Measurement of National Income

• Like the accounts of a business national income accounts have two sides: a product side and an income side.

• On the product side production and sales are measured.

• The income side measures the distribution of the proceeds from sales.

• On the product side there are two widely reported measures of overall production:

• Gross domestic product (GDP) and gross national product (GNP)

• GDP and GNP differ in their treatment of international transactions.

• GNP includes earnings of Bangladeshi corporations overseas and Bangladeshi residents working overseas: GDP does not.

• Conversely, GDP includes earnings from current production in Bangladesh that accrue to foreign residents or foreign owned firms: GNP excludes those items.

• For example, profits earned in Bangladesh by a foreign owned firm would be included in GDP but not in GNP.

• The difference between GDP and GNP is large for a country such as Pakistan and Bangladesh with a large number of residents working overseas than foreign residents working in Bangladesh

• On the income side of national accounts, the central measure is national income which will be discussed later.

Definition of GDP

• GDP is a measure of all currently produced final goods and services evaluated at market price.

• A number of aspects of this definition require clarification.

• Currently produced: GDP includes only currently produced goods and services and includes only goods and services produced during a given period such as per quarter and per year.

• Such market transaction as exchanges of previously produced houses, cars or factories do not enter into GDP.

• Exchanges of assets such as stocks and bonds are examples of other market transactions that do not directly involve current production of goods and services and therefore not in GDP.

• Final goods and services: Only the production of final goods and services enters GDP. Goods that are used in the production of other goods rather than being sold to final purchasers , the intermediate goods are not counted separately in GDP.

• Evaluated at market prices: GDP is the value of goods and services determined by the common measuring rod of market prices. Bus this excludes the services or goods that are not sold in markets, such as services of homemakers or output of home gardeners as well as non-reported output from illegal activities such as sale of narcotics, gambling etc.

• GDP can be broken down into components such as: GDP=C + I + G +X –M

• Consumption is the largest component of GDP. It consists of household sector’s purchases of currently produced goods and services. Consumption can be further broken down into consumer durable goods (automobiles, television), nondurable consumer goods (foods , clothing etc.) and consumer services( medical services, haircuts).

• The investment component of GDP consists three subcomponents .

• The largest component is business fixed investment. It consists of purchases of newly produced plant and equipment ----the capital goods.

• The second is residential construction investment, the building of single and multifamily housing units.

• The final component is inventory investment, the change in business inventories.

• Government purchases of good and services are the share of current output bought by the government sector.

• But not all G are part of GDP because not all G represent a demand for currently produced goods and services.

• Government transfer payment to individuals (such as old age pensions) are examples of expenditures that are not included in GDP.

• The final component of GDP is net exports.• These represent direct contribution of the foreign sector to

GDP.• Gross exports are currently produced goods and services

sold to foreign buyers. They are a part of GDP.• Imports are purchases by domestic buyers of goods and

services produced abroad and should not be counted in GDP.

• Imported goods, however, are included in C, I and G in GDP.• Therefore we need to subtract the value of imports to

arrive at the total of domestically produced goods and services.

National income

• We now turn to the income side of national accounts.

• Here starting point is GNP total, not GDP.

• The reason is that it is GNP that includes income earned abroad by Bangladeshi residents and firms but excludes earnings of foreign residents and firms from production in Bangladesh.

• To go from GDP to GNP, we add foreign earnings of Bangladeshi residents and firms and subtract earnings in Bangladesh by foreign residents and firms.

• GNP=GDP + factor payments from abroad –

• factor payments to abroad.

• National income is the sum of all factor earnings from current production of goods and services. Factor earnings are incomes of factors of production: land labor and capital.

Calculation of National Income

• The first charge against GNP that is not included in NI is depreciation. The portion of capital stock used up must be subtracted from final sales before NI is computed.

• Because depreciation represents a cost of production , not factor income.

• Making this subtraction gives us net national product.

• From this total, both indirect taxes-sales tax and excise taxes-and the net of some additional item labeled “other” are subtracted to arrive at NI.

Calculation of NI

• Gross National product

• Minus: Depreciation

• Net National product

• Minus: Indirect taxes and other

• National income

Components of NI

• Compensation of employees

• Corporate profits

• Proprietors’ income

• Rental income of persons

• Net interest income

• Proprietors’ income is the income of unincorporated business

From NI to Personal Income (PI) and Disposable Personal Income (DPI)

• National income is a measure of income earned from current production of goods and services.

• For some purposes, it is useful to have a measure of income received by persons regardless of source.

• For example, consumption expenditures by households would be influenced by income.

• The relevant income concept would be one of all income received by persons.

• We also want a measure of income after deducting personal tax payments.

• When we deduct tax payments from personal income we get a measure of disposable (after-tax) personal income.

Relationship between NI, PI and DPI

• National income

• Less corporate profits, contribution to social security

• Plus Dividends, transfer payments to persons, personal interest income

• Equals personal income

• Less personal taxes and Nontax payments

• Equals disposable personal income

• Less personal consumption expenditures, interest paid to business, personal TP to foreigners

• Equals personal saving

.

• A series of adjustments takes us from NI to PI, the amount of income that HH and noncorporatebusinesses receive.

• First we reduce NI by the amount that corporations earn but do not pay out, either because the corporations are retraining earnings or because they are paying taxes to the government.

• This adjustment is made by subtracting corporate profits which equals, corporate taxes, dividends and retained earnings and adding back dividends.

• The items added in going from NI to PI are payments to persons that are not in return for current production of goods and services.

• Examples are government TP such as social security payments, veterans’ pensions and payments to retired government workers.

• The other item to be added in going from NI to PI is personal interest income---mostly interest payments by government to persons

• Government interest payments are made on bonds issued by the government.

