1.

Measuring economic activities

Economic activities take place when factors of production (labour and capital), in addition to
other products (such as raw materials), are combined to obtain specific goods and services such as
cars, apples, computers or educational services.
Such activities usually take place within firms, which are institutions specialized in carrying out
the production processes, by organizing and coordinating the processes, from the input of materials
and factors to the output of the products. As productive units become more efficient, the community
receives more goods and services and the standard of living of a country's citizens improves.
The flow of final goods and services produced in a country in a year valued in monetary units
will be called Gross Domestic Product (GDP). According to the OECD manual, “Understanding
National Accounts” (OECD 2014, pp 14-15), GDP “combines in a single figure, and with no
double counting, all the output (or production) carried out by all the firms, non-profit institutions,
government bodies and households in a given country during a given period, regardless of the type
of goods and services produced, provided that the production takes place within the country’s
economic territory. In most cases, it is calculated quarterly or annually, but it can also be calculated
monthly”. Divided by the number of inhabitants, it will allow us to obtain the GDP per capita, or
per inhabitant, which is the most used economic development indicator.
The object of our study will be to describe the rules for accounting for the results of a country's
economic activities, expressed through a system of definitions, operations and accounts, the
European System of Accounts (ESA-2010), which is the one used by the countries of the European
Union. The different activity synthesis magnitudes are defined and studied, among which gross
domestic product (GDP) and gross national income (GNI) are the most important magnitudes.
Measuring economic activities is not a simple matter, for two types of reasons: it is not obvious
what needs to be measured and there are technical and documentary difficulties in quantifying
economic activities.

1.1 First problem: what needs to be measured (the definition of economic activities: the
production boundary).

It is intuitively understood that people earn their living by doing various activities. A waitress at
bar, a blue collar worker in a steel factory, or a clerk at a bank are people who work in different
activities that are unmistakably linked to the exercise of economic activities. Likewise, the tasks of
the restaurant owner, the CEO (Chief Executive Officer) of the car company or the shareholders of
the bank are related to the economic activities without offering problems. These are tasks that are
exchanged on the markets and for which a price is paid (market price).
However, there are people who perform tasks similar to the above but who are not usually
considered to be economic. Many individuals spend some time each day, or on weekends, working
to their garden. Families spend a lot of time on various household tasks: educating children,
washing clothes, cleaning the house, buying and preparing food and the like. There is no doubt that
such tasks, in addition to consuming time, work and other resources, provide goods and services to
household members contributing to their well-being.

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 However, these latter tasks (gardening for oneself or household chores) are not considered as
economic activities. Not only does this seem unfair to these people, but the calculation of goods and
services produced in a country in a year excludes a part of the real services produced.
Remember, if such tasks had been contracted out in exchange for a price (like paying a
professional gardener) then they are economic activities.
We are going to include in our accounting only activities which are included in the production
boundary: basically, those traded in markets (there is a “professional” producing them and selling it
for a price) or produced by the public administration. But there are few exceptions. The most
relevant one are services produced and/or provided by the public administrations.
Figure 2 is taken from “Understanding National Accounts” and explains what is going to be
included in the production boundary (and, thus, in GDP).

Figure 2. The production boundary

OCDE: Understanding National Accounts, p. 108

1.2. Second problem: measurement difficulties

It has just been pointed out that there are activities which, although aimed at obtaining goods and
services, are not included in the calculation of a country's economic activities. Therefore, it is
necessary to delimit such activities, indicating which are included and which are outside the
production boundary, even if they offer useful goods and services to some members of the
community.
The criterion adopted is somewhat conventional and restrictive, as it includes only those activities
whose existence can be known with reasonable approximation and whose measurement can be
carried out with levels of error not exceeding a certain limit. It does not, therefore, include some
activities whose existence and size could be known and assessed only at the level of conjecture.
Thus, for example, it would be difficult to assess the frequency and quality of the cooking done in
the household (and households have excellent cooks!). For this reason, it is not possible to measure

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activities whose existence is not precisely known or which are difficult to evaluate when referring
to goods and services that do not pass through the market.
If a woman marries her gardener, GDP is reduced, it was said at the beginning of national
accounting, to point out that, because of their difficulty in measurement, the services provided by
the members of a household are not included in the national accounts computations because of their
difficulty in knowledge and valuation. This means that the more blurred part is left out in favour of
the clearer part, which passes through the market. This has two advantages: a) although what is
included is not all that is produced, its measurement is more precise than if everything had been
included and b) it allows international comparisons on a more solid basis, as they are more
objective. For this reason, J. Hicks defined production as the activity aimed at satisfying the needs
of others through change, that is, obtaining products to be delivered to others through exchanges in
the market.
What about the illegal, activities carried out in a black market, or in the underground economy
(equivalent terms are hidden or informal economy). Those are activities that could be:
a) Legal, but performed without the licenses, or other legal formalities required to proceed with
them. They are not communicated to the public administration (tax authorities). Some examples are
the sale of goods on the street or the use of your car to provide "cab" services without a license, or
renovations made to a house by the plumber and electrician without generating an invoice and
collecting VAT
b) Illegal activities, such as trading on steal goods, smuggling of tobacco, alcohol, producing and
dealing with drugs, or prostitution in those countries where it is illegal. Obviously, the criminal
(and/or the client) will not provide information to the public administration about the amount of
services marketed or the price paid for them.
In most countries, legal market activities, but carried out in the informal economy, are included in
the GDP. There are countries where these activities constitute a very significant proportion of the
total amount of goods and services produced, and their exclusion would produce a bias against other
countries or the same country over time.
More controversial is whether we should include illegal activities, even if there is a market for
them, a price is willingly paid and the operation takes place outside the boundaries of households.
But most people think that the GDP should include goods and services that increase the country's
welfare, so why include activities such as paying a hitman for a murder?
In the EU, before 2014, this illegal activities were excluded from GDP. However, this has
changed recently, also for the Spanish case. The revision of the European System of Accounts
(ESA-2010), in order to give homogeneity to the accounts of the European Union countries,
provides for the inclusion of some of the above-mentioned activities (even if they are not legalised
in some countries). Such inclusion has already been carried out in Spain since the end of 2014, with
some controversy in the case of prostitution, since the ESA-2010 establishes that "illegal economic
actions are considered to be operations if all the units participating in them do so by mutual
agreement", and as is well known, this does not occur in some cases.
It should be noted, however, that the measurement of such activities is more problematic than that
of other services. These activities represent, on average, 1 per cent of GDP in EU countries. In
Spain, it has been estimated that in 2010 prostitution represented 0.35 percent of GDP and drug
trafficking 0.50 percent.

