomeUnderstand the problems associated with the measurement of national income

Lecture 3 National Income is the monetary value of final goods

and services produced by citizens (nationals) of a country during a period of time usually one year

Goods can be final and intermediate Final goods are those goods that do not enter into

further stage of processing or reselling. Example is sugar cane which is sold to consumers and chewed

Intermediate goods are those goods that go into further processing or resale before consumption. Example is sugar cane which is processed into sugar by a sugar factory

Lecture 3

There are three approaches in the measurement of national income which are:Income ApproachProduct or Output ApproachExpenditure ApproachThe three approaches results in identical or same results due to the circular flow of income

Lecture 3 The Circular Flow of Income makes it possible for the

national income to be measured using three approaches which gives the same results

Assumptions1) The economy is made up of two sectors – household

sector and business sector2) There is no role of saving and investment in the economy3) The role of government and foreign sector is not

captured4) There is free flow of economic activities or resources

Lecture 3Factor Market

Factor Services

Factor Income (Income Approach)

Expenditure on Goods & Services (Expenditure Approach)

Market Value of Goods & Services (Output Approach)

Product Market

HOUSEHOLD FIRMS

Lecture 3 Factor Market – Firms exchange money for the services

provided by the households, that is wages – payments for labour services, interest on capital, rent for land and profit for enterprise (entrepreneurship)

• These represents incomes received by factors of prodn• The summation of these incomes gives national income Product Market – Households exchange money for

goods and services produced by firms. The summation of the values of goods and services produced by Firms gives National Product (Output).

The summation of expenditure by Households on

Lecture 3goods and services gives the National ExpenditureFrom the diagram, one can conclude that National Income = National Product (Output) = National Expenditure

Lecture 3 This refers to the sum of all final incomes generated by

the factors of production Labour – wages, salaries, commissions etc. Land – rent, royalties etc. Capital – interest etc. Entrepreneurship – Profits from businesses Must be noted that only factor services that generates

income is accounted for Gifts, transfer payments, unemployment benefits etc

are excluded

Lecture 3 Undistributed profits of business enterprises are added

to that period’s national income The summation of all these incomes gives Gross

Domestic Income at factor cost (GDYf) The subtraction or addition of net factor income from

abroad (YA) to (GDYf) gives Gross National Income at factor cost (GNYf). (GNYf) = (GDYf) (+) or (-) (YA)

Gross National Income (GNYf) minus depreciation (dep) gives Net National Income at factor cost (NNYf) or National Income (NY). (GNYf) – (dep) = (NNYf)

Lecture 3 It shows the functional distribution of income. This

approach makes it possible to ascertain the incomes earned by the various factors of production

It provides income for Income tax planning. The income data provided by this approach forms the basic data for income tax planning. These are normally used to determine the income tax rates

Lecture 3 Difficulties in ascertaining all factor incomes Problem of transfer payments Fringe benefits – payments of income in kind Owner-occupied houses Difficulty in estimating net factor income from abroad

Lecture 3 This approach sums up the market value of final goods

and services of the productive sectors of the economy within a year

The productive sectors are the Agricultural, Industrial and Services sectors

Two ways of arriving at total product, either we sum up the values added at intermediate levels of production or the value of all final goods and services

Value Added is the difference between the gross value of a product and the raw materials that have gone into production

Lecture 3 The summation of monetary values of goods and

services produced during the year gives Gross Domestic Product (GDP) at market prices

GDP at market prices plus or minus net factor income from abroad (YA) gives Gross National Product (GNP) at market prices. (GNP) = (GDP) (+) or (-) (YA)

Markets prices are inflated by the effect of indirect taxes and deflated by subsidies

Therefore, GNP at market prices must be converted to (GNPf) at factor cost by subtracting indirect taxes and adding subsidies

Lecture 3 When depreciation (dep) is subtracted from (GNPf),

Net National Product at factor cost (NNPf) is obtained which is identical to National Income (NY)

(NNPf) = (GNPf) - dep

Lecture 3

Final goods method record value of kenkey (GHȼ 22) which is the same as 50 – 28. On the other hand, value added method sums up values added at each stage (22)

Stages of Production

Sale Value in GHȼ

Cost of Intermediate Goods

Value-Added in GHȼ

Maize

Corn Dough

Kenkey

10

18

22

-0

-10

-18

10

8

4

Total(Value of Final Goods)50

(Total cost of intermediate goods) 28

(Sum of value-added at each stage) 22

Lecture 3 Knowledge of contribution of each sector. This

approach allow an economy to know the contributions of each sector and sub-sectors

It indicates structural changes that are occurring in an economy. This approach enables an economy to know if there are changes in the output composition of the economy

