National Income Accounting
National Income
Accounting
n
In the 1930s it was impossible for
macroeconomics to exist in the form we know
it today because many aggregate concepts
had not yet been formulated, or were lacking
rigor.
n
In the mid-1930s, two Keynesians, Simon
Kuznets and Richard Stone, began to
develop this terminology.
Chapter 6
2
Measuring Total Economic Output of
Goods and Services
National Income Accounting
n
n
They developed national income
accounting – a set of rules and definitions
for measuring economic activity in the
aggregate economy – that is, in the economy
as a whole.
n
Gross Domestic Product (GDP) is the total
value of all final goods and services produced
in an economy in a one-year period.
n
It is the single most used economic measure.
National income accounting is a way of
measuring total, or aggregate production.
3
Measuring Total Economic Output of
Goods and Services
n
4
Measuring Total Economic Output of
Goods and Services
Gross National Income (GNI) is the
aggregate final output of citizens and
businesses of an economy in one year.
5
n
GDP is output produced within a country’s
borders.
n
GDP measures the economic activity that
occurs within a country.
6
Measuring Total Economic Output of
Goods and Services
Measuring Total Economic Output of
Goods and Services
n
GNI is output produced by a country’s
citizens.
n
Net foreign factor income is added to GDP to
move from GDP to GNI.
n
GNI measures the economic activity of the
citizens and businesses of a country.
n
Net foreign factor income is the income
from foreign domestic factor sources minus
foreign factor incomes earned domestically.
7
Calculating GDP
n
Calculating GDP requires adding together
millions of goods and services.
n
All goods and services produced by an
economy must be weighted, that is, each
good and service is multiplied by its price.
8
Calculating GDP
n
Once quantities of a particular good or
service are multiplied by its price, we arrive at
a value measure of the good or service.
n
All the units of value are added together to
arrive at GDP.
9
GDP Is a Flow Concept
n
n
GDP Is a Flow Concept
GDP is a measure of final output per year – it
is a flow concept, not a stock (an amount at a
particular moment in time).
It is reported quarterly on an annualized
basis.
q
10
n
The store of wealth is a stock concept.
n
The National Balance sheet is a balance
sheet of an economy’s stocks of assets and
liabilities.
Annualized basis – quarterly figures are used to
estimate total output for the whole year.
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12
GDP Measures Final Output
GDP Measures Final Output
n
GDP does not measure total transactions in
the economy.
n
Final output – goods and services
purchased for final use.
n
It counts final output but not intermediate
goods.
n
Intermediate products are used as inputs in
the production of some other product.
13
Two Ways of Eliminating
Intermediate Goods
GDP Measures Final Output
n
14
Counting the sale of final goods and
intermediate products would result in double
and triple counting.
n
There are two ways of eliminating
intermediate goods:
n
The first is to calculate only final output.
n
A second way is to follow the value added
approach.
15
Two Ways of Eliminating
Intermediate Goods
n
n
16
Value Added Approach Eliminates
Double Counting
Value added is the increase in value that a
firm contributes to a product or service.
Participants
Farmer
Cone factory
and ice
cream-maker
Intermediary
Vendor
Totals
It is calculated by subtracting intermediate
goods from the value of its sales.
17
Cost of
Materials
$ 0
100
250
400
$ 750
Value of
Sales
$ 100
250
400
500
$1,250
Value Added
$ 100
150
150
100
$500
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Calculating GDP: Some Examples
n
Selling your two-year-old car to a neighbour
does not add to GDP.
n
Selling your car to a used car dealer who
then sells your car to someone else for a
higher price, adds to GDP.
n
Calculating GDP: Some Examples
n
Selling a stock or bond does not add to GDP.
n
The stock broker's commission from the
sales does add to GDP.
n
It represents current production.
The value of the dealer's services is added to
GDP.
19
Calculating GDP: Some Examples
n
Pension payments, welfare payments, and
employment insurance benefits, are not
included in GDP.
n
Only the cost of transferring is included in
GDP.