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 1.3. The valuation criterion: the market price

The goods and services that are included in economic activities have not been produced for play
or distraction (regardless of the pleasure found at work), but to satisfy the needs of others and have
(or could have) a price. Therefore, there is a common element for their measurement: their
exchange value, that is, the price paid for them, or for similar goods and services, in the market.
The market price is known for the activities that pass through it. On the contrary, there are
difficulties in valuing goods and services that do not pass through the market. How do we know if
the food you prepare at home is worthy of a five-star restaurant, or just barely edible?
In spite of this general criterion, there are some imputations made for a small number of goods
and services that are not exchanged on the market, but could pass through the market or are similar
to some that do. For example, there is a convention of including in agricultural production the self-
consumption of farmers or attributing a value to the service provided by owner-occupied housing or
the payments in kind that some companies make to their workers.
The purpose of modern economic activities and complex productive apparatus is none other
than to provide goods and services to consumers. There are companies that supply these goods and
services directly to consumers, such as computer manufacturers, air transport services and dentists.
Other companies manufacture raw materials or, more generally, goods and services that will be used
by other companies as intermediate consumption, or other types of goods that we call capital goods,
such as machines or trucks that will be used by shirt manufacturers or potato transporters.
The numerous economic activities can be grouped into a small number of categories, as the
“statistical classification of economic activities in the European Community” (CNAE, for the
French acronym) does. The multiple operations, transactions, flows or interactions that take place in
a modern economy - such as export, consumption, wage payment or credit operations - can be
reduced to a few general categories to simplify and standardize their use in economic language.
Economic transactions or flows can be grouped into three broad categories: transactions in goods
and services, distribution transactions and financial transactions. Transactions in goods and services
are those that describe the origin (production or import) of goods and services, as well as their use
(intermediate consumption, final consumption, capital formation and exports). Distribution
operations group together the operations for distributing the income generated in the productive
process. Financial operations are those that take place with different financial instruments (debt
recognition documents); they may be the counterpart of other operations or be merely financial.
Operations on goods and services are the following: production, imports, intermediate
consumption, final consumption, gross capital formation and exports. Production and intermediate
consumption are described in the next section. Distribution operation will be discussed afterwards,
and we will talk about financial operations in the Balance of Payment lesson.

1.4. And when we don’t have a market price?

Services provided without a price, or with a very low price, by the public administration are
included in output. If we exclude them, international or inter-temporal comparison would be biased.
For example, in US most health services and most university education is produces by the private
sector, and those services have a market price and are included without doubt in output. But in most
European countries, like Spain, they are provided by the public sector, and we are not paying a
market price. If we exclude them, economic magnitudes in US could be much larger just because in

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Europe we are not including those services. But those services provided by the public sector have a
cost, and a large one. The public sector has to pay wages, has to construct hospitals and schools, has
to pay for the electricity, or the heating. We are going to make imputations: the value of this output
is going to be equal to all the expenses that we have to afford in order to produce those services.
Thus, if traffic regulation involves costs of electricity, communication, paint, petrol and others,
together with the salaries of the agents, the value of production will be the sum of both blocks:
intermediate consumption and added value. By definition, public administrations do not make a
profit (public companies which charge for their services are not including here). But there is one
item which is included as gross operating surplus: an estimate of capital consumption, i.e. the cost
of capital wear and tear on buildings and other capital goods used (we explain this concept later in
the lesson)
The components, therefore, of the total (production) costs of non-market output are
- Intermediate consumption.
- Compensation of employees.
- Consumption of fixed capital.
- Other taxes on production.

2. Production, intermediate consumption and value added

2.1. The production of goods and services

The ESA-2010 defines the production of goods and services as an activity carried out under the
control and responsibility of an institutional unit (an enterprise or a household in the case of family
enterprises) that uses labour, capital and goods and services to obtain other goods and services.
Thus, we are in a position to define a first economic magnitude, which is the result of the productive
activity: the production of goods and services, which includes all the products (goods and services)
obtained during a year in a country. It could be said that production is the result of all economic
activities, or, intuitively, the sum of the business figures of all the companies in a country, which,
from now on, should not be confused with GDP, as will be seen in the following section.

2.2. Final products and their components

It has been pointed out that, in an intuitive way, the production of goods and services is the flow
of goods and services that leave the productive apparatus of a country every year. However, in
addition to labour and capital, other products (goods and services) produced by other companies or
imported from other countries are usually used to produce these goods and services. Flour, yeast,
oil, electric power and other materials are used to produce bread, or gasoline to produce transport
services, or fodder to feed cows on a dairy farm.
Therefore, to compute the productive contribution of a company or a country, care should be
taken not to count some products more than once. For example, when calculating the production
result of the automotive industry, the production of the auxiliary industry (components, parts, tyres,
etc.) cannot be added to the cars finished by the assembly companies. We would be counting more

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than once the mentioned components, which have been incorporated into the final products (the
cars).

2.3. Intermediate consumption

In a modern country, almost all productive processes require the use of goods and services
previously developed by other productive units. We call such productive use of other companies'
products intermediate consumption, which is an important operation that is defined as the value of
the goods and services consumed as inputs in a production process. Such intermediate products may
be transformed, completely consumed or incorporated without alteration into other goods and
services. Intermediate consumption represents the value of the basic materials, components and
semi-manufactured goods going into the product, as well as the value of the electricity, the cost of
rents, IT services, insurance, legal and accounting services, etc., used in the production of a good or
a service. Intermediate consumption represents the value of all goods and services used as inputs in
the production process.
However, a distinction must be made between intermediate consumption and the use of machines
or installations. The latter, capital goods, are used over several periods and only experience the
usual wear and tear from their use. They are therefore not included among intermediate
consumption (which is continuously incorporated into the goods and services produced) but in gross
capital formation. In a the brewery, the malt is an intermediate consumption and the steel tank used
to make the beer is a capital good.

2.4. Final and intermediate products in a simple economy

Let us suppose that you are an economist working for the United Nations sent to Tupanakinstan, a
remote imaginary country, whose inhabitants receive no more than a daily ration of beer. In order to
channel an international aid programme to the country, its GDP has to be calculated.
The country is poor, but well organized. Economic activities are carried out by only three
companies: Organic Barley, Good Malt and Highland Beer, each of which produces what its name
suggests. A survey of the companies allows us to know and value their productions (which coincide
with sales):
Table 1 – Production of Tupanakinstan
Firm Production
Organic Barley 75
The Good Malt 125
Highland Beer 225
TOTAL 425
Would it be correct to say that Tupanakinstan’s GDP is 425? It would not be correct if we know,
from a survey, that all barley production is sold to the malt company and all malt production is sold
to beer manufacturers. Thus, in the end, the citizens do not have barley + malt + beer, but only one
final product, beer, since the rest of the production was necessary ingredients to produce beer.
It is the same as if, in a modern economy, we were to calculate the GDP for the batteries, tyres,
gearboxes and all the parts and components that the auxiliary industry supplies to the car factories
and, likewise, we were to include the car that incorporates these parts.

