MACROECONOMICS I

NATIONAL INCOME ACCOUNTING:

CONCEPTS AND MEASUREMENT
 NATIONAL INCOME ACCOUNTING

• National income accounts: an accounting framework used in

measuring current economic activity
• Three alternative approaches give the same measurements
1) Product approach: the amount of output produced
• Product side (measures production and sales) – GDP
and GNP measures.
2) Income approach: the incomes generated by production
• Income side (distribution of the proceeds from sales) – NI
3) Expenditure approach: the amount of spending by
purchasers
 MEASUREMENT OF NATIONAL INCOME

• Product approach
• Addition of value-added created in each production process
of the various sectors,
• Any output produced (product approach) is purchased by
someone (expenditure approach) and results in income to
someone (income approach)
• The fundamental identity of national income accounting:
• Total production = total income = total expenditure

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MEASUREMENT OF NATIONAL INCOME

• GDP (gross domestic product) is the market value of final

goods and services newly produced within a nation during a
fixed period of time
• Market value: allows adding together unlike items by valuing
them at their market prices
• Problem: misses nonmarket items such as homemaking,
the value of environmental quality, and natural resource
depletion
• There is some adjustment to reflect the underground
economy
• Government services (that aren’t sold in markets) are
valued at their cost of production
• Newly produced: counts only things produced in the given
period; excludes things produced earlier

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MEASUREMENT OF NATIONAL INCOME

• Final goods and services

• Don’t count intermediate goods and services (those used
up in the production of other goods and services in the
same period that they themselves were produced)
• Final goods & services are those that are not intermediate
• Capital goods (goods used to produce other goods) are
final goods since they aren’t used up in the same period
that they are produced
• Inventory investment (the amount that inventories of
unsold finished goods, goods in process, and raw
materials have changed during the period) is also treated
as a final good
• Adding up value-added works well, since it automatically
excludes intermediate goods

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MEASUREMENT OF NATIONAL INCOME

• GNP vs GDP

• GNP (gross national product) = output produced by

domestically owned factors of production
• GDP = output produced within a nation
• GDP = GNP – NFP
• NFP = net factor payments from abroad
= payments to domestically owned factors located
abroad minus payments to foreign factors located
domestically

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MEASUREMENT OF NATIONAL INCOME

• GNP and NNP:

GNP – d = NNP

• Net national product (NNP) = GNP minus depreciation (d)

• d represents the cost of production and not factor income.

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 MEASUREMENT OF NATIONAL INCOME

• Net national product (NNP) and National income (NI):

• NI = NNP – indirect taxes and others

• NI = NNP - indirect taxes (sales and excise taxes) - others

(additional discrepancies between factor earnings and
market prices).
• National income (NI) – the sum of the earnings of all factors
of production (land, labour and capital) that come from
current production.
• Components of NI include compensation of employees
(wages, salaries and other benefits); corporate profits;
proprietor income (income of unincorporated business);
rental income of persons and net interest income.

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 MEASUREMENT OF NATIONAL INCOME

• Expenditure approach
• Measures total spending on final goods and services
produced within a nation during a specified period of time
• Y = GDP = total production (or output)
= total income;
= total expenditure;
• C = consumption;
• I = investment;
• G = government purchases of goods and services;
• NX = net exports of goods and services.
• The expenditure approach to measuring GDP;
Y = C + I + G + NX.
MEASUREMENT OF NATIONAL INCOME

• Consumption (C) – household sector’s purchases of

currently produced goods and services. C includes:
a) Durable goods
b) Nondurable goods
c) Consumer services.

• Investment (I) – Purchases by the business sector and

residential construction. I include;
a) Business fixed investment (purchases of newly produced
plant and equipment)
b) Residential construction investment
c) Inventory investment.

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MEASUREMENT OF NATIONAL INCOME

• Government purchases (G) – current output bought by the

government. G does NOT include:
a) government transfer payments to individuals.
b) government interest payments.

• Net exports (NX = X-M) – direct contribution of the foreign

sector.
MEASUREMENT OF NATIONAL INCOME

• Income approach
• Adds up income generated by production (including profits and
taxes paid to the government)
• National income = compensation of employees (including
benefits) + proprietors’ income + rental income of persons +
corporate profits + net interest + taxes on production and
imports + business current transfer payments + current
surplus of government enterprises
• National income + statistical discrepancy = net national
product
• Net national product + depreciation (the value of capital that
wears out in the period) = gross national product (GNP)
• GNP− net factor payments (NFP ) = GDP
MEASUREMENT OF NATIONAL INCOME

• Private sector and government sector income

• Private disposable income = income of the private sector
= private sector income earned at home (Y or GDP) and
abroad (N F P ) + payments from the government sector
(transfers, T R , and interest on government debt, I N T ) −
taxes paid to government

Private disposable income = Y + NFP + TR + INT – T

Net government income = T – TR - INT

GROSS DOMESTIC PRODUCT (GDP)

• Differentiate between nominal GDP (GDP in terms of current

market prices) and real GDP (GDP in terms of constant prices
from a base year).
• Two methods to measure real GDP:
1) Real GDP in constant prices from a base year;
2) Chain-weighted real GDP
GDP deflator = (nominal GDP/ real GDP) *100
Real GDP = (nominal GDP/ GDP deflator) *100
Where the GDP deflator is the most comprehensive
measure of the aggregate price level.
• Inflation rate = (GDPdef1 – GDPdef0)/ GDPdef0

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 GROSS DOMESTIC PRODUCT (GDP)

• Limitations of the above measure;

1) every time the base year changes, the weights given to
different sectors changes;
2) changes in relative prices result in substitution among the
product categories.
• Chain-weighted real GDP – uses the average of prices in a
given year and prices in the previous year as weights.
• The base moves forward each year to eliminate the problem
caused by relative price-induced substitutions.

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 PERSONAL DISPOSABLE INCOME (Yd)

• Personal income (PI): income received by persons from all

sources.

PI = NI
– (corporate profits tax payments)
– (undistributed profits and valuation adjustment)
– (contributions to social security)
+ (transfer payments to persons)
+ (personal interest income)

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 PERSONAL DISPOSABLE INCOME (Yd)

• Disposable Income (Yd): personal income minus personal tax

payments.
Yd = PI – T
• Saving
S = Yd
– (personal consumption expenditures)
– (interest paid to business)
– (personal transfer payments to foreigners)

• Yd = C + S

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 NATIONAL INCOME ACCOUNTING
IDENTITY

• Yd = Y – T
where T = (Tx – Tr)

• Yd = Y – T = C + S
• Y=C+S+T ……..(1)
• Y=C+I+G ……...(2)

From (1) and (2):

• C+I+G=C+S+T

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 PRICE INDICES

• Three price indices:

1) GDP deflator - the index of the prices of goods and services
included in GDP. It is an implicit price index.
2) Consumer Price Index (CPI) - measures the retail prices of a
fixed ‘market basket’ of several thousand household goods
and services. It is an explicit price index.
3) Producer Price Index (PPI) Producer Price Index (PPI) –
measures the wholesale (includes raw materials and semi-
finished goods) prices of items. It signals future movements
in retail prices.

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 PRICE INDICES

• Limitation: CPI overstates increases in the cost of living. Why?

1) substitution bias – as the relative price changes, consumers
shift away from items whose relative prices rise to items
whose relative prices fall. Using weights from the base year
will overweight the items whose price has risen fastest and
overstate inflation.
2) quality adjustment - understates quality changes due to
difficulty measuring quality.
3) new products – decline sharply in price in the initial stages,
and since they are added to the market basket years after
they are introduced, the initial price declines are not
captured.

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