20
Calculating GDP: Some Examples
n
The work of unpaid housespouses does not
appear in GDP calculations.
n
GDP only measures market activities so
unpaid value added is not included in GDP.
21
The National Income Accounting
Identity
Two Methods of Calculating GDP
n
n
22
There are two methods of calculating GDP:
the expenditure approach and the factor
incomes approach.
This is because of the national income
accounting identity.
23
n
The equality of output and income is an
accounting identity in the national income
accounts.
n
The identity can be seen in the circular flow
of income in an economy.
24
The Circular Flow
The Expenditure Approach
Wages, rents,
interest, profits
n
The expenditure approach is shown on the
top half of the circular flow.
n
Specifically, GDP is equal to the sum of the
four categories of expenditures.
Factor services
Goods
Household
Imp
orts
Firms
t
rnmen (production)
T a xe s Government Gove nding
e
p
S
t
Savin
gs Financial markets Investmen
Personal consumption
Other countries
GDP = C + I + G + (X - IM)
rts
Expo
25
Consumption
n
When individuals receive income, they can
spend it on domestic goods, save it, pay
taxes, or buy foreign goods.
n
Personal consumption expenditures –
payments by households for goods and
services.
26
Consumption
n
Consumption is the largest and most
important of the flows.
n
It is also the most obvious way in which
income received is returned to firms.
27
Investment
n
n
28
Investment
The portion of income that individuals save
leaves the spending stream and goes into
financial markets.
Gross private investment – business
spending on equipment, structures, and
inventories, plus household spending on new
owner-occupied housing.
29
n
Sooner or later, plant and equipment wears
out.
n
Depreciation – the decrease in an asset's
value due to it wearing out.
n
Net private investment – gross private
investment minus depreciation.
q
new investment that is above and beyond
replacement investment.
30
Government Expenditures
n
Government Expenditures
When individuals pay taxes, those taxes are
either spent by government on goods and
services or are returned to individuals in the
form of transfer payments.
n
Government expenditures – government
payments for goods and services.
n
If the government runs a deficit, it must
borrow from financial markets to make up the
difference.
31
Net Exports
n
32
Net Exports
Spending on imports are subtracted from
total expenditures because it does not add to
domestic production.
n
Exports to foreign nations are added to total
expenditures.
n
These flows are usually combined into net
exports:
q
Net Exports = exports minus imports
33
GDP and NDP
GDP and NDP
n
34
Net domestic product (NDP) – the sum of
consumption expenditures, government
expenditures, net foreign expenditures, and
investment less depreciation.
n
Net domestic product is GDP adjusted for
depreciation:
GDP = C + I + G + X - IM
NDP = C + I + G + X - IM - depreciation
35
36
GDP and NDP
The Factor Incomes Approach
n
NDP is actually preferable to GDP as an
expression of a nation's domestic output.
n
The income approach is shown on the bottom
half of the circular flow.
n
Since it is so hard to measure depreciation in
the real world, economists use capital
consumption allowance rather than
depreciation.
n
Firms make factor payments to households
for supplying their services as factors of
production.
37
The Factor Incomes Approach
38
The Factor Incomes Approach
n
National income is the total income earned
by citizens and businesses in a country in
one year.
n
Wages, salaries and supplementary labour
income that firms pay to workers constitute
the largest component of GDP.
n
It consists of employee compensation,
rent, interest, and profits.
n
Corporate profits before taxes are also
included in income.
39
The Factor Incomes Approach
n
40
The Factor Incomes Approach
Interest and investment income measures the
difference between interest payments that
households receive on loans they have
made, and interest payments that they make
on borrowed funds.
41
n
Further included in incomes are those
incomes earned by owner-operators. Rental
income is included in this category.
n
Gains and losses from holding inventories
have to be removed from calculation, as well
as indirect taxes and subsidies, and
depreciation.
42
Equality of Income and Expenditure
Equality of Income and Expenditure
n
Income and expenditures must be equal
because of the rules of double-entry
bookkeeping.
n
GDP is calculated either by adding up all
values of final output or by adding up the
values of all earnings or income.
n
Profit is the balancing item.
n
This is because of the National Income
Accounting identity.