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 To value the productive contribution or value added of each activity, the goods and services used
to produce them (intermediate consumption) must be subtracted from their production. In our
imaginary (and assuming that other products were not used in the production of barley as
intermediate consumption, so as not to take the exercise to infinity) we would have the magnitudes
of table 2.
Table 2 – Values added of Tupanakinstan
Concept Barley Malt Beer Total
Production of goods and services 75 125 225 425
Intermediate consumption - 75 125 200
Value added 75 50 100 225
The sum of the output of the three companies is 425. However, this figure includes some items
more than once, since the citizens of this country do not have at their disposal wheat, flour and
bread, but only a final product, bread to the value of 105. We will call these products intermediate
consumption, i.e. the consumption that the companies make of the products of others in order to
carry out their activities.
By subtracting intermediate consumption (200) from the value of output (425), value added is
obtained (225). The same result would have been obtained by adding the value added for each
activity, i.e. its output minus the intermediate consumption used (75 + 50 + 100 = 225).
Value added is the increase in the values of the product generated by any unit dedicated to a
productive activity. It is obtained by subtracting intermediate consumption from production.
Therefore, in order to assess the productive contribution of the country, only the final products
(which have not been the object of subsequent productive consumption) must be taken into account
or, alternatively, the creation of value that takes place in the country as a whole must be seen, that
is, the sum of added values of each company.
A country's GDP can be obtained by adding up the value of the final products or by adding up the
value added generated by the different productive activities.
From this perspective, to produce is to add value to pre-existing products, that is, to work on
them and make changes to them that make them more useful to the consumer. Thus, bread is more
useful for consumption than flour, or jam than its ingredients separately.
Obviously, adding value is not the same as increasing the price, but adding some quality that
makes the product more attractive to the consumer, so that it will be more useful to him and he will
be willing to pay more than for pre-existing materials or those that have a different form or different
biological, geographical or economic situation.
It may be added that the classification of goods or services as intermediate or final use may give
rise to misunderstandings, since a large part of them may be susceptible to both uses. Thus, petrol
purchased by a taxi driver is an intermediate consumption operation, while petrol purchased by a
citizen for his private use (even if it is to travel to his workplace) is final consumption. It should be
noted that there is nothing in the goods which classifies them in either category, but rather it is their
use by a certain agent which determines their classification as intermediate or final goods.

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 2.5. Types of production

There are four types of production that we are included in the production boundary (and GDP):
(a) market, (b) for own final use, (c) non-market and (d) amateur. Market production is that which is
usually sold on the markets at normal prices (covering sales of more than 50 percent of the cost of
production). Production for own final use is that which an institution reserves for its own
consumption or capital formation. It includes farmers' own consumption, rental services for owner-
occupied dwellings and household services when performed by paid staff. Also included are some
capital works that companies carry out for themselves. The non-market output is mainly that of the
Public Administrations (PA) as such (public safety, environmental care, diplomatic representation
education and health services, and similar). This type of production is supplied free of charge or at
economically insignificant prices. Also included is the production of non-profit institutions serving
households (NPISHs), such as trade unions, churches, non-governmental organisations, cultural
clubs and similar. Finally, and as mentioned above, amateur production is not included because its
existence and costs are not known.

3. Distribution operations

The distribution operations are those by which the added value is distributed among the factors
that have contributed to its achievement, as well as the redistribution - fundamentally motivated by
the performance of the Public Administrations - of income and assets. The productive process
consists of the generation of goods and services and, at the same time, of income or remuneration of
the productive factors involved in it. The payment for the contribution wit labour ans capital is the
primary distribution of income

3.1. The primary distribution of income

The productive system remunerates the factors of production, labour and capital, for their
contribution to production. Workers receive the wages and what remains of the added value, in a
first approximation, we can call profit. This is the primary distribution of income, which is carried
out by the productive system itself. For this reason, national income has traditionally been defined
as the sum of the income that reaches the inhabitants of a country, part in the form of wages, and
part in the form of profits, interest and land income, for their contribution to productive activity.
These operations are:
- Compensation of employees
This operation includes all payments in money or in kind made by employers as remuneration for
paid work. It includes gross wages and salaries, together with social security contributions or
payments. The latter payments, even if made by enterprises, are considered as compensation of
employees since they are delivered on their behalf to social security, which will entitle workers to
receive, where applicable, certain benefits such as pensions, unemployment benefits and others. It is
a type of salary in kind (entitlement to various benefits in the event of contingent events).
- Gross operating surplus

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 It is the remaining part of gross value added after the compensation of employees has been
deducted. It is a residual item. In a first approximation, we had called this item profit, but it does not
exactly coincide with profit because the surplus includes other concepts.
In fact, after the payment of wages and salaries, another part of the value added remains available
to pay for loans taken out, corporate income tax, contributions for the wear and tear and
depreciation of capital equipment, shareholders' dividends, as well as the purchase of new
equipment or the making of financial investments.
- Mixed income
These are the incomes of companies with no legal personality other than that of the owner or of
family businesses in which the owner directly operates the business by contributing, in addition to
the capital, his work (family farming, small businesses, independent professionals and similar). The
difficulty of allocating part of the remuneration as labour income and part as surplus, leads to the
choice of defining the concept of mixed income for this type of income, since any other distribution
(one part for labour income and another for capital income) would be difficult and perhaps arbitrary.
It is the remaining part of gross value added after the compensation of employees has been
deducted. It is a residual item. In a first approximation, we had called this item profit, but it does not
exactly coincide with profit because the surplus includes other concepts.
In fact, after the payment of wages and salaries, another part of the value added remains available
to pay for loans taken out, corporate income tax, contributions for the wear and tear and
depreciation of capital equipment, shareholders' dividends, as well as the purchase of new
equipment or the making of financial investments.

3.2. Secondary distribution

However, the agents - and the national economy itself - not only receive income for their
contribution to the productive process, but can also receive income without having given anything
in return (at least in the same period), such as a retirement or unemployment benefit. These
donations are called transfers and are defined as donations without a counterpart. They allow
income to be increased for those who receive them or reduced for those who give them. This
process is called secondary distribution or redistribution of income. Redistributing income means
reallocating to other agents the spending capacity that some agents have initially created in the
productive processes. This redistribution alters the distribution made by the productive system,
allowing some agents a greater - or lesser - spending capacity than their contribution to the
productive process would have allowed. When the public administration pay a pension to a retired
person, or an unemployment benefit to an unemployed person, they are redistributing income,
making possible income and spending capacity for some subjects who may not have contributed to
production during the current period. Similarly, public administrations take away coercive income
(personal income tax, for example) from some agents, who had obtained it in the production
process.

4. The circular flow of Income: production, income, expenditures

The productive process is a process of generation of goods and services and, at the same time, of
income or remuneration of the productive factors (labour and capital), which intervene in this

9
process. Households, which are the owners of the factors of production, make them available to
companies and receive remuneration or income in exchange for the use of these factors. We call the
income or remuneration of labour salaries and that of capital, in a first approximation, profits.
Households use that income to buy the goods asn services produces by the firm and thus close the
circular flow of income, a circuit that goes from the production of goods and services to the
generation of income and the expenditure thereof.
Finally, an accounting equality between value added, income and expenditure (in a closed
economy without taxes) is reached. In order to describe this, we will complete the previous tables
with Table 3, which integrates all the elements described up to now.
TABLE 3.– Production, value added, income and expenditure
Activity Barley Malt Beer Total
Production of goods and services 75 125 225 425
Intermediate consumption 0 75 125 200
Value added 75 50 100 225
Income 75 50 100 225
Final consumption expenditure 225 225

The table shows how the added values of each activity are distributed (by definition) in the form
of income for the productive factors. In other words, the contribution of the factors of production
(capital and labour) increases the value of intermediate products and this value added is distributed
in the form of income (wages and benefits) for the factors of production. Finally, the factors spend
their income on the acquisition of the final goods.
In our specific example, it can be seen that final products have been generated to the value of
105. Each activity contributed value added (75 + 50 + 100) and for the same amount income to
acquire them. Thus we have that GDP or current of final goods and services created in an economy
can be seen as the sum of the added values of all productive activities (225), or as the sum of factor
income (225) or as the sum of final expenditure (225). This leads to the important equality between
value added, income and expenditure.
The circular flow of income shows as that is possible to calculate Gross Domestic Product, GDP,
using three methods.
We started the lesson with this definition:
“GDP combines in a single figure, and with no double counting, all the output (or production)
carried out by all the firms, non-profit institutions, government bodies and households in a given
country during a given period, regardless of the type of goods and services produced, provided that
the production takes place within the country’s economic territory. In most cases, it is calculated
quarterly or annually, but it can also be calculated monthly” (UNA, pp 15-16)
The key features of this definition are these ones:
- Current or flow.
- Goods and services.
- Final.
- Produced in a territory.

