5/14/2023

National Income Accounting

Mr. Lutonja, E.J

Potential GDP
• Potential GDP refers to the maximum amount of goods and services that an economy can
produce at a given period using its existing resources and technology.
• It represents the full utilization of an economy's resources, including labor, capital, and
natural resources, at their highest possible levels of efficiency.

1
 5/14/2023

Potential GDP: Factors behind

• The level of labor force participation
• The size of the labor force
• The amount of capital investment
• The level of technology
• The availability of natural resources
• The efficiency of resource allocation
• The level of institutional and legal frameworks

Potential GDP: Factors behind - 1

• Labor force participation:
• The level of labor force participation refers to the percentage of the working-age
population that is employed or actively seeking employment. A higher level of labor
force participation means that more people are contributing to the economy's output,
which increases potential GDP.
• Size of the labor force:
• The size of the labor force is the total number of people who are employed or seeking
employment. A larger labor force means that there are more workers available to
produce goods and services, which can increase potential GDP.

2
 5/14/2023

Potential GDP: Factors behind - 2

• Capital investment:
• Capital investment refers to the amount of physical capital, such as buildings,
machinery, and equipment, that is available for use in production. A higher level of
capital investment can increase the productivity of labor and increase potential GDP.
• Technology:
• The level of technology refers to the degree of sophistication in the techniques,
processes, and equipment used in production. Technological advancements can
increase the productivity of labor and capital, which can increase potential GDP.

Potential GDP: Factors behind - 3

• Natural resources:
• Natural resources include all resources that are derived from the earth, such as land,
water, and minerals. The availability and quality of natural resources can affect the
productivity of the economy and therefore impact potential GDP.
• Efficiency of resource allocation:
• The efficiency of resource allocation refers to how well resources are allocated in the
economy. If resources are used efficiently, then potential GDP can increase, but if
resources are misallocated, then potential GDP can be lower than it otherwise would
be.

3
 5/14/2023

Potential GDP: Factors behind - 4

• Institutional and legal frameworks:
• The institutional and legal frameworks refer to the rules and regulations that govern
economic activity, such as property rights, contract law, and labor market
regulations. The presence of a stable legal and institutional framework can foster
economic growth and increase potential GDP.

Actual GDP
• Actual GDP, or Gross Domestic Product, refers to the total value of all final goods and
services produced within an economy during a given period, usually one year.
• It is a measure of the economy's output and is used to gauge the overall health and growth
of the economy.

4
 5/14/2023

Actual GDP vs Potential GDP

• Potential GDP represents the maximum amount of output that an economy can produce,
while actual GDP represents the actual amount of output produced.
• The difference between potential and actual GDP is known as the output gap, and it
represents the amount of unused capacity in the economy.
• When actual GDP is below potential GDP, the economy is said to be operating below its
full potential, and there is a recessionary gap.
• When actual GDP is above potential GDP, the economy is said to be operating above its
full potential, and there is an inflationary gap.

National Income Accounting

5
 5/14/2023

National Income Accounting

• This is a set of rules and definitions for measuring economic activity in the aggregate
economy – that is, in the economy as a whole.
• National income accounting is a way of measuring total, or aggregate production

10

GDP vs GNP - 1
• Gross Domestic Product (GDP) is the total value of all final goods and services produced
in an economy in a one-year period.
• It is the single most-used economic measure
• Gross National Product (GNP) is the aggregate final output of citizens and businesses of
an economy in one year

11

6
 5/14/2023

GDP vs GNP - 2
• GDP is output produced within a country’s borders.
• GNP is output produced by a country’s citizens.
• Net foreign factor income is added to GDP to move from GDP to GNP.
• Net foreign factor income is the income from foreign domestic factor sources minus
foreign factor incomes earned domestically.

