Module H4 Session 2
Economic Concepts for Statisticians
Session 2 The national income accounts
At the end of this session, students will have an understanding of:
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Output – nominal versus real and the concept of value added
GDP: definition
GDP versus GNI
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Different measures of GDP
International comparisons – exchange rates, purchasing power parity
Output
A key concern for macroeconomists is the size of the economy. For example, we need to
know: How big is the economy of Zimbabwe? How can we compare it with the economy
of Tanzania and other countries in SADC? The way we measure size is by looking at
output – i.e. how much the economy produces.
Originally, the way this was done was to measure quantities produced. But this creates a
problem: we may be able to say that Tanzania produces around 4 million tonnes of cereals,
200 million litres of beer and 4 billion cigarettes, but how can we add these together? They
cannot be added, because they are measured differently – in tonnes, litres and individual
cigarettes! And if we cannot add them together into one indicator, how can we compare
them (a) over time, or (b) with information on output from other countries which do not
produce the same products?
Nowadays, we simplify matters. For each product, we multiply quantity by market price to
get a single, comparable indicator: market value. Table 1 (page 2) shows how this might
be done for a country like Tanzania.
Using this table – and completing it to include all the goods and services produced in our
imaginary example of Tanzania – we can give a figure for total value of national output at
market prices. This figure provides a good indication of the size of the economy, and can
be compared with figures calculated in the same way for other economies.
Key point to remember:
SADC Course in Statistics
value = quantity x price
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Table 1
Quantity
Market price
(US$per unit)
Total market value
(million US$)
Maize
4 million tonnes
250
1000
Rice
1 million tonnes
350
350
Beer
200 million litres
0.70
140
Cigarettes
4 billion sticks
0.06
240
TOTAL OUTPUT
1730
Note: These figures are imaginary (not actual) figures for Tanzania.
Nominal and real values
But what about comparing the value of national output over time? Here we run into the
problem of inflation (when prices rise over time).
Table 2
Tanzania total output value (million US$)
2005
2007
1730
2024
Note: These figures are imaginary (not actual) figures for Tanzania.
Looking at the figures in Table 2, how do you know if this is a ‘real’ increase in the size of
the (imaginary) Tanzanian economy between 2005 and 2007? Maybe output quantities have
remained the same, and all that have changed are the prices of the goods and services which
are the components of output!
This is why economists distinguish between ‘nominal output’ expressed in ‘current prices’,
as in Tables 1 and 2, and ‘real output’ expressed in ‘constant prices’.
To calculate ‘real output’, we begin by choosing a base year. The prices of goods and
services in this year will be used for a period of several years afterwards: they will remain
constant. In our calculations, all that will change will be quantities produced. Thus, if we
choose 2005 as our base year, we could modify Table 1 to produce Table 3 (page 3).
Discussion 1
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In Table 3, what is the real output figure for 2007?
What is the percentage increase in real output between 2005 and 2007?
Roughly how much of the percentage increase in nominal output between 2005 and
2007 is attributable to price increases?
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Table 3
Quantity
Market price
(US$per unit)
Total value
(current prices,
US$m)
Total value
(constant 2005
prices, US$m)
2005
2007
2005
2007
2005
2007
2005
2007
Maize
4 million
tonnes
4.5 million
tonnes
250
270
1000
1215
1000
1125
Rice
1 million
tonnes
1.2 million
tonnes
350
330
350
396
350
420
Beer
200 million
litres
195 million
litres
0.70
0.75
140
146.25
140
137
Cigarettes
4 billion
sticks
4.1 billion
sticks
0.06
0.065
240
266.5
240
246
1730
2024
1730
1928
TOTAL OUTPUT
Note: These figures are imaginary (not actual) figures for Tanzania.
Note that this method (using a fixed base year to calculate real output) has recently been
replaced in some countries by the ‘annual chain-linking’ method. Countries using this
approach update the base year annually (see note in Guidance for Trainers).
Exercise 1
If your country uses the fixed base year method, find out which ‘base year’ is currently
being used to calculate output. Interview analysts in the part of the national statistical
system which works on output to find out the reasons why that year was chosen. Are they
happy with this year, or do they plan to ‘rebase’ the series? (Check what this means). What
would be the advantages of doing so, and what might the difficulties/disadvantages be?
If your country uses the annual chain-linking method, interview analysts in the part of the
national statistical system which works on output to find out how this works. What are the
advantages and disadvantages of this approach compared with the fixed base year method?
Value added
The economy is made up of three sectors: agriculture, industry and services. In each sector,
there are companies, small enterprises and individuals producing output. The output of the
economy comprises the output of many chains of production and service provision.
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An example of a chain of production can be found in the building industry in Malawi. A
craftsman uses mud on his land to bake bricks. He sells one thousand bricks to a
transporter for 10,000 kwacha. The transporter sells them to a builder for 15,000 kwacha.