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 - In a period of time.
- Valued in monetary units.

Figure 1: The circular flow of income

Let’s explain this main points:

- GDP is a stream or flow, so in order to quantify its value it is necessary to determine the two
moments in time between which to measure its magnitude. It can therefore be distinguished from
the wealth or assets held by the inhabitants of a country at a particular point in time, which is
considered a background variable.
- They are real goods and services. GDP is not a monetary concept but a flow of goods and
services, in its most material sense. If the same amount of goods and services are produced in two
successive years, even if prices double, and thus the value of the goods and services, GDP remains
unchanged.
- It includes goods and services produced within a country (more precisely, within its economic
territory). Some foreign-owned factors, such as capital or the labour of non-residents, may have
contributed to their production.
- Annual GDP is usually calculated, although the flow of goods and services is generated
continuously, so the flow produced over any other period of time could be selected. In fact, most
developed countries produce national accounts on a quarterly basis.
- Finally, the flow of goods and services is homogenised by valuing them in the currency of the
country or, for the purpose of international comparisons, in any other widely used currency, such as
the dollar or the euro, since valuation at market prices and in a common currency is the only way to
homogenise and compare, in time and space, production flows of potatoes, computers, medical
services and other products.

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 The previous examples and the “circular flow of income have shown as that there are three
alternative way to calculate GDP. Now we will introduce these three approaches.

5. GDP: Output approach (or production, or VA, or supply side approach)

The first way of estimating GDP is by adding up the values added (output minus intermediate
consumption) of all economic activities. Grouping the activities into three large categories gives
GDP by way of supply, or value added by the different branches of activity.
GDP = Σ Values Added.
Because each value added is itself equal to output minus intermediate consumption, the end result
is:
GDP = Σ outputs – Σ intermediate consumptions.
In order to produce information that can be analyse easily, there is grouping of activities and it is
very common to present values added by 3 or 4 large groups of producers: agriculture (including
forestry, livestock, fishery…), industry, construction (sometimes included in industry), and services.
GDP = VA Agriculture + VA industry + VA construction + VA construction + VA services
Sometimes we need more disaggregated information which is usually available.

5.1. Valuation criterion

But in the real world things are a little bit more complex. There are taxes like VAT that
households pay when they buy almost any item, and are part (an not a small one!) of the price. But
from the point of view of the producer, those taxes are not perceive as a “price”. The seller will
have to forward those taxes to the tax authorities, they won’t be able to keep them to pay suppliers
or to pay wages. Because of this, when calculating the value of output for a firm we are not going to
include those taxes. This is the basic price corresponding to the revenue per unit of products sold
that remain in the hands of the producer. Basic prices therefore does not include taxes on products
(for example, value-added tax and special taxes on petroleum products, alcoholic beverages or
tobacco), because these amounts do not remain with the producer but are forwarded to the tax
authorities. On the other hand, the basic price includes the subsidies received on products. The main
ones in EU are subsidies received by farmers and linked to the amount of production. Therefore, in
the national accounts, the prices for exported agricultural products are not the low prices made
possible by the export subsidies granted to farmers of EU countries but the actual sales prices plus
the subsidies, thus a price that is closer to the real costs of production.
Because of this, and in order to get the same result, we need to include those “taxes on products
net of subsidies” (= Taxes on products – subsidies on products) when calculating GDP.
Figure 2 shows Spanish GDP using the output approach for the first quarter of 2020. If we use the
link, we can get more disaggregated information (for example, 7 different service activities instead
just one).

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 Figure 2. GDP output approach, Spain 1st quarter-2020

Source: INE: https://www.ine.es/jaxiT3/Datos.htm?t=30678#!tabs-tabla

5.2. How to calculate output: general method

The general rule to calculate output in the market sector is to start with the value of sales and
make an adjustment: some of the goods produced this year are not sold, and we keep them in the
barns or in the warehouses (remember the example with barley). But it is this year production, thus
we have to add the value of this end of the year inventories to the sales to calculate the output. But
during this year we might have sold goods produced the previous year, and already counted in last
year output, We have to deduct the values of the inventories at the beginning of the year. The
difference (inventories at the end of the period – inventories at the beginning of the period), or
changes in inventories, has to be added to sales in order to calculate output.
We also need a second adjustment: production of a firm for final own use, which is not sold in
markets. We include here farmers that produce for own consumption, and firms that produce goods
included in GFCF, like building with own resources a new warehouse, or investment in research
and development.
Let us return to the example of the beer industry in Tupanakinstan. But with one modification. At
the end of the year we have some beer, produced this year, in the warehouse of the brewery. The
amount is 25. This is how table 3 changes.
We already now that the outptut of the general government and NPISH is not sold in markets, and
we can’t use this approach to calculate output.
Note however that, even in the market sector, there are activities whose output is difficult to
measure or even identify such as banks, insurance companies and retail distributors for which the
definition of output based on sales does not work very well. They are all market activities, but their
output is mainly purchased indirectly. Therefore an alternative measure of output is needed.

13
 TABLE 4.– Production, value added, income, expenditure and investment
Activity Barley Malt Beer Total
Sales 75 125 200 400
Changes in inventories 25 25
Production of goods and services 75 125 225 425
Intermediate consumption 0 75 125 200
Value added 75 50 100 225
GDP 225

5.3 Special cases: distribution companies

UNA, pp. 116-117: “When measuring output for the national accounts, distribution (both
wholesale and retail) also constitutes a special category. This is because if the general formula were
applied the results would significantly overestimate total output, since sales in the distribution
channel are already recorded as the value of the goods created by the actual producers. Therefore,
the output for distribution is measured as the margin obtained on the products sold. So the output at
current prices of distributors is equal to the value of their sales minus the value of the products
bought for resale.
This is known as their distribution margin. The intermediate consumption of distributors therefore
excludes their purchases for resale; it consists only of rent, electricity, advertising, packaging and
other operating expenses. Their value added is calculated in the usual way, by deducting their
intermediate consumption from their output.”

5.4. Special cases: banks

UNA, pp. 114-115: “The general formula for measuring output from sales cannot be used to
measure the output of banks, because banks invoice directly only a very limited portion of their
services (for example, foreign exchange commissions, cheque-handling fees, stock-market
transaction fees, separately-charged financial advice), but not the bulk of their service, which is
making loans. Measurement using the general formula would result in their value added being very
small, if not negative; in other words, their intermediate consumption would be greater than their
sales! Because banks are obviously profit-making enterprises, there is something wrong here. The
fact is that banks make the bulk of their profits by borrowing at low interest rates from depositors
and then lending the proceeds to other borrowers at a higher interest rate. The difference between
these two interest rates, which provides the essential part of banks’ remuneration, is interpreted in
national accounts as their financial intermediation service. The banks are in fact intermediaries
between those who want to save – mainly households – and those who want to borrow – mainly
firms. Without the banks, these agents would have greater difficulty in coming together. The
national accounts therefore measure the output at current prices of banks as the sum of their sales
plus, approximately, the difference between the interest received from borrowers and the interest
paid to lenders. This difference, which forms the bulk of the total, is known as financial
intermediation services indirectly measured or FISIM”.