12

Calculating GDP
• Calculating GDP requires adding together million of goods and services.
• All goods and services produced by an economy must be weighted. Each good and
service is multiplied by its price
• Once quantities of a particular good or service are multiplied by its price, we arrive at a
value measure of the good or service.
• All the units of value are added to arrive at GD

13

7
 5/14/2023

Calculating GDP: Important Notes

• GDP does not measure total transactions in the economy.
• It counts final output but not intermediate goods.
• Final output – goods and services purchased for final use.
• Intermediate products are used as input in the production of some other product.
• Counting the sale of final goods and intermediate products would result in double and
triple counting

14

Calculating GDP: Eliminating Intermediate Goods

• There are two ways of eliminating intermediate goods.
• The first is to calculate only final output.
• A second way is to follow the value added approach

15

8
 5/14/2023

Calculating GDP: Value Added

• Value added is the increase in value that a firm contributes to a product or service.
• It is calculated by subtracting intermediate goods from the value of its sales.

16

17

9
 5/14/2023

Calculating GDP
■ There are three methods of calculating GDP: the expenditure approach, production
approach and the income approach.
■ However, only two methods will be covered in this module due to their importance and
application: the expenditure approach and the income approach.

18

Calculating GDP: Why production approach is Ignored

▪ Difficulties in measuring value-added: The production approach requires measuring the
value-added of each stage of production in the economy, which can be difficult to do
accurately. This can result in measurement errors and inaccuracies in estimating GDP.
▪ Limited information on intermediate goods: The production approach does not account
for intermediate goods and services used in the production process, as they are already
included in the value of final goods and services. This can make it difficult to accurately
estimate the contribution of each industry to GDP.

19

10
 5/14/2023

Calculating GDP: Why production approach is Ignored

▪ Ignores household production: The production approach does not account for household
production, which includes activities such as cooking, cleaning, and childcare, and
therefore may underestimate the total value of goods and services produced in an
economy.
▪ Limited data availability: The production approach may not be feasible in economies
where data on value-added at each stage of production is not available or reliable.

20

Calculating GDP: Expenditure approach - 1

▪ The expenditure approach calculates GDP by adding up the total amount of spending on
goods and services produced in a country
▪ Consumption (C): The total spending by households on goods and services, including
durable and non-durable goods, and services like healthcare, education, etc.. This
includes four components of expenditure:
▪ Personal consumption expenditures – payments by households for goods and
services.
• Investment (I): The spending on investment goods, such as machinery, equipment,
and construction of buildings.
▪ Gross private investment – business spending on equipment, structures, and
inventories.
21

11
 5/14/2023

Calculating GDP: Expenditure approach - 2

▪ The expenditure approach calculates GDP by adding up the total amount of spending on
goods and services produced in a country.
• Investment (I): The spending on investment goods, such as machinery, equipment,
and construction of buildings.
▪ Gross private investment – business spending on equipment, structures, and
inventories.
▪ Depreciation – the decrease in an asset's value due to it wearing out.
▪ Net private investment – gross private investment minus depreciation

22

Calculating GDP: Expenditure approach - 3

▪ The expenditure approach calculates GDP by adding up the total amount of spending on
goods and services produced in a country
• Government spending (G): The total spending by the government on goods and
services, including salaries and wages, purchase of goods and services, etc.
• Net exports (NX): The difference between exports and imports. If exports exceed
imports, net exports are positive and contribute to GDP. If imports exceed exports,
net exports are negative and reduce GDP.
• Therefore, GDP by the expenditure approach can be calculated as follows:
• GDP = C + I + G + (X-M)

23

12
 5/14/2023

Calculating GDP: Expenditure approach – GDP vs NDP

■ Net domestic product (NDP): The sum of consumption expenditures, government
expenditures, net foreign expenditures, and investment less depreciation.
■ Net domestic product is GDP adjusted for depreciation:

● GDP = C + I + G + (X - M)
● NDP = C + I + G + (X - M) - depreciation

24

Calculating GDP: Income Approach - 1

■ The income approach calculates GDP by adding up all the incomes earned by individuals
and businesses in the economy.
■ Firms make factor payments to households for supplying their services as factors of
production.
■ National income is the total income earned by citizens and businesses in a country in one
year.
■ This includes wages, salaries, profits, and rent.

