Lecture 2
National Income – Measurement
and Uses
Michael Insaidoo
Lecture 3
After completing this lecture, you will:
 Understand the measurement of national income
 Also understand the various approaches involved in the
measurement of national income
 Understand the uses of national income
 Understand the problems associated with the
measurement of national income
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 National Income is the monetary value of final goods
and services produced by citizens (nationals) of a
country during a period of time usually one year
 Goods can be final and intermediate
 Final goods are those goods that do not enter into
further stage of processing or reselling. Example is
sugar cane which is sold to consumers and chewed
 Intermediate goods are those goods that go into
further processing or resale before consumption.
Example is sugar cane which is processed into sugar by
a sugar factory
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There are three approaches in the measurement of
national income which are:
 Income Approach
 Product or Output Approach
 Expenditure Approach
The three approaches results in identical or same results
due to the circular flow of income
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 The Circular Flow of Income makes it possible for the
national income to be measured using three
approaches which gives the same results
Assumptions
1) The economy is made up of two sectors – household
sector and business sector
2) There is no role of saving and investment in the
economy
3) The role of government and foreign sector is not
captured
4) There is free flow of economic activities or resources
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Factor Market
Factor Services
Factor Income (Income Approach)
FIRMS
HOUSEHOLD
Expenditure on Goods & Services (Expenditure Approach)
Market Value of Goods & Services (Output Approach)
Product Market
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 Factor Market – Firms exchange money for the services
provided by the households, that is wages – payments
for labour services, interest on capital, rent for land and
profit for enterprise (entrepreneurship)
• These represents incomes received by factors of prodn
• The summation of these incomes gives national income
 Product Market – Households exchange money for
goods and services produced by firms. The summation
of the values of goods and services produced by Firms
gives National Product (Output).
 The summation of expenditure by Households on
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goods and services gives the National Expenditure
 From the diagram, one can conclude that National
Income = National Product (Output) = National
Expenditure
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 This refers to the sum of all final incomes generated by
the factors of production
 Labour – wages, salaries, commissions etc.
 Land – rent, royalties etc.
 Capital – interest etc.
 Entrepreneurship – Profits from businesses
 Must be noted that only factor services that generates
income is accounted for
 Gifts, transfer payments, unemployment benefits etc
are excluded
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 Undistributed profits of business enterprises are added
to that period’s national income
 The summation of all these incomes gives Gross
Domestic Income at factor cost (GDYf)
 The subtraction or addition of net factor income from
abroad (YA) to (GDYf) gives Gross National Income at
factor cost (GNYf). (GNYf) = (GDYf) (+) or (-) (YA)
 Gross National Income (GNYf) minus depreciation (dep)
gives Net National Income at factor cost (NNYf) or
National Income (NY). (GNYf) – (dep) = (NNYf)
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 It shows the functional distribution of income. This
approach makes it possible to ascertain the incomes
earned by the various factors of production
 It provides income for Income tax planning. The income
data provided by this approach forms the basic data for
income tax planning. These are normally used to
determine the income tax rates
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Difficulties in ascertaining all factor incomes
Problem of transfer payments
Fringe benefits – payments of income in kind
Owner-occupied houses
Difficulty in estimating net factor income from abroad
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 This approach sums up the market value of final goods
and services of the productive sectors of the economy
within a year
 The productive sectors are the Agricultural, Industrial
and Services sectors
 Two ways of arriving at total product, either we sum up
the values added at intermediate levels of production
or the value of all final goods and services
 Value Added is the difference between the gross value
of a product and the raw materials that have gone into
production
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 The summation of monetary values of goods and
services produced during the year gives Gross Domestic
Product (GDP) at market prices
 GDP at market prices plus or minus net factor income
from abroad (YA) gives Gross National Product (GNP) at
market prices. (GNP) = (GDP) (+) or (-) (YA)
 Markets prices are inflated by the effect of indirect
taxes and deflated by subsidies
 Therefore, GNP at market prices must be converted to
(GNPf) at factor cost by subtracting indirect taxes and
adding subsidies
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 When depreciation (dep) is subtracted from (GNPf), Net
National Product at factor cost (NNPf) is obtained which
is identical to National Income (NY)
 (NNPf) = (GNPf) - dep
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Stages of
Production
Sale Value in
GHȼ
Cost of Intermediate
Goods
Value-Added in GHȼ
Maize
10
-0
10
Corn Dough
18
-10
8
Kenkey
Total
22
(Value of Final
Goods)
50
-18
(Total cost of
intermediate goods)
28
4
(Sum of value-added
at each stage) 22
 Final goods method record value of kenkey (GHȼ 22)
which is the same as 50 – 28. On the other hand, value
added method sums up values added at each stage (22)
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 Knowledge of contribution of each sector. This
approach allow an economy to know the contributions
of each sector and sub-sectors
 It indicates structural changes that are occurring in an
economy. This approach enables an economy to know
if there are changes in the output composition of the
economy
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 Difficulty in valuation of goods and services produced
and consumed
 Non-inclusion of some personal services
 Double or multiple counting
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 This approach sums up final expenditures of
macroeconomic sectors of a nation
 For this purpose, the economy is divided into four
spending sectors namely Households’ consumption (C),
Firms’ private domestic investment (I), Government
spending on final goods and services (G) and foreign
sector – net exports (X – M)
 The summation of all expenditures by these sectors
gives the Gross Domestic Expenditure (GDE) at market
prices which is equivalent to Gross Domestic Product
(GDP) at market prices
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 Symbolically GDE = C + I + G + (X – M)
 GDE plus or minus net factor expenditure from abroad
or net factor income from abroad (YA) gives Gross
National Expenditure at market prices (GNE)
 (GNE) = (GDE) + or – YA
 (GNE) at market prices minus indirect taxes and plus
subsidies gives (GNE) at factor cost
 (GNE) at factor cost minus depreciation (dep) gives Net
National Expenditure at factor cost (NNE) which
identical to National Income (NY).
