TUNKU ABDUL RAHMAN UNIVERSITY OF MANAGEMENT AND TECHNOLOGY

Centre for Pre-University Studies

FPEC1014 Principles of Economics

Topic : 4 – National Income

1. National Income Accounting

National income accounting is the set of rules and techniques to calculate the total value of final
goods and services produced in a country in one year.

Gross Domestic Product (GDP)

❖ gross – total

❖ domestic – home economy

❖ product – output

❖ Gross domestic product (GDP) is the total value of final goods and services produced within
the geographical boundary of a country in a particular year.

❖ GDP concerns about the value of goods and services produced within the country,
irrespective of ownership of factors of production.

❖ GDP does not concern who or which country owns the factors of production. Therefore, GDP
includes goods and services produced by foreign factors.

Gross National Product (GNP)

❖ Gross national product (GNP) is the total value of final goods and services produced by the
nationals of a country in a particular year. In other words, GNP is the total value of final
goods and services produced by the citizens of a country regardless of where they are.

❖ Gross national product (GNP) is also known as gross national income (GNI).

❖ Conclusion:

GDP measures location, GNP measures ownership.

• Example:
The value of goods produced by a Japanese firm in Malaysia is counted in GDP of
Malaysia, but is not counted in GNP of Malaysia.

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 GNP = GDP + factor income from abroad – factor income paid abroad

 GNP = GDP + net factor income from abroad

❖ Factor income from abroad refers to the income which the country’s residents earned from
assets they own in overseas.

❖ Factor income paid abroad refers to the income earned on assets located in the country, but
are owned by foreigners.

Net National Product (NNP)

❖ Net national product (NNP) can be referred as national income which is the income earned
by the nationals of the country.

NNP = GNP – depreciation (or capital consumption)

NDP = GDP – depreciation (or capital consumption)

❖ Capital consumption means depreciation or replacement investment. It is due to the wear

and tear of capital equipment.

2. Methods of Calculating National Income

(i) Output Approach

❖ This method calculates the total value of output produced by all firms in the country.
 value of national output

❖ This method adds up the value of all final goods and services produced in the country.

❖ Intermediate goods are not counted to avoid the double counting.

❖ Final goods are goods purchased by consumers for final use, not for resale.

• Examples: bread, furniture, clothes

❖ Intermediate goods are goods used by producers to produce other goods, or goods that are
sold by a firm to be used as inputs by another firm.

• Examples: flour, wood, wool

❖ To avoid double counting, there are two ways to measure national output: either
a) sum of the value of all final output (refer to Example 1), or
b) sum of value added at each stage of production (refer to Example 2).
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Example 1:

Items Final goods and services produced Price (RM)

1 50 kg salt 1000
2 100 kg sugar 2000
3 60 pieces furniture 10000
4 500 paper rolls 5000
5 40 man-hours teaching service 2000
Total value (GDP at market price) 200000

Example 2: Output of bread in one year

Value of Cost of
Stage of Type of Value added
Output output intermediate
production industry (RM)
(RM) good (RM)

1 farming wheat 1000 0 1000

2 milling flour 1300 1000 300
3 baking bread 2000 1300 700
4 retailing selling bread 2500 2000 500

Sum of value added 2500

❖ Value added is the value of an output minus the value of an input (or intermediate good). It is
the amount added to the value of a product produced in a stage of production.

value added = value of output – cost of intermediate good

❖ GDP, GNP and NNP can be valued either at market price or factor cost.

• At market price: This measure is valued at the actual prices that consumers paid to
purchase the goods or services.

▪ Market price includes indirect taxes but exclude subsidies.

• At factor cost: This measure is valued at the cost of the factors of production. This is the
sum of incomes (i.e. rent, wages, interest and profits) earned by all factors of production in
their contributions to the production of goods and services.

▪ Factor cost excludes indirect taxes but includes subsidies.

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 ❖ Summary

Output Approach

GDP at market price

+ net factor income from abroad

= GNP at market price

– indirect taxes
+ subsidies

= GNP at factor cost

– depreciation

= NNP at factor cost

= NATIONAL INCOME

(ii) Income Approach

❖ This method calculates the total income earned by factors of production owned by a country’s
citizens.

 value of national income

❖ This method adds up rent, wages, interest and profits, i.e. the total factor incomes
generated by producing the national output.

• Rent is the income earned by property owners whose premise has been used in the
process of production. It includes the rent earned for land, farms, shops, factories, etc.

• Wages are salaries paid to households by firms and government for the supply of labour
services.

• Net interest is the interest paid by firms. Interest paid by households and by the
government is not counted because it is assumed not to flow from the production of
goods and services.

• Profits include:
▪ Proprietors’ income (which is the income earned by unincorporated business like
self-employed proprietorships and partnerships)
▪ Corporate profits

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 ❖ Transfer payments are not included in the calculation of factor income.

• Transfer payments refer to income received without any direct contribution to the
production of goods and services. Examples: pension, scholarships, unemployment
benefits

❖ Summary

Income Approach

rent
+ wages
+ interest
+ profits

= gross domestic income

+ net factor income from abroad

= gross national income

– depreciation

= net national income

= NATIONAL INCOME

(iii) Expenditure Approach

❖ This method calculates national income by adding up the expenditures needed to purchase
all final goods and services that the economy produces during a year.

 value of national expenditure

❖ National expenditure consists of consumption (C), investment expenditure (I), government

spending (G), and net exports (X – M).

