National Income Accounting
Lecture2
What is National Income?
National income is defined as the total
value of all goods and services produced
within a country in a particular period
usually 1 year.
National Income definition

The national income is a sum of monetary values
that are ​obtained by individuals as a result of
contributing to the production process
Factors of production
land
labor
Factors of production
rent
wages
Payment
+
+
capital
entrepreneurial ability
interest
+
National income
profit
+
The importance of computing
National Income

The Economy
Income and Expenditure

For an economy as a whole, income must equal
expenditure (aggregate demand) because:
Every transaction has a buyer and a seller.
 Every dollar of spending by some buyer is a dollar of
income for some seller.


This process can be seen using a Circular Flow Diagram.
The Circular-Flow income diagram
(two sectors)
Revenue
Goods &
Services sold
Market for
Goods
and Services
Firms
Inputs for
production
Wages, rent,
and profit
Spending
Goods &
Services
bought
Households
Market for
Factors
of Production
Labor, land,
and capital
Income
The Circular-Flow Income
diagram
National output
from goods and
services
National
income(factors of
production income)
The Circular-Flow Income diagram
(Four Sectors)
Consumers
Producers
Consumption spending (C)
Taxation (T)
Spending (G)
Government Sector
Imports (M)
Exports (X)
External world Sector
Gross National Product
Gross national product (GNP) :It is the
total market value of all final goods and
services produced within a country in a
given period of time.
National Product
National product :It is the total market
value of all goods and services produced
within a country in a given period of time.
What Is Counted and Not Counted
in GNP?
What
is counted in the GNP
Non-Market Activities : Goods and services that are produced
and consumed at home and that never enter the marketplace.
What is not counted in the GNP:
Transfer payments. For example, social security and
pensions.
Unpaid and domestic activities. (example: If you cut your
grass or paint your house…)
Methods of measuring GNP
To avoid the double account of GNP we
will use the value-added approach
 Value-added
Approach: measures GNP
as the sum of value added at each stage of
production (from initial to final stage)
V.A = value of sales – value of intermediate goods
Value Added Approach
Example1:
Suppose that bread is the only final good of an economy: It goes
through several (3) stages of production.
Stage of
Production
Value of Sales
Value of
intermediate good
Wheat
700
0
Flour
1000
700
Bread
2000
1000
National output
Value-added
Value Added Approach
Example2:
Suppose that there are three final products of an economy: It goes
through several (3) stages of production.
Wheat value :700 final product Sales :200
The rest is used in the production of flour
Flour value:800 final product Sales :150
The rest is used in the production of bread which
Bread value sales :1000
Stage of
Production
Value of Sales
Value of
intermediate good
Wheat
700
0
Flour
800
Bread
1000
National output
Value-added
Expenditure Approach
Expenditure Approach: measures GNP as
the sum of expenditures on final goods and
services.
GNP =C + I + G + (X - M)
GDP 
n
n
 V  P
i1
i
i1
i
 Qi
Direct and Indirect Taxes
taxes – Direct taxes are applied to
property, Tax liability cannot be passed
onto someone else. (Example: income tax,
business profit taxes..)
 Indirect taxes – an indirect tax can be
passed on from the designate to the final
consumer.(example: VAT, consumption,
production, import and export…)
 Direct
Gross investment / Net investment
 Gross
investment represents additions to
the stock of durable capital goods
(buildings, equipment, inventories)
during a year that increase production
possibilities in the future.
 Depreciation measures the amount of
capital that has been used up in a year.
 Net investment = gross investment depreciation
Expenditure Approach
Example: Suppose the economy has only
one product, namely, rice.
Good
Price per unit
Q sold
Expenditure
Rice
20
1000
20000
GDP
20000
Income Approach
Income Approach: measures GNP as the
sum of incomes of factors of production
(wages, rent, interest and profit).
 Notice: we are computing GNP using the
income approach .we need to add
Indirect Taxes and Depreciation
Income Approach (continued)
 GNP
= rent + wages + interest + profit +
indirect taxes + depreciation
 GNP = National Income + indirect taxes
+ depreciation
 Example:
Suppose that in the production of rice the
sales and expenses are as follows:
Sales
20,000
Expenses:
Wages
8000
Rent
2000
Interest
1500
Profit
6000
Indirect taxes
1000
Depreciation
1500
GNP=Sum of Payments to factors
20,000
20,000
Other Measures of Income
 Gross
Domestic Product (GDP)
 Nominal and Real GDP
 Personal Income
 Disposable Personal Income
Gross Domestic Product (GDP)
GDP is geographically focused, including
only output produced within a nation’s
borders regardless of whose factors are
used
GDP = GNP - Net external(foreign) income
Real and Nominal GDP
 Nominal
GDP the production values of
goods and services at current prices.
 Real GDP the production values of
goods and services at constant prices.
Computing Real GDP
 The
general formula for computing real
GDP is:
nominal GDP in year t
Real GDP in year t 
price index
 The
price index represents a price level
change as an index with a base of 100
100  percentage change
price index 
100
Net Domestic Product
Net domestic product (NDP): GDP less
depreciation
NDP  GDP – depreciation
The amount of output we could consume
without reducing our stock of capital
Personal Income
 Personal
income (PI): Income received by
households before payment of personal
taxes
PI = NI – profits taxes – social security taxes –
reserves +transfer payments
Disposable Personal Income
All disposable income is either consumed or
saved
DI  personal income – personal taxes
DI  consumption  saving