43
Qualifications to the Income
Accounting Identity
n
44
Equality of Expenditure and Income
To go from GDP to national income:
q
n
n
National income is all income earned by citizens of a
nation and is equal to GNI.
To move from "domestic" to "national" we add net
foreign factor income.
q
Subtract depreciation from GNI.
q
Subtract indirect business taxes from GNI.
Net foreign
factor income
Net exports
Government
expenditures
Add net foreign factor income.
Depreciation
Indirect taxes-subsidies
Inventory
adjustment
Farm income
Investment
Interest and
investment income
Consumption
GNI
GDP
Profits before taxes
National
Income
Wages and
salaries
(1)
Expenditures
=
(2)
Output
=
(3)
Income
45
Other National Income Terms
46
Other National Income Terms
n
Personal income (PI) is a measure of all
income actually received by households.
n
PI = NI + transfer payments from government
- corporate retained earnings - corporate
income taxes – employment taxes (CPP, EI)
n
47
Disposable personal income is a measure
of what people have readily available to
spend:
DPI = PI - Personal taxes
48
Comparing GDP Among Countries
Using GDP Figures
n
GDP figures are used to make comparisons
among countries and to measure economic
welfare over time.
n
GDP gives a measure of economic size and
power.
n
Per capita GDP is another measure often
used to compare nations' GDP.
n
Per capita GDP = GDP divided by population
49
Comparing GDP Among Countries
n
50
Comparing GDP Among Countries
Because of differences in nonmarket
activities, per capita GDP can be a poor
measure of the various living standards in
various nations.
n
To get around the problems of per capita
GDP, economists use purchasing power
parity, which adjusts for different relative
prices among nations before making
comparisons.
51
Economic Welfare Over Time
52
Real and Nominal GDP
n
Just because GDP rose does not mean
welfare rose – it could be the case that only
prices rose.
n
Comparing output over time is best done with
real output which is nominal output adjusted
for inflation.
53
n
Nominal GDP is GDP calculated at existing
prices.
n
Real GDP is nominal GDP adjusted for
inflation.
q
Real GDP is important to society because it
measures what is really produced.
54
Some Limitations of National Income
Accounting
Real and Nominal GDP
n
n
Real GDP is arrived at by dividing nominal
GDP by the GDP deflator.
Real GDP =
Nominal GDP
GDP deflator
Although Canadian national income
accounting statistics are among the most
accurate in the world, they still have some
serious limitations:
q
q
q
Measurement problems exist.
GDP measures economic activity, not welfare.
Subcategories are often interdependent.
55
GDP Measures Market Activity, Not
Welfare
56
Measurement Errors
n
n
GDP does not measure happiness, nor does
it measure economic welfare.
GDP figures leave out the following market
activities:
q
q
n
Welfare is a complicated idea, very difficult to
measure.
q
q
q
Illegal drug sales.
Under-the-counter sales of goods to avoid income
and sales taxes.
Work performed and paid for in cash.
Unreported sales.
Prostitution, loan sharking, extortion, and other
illegal activities.
57
Measurement Errors
n
58
Measurement Errors
Estimates of the size of the underground
economy range from 1.5 to 20 percent of
GDP in Canada.
n
59
A second type of measurement error occurs
in adjusting GDP for inflation.
q
If the price and the quality of a product go up
together, has the price really gone up?
q
How do you measure the value of increases in
quality?
60
Misinterpretation of Subcategories
n
Index of Economic Well-Being
The subcategories of GDP can be
misinterpreted.
q
For example, the line between investment and
consumption is often fuzzy.
n
The Index of Economic Well-Being (IEW)
makes adjustments to GDP.
n
The IEW tries to measure pollution,
education, and health concerns, as well as
GDP.
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62
Conclusion
n
National income accounting is a powerful
economic tool that informs average citizens
about the direction of the economy.
n
GDP measurement make it possible to think
and talk about the aggregate economy.
National Income
Accounting
End of Chapter 6
63