THE MEASUREMENT OF NATIONAL INCOME

Chapter Twenty

Principles of Macroeconomics
Economics 1202.2B
 Introduction
• Before developing a model, National
Income must be precisely defined.
• Understanding how and why National
Income changes cannot happen until we
understand how it is measured.
• This is true for most concepts in
economics.

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 National Output and Value
Added
• Calculating National Output is more difficult than adding up what is
produced.
• Double-counting occurs because one company's output is another
company's input.
• Intermediate goods are input into other goods, final goods are sold
to consumers.
• Count the Value Added = Sales Revenue - Cost of Intermediate
Goods.
• Value Added is the correct measure of each firm's contribution to
total output.
• The sum of all Value Added is the correct measure of Total Output.

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 Value Added Through Stages of
Production
• In the table on the right, the
mining firm has $1,000 value
of product but no input
purchases.
• The steel producer has $1500 of output but the $1000 of input from the
mining company is subtracted, so only $500 of value added.
• The metal fabricator has $1800 of output but $1500 of input from the steel
producer, so only $300 of value added.
• The value of all product is $4300 but this would count inputs multiple
times.
• The total value of output is $1800, the sum of the value added from the
mining company, the steel producer and the metal fabricator. ($1000
+ $500 + $300.) 

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National Income Accounting: The Basics
• Statistics Canada calculates the measure of total output
in the National Income and Expenditure Accounts
(NIEA).
• The value of domestic output is equal to the value
of expenditures on that output and to the total income
claims on that output.
• The circular flow model gives three equal measures, the
sum of the value added, the expenditures on these
goods, and the income from these goods.
• All three are equal to the Gross Domestic Product.

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 The Circular Flow Model
• The simple circular flow model is the
model previously seen, with business
sell goods in the product market and
buying labour in the resource market.
Households sell labour in the resource
market and buy goods in the product
market. 
• Governments tax income and
purchase goods in the product market.
• Financial Institutions accept savings
and loan for investment.
• The Rest of the World sells goods we
import and purchases good that we
export.
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 GDP From the Expenditure Side
• The table on the right breaks down the
expenditure side of GDP. 
• Consumption expenditures are over 55% of the
total GDP.
• Investments are about 20% of the total GDP.
• Government Purchases are about 25% of the
total GDP.
• Net Exports (Exports - Imports)
are about negative 2% of the GDP. 
• Note that there is a statistical discrepancy
necessary to make the Expenditure side and
the Income side balance. This is necessary
because the calculations are difficult and
complex.
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 Consumption Expenditure
• The Consumption Expenditure is the largest component
of GDP but many by many small players. Individual
households.
• This is all goods and services purchased by households
and the actual consumption is denoted by Ca.

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 Investment Expenditure
• Inventories are unsold outputs and unused inputs. The expenditure
on these purchased but unsold goods is an asset which can be sold
in the future.
• New plant and equipment can be used for future production. 
• New Residential Housing - apartments and new houses are investments
that will yield value for years. The resale of existing homes is just a transfer
of ownership and not part of Investment or the GDP.
• Gross Investment is total investment and replacement investment. Net
investment = Gross Investment - Depreciation
• Total Investment is the sum of all these investments, the actual Investment
is Ia.

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 Government Purchases
• Governments provide goods and services such as snow plowing
and lifeguards at public beaches.
• Cost Versus Market Value – Government services are often given at
cost since market value may not exist if the government is the only
provider of the service.
• Government Purchases vs Government Expenditures - a large part
of government expenditures are transfer payments, for
example payments to seniors in the pension plan or payments to
unemployed persons through Employment Insurance.
• The total of government purchases or government expenditures
minus transfer payments gives the actual government purchases,
Ga .

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 Net Exports
• Exports are goods and services which are sold by companies to
households and companies in other countries. They are not part of
consumption, investment or government purchases, so they need
their own category.
• Imports are goods and services which households and companies
in Canada have purchased from a foreign producer. Only a small
proportion of the purchase was for Canadian dealers or
transportation.
• Net Exports we subtract Imports from Exports to get the true value
of expenditures on Canadian goods. Consumption, Investment and
Government purchases all have import components that must be
deducted.

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 Total Expenditures
• Total expenditures or Aggregate Expenditures or
GDP is calculated by the simple equation. 
• GDP = Ca + Ia + Ga + (Xa - Ma).
• GDP = Ca + Ia + Ga + NXa.

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 GDP From the Income Side
• While we will use expenditure side
mostly, the GDP can also be
calculated from the income side as
in the table on the right.
• Wages and income are half of the
total income.
• Investment and profits are
another 20% of total income.
• Depreciation and indirect
taxes (less subsidies) are the
remainder.

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 Factor Incomes
• Wages and Salaries are payment for all labour and include all the
pre-tax income paid to workers.
• Interest includes all interest and investment income to households,
banks and businesses.
• Business Profits include both profits paid out to owners as
dividends but also profits held back as retained earnings.
• Net Domestic Income is called net domestic income at factor cost.
– It is net because it excludes the value of output used as replacement investment.
– It is domestic income because it includes income accruing to domestic factors
of production.
– It is at factor cost because is represents the value of final output associated with
the factors of production.

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 Non-Factor Payments
• Indirect taxes (most notably the GST) are hidden in the
cost of the good. While they are not income to anyone
directly, they are income to the business though they are
immediately taken in taxes. (Remember that factor
income is pre-tax.
• Subtract the value of subsidies paid to business by the
government.
• Depreciation is part of Gross Profits but must be used to
replace worn out capital.

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 Arbitrary Decisions in National
Income Accounting
• There are some arbitrary decisions, such as including
inventory at market value. This may not be true, for
example last year's model car may less for less to get it
off the lot. 
• It is important that this is consistent, even if it is
sometimes not correct. Absolute correctness may be too
costly and consistency is more valuable.

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National Income Accounting:
Some Further Issues
• Now that we have developed the GDP
from the expenditure and income side
there are some other related issues to
consider.

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 Real and Nominal GDP
• The nominal GDP tells us the
money value of output in a
year. 
• But to compare the GDP
over one or more years
the prices have to be constant.
• The real GDP
is calculated based on prices
in a base year (2007 on
the left) so the real GDP
reflects a change in output.

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 The GDP Deflator
• The GDP deflator measures the change in prices. It is
calculated by 
  
GDP Deflator = GDP at current prices/GDP at base prices x 100 = Nominal GDP/Real GDP x 100

• The GDP deflator is a comprehensive price deflator

which includes all goods and services. 
• It is not, however, a replacement for the CPI since it
includes all goods and services. 
• A consumer does not need to know inflation which is
affected by the price of bulldozers and jet airplanes.

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 Other Issues
• There is some production not included in the GDP though it does
increase output.
• Illegal activities are covered up by those people involved so they
are not included. 
• The underground economy includes people who work without a
license or who are avoiding taxes, they will not respond to surveys.
• Home production, volunteering and leisure when
the activity does not get paid, there is no unit of measure
to calculate it. 
• Economics “bads” are the negative effects of output, like pollution,
which can reduce output elsewhere. 
• The omissions do not matter much if the calculations are consistent
and the GDP movement is evident.

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 GDP and Living Standards
• The GDP can measure the material standard of living but
cannot determine some important aspects to life, such
as happiness. 
• More tires will do little to make people happier.
• More Ikea furniture will do little to improve interpersonal
relationships or improve health.
• The measure of income will be the real GDP per capita
(person) and will do little to determine the distribution of
income.

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