25

13
 5/14/2023

Calculating GDP: Income Approach - 2

■ Therefore, GDP by the income approach can be calculated as follows:
■
■

26

Calculating GDP: Income Approach -3

■ Employee compensation consists of payments for labor such as
salaries and wages.
■ Rents are payments for use of land and buildings.
■ Interest includes payments for loans by households to firms.
■ Profits are payments to the owners of firms

27

14
 5/14/2023

Calculating GDP: Other National Income Terms - 1

■ Personal income (PI) is national income plus net transfer
payments from government minus amounts attributed but not
received.
● PI = NI + Transfer payments from government + Net non-
business interest income - Corporate retained earnings - Social
security taxes

28

Calculating GDP: Other National Income Terms - 2

■ Disposable personal income is personal income minus personal
income taxes and payroll taxes.
■ Disposable personal income is what people have readily
available to spend.
● DPI = PI - Personal taxes

29

15
 5/14/2023

Calculating GDP: AS VS AD - 1
■ Aggregate Supply (AS): Aggregate supply represents the total amount of goods and
services produced by all firms in an economy.

■ AS can be calculated by adding up the value of all final goods and services produced in
the economy during a given period, typically a year. This is known as Gross Domestic
Product (GDP).

30

Calculating GDP: AS VS AD - 2
■ Aggregate Demand (AD): Aggregate demand represents the total amount of goods and
services that are demanded by all households, firms, and the government in an economy.
AD can be calculated by adding up the total expenditure on all final goods and services
produced in the economy during a given period.

■ This is known as the expenditure approach calculating GDP. Alternatively, AD can also be
calculated by adding up the total income earned by all factors of production in the economy
during a given period. This is known as the income approach to calculating GDP.

31

16
 5/14/2023

GDP Comparing among countries

■ GDP gives a measure of economic size and power.

■ Per capita GDP is another measure often used to compare
nations' GDP.

GDP Comparing among countries

● Because of differences in nonmarket activities, per capita GDP
can be a poor measure of the various living standards in various
nations.

17
 5/14/2023

GDP Comparing among countries

■ Purchasing power parity is used to get around the problems of

per capita GDP.
■ Purchase power parity adjusts for different relative prices
among nations before making comparisons.

Economic welfare over time

■ Just because GDP rose does not mean welfare rose – it could be
only prices rose.
■ Comparing output over time is best done with real output
which is nominal output adjusted for inflation.

18
 5/14/2023

Some limitations of National Income Accounting

■ Limitations of national income accounting include the

following:
● Measurement problems exist.
● GDP measures economic activity, not welfare.
● Subcategories are often interdependent.

GDP Measures Market Activity, Not welfare

■ GDP does not measure happiness, nor does it measure

economic welfare.
■ Welfare is a complicated idea, very difficult to measure.

19
 5/14/2023

Measurement Errors

■ GDP figures leave out the following:

● Illegal drug sales.
● Under-the-counter sales of goods to avoid income and sales
taxes.
● Work performed and paid for in cash.
● Unreported sales.
● Prostitution, loan sharking, extortion, and other illegal
activities.

Measurement Errors

■ A second type of measurement error occurs in adjusting

GDP for inflation.
● If the price and the quality of a product go up together, has the
price really gone up?
● Is it possible to measure the value of quality increases?

20
 5/14/2023

Misinterpretation of Subcategories

■ The subcategories of GDP can be misinterpreted.

● For example, the line between investment and consumption is
often uncertain.

Gross Progress Indicator

■ The gross progress indicator (GPI) is an alternative measure to

GDP.
■ The GPI tries to measure pollution, education, health
concerns, as well as GDP.

21
 5/14/2023

Conclusion

■ Measurement is necessary.
■ GDP measurement categories have made it possible to think and
talk about the aggregate economy.

22