14
 5.5 Special cases: insurance companies

UNA. pp. 116: “Measuring the output of insurance companies is even more problematic than in
the case of banks. For the sake of simplicity, we shall deal here only with non-life (property)
insurance (automobile insurance, home insurance, etc.). The money received by these non-life
insurers in the form of premiums does not constitute payment for an insurance service but instead
mainly goes into a fund from which indemnities will be paid in the event of claims. This being said,
insurance premiums cover these indemnities plus claim management expenses plus the profits of
insurance firms. The output at current prices of insurance companies corresponds to these two last
items: management expenses and profits. The output will therefore be measured in the national
accounts as the difference between premiums received and indemnities paid out, this being
mathematically equal to management expenses plus profits. Things are in fact slightly more
complicated than this, because insurance companies immediately invest the premiums received and
leave them invested until such time as they are paid out in the form of indemnities. They therefore
derive incomes which, economically speaking, belong to the insured and not to the insurance
companies. Therefore, the national accountants impute a repayment of this income from the
insurance companies to the insured (households or firms), which then pay them back to the
insurance companies, the sums involved still being imputed. It is as if households paid not only
premiums but also the investment income. In the end, the output at current prices of insurance
companies is equal to the premiums plus the investment income minus the indemnities”.

6. GDP: expenditure approach

6.1. Final consumption expenditure

The first component of final consumption expenditure is the one made by the households (Final
consumption expenditure of households). Almost all the goods and services purchased by the
families as consumers are going to be included here. There is going to be only one exception: the
dwellings (houses) bought by families.
Again, the real world is more complex that the picture that er have drawn previously. Not all the
final consumption expenditure is made by families. Do we introduce in GDP all the services
provided and paid for by the government? We are talking about services like health or education.
We already know the answer: yes, we are going to include it in the value of production. And we are
going to use them without paying for them (at least, we don’t pay for them immediately and in
direct proportion of the amount that we are using). This is final consumption expenditure of general
government.
There are other services provided without a market price by Non Governmental Organizations
(NGOs), trade unions, political parties… that are also going to be included as final consumption
expenditure of Non-profit Organizations Serving Households (NPISH). Then
Final consumption expenditure = Final consumption expenditure of households
+ final consumption expenditure of general government
+ final consumption expenditure of NPISH
There is an alternative way to present the information related to Final Consumption. UNA, pp
114: “Certain services provided by general government, like education and healthcare, are provided

15
to households on an individualised basis, meaning that it is possible to know who consumes them.
For instance, a family sends its children to the state school, and one therefore knows that it is a
consumer of these services. Other services are provided only on a collective basis, meaning it is
impossible to know who consumes what. An example is policing: all economic agents, households
and firms consume part of the services of the police, but it is impossible to know how much each
consumes. In the case of the individualised services, government can sometimes charge part of the
price to the consumer (for example, the contribution to the cost of a hospital bed), but this price is
usually well below the production costs of the services consumed, and the services are therefore
considered non-market”.
Final consumption
Individual consumption expenditure of households
+ final consumption
expenditure of general
+ = government
+ final consumption
collective consumption expenditure of NPISH

In Spain, in recent years, public spending has represented nearly 42 percent of GDP. Final
consumption expenditure by the public authorities is around 19 per cent of GDP. Finally, collective
consumption is around 8 per cent of GDP.
Public spending includes all expenditure by the public authorities (current expenditure, transfers,
capital expenditure, etc.), while collective consumption includes only some current expenditure
(acquisition of goods and services and wages) and, in particular, expenditure on services provided
by public authorities for the collective benefit of citizens.
Therefore, collective consumption does not include items of expenditure that can be
individualised, such as expenditure on education, health and social assistance.
Public expending is much larger than final consumption expenditure of general government
because includes important transfers (unemployment, pensions, etc.), which represent a very
important part of public spending. In this type of expenditure, the public authorities transfer funds
to private individuals with which they consume goods and services (individual consumption).
Similarly, capital expenditure (motorways, public buildings...) is not included either, which,
although it may be for the benefit of the whole community, is not considered as consumer goods but
as capital goods and forms part of the gross capital formation of the economy (next item).

6.2. Gross capital formation

In our example with Tupanakinstan we calculated GDP adding the final demand. In
Tupanakinstan there was only one product that we have at the end of the precess, beer. Barley and
malt were intermediate consumptions. But in the real world, we have goods that we have produced
and are neither used to produce other goods or services, nor by households. We still have them at
the end of the period. For example, a computer, a bus, or even the barley that we have not used to
produce malt and is still in the barns. Those goods have been produced, we have generated VA, but
are not included in final consumption expenditure of households. The final use of these goods is
investment: we will use them to produce more in the future.

16
 Final consumption and investment are two of the main components of “final” macroeconomic
demand. The great attraction of the national accounts is that they constitute a “reconciled” model of
the economy, balancing supply and demand.
In order to grasp the origin of this essential accounting equation, let us return to the example of
the beer industry. But with one modification. At the end of the year we have some beer, produced
this year, in the warehouse of the brewery. The amount is 25. The changes are shown in table 5.

TABLE 5– Production, value added, income, expenditure and investment

Activity Barley Malt Beer Total
Production of goods and services 75 125 225 425
Intermediate consumption 0 75 125 200
Value added 75 50 100 225
Income 75 50 100 225
Final consumption expenditure (FCE) 200 200
Investment (Gross Capital Formation) 25 25
Final demand (FCE+GCF) 225
GDP 225

Final demand is the result of adding final expenditure and investment, which is named Gross
Capital Formation (GCF). Changes in inventories, like in the example, is one cathegory in GCF. But
we have other one, much more important in a modern economy.
But what happens if we have a firm that produces robots, and sells the robots to other firm?
The robots are not intermediate consumption, because they will be there at the end of the year and
will help us to produce more goods in the future). This is also investment, Gross Fixed Capital
Formation, GFCF.
IN GFCF we are also including a investment with special characteristics. It is more and more
relevant for firms to use labour and intermediate consumption to create new products and to
improve the old ones. Research and development is a key competitive factor. This investment is
immaterial, is knowledge, but it will allow the firm to increase production in the future. In the EU,
until the 2010 reforms, it was excluded from output of the firm (the firm was not selling it) and was
not included in GFCF. Now it is included, and because of that, GDP figures increased (just because
a change of accounting policies).