Lecture 3 Difficulty in valuation of goods and services produced

and consumed Non-inclusion of some personal services Double or multiple counting

Lecture 3 This approach sums up final expenditures of

macroeconomic sectors of a nation For this purpose, the economy is divided into four

spending sectors namely Households’ consumption (C), Firms’ private domestic investment (I), Government spending on final goods and services (G) and foreign sector – net exports (X – M)

The summation of all expenditures by these sectors gives the Gross Domestic Expenditure (GDE) at market prices which is equivalent to Gross Domestic Product (GDP) at market prices

Lecture 3 Symbolically GDE = C + I + G + (X – M) GDE plus or minus net factor expenditure from abroad

or net factor income from abroad (YA) gives Gross National Expenditure at market prices (GNE)

(GNE) = (GDE) + or – YA (GNE) at market prices minus indirect taxes and plus

subsidies gives (GNE) at factor cost (GNE) at factor cost minus depreciation (dep) gives Net

National Expenditure at factor cost (NNE) which identical to National Income (NY).

(NNE) = (GNE) – (dep)

Lecture 3 Knowledge of various expenditure levels. This approach

enables the economy to know the expenditure levels of the macroeconomic sectors, this helps in planning

Changing pattern of private consumption. This approach also allows an economy to know the extent of changing patterns of private consumption

Idea of expansion of productive capacity of the economy. This approach indicates the level of private domestic investment thus knowing the level of expansion of productive capacity

Lecture 3 Difficulties in estimating exports and imports values.

Under invoicing and over invoicing makes it extremely difficult to determine the actual value of net exports

Double or multiple counting. This happens when a unit of expenditure is counted more than once. To eliminate this, only expenditure on final output is counted

Lack of adequate statistics on expenditure levels. Many people do not keep accurate data on their expenditure levels, making it difficult to get accurate levels of expenditure

Lecture 3 Nominal Income is the same as National Income at

prices prevailing in a particular year of computation. It is also referred to as National Income at current prices

In order to eliminate price level changes or inflation from the national income data, it is converted into real value

Real National Income is also the same as National Income at constant prices

It reflects the real volume of goods and services produced

Lecture 3 Real Nat. Inc = Nom Nat. Income × Base Yr. Price Index Current Yr. Price Index Real Nat. Inc = Nom Nat. Income × 100 Current Yr. Price Index Price Index is an index number that shows the

weighted average prices of a ‘baskets of goods’ changes over time

GDP deflator measures the price level obtained by dividing the nominal GDP by the real GDP

Lecture 3 Real GDP = Nominal GDP × Base Yr. Price Index Current Yr. Price Index Real GDP = Nominal GDP × 100 Current Yr. Price Index Income Per Capita (PY) – This the national income

divided by the population

Lecture 3 Double or Multiple Counting Non-marketed goods and services Inadequate statistical data Difficulty in estimating depreciation value Difficulty in getting accurate information from abroad

Lecture 3 Knowledge of the performance of the economy Calculation of rate of growth of output in the economy Indication of Sectoral contribution of the productive

sectors Information on the structural change of the economy Knowledge of the various expenditure levels Useful for income tax planning Computation of income per capita figure Guide for potential investors For inter-temporal and international comparison of

Lecture 3economic performance

Lecture 3 Economic welfare or wellbeing is the volume of the real

goods and services enjoyed by each citizen of a nation If the volume is high, then economic welfare is high all

things being equal and vice versa Again if the volume is high, then there is a high

standard of living all things being equal and vice versa Standard of living is inversely related to cost of living, if

cost of living is high, standard of living is low all things being equal and vice versa

Again amount of leisure (entertainment, recreation) enjoyed by citizens enhances economic quality of life

Lecture 3 Generally countries use the Income per Capita (YP)

statistic for measuring economic welfare Thus a high YP statistic indicates that citizens enjoy a

high volume of goods and services and hence an increase in their welfare all things being equal and vice versa

Lecture 3 Income distribution is not taken into account Leisure is not taken account of Product quality might be poor Composition of output – probably a chunk will be

military goods Externalities are not taken account of. Pollution, traffic

jams are not accounted for whilst positive externalities like education etc are also not taken account of

Lecture 3 Generally the income per capita statistic is used to

compare economic welfare of countries Thus if country A has a higher per capita income than

country B, it is taken that country A enjoys a higher economic welfare than country B

There is however problems with this comparison

Lecture 3 Differences in currencies Differences in quality of goods and services Differences in composition of goods ands services Differences in the level of non-marketed goods and

services Differences in the level of enjoyment of leisure Differences in Income DistributionThe World Bank and UNDP developed the Human

Development Index (HDI) in 1990 to address these problems. HDI combines income per head with

Lecture 3measures of life expectancy, adult literacy, health provision, education, leisure time and so on