The builder uses them to build a wall, for which he charges 30,000 kwacha. The value of
the finished wall is 30,000 kwacha. This is the output from the economic point of view.
It includes the amounts paid to the craftsman and the transporter. It would be wrong to
count the economic output as the sum of all these values (55,000 kwacha).
Another way to think about this is that output is the sum of the values added at each stage in the
production process:
Value added at stage 1 (craftsman manufacturing bricks): 10,000 kwacha
Value added at stage 2 (transportation): 15,000-10,000 = 5,000 kwacha
Value added at stage 3 (building wall): 30,000-15,000 = 15,000 kwacha
Total value added (1, 2, 3) = 10,000 + 5,000 + 15,000 = 30,000 kwacha
Note that at each stage of production, value added for that particular stage is obtained by
taking the value of the product and subtracting the value associated with the previous stage
(the cost of the raw materials or the intermediate products/services).
GDP - definition
The concept of value added is central to the definition of Gross Domestic Product (GDP),
which is the most commonly used indicator of the size of the economy (output). The
World Bank (2007) says that GDP is:
“the sum of the gross value added by all resident producers in the economy plus any
product taxes and minus any subsidies not included in the value of the products”.
GDP includes taxes on production, but subsidies are deducted. What is the reason for this?
After all, taxes are not part of economic output! However, product taxes – the most
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common of which is Value Added Tax or VAT – are part of total expenditure on final
products and services, while subsidies represent a part of the process not paid for by the
consumer1. So including taxes and subtracting subsidies makes the output approach
compatible with the expenditure approach to measuring GDP (see below). However,
sometimes a figure for ‘GDP at factor cost’ is also provided – this figure is simply the sum
of gross value added by resident producers without adding taxes and subtracting subsidies.
The World Bank (2007) goes on to note that GDP “is calculated without deductions for
depreciation of fabricated assets or for depletion and degradation of natural resources”. In
other words, the concept of gross (rather than net) domestic product implies that “value lost
through the ‘wear and tear’ of capital used in production is not deducted from the value of
total output” (Soubbotina, 2004).
GDP only includes the output of resident producers. This is important, as it indicates that
the output of any nationals who are resident abroad is excluded.
GNI - definition
GDP also excludes flows from abroad to those who are resident in the country. A broader
picture is given by Gross National Income (GNI), which is sometimes referred to as Gross
National Product (GNP). The World Bank (2007) says:
“GNI (gross national income) is gross domestic product (GDP) plus net receipts of
primary income (employee compensation and investment income) from abroad”.
This measure of the economy includes the value of income received from residents’
investments abroad – including rents and business profits and payments for work carried
out abroad by residents (labour income). They are referred to as ‘net receipts’ because
1
For this reason, the definition specifies any subsidies not included in the value of the product.
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primary income flows out of the country are subtracted from primary income flows into
the country, and only the net figure (inflows minus outflows) is included in GNI.
Exercise 2
1. Find examples of countries where GNI is substantially higher than GDP. What factors
may be causing this difference?
2. Can you find examples of countries where GNI is lower than GDP? What are the
reasons for this?
3. Why do you think that GDP is more often quoted by policymakers than GNI?
Note that neither GDP nor GNI includes the output of nationals of the country who are
resident abroad – unless it is sent back home, in which case it is included in GNI.
Different measures of GDP
Although GNI provides interesting information, GDP is more commonly used as an
indicator of the size of economies. GDP can be calculated as (a) a sum of all output in the
economy, as defined above (page 4); (b) the sum of all income paid to workers and owners
of capital; or (c) the sum of all expenditure on final products (goods and services).
Soubbotina (2004) points out that in theory, both the income and the expenditure method
should give the same result: “Because one person’s expenditure is always another person’s
income, the sum of expenditures must equal the sum of incomes”. In theory, both these
methods should also produce the same figure for GDP as would be obtained by adding up
the output (value added) of all resident producers (plus taxes minus subsidies).
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The expenditure approach
The expenditure approach is based on dividing aggregate demand2 (or expenditure) in the
economy into categories. The most common categorisation is:
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Consumption by individuals/private sector (C)

Investment by individuals/private sector (I)

Consumption and investment by government3 (G)

Exports (X)
These four categories account for all demand for goods and services. Thus, aggregate
demand (AD) = C + I + G + X
Supply comes from two sources: domestic production (Y) and imports (M). We assume
that aggregate supply equals aggregate demand4. Therefore:
Y+M=C+I+G+X
Subtracting M from both sides:
Y=C+I+G+X–M
In other words, domestic production is the sum of private consumption expenditure,
private investment expenditure, government expenditure and net exports (X – M). So if we
can calculate expenditure on final goods and services in these categories, we will have a
reliable measure of GDP.
2
Aggregate demand simply means the sum of the demand of all agents.