6.3. Exports and imports

In addition, if we assume that the economy is open to imports (M) and that there is external
demand reflected in exports (X), some of the beer that we have produced could be sold to firms in
other countries. And in the final expenditure of households, we could be including the expenses in
clothes that were produced in other countries. The goods and services that are available ion our
economy are not only the ones that we have produced (included in GDP without double counting),

17
but also the ones that we buy from other countries. The equation is now supplemented with these
additional flows:
GDP + Imports = Final consumption expenditure + GCF + Exports
The left-hand side of the equation consists of supply at the macroeconomic level, made up of
domestic production (GDP) and external supply (imports, M). The right-hand side consists of final
demand, broken down into domestic demand (household consumption and GCF) and external
demand (exports). We could move imports to the right side of the equation:
GDP = Final consumption expenditure + GCF + Net Exports
The left-hand side now consists solely of GDP, the principal indicator of economic activity. The
right-hand side consists of the “final uses” that are the major components of domestic demand
together with “net exports”, which is simply the difference between exports and imports. This
accounting equation is fundamental in analysing the economic condition. It provides a perfect
illustration of the impact of demand on supply, according to Keynesian reasoning. It is no
accident, in fact, that national accounting was developed during the 1940s, just after Keynes’ major
discoveries.
In exports of services, we are including the expenditure of non-residents made in our country,
which is mainly tourism. In Spain this component of exports is very relevant, and because of that is
quite common to include it the aggregate information. In imports of services the expenses of
residents in the rest of the world is also included.
If we go back to Tupanakinstan, if 15 units of our beer were sold to other countries (exports) and
because of that households in our country have spend in beer only 185 units, but those families have
bought clothes from other countries with a value of 10, we would have table 6.

TABLE 6.– Production, value added, income, expenditure, investment and exports/imports
Imports
Activity Barley Malt Beer Total
(clothes)
Production of goods and services 75 125 225 425
Intermediate consumption 0 75 125 200
Value added 75 50 100 225
Income 75 50 100 225
Final consumption expenditure 185 10 195
Gross Capital Formation 25 25
Exports (X) 15 15
GDP (FCE+GCF+net exports) 225

Table 7 shows Spanish GDP using the expenditures or demand approach for 2018 and 2019.

18
 Table 7. Spanish GDP using the demand approach for 2018 and 2019
GDP SPAIN, demand
2018 2019
Gross domestic product at market prices 1.202.193 1.245.331
National demand 1.169.570 1.210.170
Final consumption expenditure 924.621 950.525
Household final consumption expenditure 688.585 704.552
Final consumption expenditure of NPISHs 12.217 12.735

Final consumption expenditure by government 223.819 233.238

Gross capital formation 244.949 259.645
Gross fixed capital formation 233.584 249.259
Tangible fixed assets 194.023 207.970
Dwellings and other buildings and structures 115.426 124.305
Machinery, equipment and weapon system 75.564 80.241
Cultivated biological resources 3.033 3.424
Intellectual property products 39.561 41.289
Changes in inventories and acquisitions less
disposals of valuables 11.365 10.386
External balance of goods and services 32.623 35.161
Exports of goods and services 422.170 434.250
Exports of goods 290.256 293.844
Exports of services 131.914 140.406
Expenditure by non-residents in the economic
territory 56.287 58.488
Imports of goods and services 389.547 399.089
Imports of goods 319.581 321.983
Imports of services 69.966 77.106
https://www.ine.es/dyngs/INEbase/en/operacion.htm?
c=Estadistica_C&cid=1254736164439&menu=resultados&secc=1254736157760&idp=1254735576581

7. GDP: Income approach

To obtain GDP as the sum of the remuneration paid to the factors of production, the two types of
income must be added together: income from labour (compensation of employees) and income from
capital (Gross Operating Surplus, GOS), in addition to mixed income, which is a mixture of income
from labour and from capital in small enterprises. Finally, taxes less subsidies on production have to
be included,

7.1. Compensation of employees

This operation includes all payments in money or in kind made by employers as remuneration for
paid work. It includes gross wages and salaries, together with social security contributions or
payments. The latter payments, even if they are made by enterprises, are considered as
compensation of employees since they are delivered on their behalf to social security, which will
entitle workers to receive, where applicable, certain benefits such as pensions, unemployment
benefits and others. It is a type of salary in kind (entitlement to various benefits in the event of
contingent events).

19
 7.2. Gross Operating Surplus

It is the remaining part of gross value added after the compensation of employees has been
deducted. It is a residual item. In a first approximation, we had called this item profit, but it does not
exactly coincide with profit because the surplus includes other concepts.
In fact, after the payment of wages and salaries, another part of the value added remains available
to pay for loans taken out, corporate income tax, contributions for the wear and tear and
depreciation of capital equipment, shareholders' dividends, as well as the purchase of new
equipment or the making of financial investments.

7.3. Mixed income

These are the incomes of companies without legal personality other than that of the owner or of
family businesses in which the owner directly operates the business by contributing, in addition to
the capital, his work (family farming, small businesses, independent professionals and similar). The
difficulty of allocating part of the remuneration as labour income and part as surplus, leads to the
choice of defining the concept of mixed income for this type of income, since any other distribution
- one part for labour income and another for capital income - would be difficult and perhaps
arbitrary. Some times they are presented with GOS.

7.4. Net taxes on production and imports

However, these primary incomes must be increased by taxes on production and imports and by
subtracting subsidies in order to bring them into line with GDP at market prices. It should be borne
in mind that the prices of goods and services on the markets incorporate these taxes net of subsidies:
GDP = Compensation of employees + Gross Operation Surplus + Mixed income + Net taxes on
production and imports
With Net taxes = taxes on production and imports – subsidies on production and imports.
Taxes on production are taxes on products, included in the output approach, like VAT and special
taxes on oil, plus “other taxes on production”, taxes linked to business activity but not to the value
of production or sales (and non deductible), like licenses (activity, vehicles…) paid to the public
administration.
Subsidies on production are subsidies on products (the most relevant ones in Spain are the ones
received by farmers) plus “other subsidies on production”, which includes, for example subsidies
on payroll or work force (subsidies payable on the employment of particular types of persons such
as physically handicapped persons or persons who have been unemployed for long periods, or on
the costs of training schemes organised or financed by enterprises) or subsidies to reduce pollution
(subsidies intended to cover some or all of the costs of additional processing undertaken to reduce
or eliminate the discharge of pollutants into the environment). Table 8 shows GDP for Spain using
the Income approach.

20
 Table 8. Spanish GDP using the income approach for 2018 and 2019

Source: https://www.ine.es/jaxiT3/Tabla.htm?t=30682&L=1

8. GNI and other macro-magnitudes

8.1. From GDP to GNI

It has been pointed out so far that production generates income and that this is spent on the
acquisition of the goods and services produced, thus closing a cycle characteristic of an economy
without relations with the rest of the world. However, modern economies are open, not only
because there are international flows of goods and services (exports and imports), but also of
productive factors and the income corresponding to them. For example, some Spanish companies
use foreign capital and the remuneration for the use of this factor, in the form of interest or
dividends, is paid to their owners resident in the rest of the world. Therefore, part of the income
generated in Spain belongs to non-residents. In this way, residents in Spain will have a lower
spending capacity than that derived from the income produced by companies established in Spanish
territory (domestic income). But we also have operations in the opposite direction: income received
by residents who contribute capital to productive processes taking place outside the country. This is
income, in both directions, from capital employed in a country other than that of the owners'
residence.
There are also workers who reside in other countries that come to Spain to work for few weeks
(for example, residents in Morocco that come to Spain to work in the the strawberry harvest
campaign), or a Spanish resident that lives in Irun but works in Hendaye. In both examples, wages
are paid to compensate for labour of residents in other country.
Thus, the Spanish GDP, the cake obtained in Spain, must be shared with factors which
contributed to its production and whose owners reside in the rest of the world. On the other hand,
residents in Spain can also receive income from abroad (share of the“cake” produced elsewhere).
Because of these income adjustments with the rest of the world, domestic product (product
generated in the territory of a country) differs from national product or income (produced by factors
owned by residents in the country). AS UNA, p. 328 says. “GNI, which (unlike GDP) is an income-
based concept and not a production-based concept, since it includes income derived from
production abroad (and hence not recorded in its totality) and excludes the value of output repaid to
foreign factors of production. Hence, the word “Income” instead of “Product” is used in its name
GDP is the added value generated in an economic territory”