Real GDP and nominal GDP

• Real GDP is calculated at constant prices or base year prices (from July new base year is 2005-2006).

• Using 2005-2006, for example, we can compute the value of GDP in 2012-13 in terms of the price level in 2005-2006.

• Nominal GDP is calculated in terms of current prices.

Nominal GDP, Real GDP and Implicit Price Deflator

• Year Nominal GDP Real GDP Implicit Price

• Deflator

• -----------------------------------------------------------

• 2005-06 6244.4 6244.4 100.0

• 2010-11 7636.0 6928.4 110.2

• 2011-12 8079.9 7188.8 112.4

• The ratio of nominal GDP to real GDP is just the ratio of current price level of goods and services relative to price level in the base year.

• it is a measure of aggregate price level, which we call a price index.

• This index of the prices of goods and services in GDP is called the implicit price deflator.

• We measure changes in aggregate price level by comparing values of the implicit GDP deflator (IPD) in different years.

• For example, consider a comparison of the IPD• between base year 2005-06 and 2011-12 in Bangladesh

example. In the base year IPD has a value of 100.• In 2011-12 the value of IPD was 112.4. This means that

nominal GDP (GDP at current prices) was 12.4 percent higher than the same goods and services valued at 2005-06 prices.

• That is aggregate price level rose 12.4 percent between 2005-06 and 2011-12.

• We can also use the implicit GDP deflator to measure price changes between two years neither of which is the base year.

• Between 2010-11 and 2011-12 for example, Implict GDP deflator rose from 110.2 to 112.4.

• As measured by this index the percentage rise in the aggregate price level (or rate of inflation) between these two years was

• [(112.4-110.2)/110.2]*100=2.0%

• Now consider how GDP deflator got its name.

• The ratio of nominal GDP to Real GDP it termed a deflator because we can divide nominal GDP by this ratio to correct for the effect to correct for the inflation in GDP---to deflate GDP. This follows because

• GDP deflator=nominal GDP/Real GDP

• Real GDP=nominal GDP?GDP deflator.

Consumer price Index versus GDP deflator

• Just as GDP turns the quantities of many goods and services into a single number measuring the value of production, the CPI turns the prices of many goods and services into a single index measuring the overall level of prices.

• That is CPI is the price of basket of goods and services in current year relative to the price of the same basket in some base year.

• For example, suppose that the typical consumer buys 5 apples and 2 oranges every month. Then the basket of goods consists of 5 apples and 2 oranges and the CPI is:

• CPI=(5*current price of Apples)+ 2* current price of Oranges)/(5*2002 price of Apples)+(2*2002price of Oranges).

• This index tells us how much it costs now to buy 5 apples and 2 oranges relative to how much it cost to buy the same basket of fruit in 2002.

CPI versus GDP Deflator

• The GDP deflator and CPI give somewhat different information about what is happening to the overall level of prices in the economy.

• There are three key differences between these two measures.

• GDP deflator measures the prices of all goods and services produced, whereas CPI measures the prices only goods and services bought by the consumers.

• Thus an increase in prices of the goods bought by the government and firms will show up in GDP deflator but not in CPI.

• GDP deflator includes only those goods produced domestically. Imported goods are not part of GDP and do not show up in GDP deflator.

• The most important difference is the way the two measures aggregate the many prices in the economy.

• The CPI assigns fixed weights to the prices of different goods whereas GDP deflator assigns changing weights.

• CPI is computed using a fixed basket of goods whereas GDP deflator allows basket of goods to change over time as the composition of GDP changes.

• Now the question is Which one is superior as a price index?

• The answer is that neither is clearly superior.

• Suppose price of oranges increases because of serious drought in the country.

• Because CPI is computed with a fixed basket of goods that includes oranges (whereas oranges are not part of GDP), the increase in the price of oranges causes a substantial rise in CPI but does not affect GDP deflator.

• That is , CPI also called a Laspeyers index (fixed basket) tends to overstate the increase in the cost of living because it does not take into account that consumers have the opportunity to substitute less expensive goods for more expensive ones.

• By contrast, GDP deflator also called a Paascheindex (changing basket) tends to understate the increase in he cost of living.

• That is GDP deflator shows no rise in price.

• Yet surely the higher price of oranges makes the consumers worse off.

Household Work by Women a Year

• The value of unpaid HH work of Bangladeshi women is equivalent to as much as 87.2% of last fiscal year’s GDP according to a study by CPD.

• The govt. should focus on changing the estimation practice system of National Accounting so that women’s unaccounted activities are reflected in GDP.

• Women’s unpaid activities are considered non-economic and thus remain outside the traditional framework of GDP estimation.

• The CPD has used two methods in conducting the research: the replacement cost method and the willingness to accept method.

• Replacement cost is a method which measures how much money one would pay monthly if he/she were to hire someone to do the HH chores instead of doing them by himself or herself.

• In willingness to accept method, the value is calculated on how much money one wishes to pay monthly for all unpaid work that he/she does daily, considering types of work, education, age and time spent for works.

• Based RCM, the estimated value of women’s unpaid work is equivalent to 76.8% (Tk. 594,845 crore in constant prices) of the GDP in FY 2013-14.

• Based on WAM, the corresponding estimate was 87.2% (Tk. 675,398 crore in constant prices) of GDP in FY 2013-14.

• The study is conducted with a comprehensive survey of 13640 individuals aged 15 years and above of whom 8320 are female and 5320 are male residing in 5670 HH across 64 districts.

• The study also argues that the time spent for unpaid activities is about three times higher than that of a male person.

• On an average a female spends about 8 hours on unpaid activities while a male spends around three hours.