3
Note that G does not include ‘transfer payments’ by government (such as welfare
transfers, unemployment benefits and subsidies) because these are only a redistribution of
resources – they do not contribute output, income and expenditure to the economy.
4
Note that in order for the assumption of ‘supply = demand’ to hold true, investment
must include increase/decrease in unsold stocks or inventories.
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International comparisons
Having established how to measure the size of the economy, and studied two important
indicators, GDP and GNI, we can now proceed to compare one economy with another.
However, as soon as we start to do this, we encounter problems. For instance:
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The GDP of the United States was US$13,201,819 million in 2006
The GDP of South Africa was US$254,992 million in 2006
The GDP of Mauritius was US$6,448 million in 2006
So the economy of South Africa was 2% of that of the US, and the economy of Mauritius
was 3% of that of South Africa!!
GDP per capita
Is this helpful? It gives us an idea of size of the economy, but this is not enough. We also
need some idea of what this means in terms of how ‘rich’ the country is – i.e. how well-off
its people are in relation to the inhabitants of other countries. The next step, therefore, is
to divide GDP by the population to get GDP per capita (per head).
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The GDP per capita of the United States was US$44,155 in 2006
The GDP per capita of South Africa was US$5,381 in 2006
The GDP per capita of Mauritius was US$5,146 in 2006
So GDP per capita of South Africa was 12% of that of the US, and GDP per capita of
Mauritius was almost as high as that of South Africa.
It is (at least in part) because of the international importance of this statistic, that getting
population figures right is so important! If the census were to undercount the population,
GDP per capita would be reported as being higher than it actually is. Among other things,
this might disqualify the country from much-needed foreign assistance programmes.
Exchange rates and purchasing power parity
Other problems when making international comparisons are
(i)
(ii)
exchange rate movements, and
differences in the cost of living.
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We have to convert all GDP figures into the same currency so that they can be easily
compared. International comparisons are normally made using the US dollar5. GDP is
calculated in the national currency and then converted into US dollars at current exchange
rates. This means that exchange rate movements can lead to quite large changes in GDP
expressed in US dollars, even if nothing fundamental has changed in the economy.
Unfortunately, there is little that can be done about this, because exchange rate fluctuations
are inevitable! However, the World Bank has developed the ‘Atlas method’ to reduce sharp
variations: “The Atlas method smoothes exchange rate fluctuations by using a three year
moving average, price-adjusted conversion factor” (World Bank, 2007)6.
Whether using current exchange rates or applying a smoothing method, there is another
major problem when comparing GNI, GDP or GDP per capita between different
countries: one dollar buys much more in a ‘poor’ country with a weak currency than it does
in a ‘rich’ country with a strong currency. One US dollar in Zambia, for instance, might buy
ten times as much as it does in the UK. Therefore, a person earning US$100/month in
Zambia and a person earning US$1,000 in the UK might actually have similar purchasing
power or ‘purchasing power parity’.
Therefore, exchange rates designed to reflect purchasing power parity or PPP are often
used to make comparisons of GNI, GDP or GDP per capita. This gives us a measure of
the size of the economy adjusted to reflect the cost of living.
5
The choice of the dollar is because it is the most widely used around the world, reflecting
the US’s status as a world power. Theoretically, any major currency could be used.
6
The method involves complicated calculations. Details can be found in the World Bank’s
online Statistical Manual. In July 2007, this was available at the following site:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/EXTDECSTA
MAN/0,,contentMDK:20877893~menuPK:2648303~pagePK:64168445~piPK:64168309
~theSitePK:2077967,00.html
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“PPP GDP is gross domestic product converted to international dollars using
purchasing power parity rates. An international dollar has the same purchasing power
over GDP as a U.S. dollar has in the United States” (World Bank, 2007).
Exercise 3
Using the links on the World Bank’s page introducing Quick Reference Tables (in the
Data section of the World Bank website)7, compile a table of GDP, GDP per capita, PPP
GDP and PPP GDP per capita for the SADC countries. Add the US, Japan, the UK and
France – and any other countries with which you would like to make comparisons.
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
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How do the results using PPP compare with standard GDP and GDP per capita?
Observe how the comparisons between richer and poorer countries change using
the PPP approach.
What do you think are the advantages of the PPP approach?
Does it have any disadvantages?
References
Soubbotina, T.P. (2004) Beyond Economic Growth: An Introduction to Sustainable Development,
2nd edn, World Bank, Washington D.C. Available online at
http://www.worldbank.org/depweb/english/beyond/global/index.html (First edition also
available in French and Spanish)
World Bank (2007) Technical Notes in Data & Statistics section of World Bank website:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/0,,contentMDK
:20437349~menuPK:1504474~pagePK:64133150~piPK:64133175~theSitePK:239419,00.
html
7
The best way to find this page is to search for ‘World Bank Quick Reference Tables’.
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