21
 GDP
+ Primary incomes receivable from the rest of the world
- Primary incomes payable from the rest of the world
= Gross National Income, GNI
Some times we separate “capital income receivable / payable with the rest of the world and
“labour income receivable / payable with the rest of the world”
And it is also common to present the information in one line as the difference:
Net primary incomes from the rest of the world =
+ Primary incomes receivable from the rest of the world
- Primary incomes payable from the rest of the world

8.2 From GNI to GNDI

Between countries, there are also transactions without counterpart, which are called international
current transfers and which involve additional income inflows (or outflows) beyond the
remuneration obtained in the production process. An example of this is public international aid, or
also private transfers that migrants (not temporary or cross-border) make to their families in the
countries of origin. In the case of Spain, transfers in both directions are important in the framework
of the EU. Including these transfers leads to the Gross National Disposable Income (GNI).
The current transfers with the rest of the world consists of a number of items, including those
known as miscellaneous current transfers. This group includes intra-household transfers of
resources. That is, the funds that migrants send back to their home countries to help their families or
for the purpose of saving (migrant remittances). This group also accounts for an important part of
the contribution that EU countries make to the EU budget.
With the inclusion of current transfers, we move from GNI to Gross National Disposable Income:
GNI
+ Current transfers receivable form the rest of the world
- Current transfers payable to the rest of the world
= Gross national Disposable Income, GNDI
It is also very common to present both these transfers in just one line:
Net current transfers from the rest of the world =
+ Current transfers receivable form the rest of the world
- Current transfers payable to the rest of the world

8.3. From GNDI to National Savings

Until now, money has been discussed only as a unit of account or as a means of valuing the flow
of goods and services produced. Here too, this real consideration of the economy continues. The

22
concept of real capital must therefore be understood in a physical sense. Capital is the productive
goods produced (such as machinery, plant and infrastructure).
Contemporary societies are called capitalist because of the large amount of means at their
disposal to produce. Societies sacrifice the enjoyment of a certain amount of present goods
(consumer goods) in order to produce machines, installations and railways or canals, which will
serve to produce in the future. This is one of the reasons why there has been a considerable increase
in production since the Industrial Revolution: sacrificing part of present consumption to create
working instruments that will allow an increase in production in the future. It is the accumulation of
capital or the creation of a fund of goods that will be used to produce in successive periods.
The accumulation of capital is carried out by sacrificing or abstaining from consumption: society
saves part of its income. Gross National Saving (GNS) is defined as:
GNS = GNDI - FCE
Gross National Savings (GNS) is GNDI minus consumption (FCE), i.e. savings is the part of
income not consumed. As families are well aware, when they set aside part of their income to buy a
house, they are saving.
Saving is very important in modern society. W. A. Lewis, a Nobel Laureate in Economics and one
of the most important scholars of economic development, pointed out how one of the keys to a
country's growth was the move from saving 4 per cent of its income to 12 or 15 per cent of it. It can
be pointed out that saving in itself is not a virtue. It would be an act of masochism (except for
precautionary reasons) in a mass consumer society. What is relevant about saving is its productive
use, its use for gross capital formation, in order to improve the productive structure of a society,
making it more efficient, either by improving the machinery used in the productive processes or by
better equipping all kinds of infrastructures to enable all activities to function more efficiently.

8.4. From GNS to Net Lending / Borrowing position

GNS is the income that we are not using for FCE, and it is available for productive investment
(machines, buildings, roads, R&D….). But we can have more resources for investment. In Spain,
we receive funds from the EU to build new highways. They have to be used for that. Those transfers
are not included in current transfers, because they have to be used to increase GFCF. We could also
be making a capital transfers to the rest of the world (for example, an aid to an African country to
build a hospital). If we add to GNS the capital transfers receivable from the rest of the world, and
we subtract have the amount payable to the rest of the world, we have the amount at our disposal to
invest in GCF. But that doesn’t mean that we are going to spend just that money in physical
investment. It can be more than that, or less. If it is more, we will have money left, money that we
can lend to other countries. But we can also spend more in investment, borrowing money from the
rest of the world:
GNS
+ Capital transfers receivable from the rest of the world
- Capital transfers payable from the rest of the world
- GCF
= Net lending (if the result is positive) o net borrowing (if the result is negative) 1

1 We are not including in this presentation “Acquisitions less disposals of non-produced non-financial assets”. The
relevance is very low and it is not worthy in this introductory course.

23
 In table 9 we can see the transition from GDP to Net lending / borrowing position for Spain in
2015
Table 9. From GDP to Net lending / borrowing. Spain 2017-2018

Source: OCDE https://www.oecd-ilibrary.org/economics/data/aggregate-national-

accounts/disposable-income-and-net-lending-borrowing_data-00002-en?parentId=http%3A
%2F%2Finstance.metastore.ingenta.com%2Fcontent%2Fthematicgrouping%2Fna-ana08-
data-en

8.5. Gross and Net magnitudes

UNA, p. 21: “A distinction is also made between GDP and Net Domestic Product (NDP). In order
to produce goods and services (“the output”) at least three factors are required: labour (the “labour
force”), goods and services (intermediate consumption) and capital (machinery). These various
factors represent the “inputs” in the production process. In order to arrive at a genuine measurement
of the new wealth created during the period, a deduction has to be made for the cost of using up
capital (such as the “wear and tear” on machinery). This is known as consumption of fixed capital.
When this consumption is deducted, the result is net value added, and NDP is the sum of these net
values added: NDP = Σ Net Values Added. Although less widely used than GDP, NDP is, in theory,
a better measure of the wealth produced since it deducts the cost of wearing out the machinery and
other capital assets used in production. For similar reasons, in theory, Net National Income is a
better measure than GNI of the income created because Net National Income deducts the cost of
using up capital assets. However, OECD economists tend to prefer GDP or GNI (over NDP and
NNI) for two reasons. First, methods for calculating consumption of fixed capital are complex and

24
tend to differ between countries, thus creating doubts about the comparability of results. Second,
when ranking countries or analysing growth, the differences between GDP and NDP are small and
do not change the conclusions.”

9. The aggregation of units in ESA-2010

In the economic reality there are specific units of a diverse legal, administrative or accounting
nature, susceptible to statistical treatment, such as companies, households and various bodies. In
order to be able to carry out the accounting of the economic activities that take place in a country,
some kind of grouping of such units according to significant economic categories is required. To
this end, different criteria are used which are related to the objectives pursued by the systems of
national accounts. Thus, the ESA-2010 analyses economic activity from a dual perspective:
a. The institutional approach: it analyses the behaviour of economic agents in economic
activity. In this case, the so-called institutional units are grouped into institutional sectors.
b. The functional approach: it focuses on the study of the production process, being interested
in the analysis of what and how it is produced and not in who produces it. The aim is to highlight
technical-economic relationships. Local economic activity units are grouped into branches of
activity.