 (NNE) = (GNE) – (dep)
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 Knowledge of various expenditure levels. This approach
enables the economy to know the expenditure levels of
the macroeconomic sectors, this helps in planning
 Changing pattern of private consumption. This
approach also allows an economy to know the extent of
changing patterns of private consumption
 Idea of expansion of productive capacity of the
economy. This approach indicates the level of private
domestic investment thus knowing the level of
expansion of productive capacity
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 Difficulties in estimating exports and imports values.
Under invoicing and over invoicing makes it extremely
difficult to determine the actual value of net exports
 Double or multiple counting. This happens when a unit
of expenditure is counted more than once. To eliminate
this, only expenditure on final output is counted
 Lack of adequate statistics on expenditure levels. Many
people do not keep accurate data on their expenditure
levels, making it difficult to get accurate levels of
expenditure
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 Nominal Income is the same as National Income at
prices prevailing in a particular year of computation. It
is also referred to as National Income at current prices
 In order to eliminate price level changes or inflation
from the national income data, it is converted into real
value
 Real National Income is also the same as National
Income at constant prices
 It reflects the real volume of goods and services
produced
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 Real Nat. Inc = Nom Nat. Income × Base Yr. Price Index
Current Yr. Price Index
 Real Nat. Inc = Nom Nat. Income × 100
Current Yr. Price Index
 Price Index is an index number that shows the weighted
average prices of a ‘baskets of goods’ changes over
time
 GDP deflator measures the price level obtained by
dividing the nominal GDP by the real GDP
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 Real GDP = Nominal GDP × Base Yr. Price Index
Current Yr. Price Index
 Real GDP = Nominal GDP × 100
Current Yr. Price Index
 Income Per Capita (PY) – This the national income
divided by the population
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Double or Multiple Counting
Non-marketed goods and services
Inadequate statistical data
Difficulty in estimating depreciation value
Difficulty in getting accurate information from abroad
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 Knowledge of the performance of the economy
 Calculation of rate of growth of output in the economy
 Indication of Sectoral contribution of the productive
sectors
 Information on the structural change of the economy
 Knowledge of the various expenditure levels
 Useful for income tax planning
 Computation of income per capita figure
 Guide for potential investors
 For inter-temporal and international comparison of
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economic performance
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 Economic welfare or wellbeing is the volume of the real
goods and services enjoyed by each citizen of a nation
 If the volume is high, then economic welfare is high all
things being equal and vice versa
 Again if the volume is high, then there is a high
standard of living all things being equal and vice versa
 Standard of living is inversely related to cost of living, if
cost of living is high, standard of living is low all things
being equal and vice versa
 Again amount of leisure (entertainment, recreation)
enjoyed by citizens enhances economic quality of life
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 Generally countries use the Income per Capita (YP)
statistic for measuring economic welfare
 Thus a high YP statistic indicates that citizens enjoy a
high volume of goods and services and hence an
increase in their welfare all things being equal and vice
versa
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Income distribution is not taken into account
Leisure is not taken account of
Product quality might be poor
Composition of output – probably a chunk will be
military goods
 Externalities are not taken account of. Pollution, traffic
jams are not accounted for whilst positive externalities
like education etc are also not taken account of
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 Generally the income per capita statistic is used to
compare economic welfare of countries
 Thus if country A has a higher per capita income than
country B, it is taken that country A enjoys a higher
economic welfare than country B
 There is however problems with this comparison
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Differences in currencies
Differences in quality of goods and services
Differences in composition of goods ands services
Differences in the level of non-marketed goods and
services
 Differences in the level of enjoyment of leisure
 Differences in Income Distribution
The World Bank and UNDP developed the Human
Development Index (HDI) in 1990 to address these
problems. HDI combines income per head with
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measures of life expectancy, adult literacy,
health provision, education, leisure time and so
on