❖ Consumption (or consumer expenditure) refers to the total value of all consumer goods
and services purchased by consumers.

❖ Investment expenditure is also known as gross private capital formation. It is the

investment spending by firms, which include investment in capital (plants and equipment)
and inventories or stocks (such as raw materials).

❖ Government spending (G) refers to expenditure by the government on goods and

services.

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 ❖ Net exports (X – M) refer to the value of exports (X) minus the value of imports (M).

▪ In an open economy, part of the total final output produced in the country may be
consumed by foreigners abroad through exports, while part of expenditure may be on
imported goods which are produced in other countries.

▪ Therefore, to calculate GDP using the expenditure approach, we add exports because
the sale of exports represents the country’s output, and deduct imports because it is the
spending on goods and services made in foreign countries.

GDP = C + I + G + ( X – M )

❖ Summary

Expenditure Approach

consumption (C)
+ investment expenditure (I)
+ government spending (G)
+ net exports (X – M)

= GDP at market price

+ net factor income from abroad

= GNP at market price

– indirect taxes
+ subsidies

= GNP at factor cost

– depreciation

= NNP at factor cost

= NATIONAL INCOME

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3. Uses of National Income Statistics

The computation of national income is done annually by every country in the world. National
income statistics have many uses. This includes:

❖ To measure the standards of living

There is a correlation between national income and standard of living. Generally countries
with higher national income enjoy higher standards of living, and vice versa. For example,
countries like Spain, UK, Japan and US have higher standards of living compared to Sri
Lanka and Myanmar.

❖ For comparison over time

From national income statistics, we are able to determine if the country is growing, stagnating
or deteriorating throughout the years. National income of Malaysia has improved steadily
over the years indicating a stable economy and high productivity. In countries whose
economies are deteriorating e.g. Iran and Greece, the government should take necessary steps
to accelerate their economic growth and development.

❖ For comparison between countries

We can differentiate between developing and developed countries through national income
statistics. Developing countries could follow the economic policies of developed countries to
boost economic growth and productivity.

❖ To determine sectoral contributions

There are three sectors in the economy:

• primary sector, e.g. agriculture, fishing and mining

• secondary sector, i.e. manufacturing and construction
• tertiary sector, i.e. services e.g. banking, shipping, hotel and restaurants

By analysing the contribution of each sector, we will be able to know which sector contributes
the most to the nation’s economic growth. In Malaysia, both the secondary and tertiary sectors
are the major contributor to the national income.

❖ For national planning

The government is able to formulate economic plans such as development plan or five-year
economic plan based on the national income statistics. The government can plan and forecast
future developments on the basis of present economic performance.

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4. Comparison of living standards between countries

Generally, gross domestic product (GDP) per capita or income per capita is used to measure the
living standards or economic well-being of citizens in a country.

GDP per capita = GDP

total population

If the income per capita is RM20 000, it means that in average, everyone in the country earns this
amount of income in a year. Generally, the higher the income per capita, the higher the standards
of living. If this figure rises over time for a country, then its standards of living had improved.

However, economists do not have full confidence on this method to measure the standards of
living between countries. This is due to the following reasons:

❖ Different national income concepts

There are two methods in terms of national income accounting:

i) The Anglo-American concept which measures the flow of goods and services. This
method is used by most capitalist and mixed economies such as Malaysia, Singapore and
the United States of America.

ii) The Soviet concept which measures the flow of physical goods only. This method is used
by most socialist economies such as Poland.

If the basis for calculation is different, then the use of national income figures to compare
living standards is neither reliable nor valid.

❖ The existence of informal economy in each country

National income measures only transactions that involve payment of money. The omission of
non-monetary income is a major problem, such as unpaid services of housewives and
voluntary services that never passed through the market and therefore not recorded.
Difficulties are also encountered when goods and services do not have market prices. For
example, farmers themselves consume some of their own vegetables. This is not counting in
calculation of national income because no payments are made.

However, if the same services i.e. housekeeping is done by maids that are employed and paid,
the services are counted in the national income. Therefore, a country with a high non-
monetary economy will have a low national income. Such a situation frequently occur in
developing economies like in Myanmar, Nigeria and Kenya.

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❖ Different cost of living

Although a country is showing high income per capita, its living standards are actually lower if
prices of goods and services in the country are equally high. For example, income per capita
of Japan is higher than Malaysia, but housing, transport, utility and food are much more
expensive in Japan, therefore it is not necessary true that Japanese enjoy better living standards
compared to Malaysians. Other countries with high cost of living are Singapore and Hong
Kong in China.

❖ Different working hours

Another factor that income per capita fails to reflect living standards is the amount of time and
work people put in to earn that level of income. A country whose income per capita is twice
that of another country, but the workers puts in three times the effort of work cannot be said to
have higher standards of living. Longer working hours may mean less leisure time and
lower living standards. For example, income per capita of Japan is higher than Malaysia but
working hours in Japan is much longer than in Malaysia, therefore it cannot be concluded that
the Japanese have better economic well-being or living standards compared to Malaysians.

In conclusion, due to lack of better methods, income per capita is universally used to compare
living standards between countries. This method can be misleading and is unable to reflect the
actual living standards of citizens in different countries.