9.1. The institutional sectors

Institutional sectors are groupings of institutional units. An institutional unit is a basic centre of
economic decision-making characterised by uniformity of behaviour and autonomy of decision in
the exercise of activity. The characteristics of an institutional unit are therefore: capacity to carry
out economic activities and operations, autonomy of decision, capacity to own assets and liabilities
and to have a system of accounts.
The ESA-2010 distinguishes five institutional sectors, using as criteria for grouping the different
agents participating in an economy the main function they perform (production, consumption, etc.)
and the main source of resources (sales, taxes, wages, etc.). Additionally, a distinction is usually
made by type of producer (market or non-market). According to these (see table 1.4), the
institutional sectors in the Spanish national accounts are
- Companies and quasi-financial corporations: companies are resident institutional units whose
main activity is the production of non-financial goods and services for the market and whose
resources come mainly from income from sales. Quasi-corporations are units that do not have their
own legal personality, provided that their mission, type of management and financing are similar to
those of the companies, and when their economic and financial behaviour differs from that of their
owners (such as public companies).
- Financial institutions: this sector comprises all companies and quasi-corporations engaged in
financial intermediation and activities auxiliary to it. They channel funds from surplus units to
deficit units. Also included are insurance institutions and pension and similar funds.
- General government (GG): includes non-market producers (production not intended for sale)
that are intended for individual consumption (such as public health medical services) or collective
consumption (such as environmental care or diplomatic services). They are usually financed by

25
coercive income (taxes). The sub sectors included are: Central Administration (State and
Autonomous Administrative Bodies), Territorial Administration (Autonomous Communities and
Local Corporations) and Social Security Administration.
- Households (or families): groups the set of units whose main function is to consume and whose
resources come from labour and property income as well as transfers.
Households also includes individual companies without legal personality, assets or accounts other
than those of their owner. In the Spanish case, companies have traditionally been classified under
this heading according to their legal nature (natural persons) and taking into account the number of
employees (less than nine). Therefore, they also produce goods and services and earn income from
sales. In addition, households are considered as producers for own final use of imputed rent (when
an owner occupies his own dwelling), as well as paid domestic services and self-consumption by
farmers. They also carry out gross capital formation when they purchase new dwellings.
- Non-profit institutions serving households (NPISHs): are non-profit institutions with legal
personality that provide non-market goods and services to households. Their income is usually
derived from voluntary contributions from other sectors. These are charitable institutions, trade
unions, consumer associations, political parties, clubs, NGOs, churches and the like.
- Finally, the ESA-2010 includes what is called the Rest of the World. The rest of the world includes
non-resident units insofar as they relate to residents, through trade in goods and services,
remittances of income, as well as transfers and other operations. This sector presents the counterpart
of the national accounts balances.
- The differentiation between residents and non-residents of a country is decisive for its definition.
In principle, the national accounts consider as resident in a country those persons, whether natural
or legal, who have a centre of economic interest on the economic territory of that country, i.e. when
they carry out economic activities over a long period of time (at least one year).

TABLE 1.4. – The institutional sectors

Sector Producer type Main function Main income
Non financial companies Market Production of goods and Sales
services
Market Market Production of finanncial Insteres and
services fees
Public administrations Non market Production of non market Taxes and other
services an income coarcitive
redistribution payments
Households Market or self Consumption Income and
- as consumers consumption Production of goods and transfers

- as producers services Sales

NPISH Non market Production of non market Voluntary

services payments
Rest of the world - - -

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9.2. The branches of activity

In the exercise of activities, resources of all kinds are combined to produce goods and services. In
practice, many institutional units (such as enterprises) that produce goods and services carry out
several activities simultaneously. They carry out a main activity (the one that generates the most
added value) and other secondary activities, in addition to some auxiliary ones (such as internal
transport, storage, security, cleaning and others) that are intended for the company itself as support
for producing the others.
This circumstance, together with the need to have units that highlight technical-economic
relations in order to analyze production processes, means that institutional units must be divided
into smaller and more homogeneous units from the point of view of the type of production. Local
Kind-of-activity unit (local KAU) are intended to be an approximation of these.
A local KAU is an institutional unit, or part thereof, which produces goods and services and
which is located in a geographically defined place (such as an establishment or an industrial or
commercial plant). A large company may have several different production plants, or of the same, in
different locations, in addition to storage or distribution plants. Each of these establishments is what
is called an local KAU. Likewise, the production of non-market services (mainly from the public
authorities) in a given location, such as a public authority office, is also considered a local KAU.
The grouping of local economic activity units gives rise to the branches of activity. A branch of
activity is therefore a group of local KAUs carrying out the same or a similar activity. In order to
organize and systematize the many economic activities that exist, classification codes have been
drawn up for them, with the aim of reducing them to a few standardized categories that define them
as uniformly as possible. In Spain, the classification in force at the time of writing this lesson is the
Clasificación Nacional de Actividades Economicas, CNAE (in Europe is known as NACE,
following the french acronym) for the year 2009. This classification considers economic activity to
be the productive action resulting from the combination of means of production and aimed at
obtaining goods and services. The activities are grouped according to certain criteria that give them
uniformity: production factors used, technological process employed and destination of the
products. The groupings can be made at different levels of aggregation, which are identified with
alphabetical codes or a different number of digits. In table 1.5 we present the highest level og
aggregation:
Table 1.5. Highest level of NACE aggregation

Source: NACE rec 2. Statistical classification of economic activities in the European Community. Eurostat, p. 43.

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 We cannot fail to point out that the most widespread language can lead to some inaccuracies, as
we usually talk about the footwear, automobile or construction sectors. The ESA reserves the
denomination of branches of activity for these sectors, while the denomination sectors is reserved
for the institutional sectors.

BIBLIOGRAPHY

This lesson has been written using as references this books:

- Lequiller, F. and D. Blades (2014), Understanding National Accounts: Second Edition, OECD
Publishing.
http://dx.doi.org/10.1787/9789264214637-en
- EUROSTAT - European Commission (2013) : European System of National Accounts, European
Union
- Muzoz, C. Iraizoz, C. and Rapun, M (2020); Introducción a la economía aplicada. Magnitudes y
cuentas económicas. Civitas-Thomson Reuters.

The data about the Spanish accounts have been taken from INE and OCDE. These are the web
pages:
https://www.ine.es/jaxiT3/Datos.htm?t=30678#!tabs-tabla

https://www.ine.es/dyngs/INEbase/en/operacion.htm?
c=Estadistica_C&cid=1254736164439&menu=resultados&secc=1254736157760&idp=125473557
6581

https://www.ine.es/jaxiT3/Tabla.htm?t=30682&L=1
https://www.ine.es/dyngs/INEbase/en/operacion.htm?
c=Estadistica_C&cid=1254736165305&menu=ultiDatos&idp=1254735576581

https://www.oecd-ilibrary.org/economics/data/aggregate-national-accounts-sna-2008_na-ana08-
data-en;jsessionid=dt3thcl1rsfcr.x-oecd-live-02

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